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Baxter International Inc. (NYSE:BAX)

Q3 2007 Earnings Call

October 18, 2007 8:30 am ET

Executives

Mary Kay Ladone - VP of IR

Bob Parkinson - Chairman and CEO

Rob Davis - CFO

Analysts

Michael Weinstein - J.P. Morgan

Rick Wise - Bear Sterns

Larry Keusch - Goldman Sachs

David Roman - Morgan Stanley

Operator

Good morning, ladies and gentlemen and welcome to BaxterInternational's Third Quarter Earnings Conference Call. Your lines will be in alisten-only mode until the question-and-answer segment of today's call.(Operator Instructions). As a reminder, this call is being recorded by Baxterand its copyrighted material that cannot be rerecorded or rebroadcast withoutBaxter's permission. If you have any objections please disconnect at this time.

I would now like to turn the call over to Ms. Mary KayLadone, Vice President Investor Relations at Baxter International. Ms. Ladone,you may begin.

Mary Kay Ladone

Thanks Sean. Good morning everyone and welcome to our Q32007 earnings conference call. Joining me today are Bob Parkinson, CEO andChairman of Baxter International and Rob Davis, Chief Financial Officer.

Before we get started let me remind you that thispresentation, including comments regarding our financial outlook, new product developmentand regulatory matters contain forward-looking statements that involve risksand uncertainties and of course our actual results could differ materially fromour current expectations.

Please refer to today's press release and our SEC filings formore details, concerning factors that could cause actual results to differmaterially. In addition, in today's call, non-GAAP financial measures will beused to help investor understand Baxter's ongoing business performance. Areconciliation of the non-GAAP financial measures being discussed today to thecomparable GAAP financial measures is included in our earnings release issuedthis morning and available on our website.

Now, I would like to turn the call over to Bob Parkinson.

Bob Parkinson

Thanks Mary Kay. Good morning everyone and thanks forcalling in this morning. We are very pleased with our third quarter financialresults that were reported earlier this today. Not only did we again exceedexpectations on key financial metrics, we continue to improve the quality ofour earnings and also strengthen our overall financial position.

While Rob will provide a more detailed explanation of ourfinancial results in just a few minutes, I would like to point out a fewimportant highlights at the outset this morning. As you saw adjusted EPS againexceeded consensus for the quarter, reflecting a 23% increase versus the prioryear.

I am also pleased that the sales growth for the quarter,after adjusting for both FX and the TT divestiture, grew a very solid 7%despite the loss of BeneFIX sales, in Europein the third quartet. Year-to-date sales growth again adjusting for FX and thesale of the TT was 8% versus 2006. So clearly we are tracking very well againstthe projections that we provided all of you, at our Investors conferenceearlier this year.

Another aspect of our Q3 results that I want to emphasis isthe continuing improvement in the profile of the P&L. Gross marginsimproved, as you saw to 50% in the quarter, which his our highest level in manyyears and likewise on an adjusted basis operating income as a percentage tosales achieved 21.9% for the quarter, both these key metrics continue toimprove sequentially, as well as versus prior year.

As I commented during last quarters call, our improving marginsare the result of improving product mix and business mix, intense focus onpricing opportunity throughout all of our businesses, disciplined control ofmanufacturing cost and productivity improvements throughout our globalmanufacturing footprint, also supported further by the pruning ofunderperforming and lower margin businesses and product lines most notably therecent divestiture of the TT business.

And finally, we continue to accelerate our overall R&Dspending, both internally and through ongoing business development initiatives.As we saw R&D spending for the quarter increased by 13% on an adjustedbasis versus the prior year and we are actually up some 16% year-to-date versus2006.

What I like to do is just take a few minutes to provide someadditional color and update you on some business development and R&Dmilestones that were achieved during the third quarter. Let me start withbusiness development activities, which included first the collaboration in ourrenal business with DEKA Research and development corporation, for thedevelopment of the next-generation home hemodialysis machine. This reinforcesour ongoing commitment to innovation in end stage renal disease treatment andexpansion of our leadership position in at-home dialysis.

I should also mention that a study, which was recentlypublished in the Journal of American Medical Association and funded by theKidney Foundation of Canada, highlighted that nocturnal hemodialysis, done sixtimes per week, may be better than conventional in-center dialysis. Thisfurther supports the broader use of at-home dialysis where Baxter has unmatchedexpertise.

In our medication delivery business we finalized the jointventure in the third quarter for parenteral nutritional products in China.This venture will allow us to improve access to care by expanding theavailability of Baxter's innovative parenteral nutrition products to patients,physicians and pharmacies in the region and also reflects the importance of China to ourcontinued geographic expansion and growth.

In BioScience, we expanded our relationships with HalozymeTherapeutics, forming a new collaboration focused on the development ofsubcutaneous liquid IVIG. This delivery enhancement will apply Halozyme'sproprietary enhanced technology with Gammagard liquid, increasing convenienceand improving delivery of the therapy.

