Abbott Laboratories
Q3 2011 Earnings Call Transcript

Published: 19 Oct 2011

[Operator:]

Good morning, and thank you for standing by. Welcome to Abbott's Third Quarter 2011 Earnings Conference Call. [Operator Instructions] This call is being recorded by Abbott. With the exception of any participants' questions asked during the question-and-answer session, the entire call, including the question-and-answer session, is material copyrighted by Abbott. It cannot be recorded or rebroadcast without Abbott's expressed written permission. I would now like to introduce Mr. John Thomas, Vice President, Investor Relations and Public Affairs.

[John B. Thomas:]

Thanks, Elan. Good morning, everyone. Thanks for joining us. Today, we're going to be discussing 2 important Abbott news events. First, our announcement to separate into 2 independent publicly-traded companies, one in diversified medical products and the other in research-based pharmaceuticals. And second, we'll be talking about our strong third quarter ongoing earnings results. Joining me on today's call is Miles White, Chairman of the Board and Chief Executive Officer; Tom Freyman, our Executive Vice President of Finance and Chief Financial Officer; Rick Gonzalez, Executive Vice President Global Pharmaceuticals and Larry Peepo, Divisional Vice President of Investor Relations. Miles and Rick will review the strategic rationale related to our announcement this morning, as well as provide an overview of each of these new companies and their investment identities. Tom will discuss certain financial aspects and conclude with a brief review of our third quarter results, which we summarized today to allow for sufficient time to discuss today's other major announcements. Details on our third quarter can be found in our earnings news release. Following our comments today of course, we'll take any questions you have as always. I'd also note that we posted a 12-page slide deck to our Abbott website this morning at www.abbottinvestor.com, and this deck summarizes the details of our announcement this morning regarding the separation. In addition, this morning, I'm pleased to announced that we will be hosting a 2-hour Investor Meeting this coming Friday in New York. Miles, Rick Gonzalez, Tom Freyman, as well as Dr. John Leonard, our Head of Pharmaceutical Research and Development will be in attendance, along with myself, Larry and some other people from our Investor Relations and Media Department. At Friday's meeting, we'll discuss the growth opportunities in Abbott's diversified medical products business, as well as growth opportunities in the research-based pharmaceutical company. We're going to walk you through the pharmaceutical pipeline in more detail and we'll spotlight certain programs that we're particularly enthused about, including early data from our HCV trials and Rick will talk about -- more about that in a minute. So given that you're going to hear from us this coming Friday, we're going to try to limit and focus our call today and try to keep it to approximately an hour. Before we get started, let me remind you that some statements may be forward-looking, including the planned separation of the research-based pharmaceutical company from the diversified medical products company and the expected financial results of the 2 companies after separation. Abbott cautions that these forward-looking statements are subject to risks and uncertainties that may cause actual results to differ materially from those indicated in the forward-looking statements, and there is no assurance as to the timing of the planned separation or whether it will be completed. Economic, competitive, governmental, technological and other factors that may affect Abbott's operations are discussed in Item 1A - Risk Factors to our annual report on Securities and Exchange Commission Form 10-K for the year ended December 31, 2010, and then the interim reports filed on Form 10-Q for subsequent quarterly periods. Abbott undertakes no obligation to release publicly any revisions to forward-looking statements as a result of subsequent events or developments. On today's conference call, as in the past, non-GAAP financial measures will be used to help investors understand Abbott's ongoing business performance. These non-GAAP financial measures are reconciled with the comparable GAAP financial measure in our earnings news release, as well as regulatory filings from today, which will be available on our website at abbott.com. And with that, I'm now pleased to turn the call over to Miles. Miles?

[Miles D. White:]

Okay, thanks, John. Good morning. As you can see from our strong third quarter results, Abbott delivered another quarter of strong performance across our mix of businesses. Our ongoing earnings per share growth was more than 12%, as we've now posted double-digit growth in 17 of our last 18 quarters. We'll generate similar performance for the full year, which will again place us among the top performers in our peer group. So we're pleased with our consistent financial performance. But as evidenced by today's other important news, we are taking a significant next step in aligning our long-term strategic goals with our shareholders' best interest. Today's announcement to separate into 2 publicly-traded companies in diversified medical products and research-based pharmaceuticals is a logical step in the further evolution of our company. Over the past 12 years, our actions have dramatically reshaped Abbott. Let me give you some background and examples. Since 1998, Abbott has nearly quadrupled in revenues to nearly $40 billion in annual sales. During that same 12-year period, we shifted our geographic sales mix from what was more than 60% U.S.-based sales in 1998 to more than 60% international sales today. In 2001, the reshaping of our pharmaceutical business began in earnest when we purchased Knoll Pharmaceuticals, which included an R&D program that's now called by its well-known commercial name HUMIRA. As you know, HUMIRA is on track to soon become the world's leading biologic for autoimmune diseases with annual sales this year of approximately $8 billion. And today, our total research-based pharmaceutical business generates nearly $18 billion in annual sales. In 2006, we globalized our leading Nutritionals business to sharpen its focus and better capture international growth opportunities and it worked. We doubled the division's international sales over the last 5 years. Also in 2006, we acquired Guidant vascular and subsequently built our existing vascular business into a leading interventional cardiology company, headlined by the number one global drug-eluting stent brand XIENCE. In the last 4 years, we've also rebuilt our core diagnostic business to deliver higher returns, doubling its operating margin and significantly improving its cash flow. So these are just some of the actions that we've taken over the last decade. More recently, we've moved to advance our strategy with an eye toward 2 major initiatives

[Richard A. Gonzalez:]

