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Executives

Karen King

F. Michael Ball - Chief Executive Officer, Director and Member of Science, Technology & Quality Committee

Thomas E. Werner - Chief Financial Officer and Senior Vice President of Finance

Sumant Ramachandra - Chief Scientific Officer and Senior Vice President of Research & Development & Medical Affairs

Analysts

Shibani Malhotra - RBC Capital Markets, LLC, Research Division

David H. Roman - Goldman Sachs Group Inc., Research Division

Christopher Schott - JP Morgan Chase & Co, Research Division

John M. Putnam - Capstone Investments, Research Division

Gregory B. Gilbert - BofA Merrill Lynch, Research Division

Marshall Urist - Morgan Stanley, Research Division

David G. Buck - The Buckingham Research Group Incorporated

Matthew Taylor - Barclays Capital, Research Division

Jason M. Gerberry - Leerink Swann LLC, Research Division

Ami Fadia - UBS Investment Bank, Research Division

Jayson T. Bedford - Raymond James & Associates, Inc., Research Division

Aaron Gal - Sanford C. Bernstein & Co., LLC., Research Division

Hospira (HSP) Q3 2012 Earnings Call November 7, 2012 9:00 AM ET

Operator

Welcome to Hospira's Third Quarter 2012 Conference Call. [Operator Instructions] I would now turn the call over to Karen King, Vice President of Investor Relations. Karen, you may now begin your conference.

Karen King

Thank you. Good morning, everyone, and welcome to our third quarter 2012 conference call and webcast. Participating in today's call are Mike Ball, Chief Executive Officer of Hospira; Tom Werner, Senior Vice President, Finance and Chief Financial Officer; and Sumant Ramachandra, Senior Vice President and Chief Scientific Officer.

We will be making some forward-looking statements today which are subject to risks, uncertainties and other facts that may cause actual results to differ materially from those indicated. A discussion of these factors is included in the Risk Factors and MD&A sections in Hospira's latest annual report on Form 10-K and subsequent Form 10-Qs on file with the SEC. We undertake no obligation to release publicly any revisions to forward-looking statements as a result of subsequent events or developments.

On today's conference call, non-GAAP financial measures will be used to help investors understand Hospira's base business performance. These non-GAAP financial measures are reconciled to the comparable GAAP financial measures in the press release and Form 8-K issued this morning and are also available on the Presentations page in the Investor Relations section of our website.

Also posted on our website is a presentation of complementary materials that summarizes the points of today's call. While we don't speak directly to the material, it is more use for a reference to use as an enhanced communication tool. You can find the presentation on our website at www.hospirainvestor.com.

Finally, we will be ending the call at the top of the hour this morning. [Operator Instructions]

And with that, I'll now turn the call over to Mike.

F. Michael Ball

Thanks, Karen. Welcome to our third quarter 2012 conference call. As has been our practice this year, I'll start with an update on our quality improvement efforts, talk a bit about our growth expansion plans and then discuss our third quarter sales results which, like our adjusted EPS, were in line with our expectations. Tom will provide a deeper dive into the financials, and I will wrap up with closing comments.

As you are aware, we have been providing a list every quarter of current FDA inspections and the significant interactions between Hospira and the FDA. Due to the number of plants we operate, the FDA and other regulatory agencies are in our plants on a regular basis. However, the frequency of FDA inspections and interactions increased in the third quarter, including an uptick of activity on our device operations.

As we've said in the past, we support this ongoing interaction with the agency as we believe it will ensure that we are aligned and that our remediation efforts meet their expectations. Eventually, we expect the heightened quality systems and processes that we are implementing to be a competitive advantage.

As I mentioned on our second quarter earnings call, our overall quality initiatives are proving more extensive and taking more time than we originally thought. And as we know now, they are costing more. But the results we're seeing underscore our belief that we are making progress with our pharma remediation. We are engaging more deeply and frequently with the agency. We are meeting with every district in which we have a major manufacturing facility in a very open and constructive manner which we view is a positive, and we believe we are meeting the commitments we outlined to the agency in our various plant action plans.