And finally, earlier this week we announced an agreementbetween BioScience and Kaketsuken, the chemo-sero-therapeutic researchinstitute, based in Kumamoto, Japan, for the worldwiderights to develop, manufacture and market the recombinant protein ADAMSTS13.

In the absence of ADAMSTS13 in the blood, patients develop asevere, often life threatening condition called thrombotic thrombocytopenicpurpura, marked by the formation of platelet-rich blood clots in blood vesselsthroughout the body. Recombinant ADAMSTS13 is being developed for the treatmentof TTP and related disorders and will be evaluated for other indications in thefuture.

During the third quarter, we also achieved a number ofR&D milestones. First, we announced promising Phase I/II European studydata for our candidate seasonal influenza vaccine, indicating that the vaccineendures the strong antibody response and demonstrated good tolerability in allstudy populations.

Second, we signed an advance supply agreement with the UKDepartment of Health for our candidate pandemic H5N1 influenza vaccine. And wecontinue to work closely with governments around the world on pandemicpreparation. As you know, both our pandemic and seasonal vaccines aremanufactured in a serum-free, vero cell-based system which offers severaladvantages over the conventional egg-based technologies.

Third, we announced plans to initiate a Phase III old-timersclinical trial with liquid GAMMAGARD, which will begin in early 2008. Thisdecision was based on the results and preliminary analysis of interim data froma double-blinded placebo-controlled Phase II study completed by Dr. Norman Relkinand colleagues at Weill Cornell MedicalCollege in New York City. In this study 24 patients withmild to moderate old-times were treated with IVIG, and demonstrated a favorableresponse relative to those given placebo.

We expect the final results of the Phase II trial to beformally published in early 2008. And finally, I'd like to mention that thetransition to our new state-of-the-art plasma fractionation facility in Los Angeles is proceedingas planned. In fact, I'm pleased to announce that we've recently receivedregulatory approval from the FDA to process liquid IVIG at our new fractionationfacility. This approval which was actually received earlier than expected marksthe final milestone for the US, as we are now labeled to commercialize all keyplasma proteins produced at his new facility for the US market. As you know,this facility is expected to more efficient in overtime, enhanced fields of ourfractionation process.

Before turning the call over to Rob, let me provide you witha brief update on the ongoing situation with the COLLEAGUE infusion pump. Firstof all, I'm pleased to communicate this morning that the FDA was recentlynotified by PAREXEL, our outside expert, that our quality systems have beeninspected and certified, thereby triggering an inspection by the FDA within thenext 30 days. We continue to make good progress with the remediation of the US installed base of single channel COLLEAGUEs,with now approximately 40,000 of the US installed base of 150,000devices remediated today. And these upgraded single channel COLLEAGUEs areperforming very well in the market place.

We've also defined the fix to the triple channel COLLEAGUEissue which as you know was the basis of the July field corrective action. Andwe are in the final stages of completing the necessary testing validation ofthe software modifications. We expect to submit our pipeline to the agencyreflecting our enhancements to the pump before our next earnings call onJanuary.

As you know, we did communicate that our financial guidanceto the remainder of 2007 does not reflect any sales or earnings associated withthe re-commercialization of COLLEAGUE. We'll be in a position to provideguidance regarding COLLEAGUE sales for 2008 when we provide overall Baxterguidance in January. And I'd be happy to discuss any questions on this matterduring our Q&A this morning. But first, let me turn the call over to Robfor a more detailed discussion of our Q3 results. Rob?

Rob Davis

Thanks Bob, and good morning everyone. As Bob mentioned, wereported strong financial results today which favorably compare to the guidancewe previously provided. The quality of our performance is the result of solidrevenue gains and continued gross margin expansion, which again allowed us theflexibility to selectively invest in sales and marketing programs and R&D.You may have noted that our GAAP results included after tax charges totaling$63 million or $0.09 per diluted share. These charges are for in-processR&D associated with collaborations renounced during the period with DEKAResearch and Development Corporation and Halozyme Therapeutics, both of whichBob referred to earlier.

And a charge to establish reserves for litigation, relatedto ongoing disputes concerning historic average wholesaler pricing practices.Excluding these charges, adjusted earnings per diluted share of $0.70 increased23%, and compared favorably to our earnings guidance for the quarter of $0.64to $0.66 per share. And I'll walk you through P&L by line item, and I'llspend most of my time this morning on the sales discussion by business and ourrevised outlook for the year, given that the P&L for the quarter is prettystraightforward reflecting strong operational results.