Thank you, Miles, and good morning. As Miles indicated, our new research-based pharmaceutical company has a long track record of demonstrated commercial and operating strengths. These attributes position us well for sustainable performance going forward and help us succeed when we become an independent publicly-traded company. Having worked in leadership positions across Abbott for quite some time, including leading our pharmaceutical business for the last 2 years, I can tell you this is truly a very strong business. It's an organization with a long track record of industry-leading performance. This includes double-digit sales growth, 4 out of last 5 years, a significant accomplishment in today's healthcare environment. The fact that we have maintained such strong performance underscores the strength and experience of our pharmaceutical management team. We have industry-leading specialty-focused portfolios that include a mix of growth brands such as HUMIRA, as well as sustainable performers such as Synthroid and Lupron among others. Over the past several years, we built a promising R&D pipeline of specialty medicines, focused on important disease states such as Hepatitis C, chronic kidney disease, multiple sclerosis, oncology and other areas of significant medical need. Since I will providing a more detailed overview of our pharmaceutical business and R&D pipeline on Friday, I'll keep my message focused on 2 basic things today. First, the sustainable performance of our existing commercial portfolio. And second, a brief review of select highlights from our advanced late stage pharmaceutical pipeline. Our new research-based pharmaceutical company generates nearly $18 billion in annual sales today, driven by strong marketing presence and leadership positions across more than 20 major pharmaceutical brands. These include

[Thomas C. Freyman:]

Thanks, Rick. Let me review some of the key aspects of the transaction as we see them today. We expect to accomplish the separation through a tax-free distribution to shareholders. At the time of separation, Abbott's then current shareholders will own 100% of both publicly-traded companies. The final distribution ratio will be determined later in the process. We expect the separation to be completed by the end of next year, subject to regulatory approval and final approval of the distribution of shares of the new company by our Board of Directors. Both companies are expected to have strong balance sheets and cash flow to support the strong investment-grade credit rating. Credit ratings for the 2 companies will be determined by the rating agencies based upon financial projection and capital structures that will be determined in the coming months. We'd expect a tender for a portion of the current Abbott long-term debt outstanding in conjunction with this transaction funded with debt issued by the new pharmaceutical company. It's expected that Abbott and the new pharmaceutical company will pay a dividend, that when combined, would equal the Abbott dividend at the time of separation. We expect to incur onetime separation costs, including bond refinancing costs over the course of the separation process. These costs will be quantified at a future date and will be treated as onetime items in our quarterly reporting. As a result, there's no impact from this separation to our 2011 ongoing earnings per share guidance. The complete audited financial statements that will result in a 3-year financial history for the new pharmaceutical company, this information will be part of a Form 10 filing which is targeted to occur in the next few months. And finally, we expect to complete this process in an efficient manner given the experience in integration and separation that we built over the years. I'll close our prepared remarks with a brief summary of our third quarter earnings release. As you've now seen, we reported very strong third quarter results that beat the Street estimates and were at the high-end of our forecast. We delivered another quarter of double-digit sales and ongoing earnings growth, with ongoing earnings per share of $1.18, up 12.4%. And we confirmed our full year outlook for double-digit ongoing EPS growth in 2011. Sales growth in the quarter was 13.2%, including a favorable 5.3% impact from exchange rates. Organic sales growth in the quarter was nearly 7%. The majority of our major businesses have delivered double digit reported sales growth. This includes more than 15% growth for Durable Growth businesses, driven by double-digit growth in Nutritional, Core Laboratory Diagnostics, Diabetes Care and Established Pharmaceuticals. Our Proprietary Pharmaceuticals business also delivered strong growth, with reported sales up more than 13%. This reflects impressive worldwide performance for HUMIRA, which increased nearly 26% on a reported basis and more than 18% excluding exchange. HUMIRA is on track to exceed the sales guidance of high teens growth that we raised just last quarter. In our innovation-driven device businesses, sales increased 6%, including continued double-digit growth in molecular diagnostics and double-digit international growth in vascular and medical optics. And emerging markets continued to represent a significant growth contributor with sales in the quarter of $2.6 billion, an increase of 21% consistent with the high growth expectations we have for these markets. Regarding other aspects of the P&L in the quarter, the adjusted gross margin ratio was 60.4% ahead of our previous forecast driven by improved product mix. As reflected in higher SG&A expense, we increased our litigation reserves for previously disclosed litigation identified as a specified item in our earnings release. Turning to our full year outlook. Today, we're confirming our expectations for double-digit ongoing earnings per share growth for 2011 and narrowing our guidance range. Our guidance for the full year is $4.64 to $4.66, reflecting 11.5% growth at the midpoint of the range. For the fourth quarter, today, we're issuing ongoing earnings per share guidance of $1.43 to $1.45. The midpoint of this ongoing EPS range represents continued double-digit growth over the prior year. We forecast specified items of $0.30 in the fourth quarter, primarily reflecting integrations costs from past acquisitions and cost of previous restructuring actions. We're forecasting mid-to-high single-digit sales growth in the fourth quarter including a favorable effect from foreign exchange of approximately 1%, and a gross margin ratio approaching 61%. So in summary, while we delivered another strong performance in the quarter, more significantly we announced a major strategic change for Abbott. The separation of Abbott into 2 publicly-traded companies creates 2 enterprises that are well positioned in their respective markets. Abbott is expected to be one of the fastest-growing large cap diversified medical products company with a durable mix of products. And the research-based pharmaceutical company will be a leader in its industry with a strong and sustainable portfolio of specialty medicines and a promising pipeline. We believe that both of these companies will be attractive opportunities for investors. And with that, I'll turn the call back to John and we will take your questions.

[John B. Thomas:]

Thanks, Tom. Elan, we're now ready to take questions please.

[Operator:]

[Operator Instructions] Our first question today is from Jami Rubin from Goldman Sachs.