Let me highlight for you some of the progress we're making at Rocky Mount. First, the plant. Over the past couple of quarters, we made significant investments in capital improvements and facility modifications. For example, we have started building our new state-of-the-art quality control lab and have installed our first automated visual inspection machine in Rocky, which is currently being qualified. When you consider the volume of product involved, these improvements and others should have a meaningful impact over the long term in helping us produce high-quality products in a cost-efficient manner.

Second, people. As planned, we have significantly decreased the number of consultants at the facility as they transition from frontline production activities toward more oversight and verification of our manufacturing and remediation activities. These consultants are being replaced with our own newly-hired and fully trained frontline employee operators and quality personnel to ensure that the training improvements we have in place are integrated and sustained.

Third, process and technology. We are implementing information technology solutions to help us enhance our quality systems, from systems that manage batch documentation release to systems that track the training and qualifications of our employees. All of these changes are helping improve the robustness of our manufacturing practices, which should result in better first-pass quality, more stable production and eventually, lower waste and overall cost.

And finally in production and release levels, our investments are yielding improvements. Our production and release levels are moving in the right direction as we continue with our plan to modestly increase our production levels through the end of the year in an effort to improve the supply of market-critical drugs. However, if increasing our production destabilizes the plant or adversely impacts our remediation efforts, we will adjust our production to release levels as necessary to sustain compliance.

As we have said previously, we believe the next key milestone at Rocky Mount will be the FDA inspection of the facility. We are working diligently to ensure that we are fulfilling the commitments we outlined in our action plan and that we are fully meeting the expectations of the agency.

Moving to Clayton. During the third quarter, we manufactured a limited amount of propofol. Based on reaching certain milestones, we plan on manufacturing and building inventory levels through the remainder of the year. We want to have an adequate supply of product prior to our reentry into the market, which we ultimately expect to be late this year or early next year.

Regarding other facility inspection developments at Austin. We indicated we were inspected during the quarter and received a 483 with 19 observations. We have provided the FDA with a full response and set of commitments to address the 483 observations and are moving forward with our remediation efforts.

At IKKT, our Hospira India anti-infective facility. The FDA performed an inspection of the plant, which resulted in a 483 with 5 observations. As a result of the observations, we made the decision to voluntarily stop production last month to expeditiously address certain observations related to aseptic practices and to put our operators through an extensive retraining and certification process. We have recently resumed producing and expect to be fully operational in the next few weeks.

At McPherson. The FDA performed a full cGMP inspection. The inspection was recently completed and we received a 483 with 2 observations. The results of the inspection help confirm our belief that our remediation is largely on track.

At our joint venture in India, the FDA performed an inspection with the facility which resulted in 0 observations.

Turning now to devices. At Costa Rica, as we disclosed, the FDA issued a Warning Letter in August on the facility following an inspection in April. We have provided the FDA with a response, which we believe fully address all of the matters cited in the Warning Letter.

At Lake Forest, where the FDA inspected the device design controls and complaint system. If you recall, we received a 483 with 10 observations at the beginning of the third quarter. We have since submitted our action plan to the agency and remain on target to complete the commitments identified in the action plan. Last week, we received from the FDA what is referred to as an Untitled Letter. The letter indicates that the agency was not satisfied with the corrective actions we outlined to resolve 2 of the observations in the Form 483. We are working on a response to the agency to address their concerns.

Regarding additional device developments. Last week, we initiated a voluntary recall with respect to our Symbiq pumps, which was classified by the FDA as a Class 1 recall. This action is due to the device's LCD touchscreens that may occasionally not respond in the intended manner. The FDA is not requiring us to remove any Symbiq pumps from the field. We are in the process of sending a second field notification letter to our customers reiterating the appropriate steps to take with regard to this issue. While we anticipate that the major cause of the issue will be addressed with a software update, we are working to finalize an appropriate solution. In the interim, as we work through this issue with the agency, we have voluntarily placed our Symbiq general infusion pumps on ship hold for new U.S. customers, but will continue to service our existing customer base.