Now, starting with sales. Our reported sales totaledapproximately $2.8 billion and increased 8%. Currency contributed 4 percentagepoints of growth, so sales growth excluding foreign currency was 4% and in linewith our sales guidance of 3% to 4% at constant currency rates. As Bobmentioned, excluding Transfusion Therapies from both years, reported salesincreased 11% and excluding foreign currency, sales growth was 7%. In addition,I'd like to remind you that we faced difficult comparisons to prior year inboth BioScience and Medication Delivery due to the planned transition ofmarketing rights were BeneFIX and PROPOFOL which have combined sales totalingmore than $60 million in Q3 of last year for these two products.

Turning now to the individual business performance, let mestart with Medication Delivery, which had sales totaling over $1 billion, anincrease of 10%. Currency contributed 4% points of growth and excluding foreigncurrency, Medication Delivery sales increased 6%. As we expected, MedicationDelivery growth accelerated versus Q2, primarily as a result of strongperformance in our anesthesia business and solid improvement across the rest ofthe portfolio.

U.S.sales for the business increased 8%, while International sales increased 13%.By segment, anesthesia sales totaled a $111 million in the third quarter. Salesincreased sequentially by approximately $15 million or 16% and increased 46%compared to prior year.

We remain encourage by the strong underline fundamentals inthis business, as reflected by the continued growth and end-user demand. Oursuccess with our proprietary anesthetics SUPRANE, reinforces our position asthe only supplier with all three modern inhaled anesthetics in the globalmarketplace. Global Injectables and pharma partnering sales of $372 millionincreased 6%, with currency contributing three percentage points of growth.

Strong growth in the pharma partnering business, which wasup 20%, partially offset the decline of Propofol, which had sales ofapproximately $20 million in Q3 last year.

IV Therapy sales totaled $346 million, an increase of 9%with currency contributing six percentage points of growth. U.S. growth in IV Therapy was driven by solid demandand modest pricing improvements, while International performance was a resultof growth in our nutrition business, in addition to volume gains in IV Therapyproducts, particularly in Europe, Latin American and China.

Infusion system sales totaled $207 million, similar to thefirst two quarter of this year. Sales growth of 5% or 3% excluding foreigncurrency was in line with overall market growth. I'd also like to point out thatgiven the breadth of our Medication Delivery portfolio, during the thirdquarter we announced a two year extension of the sole source contract for IVtherapy and nutrition products and the continuation of our infusion pumpagreement with Novation, on behalf of the University Healthcare Consortium. UHCincludes the most prestigious academic hospitals in the U.S. and our new contract is valuedat approximately $200 million over the award period.

In summary, we remain encouraged by a number of positivetrends across our Medication Delivery business, including the solidfundamentals in our IV Therapy and anesthesia businesses and the growthprospects in pharma partnering. As a result, we continue to expect MedicationDelivery to contribute sales growth, excluding the impact of foreign currency inthe 4% to 6% range for the full year.

Moving now to renal, third quarter sales totaled $560million and increased 8% with foreign currency contributing 5 percentage pointsof growth. Global PD sales increased 10%, with currency contributing fivepercentage points of growth. This consistent performance is once again theresult of strong international growth with the accelerating patient gains,particularly in China, therest of Asia, Central and Eastern Europe, and Latin America.

In the U.S.the positive patient growth trend also continues, with both patient gains andPD sales growth in the quarter approximating 3%. In hemodialysis, whilereported sales increased modestly, excluding currency, sales declined in midsingle-digits versus prior year, due to lower sales of dialysers and ancillaryHD products. And expected decline in hemodialysis is consistent with ourstrategy of deemphasizing lower margin businesses in the portfolio.

In summary, excluding the impact of foreign currency, wecontinue to expect 4% to 5% growth in renal for the full year. The success ofour back to basics approach is strengthening our global leadership position andwill continue to expand our presence geographically.

BioScience, reported another outstanding quarter with salesof approximately $1.1 billion, an increase of 14%. This growth includes four percentagepoints of benefit from foreign currency. Excluding foreign currency salesgrowth in BioScience was 10%. U.S.sales increased 19% driven by double-digit increases in all product categories.While international sales growth increased 9%, with currency contributing 7points of growth.

As I mentioned earlier, BioScience sales growth was impactedby the planned transition of international market right back to Wyeth forBeneFIX. BeneFIX sales last year totaled more than $40 million in the thirdquarter. Therefore, BioScience sales growth, excluding BeneFIX was 19% andexcluding foreign currency, sales growth was 16%. This is consistent with thegrowth generated by BioScience in the first half of this year. In addition,international sales growth, excluding BeneFIX was 19% or 12% excludingcurrency.

In the period, we continue to see conversion to ADVATEglobally with ADVATE sales now comprising more than 70% of our totalrecombinant business. Conversion in Europe remains over 90%, while we'veconverted more than 50% of our patients to ADVATE in U.S. and the rest of theworld, largely driven by Japan and Canada where we are approaching a 100% conversionto the therapy. Recombinant sales of $432 million increased 11% with stronggrowth in the U.S.of 13% and 10% growth internationally.