[Jami Rubin:]

I just wanted to ask a couple of questions. Just apart from splitting up the 2 businesses and getting the higher values for those businesses, obviously the device business has been under pressure, not under pressure but the multiple has reflected concerns around the HUMIRA franchise and therefore, you haven't gotten full value for some of your Durable Growth businesses. But aside from splitting up the businesses and getting what you would think, what you would imagine to be appropriate valuation for the 2 very distinct businesses with different risk and growth profiles going forward. Can you talk about some of the other advantages to breaking up such as how we should think about capital deployment, how we should think about operating margins of these businesses? I mean, one thing that we have noticed is that Abbott has a very large overhead or redundancy that I would think would be able to go away if you complete this transaction. So if you could just talk about some of the other efficiencies that you can create by splitting up the 2 companies. And then I have a question for Rick on the pharma business. I mean, clearly, HUMIRA was a big driver of the overall business and will be an even bigger driver in terms of its contribution to the Proprietary Pharmaceuticals business. With competition coming in the next year or 2 from tofacitinib, with competition from biosimilars, clearly this will be an issue and I'm just wondering if you could talk a bit about strategies you have in place to protect that franchise?

[Miles D. White:]

Okay, Jami, that may be the longest question I've ever experienced in my 13 years. The fundamental -- let me just get by way of back on the -- the fundamental basis for the separation here. And I heard a comment this morning from another analyst source that causes me to want to make sure I make the point. We've always pursued a diverse model and we believe in that model and we believe in the diversity of the business and the growth opportunities it gives us and frankly, the reliability and sustainability over time. But what’s happened here is we've been so successful in our Proprietary Pharma business over time. It's grown quite large. And frankly, arguably, I believe it will be very successful going forward. I think when the companies are split, I believe both will be valued at the top of their peer groups, but for very different reasons. In a portfolio of diverse companies, the characteristics of those businesses need to be similar. And as our Proprietary Pharma business has grown large, it has different characteristics and it's also quite dominant now in the portfolio. And I think that it's given the company clearly an identity of pharma with, oh by the way, you have these other diverse businesses. But as you can see by how we proposed to split, the company has $22 billion in a very diverse mix of similar characteristic businesses as I described, and a very successful Proprietary Pharma business that is delivering great returns and cash flows and has great potential and durability going forward, but it's a business that investors seeking return will look to. Investors who are looking for a large cap diverse double-digit grower aren't necessarily looking for the same type of investment identity as pharma. So what happens here as the pharma piece got so big and is different, that these 2 investments make sense separately and both are of a critical mass and size that they have great sustainability going forward as independent companies, et cetera. And as we divide them, their characteristics, their P&Ls, their balance sheets, et cetera, are quite different. The capital structure, I'll have Tom deal with in just a minute, but both have strong cash flows, both have strong pipelines of products, arguably, they're different. One is dependent on big products, one is dependent on hundreds or thousands of products over time. The diverse company will be dependent on a lot of market growth and international expansion. The pharmaceutical company is still quite heavily a developed market company and it will too have emerging market opportunities, but it's very much a developed market game. So they become very different. And I think that both will be valued more accurately or frankly, appreciated more by investors. And I think we'll see that we attract investors who haven't been in our company or haven't invested in our stock, as we allow them the choice of these 2 distinct identities. I think there's opportunity for operating margin expansion and gross margin expansion, particularly in the diverse company. I think visibility to margins in the pharma company, what will compare quite favorably to its peer group. I think you'll see that. With regard to the overhead question you asked, I would say we're always looking at the opportunity to be more efficient. And given the distinctive separation of the companies, that is something that we will look at because there's a different mix for the pharma business and a different mix for the international-based diverse products business, and we will be looking for those opportunities to be a lot more efficient. That's about all I'd say about that at the time. But at this point, I think... [Audio Gap]

[Thomas C. Freyman:]

The points I'd make and I think we made these points in the remarks. I mean both of these companies are going to have extremely strong cash flow, both of them are going to have very good balance sheet. It's going to give both companies a lot of options to use that cash flow. I mean, we've talked about our expectations on the dividend, then I -- there will continue to be a dividend in line with what Abbott is paying today is our current view. The one thing I'd point out on cash flow is between the 2 businesses and if you look at our amortization expense, which as you know is a fairly large item in our P&L, in the $1.4 billion range. More of the amortization relates to the diversified company than to the new pharmaceutical company, which means that the cash flows are even a little more balanced than the profit levels when you look between the 2 businesses. So both are healthy. They're going to have a lot of options and both managements will -- it's kind of a nice problem to have as they move forward as they consider what to do with those cash flows.

[Jami Rubin:]

I was just wondering if Rick was going to address my question or we could wait until Friday, but that is going to be the key pushback in my opinion, which is the pharma business is now completely dominated by HUMIRA. And how, Rick, we should be thinking about that equation going forward with competition coming from tofacitinib and biosimilars 2016?