As I mentioned earlier, we have seen an uptick in activity related to our device products. This is due in part to the normal inspection cycle of our device plants, but is also due to the progression of our comprehensive device review. If you recall, we've been updating you every quarter on the status of that review, which has recently advanced the point where we are beginning to identify root cause and the necessary areas of remediation. While we anticipate this may lead to additional recalls and field activity, as it did in our pharma operations, we take this as a sign of progress, not regression. As I repeatedly said, I want the organization to identify and surface issues, drive to root cause and then fix the issues. This is the only way to put these quality matters behind us. And this is important to do because our customers and patients around the world depend on our pumps on a daily basis. Our highly sophisticated devices bring value to our customers through reducing medication errors and, more recently, with the increased safe -- patient safety and enhanced workflow that IVCI enables.

We are in discussion with CDRH, the device side of the FDA, as we are trying to build the same level of open communication and cooperation we have established with the pharma side based on our extensive interactions over recent months. Our commitment to product quality and manufacturing compliance equally applies to our Medication Management business, and we are in the midst of dialogue with the agency to outline our current remediation plans and to better understand their expectations. We believe this increased interaction with the agency will not only help ensure that our remediation efforts meet their expectations, but it also supports the holistic improvement initiatives we're committed to making across our pharma and device quality and manufacturing footprint.

Moving to growth. I want to highlight for you some of the continued progress we have made on our pipeline and growth initiatives. Under our global expansion program, through the end of the quarter, we filed approximately 35 new-to-country submissions and are on track to exceed the target we previously announced of 50 new-to-country submissions by the end of the year. We completed the renewal of several major GPO pharma contracts, which overall have been neutral to positive from a sales perspective. We raised prices on certain drugs where we have significant market positions and lost [ph] volume on a limited number of products. These contracts became effective at various points during the third and fourth quarters.

We announced during the quarter an agreement to acquire from Orchid Pharmaceuticals a manufacturing facility that produces active pharmaceutical ingredient, or API, together with an associated research and development facility. Once completed, the acquisition will enable us to vertically integrate APIs into certain critical beta-lactam antibiotics. It is also expected to improve our cost position and ensure supply in this important therapeutic space.

Finally, we also entered into an agreement with Mochida Pharmaceuticals to distribute and co-promote our generic oncology products in Japan. The combination of Hospira's global leadership in the generic injectable market with Mochida's brand as one of the Japan's most trusted pharmaceutical companies creates a strong new partnership to improve access to high-quality, lower-cost therapies for Japanese cancer patients.

Turning now to our sales results for the quarter. All references to net sales results are on a constant currency basis, which excludes the impact of foreign currency fluctuations. Our press release provides full details on the impact of foreign currency on net sales by segment and product line.

Net sales were up 4% compared to the third quarter of 2011, driven primarily by strong volumes in certain specialty injectable products both in the U.S. and across EMEA, as well as higher device sales.

By product line, global specialty injectable net sales increased 5% for the quarter. Strong SIP performance in both the Americas and EMEA were offset by softer results in our APAC region.

Let we now discuss performance by region. In the Americas, specialty injectable net sales were up 4% for the third quarter. The increase related to primarily to 2 factors. First, Precedex. Precedex had another great quarter, driven by continued strong demand for the product. And second, oxaliplatin. We successfully relaunched oxaliplatin in the U.S. in August as planned. Despite a fairly crowded market and a significant price erosion of over 90%, we were able to gain a strong position of over 30% market share.

Turning now to the EMEA segment. Net sales of specialty injectables were up 14% compared with the third quarter of 2011. Highlights during the quarter were meropenem, which has gained significant momentum and is now our top-selling generic product in the region, and our biosimilars, Retacrit and Nivestim, which continued to perform well.

In APAC, net sales of specialty injectables decreased 1% in the quarter. Strength in our biosimilar Nivestim in Australia was offset by the timing of Precedex deliveries in Japan.

Turning now to Medication Management. Global net sales increased 1% during the third quarter due to continued momentum in customer demand for our smart infusion pumps.