In the quarter, I'd like to note that we anniversariedADVATE launches in both Australiaand in Canada.The strong U.S.performance reflects demand for our ultrahigh potency 3000 IU dosage form ofADVATE, which was launched in August of this year. As you may know, the new3000 IU dosage strength makes it easier for patients requiring higher doses toadminister ADVATE by reducing the number of vials needed and the total infusiontime.

Turning now to the plasma business. In the quarter, plasmaprotein sales of $246 million increased 15% with currency benefiting sales by 5percentage points. Performance continues to be driven by the further conversionto especially therapeutics, like FLEXBUMIN and ARALAST, as well as, increaseddemand and improved pricing across the portfolio.

Antibody therapy sales increased 25%, and totaled $245million with currency benefiting sales by two points. Growth was driven bycontinued conversion to liquid GAMMAGARD and price improvements in US, as wellas, in Europe. Sales of our regenerativemedicine business increased 14%, driven primarily by strong growth of FloSeal& CoSeal

As we’ve mentioned in previous quarters, we continue to seea balance between supply and demand. Collections which as you know arecurrently the bottleneck to supply, continue to keep pace with global demandgrowth. We continue to have good visibility to the drivers of accelerateddemand, as well as, our own supply capabilities, and as a result, the marketfundamentals and our outlook on this business have not changed. This businessremains a sustainable growth opportunity for the company going forward.

Finally, revenues in the other category totaled $94 millionand declined 2%. The difficult comparison for BeneFIX offset strong vaccinesgrowth which was the continued result of increased demand for our FSME,encephalitis and meningitis vaccines, particularly in Germany. As well as, approximately$15 million in revenue associated with our influenza development effort in the US.

As you know, BioScience has reported excellent results sofar this year. Because of this, we would expect sales growth to be at the highend of our previously issued guidance up 11% to 13%, excluding the impact offoreign currency.

For the fourth quarter, sales growth for BioScience isexpected to be in the high single-digits excluding currency. While this mayappear to be somewhat lower than previous quarters, excluding the othercategory where we record vaccine sales, BeneFIX and third party plasma contractsales. Core BioScience sales growth is expected to be consistent with the firstthree quarters of this year.

Turning now to gross margin. Gross margin in the quarter of50% improves sequentially and also improved 2.5 points versus last year's grossmargin of 47.5%. The primary driver of margin expansion continues to beimproved business and product mix. In the third quarter, SG&A of $607 milliondeclined sequentially and increased 8% compared to priory year. This growthincludes approximately three points of growth from foreign currency.

R&D spending of $168 million increased 13% on anadjusted basis, joined by significant increases in BioScience related toclinical trials and milestone payments to partners. Our operating margin in thequarter was 21.9%, an improvement of 2.2 percentage points despite increases inSG&A and R&D. Other expense of $21 million and interest expense of $6million were both similar to last year. And our tax rate in the quarter of20.2% was in line with our expectation.

Finally, earnings per diluted share of $0.70 increased 23%compared to an adjusted basis, EPS of $0.57 last year. Our share count was 651million shares down sequentially and down from the prior year contributing apenny of upside versus our original expectation.

Moving to cash flow. Cash flow from operations for thequarter totaled $608 million, and year-to-date, we've generated cash flow fromoperations of approximately $1.6 billion. Inventory terms of 2.3 terms areslightly lower than 2.4 terms last year. I should note however, that thiscontinues to be due primarily to inventory build in Medication Delivery for theCOLLEAGUE remediation efforts, and an increase in BioScience inventory as weseek to reestablish safety stock levels of our plasma proteins.

DSO of 59 days was higher than last year, as DSOsinternationally due to change in geographic mix. We are partially offset by lowerDSOs in the US.On a country-by-country basis however, DSOs generally remain flat or bettertill last year. In the third quarter, we increased the pace of sharerepurchase, repurchasing $827 million of common stock, or 15.3 million shares.This represented one half of our repurchases year-to-date of approximately $1.6billion, or 30.4 million shares.

We remain committed to returning value to our shareholders,with continued share repurchases and our quarterly dividend. In the fourthquarter, we would expect to return to our historical pace of repurchases, andfor the full year we therefore expect to repurchase approximately $1.8 billionin stock, or $1.2 billion on a net basis.

Finally, let me conclude my comments this morning byproviding our revised outlook for the full year 2007. As you saw in the pressrelease this morning, given our strong Q3 results, we are now expectingearnings of $2.75 to $2.77 per diluted share. For the full year, we continue toexpect sales, excluding the impact of foreign currency to increase in the 4% to5% range. At current rates, we would expect currency to contributeapproximately three percentage points of growth for the full year. Therefore,full year reported sales growth would approximate 7% to 8%.

Our sales guidance also reflects the impact of BeneFIX and Propofol,as well the transfusion therapy divestiture. As we previously discussed,revenues related to the transition services provided to the transfusiontherapies business are expected to total more than $200 million for the year.