[Richard A. Gonzalez:]

I think it's a very good question, Jami. I'd characterize it this way. So I'd start at the very top. If you look at where our pipeline starts to emerge in 2015 and beyond in a very meaningful way, it will add to the performance of the business above and beyond HUMIRA. If you look at the performance of HUMIRA, we believe that performance is very sustainable going forward. In fact, if you look back to 2007, HUMIRA has grown on average, $1.1 billion every year and we believe that is sustainable and actually slightly accelerating as we move from 2011 to 2012. Now what drives that is the ability to continue to penetrate the markets that we're in today like RA, like psoriasis, like Crohn's. Those markets are still tremendously underpenetrated. I'll give you an example. Psoriasis has a penetration rate of about 6%. Our most mature market, RA, has a penetration rate in the 20% range. And so the goal here and you've seen us introduce programs around the world that allow us to be able to drive the market to grow faster to early diagnosis of patients and then cycling them through less effective old therapies more rapidly. And you've seen that market growth particularly outside the U.S. emerge very, very rapidly, where the market is growing mid-teens in many countries around the world, even in Europe. And so there's still a lot of opportunity to drive growth for HUMIRA in the markets we're in today. Additionally, we have 6 indications that we are in the process of developing and submitting for HUMIRA. Those 6 indications will have a material impact on the growth of the product going forward. And they're likely to be indications that competition doesn't have, at least out of the blocks. So I would tell you that I feel very confident that HUMIRA has a lot of legs going forward and can continue to be a sustainable growth vehicle for us for a long, long time. Now let me address the competition. I'll start with orals first. As we look at this market, let's just say from a global standpoint. This is a very difficult market for competitors to break into. And you know the data as well as I do. So 6 competitors have entered the biologic market over the last 5 years. Not one of them has gotten over 3% market share collectively in total. All 5 of them have not gotten over 11% market share. So the 3 major players

[Operator:]

And our next question is from Mike Weinstein from JPMorgan.

[Michael N. Weinstein:]

Let me do a couple of financial questions first and then talk more strategy and, Tom, hopefully you can help here. But maybe 2 quick ones. Tom, first off, when I think about the tax structures of these 2 businesses, the proprietary pharma piece would seem to have a lot lower tax structure versus the durable medical products business. Am I thinking about that correctly? And is there any damage to the tax structure from the split? I'm assuming no, but if you could give me your thoughts on that, that will be helpful.

[Thomas C. Freyman:]

Yes, Mike, we're not going to go into a lot of modeling issue today as we talked about in the beginning. We're trying to focus today more on the strategic discussion here. What I would say is, I think it's accurate that between the 2 companies, the diversified will be a little bit higher than the other company but that's about as much as we'll share with you today.

[Michael N. Weinstein:]

Okay. And then on the proprietary piece, can you give us an estimate of the percentage of the profits in the proprietary piece that would come from HUMIRA post-spin?

[Thomas C. Freyman:]

As you know, we -- if you're looking at -- just to get a sense of profitability on these businesses, we do disclose in our segment footnotes these businesses broken out. So that gives you a good sense overall. And clearly, HUMIRA is an important product for us. You can have a sense of the relative sales and -- so it's definitely an important part of that business. But as Rick said, it's one that we think has a very long-term future, lots of growth opportunity, continuing to grow, new indications and plenty of opportunity to be a long-term contributor to the business.

[Michael N. Weinstein:]

Okay, last financial piece. You talked, Miles, about growth in some of the DMP pieces, or medical profits pieces. You talked about Nutritionals, growing double digits. You talked about some other pieces including vascular. You often suggest that those businesses would accelerate, like Nutritionals globally hasn't grown double digits. It's grown more like high-single digits and so there was some expectation that growth would accelerate. Could you just maybe touch on why should we assume that those businesses accelerate and how DMP goes from being what right now looks to be more mid-single digits to high-single digits?

[Miles D. White:]

Yes, we'll go into more on it on Friday, Mike. But actually, let me correct you. Nutrition has grown double digits outside the United States and frankly, I do expect even more acceleration from the businesses particularly as we expand the footprint in emerging markets and internationally. So I do expect not only acceleration of the sales but also acceleration of the bottom line. And those programs are underway. But this is the -- the performance and elements are there now and we are seeing that. At any given point in time, one country or another, is going to look different than the mix of the whole. But yes, we can talk about that more on Friday.

[Michael N. Weinstein:]

Okay. Just so I'm clear, you're taking the whole Nutritionals business, not just international piece, right?

[Miles D. White:]

You mean on this side of the business?

[Michael N. Weinstein:]

Yes, right.

[Miles D. White:]

Yes.

[Michael N. Weinstein:]

Okay. All right, Okay. Because I was talking about overall growth profile in Nutritionals but...

[Miles D. White:]

Yes you'd be right about overall but the international piece has doubled in size in the last 5 years, and we can back into that growth rate, that's clearly double digits.

[Michael N. Weinstein:]

Right, absolutely. So let me just talk more strategy stuff. So I guess what people are asking me probably #1 today, is the decision on why today versus a year ago or a year from now, so the timing question. And then 2 in your -- in the math that you did on this in trying to -- you're going to go through a very tough process here in splitting the company up. How much value in your estimation are you unlocking by the math that you guys did in doing this to make it worthwhile?

[Miles D. White:]

I'm going to enjoy answering that one. Let me address the why now. There's actually method in the madness as to why now. As you know, we acquired Solvay and Piramal and we went through an integration process. And then frankly, a separation process internally of our Proprietary Pharma business and our Established Pharmaceutical business which are very, very different businesses. So we had kind of a double task there of not only the integration of the legacy Abbott businesses, but also those 2 new ones and not to mention our additional agreement with Zydus in India, which enhanced our product lines. But there was a process there to establish that infrastructure and stabilize all of that and separate the 2 pharma businesses. That is essentially complete. And that was necessary work to do regardless. But we needed that to be complete and we also wanted some of our pipeline initiatives on the Proprietary Pharmaceutical side to have been completed. And frankly, our internal organic pipeline to have advanced in order to be at a point of what we would consider to be readiness. Those are the primary drivers of why now. I don't think we'd have been ready a year ago and I think we are ready now. We've got the positioning and a lot of the work done, so that the difficulty of separation, frankly, has -- a lot of it's been done and it's ready to go. So there's no real point in waiting now as we get on with it. With regard to unlocking, as you might guess, I've looked at more investment banker and consultant and other presentations and estimations and so forth of the so-called unlocking of value. I would not venture an estimate or a guess because I've been here long enough to have seen a PE of a company in the high 20s and a PE in the low teens or whatever. You can talk about unlocking value. But at the end of the day, the background of what's happening in a marketplace with the values of companies as a whole, of the economy as a whole can clearly affect that up or down. Do I think investors will realize or see or recognize higher value on both sides of the company as separate companies? I do. I think investors will appreciate both companies more than is the case today because I think there will be a lot greater appreciation and attraction to investors who focus on these 2 very different investment profiles. The same investor doesn't invest in both profiles necessarily and vice versa. So I think we'll see appreciation for both companies. But what happens in the overall marketplace over time, I don't know. So I wouldn't venture a guess. I leave that to you guys.