Sales in our Other Pharma product line were up 6% in the third quarter compared to the prior year quarter, primarily due to increased demand and a higher release of product in our contract manufacturing business to various customers.

With that, I'll now turn the call over to Tom for an overview of our financial results. Tom?

Thomas E. Werner

Thanks, Mike. Good morning, everyone. As Mike mentioned, on a global basis, net sales were up 4% compared to the third quarter of last year. Adjusted gross margin as a percentage of net sales in the quarter was 34%, down from 37% in the third quarter of last year. This primarily due to costs associated with strengthening our quality systems, as well as lower manufacturing volumes.

R&D expense decreased 5% in the third quarter to $66 million. This is a result of the timing of spending on clinical trials. As a percentage of net sales, R&D was 6.7% compared to 7.1% in the third quarter last year.

SG&A expense for the third quarter was $155 million, up 4% from $150 million in the third quarter last year. The increase here is associated with increased selling and promotional expenses, as well as higher costs for information technology.

Adjusted operating income was $113 million. This compares to $142 million in the third quarter last year. Adjusted operating margin was 11% compared to 15% in last year's third quarter. The adjusted tax rate in the quarter was 19% versus 17% in the third quarter last year. And finally, adjusted diluted earnings per share for the third quarter was $0.47 compared to $0.66 in the third quarter last year.

Turning to cash flow. Cash flow from operations for the 9 months ended September 30 was $404 million compared to $277 million in the 9-month period last year. This, despite lower net income, our improved management of inventories and receivables, as well as the timing of some cash disbursements, drove these year-over-year improvements.

Capital spending for the first 9 months of this year was $202 million, down just slightly compared with $211 million for the same period last year. The largest portion of capital spend for the 9 months this year reflects investments we're making relative to our capacity expansion efforts, primarily at the greenfield plant we're building in Vizag, India.

Our cash balance at September 30 was $841 million, up from $598 million at the end of last year.

Next, turning to guidance. We are maintaining our net sales guidance of down 1% to up 2% on a constant currency basis with foreign exchange expected to contribute a negative 1% to negative 2%. For adjusted EPS, we continue to believe that we'll be at approximately $2 per share. We're maintaining all other income statement guidance for the full year of 2012.

For cash flow, we now expect cash flow from operations to come in at the lower end of our previous -- previously communicated range, should be between $475 million and $500 million, and capital expenditures will be between $325 million and $350 million. The lowering here a result of the timing of projects spending.

Next, regarding the remediation cost range of $300 million to $375 million that we've previously provided for both pharma and device remediation. On our second quarter earnings call, we indicated that based on our estimates at the time, we would come in toward the upper end of that range. Now we've already incurred charges of over $300 million to date since we set that range. We now estimate we'll be above the upper end of that range. We're working to solidify projections on some of the project and remediated -- and remediation-related costs, particularly with respect to devices, so as to be able to provide more clarity on our future projected costs. Outside of the costs we just discussed, these remediation activities are continuing to have a significant impact on our ongoing operations, putting pressure on our gross margins.

With that, I'll turn the call back to Mike for some final comments.

F. Michael Ball

Thanks, Tom. While we're committed to keeping you fully informed regarding our remediation activity, I am looking forward to the day I spend most of the call talking about our growth and strategic initiatives. Remember that at the end of the day, the efforts and investments that we are making will pay off and we will be in an even greater competitive position in our industry. And while our overall quality initiatives are proving more extensive than we originally thought and will take more time and money to complete, they are the right thing to do for Hospira, for our customers and the patients they serve and ultimately, for all of our stakeholders.

With all of the remediation activity, it's easy to lose sight of our powerful fundamentals and exciting prospects. Let me remind you, we currently supply more than 200 generic injectable drugs to the market. We have 1/3 of the market share in the U.S., giving us the leading market share position. And we have an installed base of over 0.5 million drug delivery pumps playing a critical role in sustaining our health care system.

We are investing in global expansion and bringing our broad portfolio of drugs to the global markets.

We are a leader in the biosimilar market. We already have 2 biosimilars on market in Europe, 1 in Australia, another 1 in registration in Europe and 1 in Phase III clinical trials in the U.S., paving the way as a market leader for entry into the U.S. when the market forms.