Adjusting for foreign currency and transfusion therapies inboth years, we continue to expect our full year sales growth to approximately8%, consistent with what Bob outlined in his opening remarks.

We now expects gross profit as a percentage of sales toimprove by approximately 250 basis points and operating margin to improve bymore than 200 basis points. We expect interest and other expense, combined tototal less than $70 million.

For the full year we expect our tax-rate to be approximately20% and given our share repurchases to date, we now expect our full yearaverage share count to be approximately 655 million shares.

Lastly, we continue to cash flow from operations to totalapproximately $2.3 billion and capital expenditures to total approximately $700million. For the fourth quarter, we expect earnings per diluted share of $0.72to $0.74 and sales growth, excluding the impact of foreign currency, up 2% to3%. This equates to the 7% we mentioned in the press release, excluding thetransfusion therapy sales.

In summary, we’ve generated very strong revenue growththroughout 2007, consistent with our long range expectations and we are proudof the improved profile of the P&L. The consistency and continuing strengthof our financial results further validates the benefits of our diversifiedhealthcare model and stated growth strategies, and reinforces our confidence inour future prospects.

Now, I'd like to turn the call back over to Bob for someclosing comments.

Bob Parkinson

Thanks, Robert. Actually just a couple of closing thoughtsbefore we open up the call to q-and-a. Our continuing financial strength hasallowed us over the course of the last couple of years obviously to accelerateour investment in R&D. Our new product pipeline, which we presented all ofyou in some detail during our March, Investors Conference continues to evolveand in fact strengthen.

As our company has transitioned over the past two to threeyears, we are now spending much more time and effort on those initiatives thatwill contribute to revenue acceleration over our long range plan. New businessdevelopment initiatives such as those discussed earlier are important part ofthis effort.

Finally, as you know, we'll provide financial guidance for2008 during our Q4 call mid January. Without being specific today, it's fair tosay the 2008 is shaping up to be another solid year for Baxter.

We believe there continuous to the opportunity for furthermargin expansion. We see building momentum in Medication Delivery and our corePD business within renal, augmenting continuing strength in BioScience. And weare gradually accelerating our business development efforts in a disciplinedfashion to complement our accelerating internal R&D.

So while we are not without some challenges of course,generally things are moving ahead quite well and very much in accordance withour plans.

So with that we'll now open up the call to Q&A.

Question-and-AnswerSession

Operator

(Operator Instructions). I would like to remind participantsthat this call is being recorded and a digital replay will be available on theBaxter International website for 30 days at www.baxter.com. Our first questioncomes from Michael Weinstein from J.P. Morgan.

Michael Weinstein -J.P. Morgan

Thank you. Good morning.

Rob Davis

Good morning.

Michael Weinstein -J.P. Morgan

A nice job this quarter, once again.

Bob Parkinson

Thanks Mike.

Michael Weinstein - J.P. Morgan

Let me start with a couple of different items. First, whenyou come out with your 10-Q every quarter, we get a better picture of themargin improvement within the three businesses. With the step up we are seeinghere in growth of the Medication Delivery now, once we see the 10-Q, how isthat going work? I mean, the question I am getting to is we continue to seethis great improvement in margins for the last several quarters withinBioSciences, that's been obviously the big margin driver. We'll continue to seeobviously the total corporate picture here, this great step up in gross marginsagain this quarter. How much of that is coming from BioSciences? How much iscoming from renal division?

Bob Parkinson

Well, Mike let me comment and than Rob if, you want to maybepitch in when I am done. Stating the obvious BioScience is driving that, thestrength in the plasma business, the associated pricing has been, continues tobe and we believe we'll be going forward a significant contributor to continuedmargin improvement. But, as we point out Mike, continuously I even referencedbeginning of my prepared comments this morning.

We think, there are continuously to upside going forward inmargin improvement really driven by a number of things beyond the BioSciencestory. What you'll see in Q3 margin for Medication Delivery is a very niceimprovement in overall margins in Medication Delivery, actually, in all the keymarket segments. And again, this is a combination a factors. First of all, weare starting to get price in the core IV business, which is quite encouraging,that manifest itself across all of the businesses. Some of our higher marginbusinesses, whether it's our B2B business, our anesthesia business, thenutritional business and so on tend to grow faster than the overall business.And again, those are higher margin product segments, so what you get withinMedication Delivery is a positive product or business unit mix effect that webelieve will continue to contribute to improving margins in MedicationDelivery.

Renal, as we continue our focus on PD and so on, and weaccelerate our growth, all be it modestly. Nonetheless, I think it’s acontinuous improvement over the last year or two. In the Renal, PD as well iscontributing to that, and so, it really is a combination of factors. The otherthing I would say is we continue this year despite escalating material cost inmany of our businesses to more than offset that with cost reduction programsthroughout our global manufacturing footprint.