[Operator:]

Our next question is from Tony Butler from Barclays Capital.

[Anthony Butler:]

And, Miles, really just 2 questions. One, any considerations instead of a tax-free spend for an outright sell of the pharma business and maybe even to some degree even rights to HUMIRA as one would think about this perceived unlocking of value or either less reliance on a single product? And then the second question's a little more related to strategy. And if you go back to your Q4 comments, one asked either about sentiment around HUMIRA or either selling the -- or spending out the Nutritionals business. You commented or at least the sentiment I took away was that the sentiment in the market is wrong. We need to do a better job of really talking about each particular business and the long-term opportunities and you seemed to harp on this notion of, if you make a knee-jerk decision on what the market wants you to do in the very, very near term, you may be wrong a year or 2 years or 3 or 5 years later. And I'd like for you to comment on that because that seems to be slightly different in tone than what we see today.

[Miles D. White:]

Okay. Let me deal with the first part, did we consider a selling? I think the obvious here is, first of all, that would take a long time. And secondly, the tax on a sale like that and whether there was somebody that was interested in such a thing is prohibited. Now, I have to tell you, I think we've got 2 long-term sustainable companies here. We have no interest in selling. We have no intention to sell. We're not looking to sell it or merge it with something else, et cetera. We think we've got the best path for investors here, which is 2 independent companies going forward that both have great cash flow, profits, growth prospects, et cetera, depending on the company here. But they're 2 different investments. And I think that, for investors and for the sustainability of these investments, is the right path for both companies. Otherwise, I don't think we're doing the right thing if we just try to sell it. That doesn't strike me as the right path here at all, which is why we believe the path of separation and letting investors appreciate each country -- company appropriately is the right path. With regard to the last call or whatever that you're referencing, the call at the time or the question at the time was a focus on Nutritionals. And the point I tried to make at the time and let me be clear, this was in our planning and preparation for some time. This is not some knee-jerk reaction to the last few months or years even. We have been considering what is the appropriate long-term disposition of the company or companies for several years. Obviously, I can't speculate about that to analysts or investors on any given call. But as you know, analysts speculate to me. So when they speculate to me publicly about, for example, in this case nutrition, one thing I feel obligated to do sometimes is disabuse us of the notion of some path that may not be correct. And that isn’t correct and it wasn't correct at the time. I do think what I reflected or intended to reflect at the time was kind of the precursor to this notion of investors will appreciate the parts of the company differently. There is a different investment identity to different parts of the company. And I think that the notion that the different parts of the company weren't being appreciated that way or different investors weren't seeing it that way was clearly in those comments, and that's probably the tone you heard. But the answer to that which I think you see today, I think is the right answer. I don't think it's to just break things up into little pieces. I do believe there is value in the diversified model that is Abbott. We believe that fundamentally and I think that's been proven out over decades. But I also note that the characteristics of the elements of that diverse model do have to have a common or complementary characteristics and balance. And the big distinction here is, it was our Proprietary Pharma business that did so well and dominated the identity of the company over time. And not only were we out of balance, but the identity of that business is very different as it evolved. So what we ended up with is 2 very distinct, successful pieces. And the notion that nutrition was, the proper piece of that was the part that I didn't agree with because it's very consistent with a lot of the characteristics of the rest of the company, the growth prospects, et cetera, at the time it was being compared to a PE of a competitor. Now, I think all of us in this industry would love to have the PE of that competitor. Who knows how sustainable any of these PEs are over time. But I think that the mix as we’ve described it today is correct, given our strategy as a diverse company in healthcare with a particular balance. So I don't think this is at all inconsistent, Tony, with what the tone I communicated at the time. I think it's frankly very consistent. But at the time, I couldn't say to you, hey, good idea but you got the wrong business, that you carved out here. That's kind of the essence of this. That the notion at the time, the question I got was more a notion of, are you sure all of this mix fits together? That's how I would take it. And the hypothesis was, gee, the nutrition was the one you could carve out. I think the notion had merit. I think the Proprietary Pharma business is the one that has the distinctly different identity and I think this makes sense today.

[Operator:]

Our next question is from David Lewis from Morgan Stanley.

[David R. Lewis:]

Miles, just a quick question that's been addressed here a little bit, but I want to ask it maybe in a very different way. We believe Abbott is undervalued and the primary issue certainly does seem in the eyes of most investors to be confusion over HUMIRA. So as I think about your current multiple, it does imply real concern around HUMIRA, its cash flow growth and profitability. But you are in management is much more bullish on the potential for HUMIRA than consensus. So I wonder why not wait to see for that to be appreciated in the market as competitive threats prove less material than those people think, which is only really 2 to 3 years away?