We are modernizing our existing facilities and building a new state-of-the-art plant, which is expected to significantly boost our production capacity and lower our costs.

In sum, we are working hard through the issues we face today while remaining focused on driving growth. We believe the barriers to entry are increasing both in pharma and device, and that we will be positioning Hospira through our quality and growth efforts to be an even stronger leader going forward.

With that, operator, we are ready for questions.

Question-and-Answer Session

Operator

[Operator Instructions] Your next question is from the line of Shibani Malhotra with RBC Capital.

Shibani Malhotra - RBC Capital Markets, LLC, Research Division

Mike, I know you're doing everything that you can to resolve the remediation, but you did say that it's more extensive and will take longer than you expected. Can you just comment conceptually about whether you feel you're moving forward, and how long you think this is going to remain an issue? And in particular, as this relates to the Austin facility and the fact that you've had quite a few interactions with the FDA, but the observations tend to be the same -- or look the same on the surface level, so can you just talk about the progress and how long you think it's going to take?

F. Michael Ball

Okay. So from our standpoint, I believe we are really making progress meeting our commitments but as I've said before, there's still work to do. And the fact that the FDA is in our plants, I think is a necessary thing to continue our constructive dialogue. We are making sure we are in alignment with their expectations. And as we go through the inspections and have an opportunity to discuss the inspections with them and again have this continued interaction, I feel like we are gaining the trust and credibility with the agency as we move forward. So I'm actually very pleased with the interaction with SEDAR and the districts. Over the last...

Shibani Malhotra - RBC Capital Markets, LLC, Research Division

Can I just -- sorry, carry on.

F. Michael Ball

So I'll address Austin now because that was at the tail end of your question there. So with respect to Austin then, when we actually look at the 483 and its observations, we believe that if the FDA had looked at the observations from the prior 483 and also had reviewed the commitments only, we would’ve had a very different outcome there. When you look at the 483, it's focused on very different things than the original 483 was. And when we talk to the district, in fact this was prior to the inspection, we made the point that we've lived up to our commitments, but there was still work to do. And I think what this 483 confirms is, that's exactly right. Now with respect to that 483, my sense of it is these issues are entirely manageable. We have put a response back into the agency, and I feel very good that we will be able to live up to the commitments we've made in this next response. And I also feel good that the agency went in with a very extensive 4-week, 4-inspector, national expert review of the plant. So from my standpoint, we're making good progress.

Shibani Malhotra - RBC Capital Markets, LLC, Research Division

Okay. Can I follow-up or I can get back in the line?

Karen King

Shibani, get back in the line because we need to move on. Thank you.

Operator

Your next question is from the line of David Roman with Goldman Sachs.

David H. Roman - Goldman Sachs Group Inc., Research Division

Tom, I was hoping you could expand a little bit more detail on your comments regarding the gross margin line and the increased spending and maybe specifically, if you could help us by using the third quarter as a starting point. If I look at the 33.6% number you put up in Q3, how much of that was impacted by the standard plant shutdowns that occurred in the third quarter? Because your guidance obviously has gross margins in the second half, but lower than they were on the first half. So as we think about the moving parts around that line item, can you maybe just walk us through the pivot points up and down on the gross margin line going forward?

Thomas E. Werner

Yes. Our margins in the quarter were a little bit lower than we had initially expected. Overall, the earnings were fine as we got through the rest of the income statement. But as you look at the margins in the third and fourth quarter, they're always impacted about 100 basis points negatively by the shutdowns that occur right around 4th of July and then over the Christmas, New Year's holidays, sometimes into the new part of the year, so about 100 basis points there. The other things that affected margins in the quarter, obviously the shutdown was something we planned and factored in. But our inventory losses in the quarter, as well as failure to supply penalties, all related back to the quality issues and the supply issues impacted the margins as well, roughly about 125 basis points. So hopefully, that won't continue on and on. Again, in the fourth quarter, we'll have another set of shutdowns and the inventory losses and the failure to supply, those are always things that are pretty difficult to call ahead of time, but those were the main factors.