So, it's easy to say BioScience and more specificallyplasma, obviously, that's been a major contributor. But this is more than a onetrick pony, and it's why we look forward to '08 and beyond with confidence whenwe talk about continued leverage in improving our gross margin. Rob, I don'tknow if you want to add to that.

Bob Parkinson

Yeah, the only thing I would add is, as you know Mike, wehave seen margins -- pretax margins, improving BioScience. I think though, ifyou look at Medication Delivery, over the three quarters in 2007, they havealso shown consistent increases, and actually when you see the 10-Q, you'll seethe third quarter pretax accelerated faster in Medication Delivery than it didin BioScience.

So, that being said, BioScience still runs about 45% of thetotal driver on a percentage point basis of our gross margin, but in MedicationDelivery, it's vastly approaching that. It's just about 35% with Renal around18%. So, if you look at it, BioScience still is the main driver, but it ispretty balanced overall across all the businesses.

Michael Weinstein -J.P. Morgan

Let me just follow-up with two items that just might behelpful to people. One, on the second quarter call, I think coming out of thatthere was confusion as to what your guys were saying about the health and thestability at the Plasma Proteins market and your outlook for pricing there. So maybeyou want to take the opportunity just to clarify your views on that. And thensecond, just to focus on your comments there about Med Delivery business. Oneof the challenges that I have is trying to walk people through the differentmix drivers within these businesses and how mix itself should be driving grossmargins. So, if you just focus for a minute on Med Delivery and talk about thegrowth drivers, and why does the natural mix shift within that business had to--?

Bob Parkinson

Well, let me just kind of reiterate Mike, what I commentedon a couple of minutes ago. Yeah Med Delivery is really an amalgamation of anumber of distinct business segments, they happened to be interrelated at ahigh level, but we look at an anesthesia as to franchise very differently as anexample. Then we do nutritionals, we look at both of those very differentlythan we do our BDB operation, where we collaborate with pharma companies. Allthree of those business segments are significant for us, they all representhigher gross margins than overall medication delivery as a business, and allthree of those are growing in a faster rate than medication delivery overall,largely because it's weighted by very low single-digit volume growth in thecore IV business, predominantly in the US, and so on.

So, that's really what is contributing primarily to theimproved gross margins in Med Delivery. And as we've discussed many timesbefore, and grab those three businesses is an example, anesthesia, nutritionalsand our BDB business, our areas of continued investment, promotional focuswhich is why we believe they are going to continue to grow at a faster rate.So, does that answer your question?

Michael Weinstein -J.P. Morgan

Yeah. That's great.

Bob Parkinson

Yeah.

Rob Davis

Maybe I'll take the former part of that question. To beclear, we continue to see this to be a very stable market, and we are veryfocused, the plasma markets what I am referring to, and we clearly our aimed atmaking sure that we drive our supply to match demand, and we'll continue to doso. And in doing that, we believe we are going to see price appreciation, welaid it down in the past, but going forward we do expect to see low to midsingle-digit price growth over our long range horizon, combined with mid tohigh single-digit volume growth driving to about 10% overall growth in thatbusiness. So, nothing has changed, and I tried to highlight that in theprepared comments in our outlook on the stability and strength of thatbusiness. And I think that's the key message that we continue to be verybullish on this business.

Michael Weinstein - J.P. Morgan

Perfect. Thankyou, guys.

Bob Parkinson

Thanks Mike.

Operator

Rick Wise of Bear Sterns is on the line with a question.Please state your question.

Rick Wise - BearSterns

Can you hear me?

Bob Parkinson

Yeah, we can Rick. Go ahead.

Rick Wise - BearSterns

Okay, good. Sorry about that. Bob, a couple of questions.First, on COLLEAGUE, I mean you are clearly making progress on each of theremediations, the filing, the inspections and so forth. Can you just give usyour best impression of, when you think you can get this basically resolved? Isit possible by year end or not possible? Would you hope to get it resolved bythe end of the first quarter? Just any thoughts you could give us will beappreciated.

Bob Parkinson

Yeah. I don't think it's reasonable to suggest, we are goingto get all of that resolve by year end, so I wouldn't assume that at all,relative to when it will get resolved in 2008. There are still too many movingparts to be specific as to a specific date on that, Rick, which is why I'dmentioned in my comments, stay tuned to the guidance in January. As you allknow, there is multiple timelines here. There is the regulatory pathway on the 510(k),on the triple channel. There is the remediation pathway, which is I commentedwe continue to make very good progress.

And then there is the pathway under the consent decree,which was why what I communicated this morning about Paracel issuing theircertification and thereby triggering the inspection by the FDA within 30 days,is really an important milestone on that third pathway. But it's complex, asyou know, as we’ve discussed before a lot of moving parts. I’m pleased with theprogress we are making. I really am and I believe we'll manage through this.

But relative to the magic question of re-commercializationdate in 2008, I just want to little bit more visibility on some of these movingparts before we would specifically communicate anything on that. I think that'sthe right thing to do, but I’m very confident that we can be much more specificin our call in January. So sorry I can't do any repairs on that.