[Miles D. White:]

Well, I think 2 things. First of all, I think that the -- this split is not about confidence around HUMIRA. It's around the identities of the businesses as I described earlier. I agree with you that the company is underappreciated and perhaps undervalued, but I don't know any CEOs out there who wouldn't claim that their companies are undervalued. I think the entire sector may well be undervalued. The entire stock market could be undervalued. It depends on your perspective for the business, it depends on your perspective of the development of international markets, it depends on your perspective of a lot of things. I'd support your notion that we're undervalued. But I think the notion of a split here, it has the right merit, logic, given our intent regarding the investment identities of the company and what belongs in the diverse mix. At the end of the day, the questions around HUMIRA's durability will clearly be answered. I think we will go a long way toward answering that even more thoroughly on Friday. Rick answered a lot of it earlier in the phone call. But I think we can respond to the durability of HUMIRA going forward. As Rick acknowledged earlier, the growth of HUMIRA continues to be very strong and continues to be in excess of about $1 billion a year. That's equivalent of a so-called blockbuster a year here in growth. Now granted, that's not going to happen forever, but there's obviously several years left of that kind of durability and growth and strength in that business and that franchise. And I believe that with further explanation on Friday, we will further lay out why we see the development of the market, the biosimilars, the orals, et cetera, as we do and investors will make their choices. But I think we have evaluated that pretty closely and pretty carefully over the last couple of years. We have a view. We have a view of the durability of HUMIRA. We'll share that with investors and I think the obvious next question an investor has is, what about after HUMIRA? What then? And I think that greater visibility to the pipeline of the Proprietary Pharmaceuticals business will go a long way towards filling in those gaps for analysts and investors, and I think we're beginning to fill those gaps now. But even if there were great visibility to that on the part of investors and analysts and even if there were great understanding of all of that. By the same, we would still be splitting the company because we believe there are 2 really distinct different and valuable investment identities here that make sense as 2 separate public companies.

[David R. Lewis:]

That's very clear. And maybe just one more strategic question. You, like a lot of healthcare CEOs have talked about the healthcare environment and what they may look like over the next 3 to 5 years. And I guess the question is, isn't size an asset in this environment and I wonder, will this limit your flexibility at all? For example, if your device franchise standalone, needed more breadth to compete and more bundling were occur in that segment of the marketplace, couldn't HUMIRA cash flow have enabled future acquisitions there? So simply, is size an asset? Does this limit your flexibility at all?

[Miles D. White:]

No, I don't think it limits our flexibility at all. You got to remember, we're a very large company becoming 2 very large companies. These are both large cap companies at the end of the day. They're both very strong companies and they both have very strong cash flow. The cash flow of each of these companies is equivalent to what the entire company was not that long ago. The cash flows are very strong on both sides. I don’t feel like either one of these 2 companies is going to be constrained or limited by what it may wish to do. We're not actively seeking large acquisitions. I think at least on the side of the diverse medical products company, I'd tell you that I think is there is so much potential for growth and sustained double-digit margin growth that we can do that organically. For us, any acquisitions or additions to the company, I think will be very much opportunistic and because there's an opportunity we believe we can uniquely leverage in the mix of our business over time. Will there be those opportunities? I think there will be over time and we'll react to them and evaluate them as they come and we'll be able to do it opportunistically and we'll have no shortage of capital or flexibility to do it. On the Proprietary Pharma side, I think the same is true. I think as there are pipeline opportunities for Rick to add to that business. There is no shortage of capital flexibility to do so. Both will have very strong cash flows. We are not reliant as a company on HUMIRA alone. As I indicated earlier, all of these businesses are generating positive cash flow today. And actually, and if you went back 10 years ago, that wasn't true. The Diagnostics business didn't generate cash. The Diabetes business didn't generate cash at the time. Today they do. All of these businesses generate strong cash flow. So no shortage of flexibility.

[Operator:]

Our next question is from Rick Wise from Leerink Swann.

[Frederick A. Wise:]

I'll start with sort of pick up where you left off with David's question. Is it too soon, Miles, to talk in little more detail about your preliminary vision for the ongoing Abbott. You said, you made some comments we’ll continue to expand in emerging markets. I'd expect to hear that. You're already a strong presence. But you talked about channel synergies and you talked -- you highlighted the self-paid mix. Maybe help us think here. Where does Miles White see the company going over the next 5 years, more of a consumer-oriented company, is there other capital -- opportunities in capital or IT? Just any preliminary thoughts would be fabulous?

[Miles D. White:]

Well, Rick, as we've talked about on previous calls, the emerging markets in particular are big growth opportunity because of the expansion of those economies and the expansion of the healthcare systems in those economies. And the structures of those markets are very different. Not different just with each other, but different than, say, the U.S., Europe, Japan historically. They are much more self-pay markets than reimburse markets in general, and our Established Pharmaceuticals or branded generics business and our Nutritional businesses are generally speaking in those markets, self-pay businesses. And yet growing very rapidly in those markets. They share common outlets. They share common distribution channels and so forth. And while we have not, at this point, attempted any kind of synergy between them, they do share common visibility, brand, outlet, pharmacy, wholesaler, et cetera, in all those markets. And I think that footprint will definitely benefit us going forward. I think it's a plus to have a mix of sources of how your products are paid for. For a company, in our business, if you're solely dependent on the U.S. and Europe, well, then you're going to be dependent on governments and payers that are highly concentrated. And that's going to be true of the characteristics of our Proprietary Pharma business and that's been the case for a lot of our mix of business over time. One of the things that was attractive to me about the ophthalmology business was that a big chunk of that business is consumer discretion business, the LASIK business. And while that business has been pressured by the economy in the last few years, I like the fact that we're not just dependent on government reimbursement in a lot of cases for payment for our products. Because I think for those countries, those businesses, those products, where consumers make the decision, your businesses is somewhat less vulnerable to large structural moves in the payment system. So I think that mix is good. I think that we will continue to expand in emerging markets because as I said earlier, growth is there. We are not ignoring developed markets. There's a big chunk of the company, both companies frankly in developed markets and those are important markets to us. But I will tell you that I think the developed markets will be much slower growers for the future, and a lot of the growth will come internationally and especially in emerging markets. So I think that the obvious distinction that way between the pharmaceutical business and the diverse medical products business is -- the diverse medical products business has the market growth, the expansion, the expansion of those economies, a tailwind of growth. It's not going to be that dependent on single large products. The pharmaceutical business will always be dependent on single large products because that's the nature of that business. And the productivity of our R&D and therefore, the importance of our pipeline and the durability of products like HUMIRA, very important for that business. And I think that's why our pharmaceutical business has been so successful over the last decade and I think will continue to be going forward, but those are different, in different market dynamics.