David H. Roman - Goldman Sachs Group Inc., Research Division

So just to quickly follow-up on that, the guidance that you're providing does assume that gross margins have to be up fairly significantly sequentially in 4Q, so how do we think about that in 4Q? And how realistic is that given what you just laid out? And is the second half of '12 the right run rate going forward for '13, can gross margins be up next year?

Thomas E. Werner

Yes, we can -- when we follow-up with you in terms of the sequencing, I can walk you through that. I'm not sure I would agree with your comment. And then we need to move on to the next question.

Operator

Your next question is from the line of Chris Schott with JPMorgan.

Christopher Schott - JP Morgan Chase & Co, Research Division

Maybe if you could just elaborate a little bit more on the GPO contracts that were signed. Can you just give us a little bit more sense of the price dynamics that we saw with these contracts, [ph] was pricing up? And also, just as we -- given the manufacturing challenges you faced, were there any concessions you had to make in these discussions, or was -- were these kind of business as usual kind of discussions with your bigger customers?

Thomas E. Werner

Thanks, Chris. It's Tom. I'll take that one. As we indicated in the prepared remarks, we were able to take pricing up on certain products. Net-net, we view the renegotiation of these 3 GPO contracts to be neutral to positive. There were some business that we shed in terms of volumes, but pricing that we put through was more than enough to offset that. So overall, a neutral to positive outcome. And in terms of concessions relative to manufacturing, I would say that we're doing everything we can to stay away from any failure to supply type clauses in contracts.

Christopher Schott - JP Morgan Chase & Co, Research Division

Okay. And just as a quick follow-up to that, the business you shed, was that business that you were actively pursuing, or was that a conscious decision that there's certain lines that you didn't want to be in anymore?

Thomas E. Werner

Yes. There's so many moving pieces there, Chris. It's hard to sort of generalize there. And maybe we can get into more detail when we follow up with you.

Operator

Your next question is from the line of John Putnam with Capstone Investments.

John M. Putnam - Capstone Investments, Research Division

Tom, I was just wondering about the tax rate and the tax situation going forward. You had a pretty large tax benefit this quarter. Can you kind of walk us through what those -- or how you derived that? And what you think about the end of the fourth quarter?

Thomas E. Werner

Yes, John, the guidance for the tax rate remains the same, 18% to 20%. In terms of the benefit you're seeing, I think you must be referring to the GAAP income statements. On the ongoing we were at 19%, smack dab in the middle of the range. What is ending up happening in the GAAP is that the mix of earnings, because of the remediation costs being so dominant in the United States that its tax rates, we actually generate a slight benefit there because of the mix of earnings that we're getting. But that's on a GAAP basis. And on an ongoing basis, we're right where we expected to be.

Operator

Your next question is from the line of Greg Gilbert with Bank of America.

Gregory B. Gilbert - BofA Merrill Lynch, Research Division

Mike, when do you expect Rocky to be reinspected and will you all tell us proactively when they show up? And since it sounds like you're looking forward, Mike, to the day where you can talk more about offense than defense, can you talk about whether you're considering any strategic transactions in either direction at this point? That was interesting to see the Orchid people, for example.

F. Michael Ball

So on the first question then, Greg, with respect to Rocky Mount, it's getting late in the year, so I suspect the FDA will be in first or second quarter next year. As you know, they don't preannounce when they come in. They just basically show up at the door. So I think what we will do then is await their arrival. We're obviously working diligently in the plant and continuing to make great progress in there, as I mentioned in the prepared text. And then again, as appropriate, we will disclose the information to the Street as we get it. With respect to strategic moves, what I've been saying is that we are looking to -- from an M&A standpoint, look at getting critical mass in key countries, specifically emerging markets would be our #1 target, but I would not exclude developed markets. So the major objective there is gaining critical mass in the international arena. And the other thing we are looking at is, again, API. Where we think the API is an important consideration in terms of cost of goods and may give us a competitive advantage, we are looking at moving into API. But I wouldn't call all of these things tuck-in acquisitions. We're not looking to make a major transformative move at this point.