Mary Kay Ladone

No, just.

Bob Parkinson

It is what it is, okay

Rick Wise - Bear Sterns

Exactly. Turning to two other things, just thinking aboutnew growth drivers, can you just maybe, whatever level you want to update ussome of thoughts about some of the wildcards, obviously, IVIG is very much ineverybody's mind, but maybe something that whatever you are thinking about thatcould be impactful for '08, '09 and any updates there? And second, on theacquisition front, again you've been very vocal in suggesting, we could seeacquisitions that the piece of acquisition pick up. What expectations should wehave there for the next 6 to 12 months as well? Thank you so much Bob.

Bob Parkinson

Okay, thanks Rick. Let me start with the second piece onacquisition, first of all let me reiterate our position. Any deals that we dothat our traditional acquisition are in fact going to be smaller in scope aswe've characterized previously, adjacencies, built on whatever terms one mightwant to use. And so, we continue to actively evaluate the number ofopportunities there with our business development organizations throughout thecompany. But again, just to be clear, we don't feel we need to pursue anythingof a large scale so that is not in our plans.

The other piece of business development, beyond traditionalacquisitions, I think you can see by some of the things we communicated orsummarize for the third quarter, the business development wheel is starting tomove at a faster rate and we would expect that, virtually every quarter goingforward there will be a handful of things that we will be updating you on interms of new initiative.

So relative to the wildcard question, we introduced thatnotion, I think at our March, Investor Conference and presented a list ofthings. All these things continue to remain very active, with six months on Ithink for the things that have a risk element to them such as these. From aR&D point of view I think it's encouraging to say virtually all thesethings are on track. We continue to make great progress, not only with ourpandemic flu program but our seasonal flue program.

We updated you again this morning on the all timers program,which we commented on, the Halozyme initiative in collaboration, we expandedfurther in the third quarter with our collaboration on IVIG. And so really inits way I addressed the way I did in my prepared comments. The productpipeline, the new product pipeline that we disclose in some detail with theMarch Investor Conference is more robust today, six months on and it was sixmonths ago. And there wasn’t' anything that was on the list including on thewildcard was that's really fallen off the table.

So clearly the wildcard things are little longer term or theother one would be the cell therapy program, which we continue to activelyenroll patients in Phase II. We continue to be encouraged, very encouragedabout it. So generally all the wildcards continue to be in play and again justto reinforce what I think all of you know, is to the degree these thingsmanifest themselves in the coming years with that represents an upside webelieve to our base case projected revenue growth over the next five plus yearsof 7% plus. So, as we aspire to accelerate that top line revenue growth I thinkwe are confident that these wildcards will be a significant contributor tothat.

Rick Wise - BearSterns

Thanks, guys.

Bob Parkinson

Yeah.

Operator

Larry Keusch of Goldman Sachs is on the line with thequestion. Please state your question?

Larry Keusch -Goldman Sachs

Yeah. Hi, good morning guys.

Bob Parkinson

Hi Larry.

Larry Keusch -Goldman Sachs

Couple of quick ones. First, in thinking about your mothballmanufacturing suite, I think, which is a Thousand Oaks. Is the ADAMTS13 product-- just trying to think of where that's going to be manufactured and again howyou are thinking about that use of that suite, which has been written off?That's question one. And then, the other two just are, in your cash flow, whichcontinues to really see very nice improvements. Again, how you are thinkingabout share repurchase. I know that you said you are going to moderate some ofthat pace going forward, but do you expect to be a very consistent sharepurchasing for here than returning cash over the next yea? Then last yourtiming on the Sub-Q, which I think is really interesting Talecris and CSL, Iknow are developing their own Sub-Q products?

Bob Parkinson

Larry, let me start with the utilization of themanufacturing footprint. And then Rob address the cash flow and we can decideto address this, it's up to you. The question, yeah, the ADAMTS13 and ourRecombinant Von Willebrand's factor which we’ve talked about before, bothrepresent opportunities for further utilization of installed assets, which isgreat. We have been, at this stage, specifically decided how we are going todeploy that capacity, I think, the important Larry, to note is that we have acouple of things now on the table that could represent opportunities, andfrankly we are looking at some other things as well, as part of our businessdevelopment initiative.

So, I think as we said today, we are reasonably confident,and we are going to figure out a way how to utilize that asset which obviouslyisn't very encouraging, but specifically how we are going to do that is alittle bit early I think. So, Rob, do you want to comment on the cash flow?

Rob Davis

Yeah, good morning Larry.

Bob Parkinson

And share buyback.