[Frederick A. Wise:]

Just a follow-up, you highlighted the potential for improving gross margins and operating margins. Maybe you want to talk a little bit about that. Is that factory consolidation? Is it just realigning how products are made and where and distributed? Is that significant in your mind? And maybe just, Tom, when will we see you start reporting some kind of breakdown for the 2 companies differently? Will it wait until the Form 10-Q comes out?

[Miles D. White:]

Rick, I'll just say we're going to explain more about this on Friday, the first question on margins.

[Thomas C. Freyman:]

Rick, in our segment information, you already have quite a bit of basis for understanding the major businesses here. So, I mean, obviously we do need to go through this carve-out financial process, which is going to take several months. And that's when you'll see a little more specifically more of a fully allocated picture of the pharma business than what you see in the segment footnotes. But you have pretty good information right now. And I'd say, as we get later into the process, after we do the Form 10 and get closer to the true separation, we'll be getting more granular on how these 2 businesses look.

[Miles D. White:]

Just to answer the granular point you put upfront on the gross margin. There are several businesses here that are changing the structure of manufacturing and other things, the sourcing and even how they go to market in some cases. Diagnostics is having a great program underway that way and has expanded its gross margin. Diabetes Care, same. Nutritionals, major programs underway right now to change the mix of its gross margin. Some of it is our manufacturing strategy globally. Some of it's whether we make it ourselves versus source-it, et cetera. There are a number of factors that contribute to it. But we will talk about it a little more on Friday.

[Operator:]

Our next question is from Glenn Novarro from RBC Capital Markets.

[Glenn J. Novarro:]

I have 2 questions. One, the Established Pharmaceuticals business, I wonder if you can walk through the reasoning why that wasn't put with the pharmaceutical business? I would've expected that this could have been a nice buffer against any pipeline failures and government intervention that you mentioned, so maybe comment on that? Then the second question, I wonder, we're all asking about timing, but also -- we're now in this unusual period now where there's Health Care Reform implementation. We've got a super committee discussing further Medicare cuts. I wonder if this also played into the time now to do the split?

[Miles D. White:]

Okay, first comment on the Established Pharmaceuticals business and the Proprietary business. I'll tell you, other than the fact that they both have the word pharmaceutical in their headline, they're really different. Their business models are different, the markets where -- that are attractive to them are different. The Proprietary Pharmaceuticals business is very much a developed economy business for all the reasons we know. The kinds of products that we sell and the cost of those products and so forth, their affordability and so on. Those are developed market products. The Established Products division at least here, you'll note doesn't have a U.S. business and won't. It is not our anticipation to be in the U.S. because it wouldn't make money here. And at the end of the day, we are trying to earn a return on the investors' capital. So that business will stay focused on international markets. And then the nature of the competition and the selling, frankly, Glen, has a lot more in common with businesses like our nutrition business than it does the Proprietary Pharma business. It's a business about a breadth of product line and key leaders in key categories, your feet on the street, than relationships with many, many pharmacies and wholesalers and so forth in these emerging markets. The business model and how money is made are very, very different. And there isn't actually a lot in common there. So it made sense to us that the Established Pharmaceutical business belonged with the other very Durable Growth business and not with the Proprietary Pharma business. With regard to Health Care Reform, I would say Health Care Reform is a contributor to the environment in general. It clearly has impacted the environment for healthcare products. It has impacted the environment for pharmaceuticals and/or medical device products. Frankly, so has the debt crisis and pay crisis in Europe. The impacts on the economies in the U.S. and Europe, aging populations, all the things that we know are happening to pressure the healthcare products markets in the U.S. and Europe, all contribute to a different environment. And at the end of the day, I'd say all that does is change the nature of the environment in which we compete and operate. That's going to clearly have an impact on all the businesses, not just pharma. This is not motivated solely by Health Care Reform at all. But the Health Care Reform, you could say, is a contributor to the overall environment that has contributed to a bigger consideration about the investment identities of these 2 businesses.

[Operator:]

Our next question is from Catherine Arnold from Credit Suisse.

[Catherine J. Arnold:]

I wanted to probe a little bit on the pharmaceutical business if I could. I know, I for one, have been looking for more and more disclosure on your pipeline. And I guess we'll get that on Friday. But I know you have a high level of optimism about the outlook for that business and I am anxious to hear the details. But clearly, some of the assets like hepatitis and MS are very much changing quickly in terms of standard of care and have a lot of intense competition. So there is, let's just say, there is some risk in terms of the pipeline of that particular Proprietary Pharmaceuticals business. How are you thinking about that in regards to business development? And if you could comment about the cash flow outlook, I think that you're sort of implying HUMIRA will probably grow another $1 billion per year for, I would say, a couple of years. I don't know if that would mean, a couple means 2 or 3 to me. But at the same time, you're losing the lipids franchise. So there's -- where are we in the adequacy of the cash flow for business development? Because I'm sure you want to make sure that there's some cushions and buffer in the outlook for the pipeline, given the competitive dynamics in some of the key franchises in the late stage. And given, obviously, longer-term acknowledgment of some risks on HUMIRA. That's a mouthful, I appreciate that.

