Becton Dickinson and Co (BDX) 2004 Q1 法說會逐字稿

Hello and welcome to the BD's first fiscal quarter earnings release conference call. [OPERATOR INSTRUCTIONS]. Beginning today's meeting is Ms. Patricia Spinella, Director of Investor Relations. Ma'am, you may begin.

Thank you. Good morning everyone and thank you for joining our call to discuss our first quarter results for fiscal 2004. Today's call is being simultaneously Web cast and will be available for play back or by phone at 1-888-568-0139 for domestic calls and 1-402-530-7805 for international call. During today's call, we will discuss some non-GAAP financial measures with respect to our performance; a reconciliation of this non-GAAP to GAAP measures can be found in our first quarter press release, and the related financial tables. A copy of the release and the financial tables is posted on the investor page of the bd.com Web site.

We will also make some forward-looking statements. And it's possible that actual results could differ from our expectations. Factors that could cause differences appear in first quarter press release and in the MDNA sections of our recent SEC filings. Leading the call this morning is John Considine, our Executive Vice President and Chief Financial Officer. Also joining us today are Gary Cohen, President of BD Medical, Bill Kozy, President of BD Diagnostics and Vince Forlenza, President of BD Bioscience. I will now turn the call over to John.

Thanks, Pat. And good morning to everyone. By now I assume you have had time to review the earnings release and the attachments that we sent out this morning. We'd like to devote as much time as possible for answering your questions, but before beginning we'd like to make some brief comments regarding our first quarter results. Overall, there are two takeaways from the quarter. On one hand, we had a one-time charge pre-tax charge of 45 million in connection with certain actions we have taken regarding blood glucose, drip inventories and meters.

More importantly on the other hand we had a very strong quarter marked by double-digit sales growth, meaningful improvement in gross profit and continual control over SG&A spending all resulting in earnings growth ahead of our estimates. From a revenue standpoint we reported revenue growth of 14%, which includes about a 7% point benefit from currency translation, in particular due to the strong euro. Each of our three segments benefited by 6% to 7% due to currency.

Looking at our medical segment reported growth of 10% was driven in part by sales of safety engineered devices in the U.S. Our company wide U.S. safety revenues which you will recall come from both the medical surgical systems unit of BD Medical and the pre-analytical systems unit of BD Diagnostics grew about 15% to a $188 million.

We continue to estimate that U.S. safety sales will increase about 12% to 15% for fiscal 2004, from a base of 680 million in fiscal 2003. Also adding to Medicals growth were sales of flush prefilled products, hand needles and blood glucose drips. BGM strip sales while small in total at about 5.7 million were in line with our internal expectations for the quarter and benefited from a favorable comparison to last year in that we launched BGM in the U.S. in the second quarter of fiscal 2003. Growth in first quarter was offset in part by flattish sales in pharmaceutical systems, modest sales growth in the medical/surgical systems unit and a decline in sales of our home health care product line.

Going down a bit more into worldwide pharmaceutical sales system, it should be noted that this unit had an outstanding fiscal 2003 growing by 34%, which included a 13% benefit from favorable currency rates and this naturally makes for a tough comparison with the current year. For instance, the first quarter of last year saw sales increase by 30% on an as reported basis, which again included a 7% benefit from currency. Fiscal 2003's first quarter contained a sales ramp for our pharmaceutical customers, product launches in Japan as well as sales of bifurcated needles in Europe that were not expected to repeat in fiscal 2004. In addition this year, several large pharma customers in Europe requested that deliveries in the quarter ended December 31 be minimized in an effort to more effectively plan the year-end and employee balances.

All that being said we expect to see a growth rate in fiscal 2004, which will be noticeably lower than in 2003 due primarily to the series of very positive events last year that caused us a tough comparison with this year. Overall, sales in the medical surgical systems unit of the U.S. increased about 3% due in part to fiscal 2003's first quarter, which contains some pre-SAP buy-in by distributors that we had not included in our consignment inventory program. The segments growth was also affected by weak sales of U.S. home care health products. These products include our ace and true fit brands and are facing strong competition. Turning back to the discussion of blood glucose monitoring in a moment I'll ask Gary Cohen to provide some additional comments on the actions we announced today.

But before I do that, I wanted to give you the breakout of the components of the pre-tax $45 million charge related to these products. The charge involves two separate actions. First, we have recorded a pre-tax charge of approximately 36 million, the majority of which provides for strips in our inventory, and to a lesser extent the expected return of recalled strips in the marketplace. Second, we have recorded a pre-tax charge of approximately $9 million to write off BD latitude blood glucose meters and related fixed assets. As a result of deciding to focus our U.S. marketing efforts solely on the BD logic and Paradigm Link Meters. Let's now turn to Gary.