Rob Davis

Clearly, part of the driver of our acceleration in the thirdquarter was, what we saw to be the dip in our stock price, and we felt based onour own confidence in the business, a great buying opportunity, and that's whatwe did, and that's really what you see reflected in that acceleration. As youlook forward, I think to your comment, yes, you should expect that we willcontinue buying shares in the next year at a pace similar to where we were thisyear, not the third quarter, but if you look kind of year-to-date. So, we'll bedefinitely probably at a billion of net repurchases or more next year as well,as we continue to execute on the capital allocation framework that we laid out,that nothing's changed there. And that continues to be an important way for usto return the value to shareholders.

Bob Parkinson

On the Sub-Q, you're referring to the Halozymecollaboration?

Larry Keusch -Goldman Sachs

Correct.

Rob Davis

Larry.

Larry Keusch -Goldman Sachs

Yeah.

Mary Kay Ladone

Hey Larry, it's Mary Kay.

Rob Davis

Mary Kay please comment on that, yes.

Mary Kay Ladone

Yeah, the Sub-Q with Halozyme, we are looking at the end ofour LRP period, so, probably in the 2010, 2011 timeframe.

Larry Keusch -Goldman Sachs

Okay, great. And then just on that manufacturing suite, thathas been written off, is that correct, so, anything that you bring back intothat obviously some economic advantage?

Rob Davis

Yes. That's correct, exactly right.

Larry Keusch -Goldman Sachs

Okay, terrific. Thanks guys.

Bob Parkinson

Thanks.

Operator

Glenn Reicin of Morgan Stanley is online with the question.Please state your question.

David Roman - MorganStanley

Good morning. This is David [Roman] filling in for Glenn.Just a couple of questions here. First on cash flow, it looks like operatingcash flow guidance for the year did in change although earnings guidance wentup. Can you kind of walk us through what's going on there?

Rob Davis

Sure. If you look at it, what we are seeing is and in partof when we looked at what's going on in our inventory levels, because we didhave a build in inventory of the COLLEAGUE pump, and really, this is not onlycompleted pumps, but it's also all the spare parts and other tools we need tobe able to do remediation. That's, as we look at to the fourth quarter,something that likely will absorb any incremental cash flow benefit we get fromoperations coming from net income. So that's really the biggest piece of it.

David Roman - MorganStanley

Okay. And then, I think this is a first full quarter afterall the FX hedges have rolled off, that you entered into in 2002. Can you helpus -- was there any impact on the quarter and could you kind of help us understandwhat its reversal contributed to gross margin improvement?

Rob Davis

Well, to be clear, and if you looking on a year-on-yearbasis, I guess it would be, but those ended coming into the beginning of thisyear.

David Roman - MorganStanley

Okay.

Rob Davis

And we have signaled about $30 million of benefit flowinginto our gross margin year-on-year. I would have to look to see what the splitis. They were roughly ratable through the year, so it was probably about aquarter of that where they've hit in this quarter.

David Roman - MorganStanley

Okay. And then lastly, you talked a little bit about IVIGand old-timers, and I think we are going to see Phase II top-line data inNovember, but I think Bob referenced publication early next year. Are we so expectingto see something next month?

Rob Davis

Well, as you know, we are doing this in partnership with Dr.Relkin from Cornell Medical College.He is really controlling the timing of the release of the data. And I thinkit's safe to say, he is looking for the most visible and prestigiousopportunity he can, to bring that forward. There is a conference, actually now,scheduled, I think in February, where he is looking to present that ad. And,I'll leave it to him to give more details, but that really is the driver of achange.

So, we won't be publishing anything next quarter, we arewaiting for him. Obviously, when we came out and announced that we were goingto initiate the Phase III clinical trials, we did at their time indicate thatwe did see favorable results with patients on GAMMAGARD versus those onplacebo, and felt good about achieving the endpoints in the clinical trial,which is what led us to decide to go ahead with Phase III. So, in that sensenothing's change, it's just the timing of when Dr. Relkin is not in theconference to present the data, all that’s moved here.

David Roman - MorganStanley

Okay guys, one last quick one. The tax rate was a littlehigher than what we thought in the quarter. Are we still looking for the 20%range for the full year?

Bob Parkinson

Yeah. Actually, you are going to see in the fourth quarterthe tax rate is probably going to be down closer to 19%. We have seen overalloperations in our lower tax jurisdictions outside the US, better than expected.

David Roman - MorganStanley

Okay.

Bob Parkinson

And so, you will see an overall rate for the year of 20%,and obviously to get that, that drives about a 19% in the fourth quarter.

David Roman - MorganStanley

Got it. Thank you very much.

Mary Kay Ladone

Sean, we have time for one more question?

Operator

And our final question comes from Matthew Dodds ofCitigroup. Please go ahead with your question, Mr. Dodds. Could you trypressing your mute button or picking up the handset.

Mary Kay Ladone

Next question Sean.

Operator

I’m not showing any other questions. Ladies and gentlementhis concludes today's conference call with Baxter International. Thank you forparticipating.

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Source: Baxter Q3 2007 Earnings Call Transcript

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