[Miles D. White:]

It was a long question. A big part of that we're going to answer on Friday. I would tell you, we understand the competitive dynamics pretty well in hepatitis, as well as MS and I think we can walk through that on Friday. I'd also tell you just don't focus on hepatitis and MS. Bardoxolone is a big asset. We have a number of other assets that we'll talk to you about. But clearly, the areas we're going into are areas of high unmet clinical needs. They're competitive, okay. I think we understand the profile that we need. HUMIRA, I think you described -- you’ve described it in a way that's consistent with what we think, although I would say, I have view that's different than you about sustainability. And that is the key to this, right? We believe there's strong underlying growth that will be maintained for a longer period of time. We believe there's plenty opportunity to penetrate these markets. And on top of that, the pipeline will play out. There certainly will be a period where the generic impact on our dyslipidemia franchise will depress overall growth rates but the underlying growth rate will be very, very strong. And so when that plays through, you'll see it pop back up to very healthy growth.

[Operator:]

Our final question is from Barbara Ryan from Deutsche Bank.

[Barbara A. Ryan:]

Most of them have been asked, but I'm just wondering, I think you answered why you separated emerging established products from the Proprietary business because of the risk profile and the cash flow characteristics and persistency make it fit more with the medical products business. But I'm just wondering, when you acquired those businesses, you did talk about the opportunity to cross-sell the 2 companies' products, I'm just wondering if there's any dis-synergies associated with separating those 2? I know you talked about that they have been separated largely internally. And if there's a plan to commercializing some of your proprietary products in those emerging markets that are dominated by these established products and then I have another question?

[Miles D. White:]

It's interesting. I don't expect the synergies, and the companies will, in some cases, still maintain common brands in some examples where the EPD business will have a brand overseas in some markets and the Proprietary business will have it in the U.S. or some others. That's not uncommon. As you know, products like Enbrel or Remicade and others have had 2 companies marketing them in different markets over time. So I think, that some of the things that some might assume would be dis-synergies or conflicts won't be and it won't be for us. So I don't see that there's an issue there. The notion of cross-selling and shared. The company is, frankly, where it makes sense can cooperate. We're not going to be in any kind of direct competition any way, we aren't now. So I think that -- I don't think there's any threat to the original comment. Although clearly, Barbara, neither necessarily relies on that for its success. I think both can be completely independently successful without reliance on the other even if there are some shared assets. Rick, you want to add anything to that?

[Richard A. Gonzalez:]

No. I mean, I think that covers it. I mean, clearly, emerging markets aren't as significant for the Proprietary business as they are for the other business. But they are a significant contributor to our growth in certain emerging markets where you have reimbursement access. That's the key for the proprietary product.

[Miles D. White:]

I think that's an important point. The Proprietary business will also have opportunities in the emerging markets, and we'll definitely go after those opportunities. They have presence there now, they have people there now and there's market there now, albeit smaller in terms of numbers of people or whatever but sizable in terms of dollars for some of the places that Rick mentioned.

[John B. Thomas:]

So, Barbara, you had one more question?

[Barbara A. Ryan:]

Yes. The question really is about the outlook. You made this very specific comments about the growth outlook both for top and bottom line in the medical products business. You spoke to sort of competitive low single-digit top line growth for Proprietary business, but you didn't comment on earnings. And I'm just wondering, given the fact that the company has been diversified and along with that your investor base is looking for persistency and consistency and double-digit earnings growth, whether there is likely to be any change in the investment profile of the Proprietary business, i.e. do you see opportunities to spend more on that business that you were reluctant to do and maybe believe you should be doing that you were married to a business with different kinds of expectations?

[Richard Gonzalez:]

I think if you look at the investment identity of pharmaceuticals within Abbott, I would say that the way we plan, the way we run businesses within Abbott, it's -- although we're all part of a big family, the reality is we build our own P&Ls, our plans by year, and we try to invest in a way that's appropriate for the right return for the investor. And so I can tell you without question that the pharmaceutical business was never underfunded on programs that they believe that they could advance more rapidly. Now, it depends a lot on the evolution of your pipeline. As you get more and more of your pipeline in Phase III, it's far more expensive to be able to develop those products. But whether we were inside of Abbott or outside of Abbott, that would be the same investment profile that will drive the business in order to maximize the return on that investment going forward.

[Miles D. White:]

Barbara, I think you'll see eventually here in the split of the companies in their P&Ls and balance sheets and so forth, a profile in the Proprietary Pharma business is pretty healthy, a profit profile and a spending profile is pretty healthy. Its R&D spending compares well. Its SG&A spending compares well, particularly given the focus of its business in specialty categories. I agree with what Rick said. It's not in any way been underfunded or had to subsidize anything else. When you look at the whole Abbott Laboratories and you look at the profiles of R&D spending or profits and so forth, there's a dilution that occurs there in the mix of all of that, that makes it difficult to see the individual profiles of businesses. The R&D intensity of Nutritionals business by comparison is low-single digits. It's not necessarily to spend nor does it take more. And when you marry the size of the sales of a business with a lower profile, where your spending is much higher in SG&A than it is on R&D and so forth, and you look at the combined total, I think you could question that. But as you see the Proprietary business broken out, I think what you'll see is a very healthy profile that in no way constrains it. And I think you'll see proper profiles that are competitive and the other businesses as well on the other side.

[John B. Thomas:]

That concludes our conference call today. As I mentioned earlier, we did post a 12-page slide deck to our Abbott Investor website that summarizes today's announcement about the separation into 2 publicly-traded independent companies. I also mentioned if you joined us late in the call that we are hosting an investor meeting this Friday, October 21 in New York from 9

[Operator:]

Thank you. And this concludes today's conference. You may disconnect at this time.