Gregory B. Gilbert - BofA Merrill Lynch, Research Division

And are you at all worried about others being opportunistic in a time of weakness or defense?

F. Michael Ball

Well, I think we are doing all the right things with this company. I think we have a really bright future. I think that with the barriers to entry that continue to go up in this particular marketplace, I think we will be very well served to move forward as an independent company. Obviously, there's a lot of people looking for great transactions out there. But what we need to do is stay focused at the game on hand right now and work through these remediation while preparing for the future. So I see a great future.

Operator

Your next question is from the line of Marshall Urist with Morgan Stanley.

Marshall Urist - Morgan Stanley, Research Division

Tom, I was hoping you can help us to understand a little bit more of your comment about the gross margin implications of the device remediation and kind of how we should think about the kind of gross margin implications of that into next year. And then particularly on the -- is there any offsetting mix benefit, if gross margins are depressed there versus progress you're making on SIP, and how that might flow through the income statement?

Thomas E. Werner

Thanks, Marshall. The way that those costs are going to likely be handled is they will receive a onetime treatment and then go away. So they really should not be directly impacting gross margins on the ongoing side. So that's how we anticipate most of the costs will be handled. There could be some that would bleed through to the ongoing side, but I don't expect it will be much.

Operator

Your next question is from the line of David Buck with Buckingham Research.

David G. Buck - The Buckingham Research Group Incorporated

Just 2 quick questions. First on gross margin, maybe for Tom. Can you talk about what you think the penalty is likely to be on gross margin for remediation all in, in 2013, and perhaps what the benefit might be from Vizag starting up in '14? And then can you talk a little bit about what impact we should be assuming for medical device tax in '13 on, I guess, revenues specs?

Thomas E. Werner

Yes, the device tax, I think we've said, is about a dime of our earnings hit in 2013. Beyond that, David, we're still in the middle of getting the plant locked on for next year. And Mike did say at the outset that the remediation is taking a little longer than we expected and it's costing more than we expected. But in terms of projecting the impact for next year, we're just going to have to wait until we get our plant locked down, so sorry.

Operator

Your next question is from the line of Matt Taylor with Barclays.

Matthew Taylor - Barclays Capital, Research Division

I just wanted to try and understand how to triangulate your comments over the production ramp this quarter versus what you had said and guided to previously. So it sounded like you are confident that you can start to ramp production broadly, but if you could provide any specifics by facility, that would be great. And maybe, is that a little bit of a slower pace than you had said before? Is that the right read?

F. Michael Ball

So what I'd said before on the second quarter call was that the production levels would stay in the third quarter steady with the second quarter and then have a modest ramp in the fourth quarter. And that's precisely what we're seeing and what we're saying right now. So our view is, we will -- we are headed in the right direction. Obviously, it's choppy week-to-week, month-to-month, but we definitely see a trend line going in the right direction. So I would say what we're seeing right now is precisely what we represented on the second quarter call.

Operator

Your next question is from the line of Jason Gerberry with Leerink Swann.

Jason M. Gerberry - Leerink Swann LLC, Research Division

Just a question for Tom on Costa Rica, I know that you indicated, I guess, remediations spend will be above the range, but I don't think you specified. Is it just that costs associated with Costa Rica are still unknown, or is it just that they're not material?

Thomas E. Werner

Well right now, I wouldn't characterize the device costs as necessarily relating to Costa Rica. Most of the remediation that could be taking place on the device side will be out in the field, making updates to pumps, replacing components. There'll be a labor component to that, and we're just still really in the process of completing those comprehensive product reviews and then getting to root cause and beginning to take action steps. But that's why we're not in a position to really finalize the estimates, but I wouldn't say that they're Costa Rica related. They're more out in the field if anything would be happening.

Operator

Your next question is from the line of Ami Fadia with UBS.

Ami Fadia - UBS Investment Bank, Research Division

Could you give us a sense of when you think the production levels could come back to over 90% levels, and what time in 2013 could we expect that? And if not, do you think that you would need to wait for the FDA to come back and reinspect the facilities before you can give us a better overview? And also, just a follow-up from a question on gross margins, based on what you know so far -- Tom, you'd earlier said that you'd expected the longer-term impact on gross margins to be about 300 basis points, correct me if I'm wrong. What is your current thinking on that?

F. Michael Ball

So with respect to Rocky Mount, I'll handle that and, Tom, you've got the second one. So with respect to Rocky Mount then, there's a couple events going on here. So as I said, the trend line looks positive as we felt it would. We have a plant shutdown coming up and it's scheduled, a normal scheduled plant shutdown in January. We will see if there's any surprises at that particular juncture. As I said, we have the FDA, we believe will be in, in the first quarter or second quarter. Again, we will see where the FDA is at in terms of our remediation. So right now what I would say to you is, we will continue to make modest improvements. I think the FDA inspection will be a seminal event, which will tell us are we on the right track with respect to remediation and are we able to continue remediation and get the plant up close to normal levels? So I really look at the FDA inspection as being a major guidepost to us. However, just to be absolutely clear, it's not a necessary thing. In other words, we can ramp the plant up as we believe we should and are able to, but that FDA inspection will be critical in terms of telling us the path forward.

Thomas E. Werner

In terms of the margin, the 300 basis point comment, what I've said is that coming into this year off of a normalized 40% to 41% margin range, that 300 to 400 basis points was related to quality initiatives and strengthening the foundation. At this point, I wouldn't come off those comments and I would just like to wait until we get the plan for 2013 pulled together and we'll be able to let you know if that amount is still relevant or would need to be changed.

Operator

Your next question is from the line of Jayson Bedford with Raymond James.

Jayson T. Bedford - Raymond James & Associates, Inc., Research Division

On the device side, you alluded to the potential for additional remediation and you've talked about it for a while. When do you think this review will be complete, and when will we get more detail on your plans going forward?

F. Michael Ball

So maybe I'll handle that one then, Jayson, the -- just to remind you, we made a commitment to the FDA back in 2010 to do a 2-year comprehensive device review. So we have taken then that past period of time to go through the assessment phase, and we are now in the action phase. And what we've done then is for our first 2 pumps, Symbiq and Plum, have developed action plans around those devices that we are in discussions with on the FDA and discussions on the other pumps will follow. So at this particular juncture, I can't give you a lot of clarity as to how long those discussions take, et cetera. But I think we'll be able to give you some more clarity on the fourth quarter call as we have more interaction with the agency. We really are just at the start of the interaction with CDRH.

Operator

Your next question is from the line of Ronny Gal with Sanford Bernstein.

Aaron Gal - Sanford C. Bernstein & Co., LLC., Research Division

Just on couple of quick [indiscernible] product. First on Precedex, can you tell us a little bit more about your lifecycle management plan? And second, on Remicade, do you expect to be able to launch this product in 2013 into the European market? And if so, in which countries?

Sumant Ramachandra

So, Ronny. This is Sumant. So in terms of Precedex, if you know, as in any good product, we continue to do lifecycle management of the product over time. As you know, the pediatric program is ongoing and that we expect to make a submission for that dossier by the end of this year. And as I've mentioned to you before, we continue to look for lifecycle management opportunities all the time on Precedex. So our hope is that Precedex is a product that will keep generating a lot of benefits for patients and for Hospira. And in terms of Remicade, you asked about 2013. We have not talked about Remicade within our pipeline. As you know, we have a robust pipeline of oncology products and then we have a partnership with Celltrion on a number of monoclonal antibodies. The 2 that we have discussed in terms of Celltrion and infliximab and trastuzumab, but -- which is, infliximab would be with Remicade. And that is currently under review at the EMA, both our dossiers, both Celltrion dossiers, as well as our dossier, as part of the agreement. So based on that review, we'll see when the launch actually occurs.

Karen King

Thank you. And I just want to thank everyone who did keep their questions limited because I think we got through a lot more people that had questions. So thank you for joining us today.

Operator

This concludes Hospira's Third Quarter 2012 Conference Call. You may now disconnect.

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