Thanks, John. I'd like to start by explaining the situation that led to the recall and I'll do this in some detail. The product performance issued that recently emerged with the blood glucose monitoring strips involved an increase in frequency of E3 messages from the blood glucose meter. E3 messages can result from a number of different conditions, including insufficient blood in the test strip, too much in blood in the strip, user double dipping of the sample, and reuse of the single-use strip. E3 messages are protective feature of the meter, intended to reduce the likelihood of an inaccurate blood glucose result by triggering the meter to not provide a reading when one of the above conditions exist. Internal testing performed to BD showed an excessive rate on E3 error messages on a number of more recent lots. In addition there had been an increase in the number of customer complaints related to E3 error messages. In order to better understand and address this, we performed extensive testing on most lots of BD test strips and identified the significant number lots where the E3 message rates were in excess of what customers would expect and what BD finds acceptable. Some of the lots had been released for sale and are now the subject of the recall. A far larger number of affected lots had not been released for sale but break in our inventory. These lots in inventory are considered non-performing and will be disposed of along with the recall product.

We have sufficient quantities of test strips in our inventory that do meet the performance requirements to replace the recall product and to continue supplying the market. We're working closely with our blood glucose meter and strip supplier to ensure an ongoing supplier strips that meet the requirements. We have scaled up our customer support capabilities to minimize any disruption to our customers during the process of recalling and replacing their test strips and we're also working with Medtronic to help insure smooth implementation of the steeled action with their customer base.

BD is taking these actions to help insure that our products meet the high quality standards and the customer's performance expectations. It is important to note that an E3 message typically does not constitute a health hazard on an individual basis because the impact of such readings is to not get a test result. The expected customers responds to an E3 message is to retest. The only circumstance when an E3 message could become a health hazard would be when a subset of users are unable to get a test result after repeated attempts, and this inability to get a test result could impact their subsequent therapy decisions.

It was on this basis that BD established health hazard criteria that determined which lots were subject to the recall. The same criteria are now being applied for acceptance of any test strip lots being manufactured by the supplier. BD met with the FDA regarding the recall action. The recall is being issued today through communications to wholesalers and retailers. We're also issuing a release to advise general consumers of this issue. Also, as John mentioned included in the first quarter charge is the write down of the BD latitude blood glucose monitoring laboratories.

Based on our experience today in the blood glucose monitoring market. We decided to foe course sales and marketing efforts on the BD logic and Paradigm Link Meter and to withdraw the BD latitude offering in the United States. We'll continue to sell BD latitude in Canada. BD glucose blood and revenues in the first quarter mentioned by John was 5.7 million while it was a modest number relative to the sides of the overall market these results were actually slightly above our internal plan for first quarter. We remained committed to the blood glucose strategy and believe the impact of recall it will be short term in nature. We also remained committed to pursuing the strategy in a manner that enabled the overall company to achieve consistent predictable earnings growth.

While the financial charge and customer inconvenience associated with the recall are recall just pointing to us, we believe that these were necessary actions to support our ongoing commitment to quality and our goal of getting a sustainable position in the flood glucose monitoring market. After John finishes the remarks I will be pleased to answer any questions you might have about blood glucose monitoring on the call.

Thank you, Gary. Moving on the diagnostic segment in addition to the contribution from safety sales and pre analytical systems, the diagnostic systems tuned enjoyed exceptionally strong sales of respiratory and flu diagnostics tests in Japan and in the U.S. In fact, versus last year, flu revenues grew by $29 million, contributing approximately 4 cents in incremental EPS to our expectations. This result doesn't happen by luck.

In fact, a great deal of preparation went into planning for the flu season and involved buying raw materials early and having our sales and marketing forces prepared. You might be interested in knowing that of all the flu product suppliers there were only two that were not out of stock and we were one of them. Additionally feeling the growth for sales of the BD Protec ETH still in platform, which increased to 21 million versus 13 million in last year's first quarter.

In the BD Bioscience segment revenues for the quarter was 16% ahead of last quarter. Immune psychometry system sales that's anticipated were strong, up 28% including currency related -- reflecting very favorable worldwide customer response to the new fact Aria instrument platform, which was launched at the end of the second quarter of fiscal 2003, as well as strong reagent sales.

Regional revenue growth continues to benefit from the ongoing increase in our installed instrument base and the introduction of new research reacts. Sales performance of contact molecular biology products continuously to be negatively affected by a slow down and some research segments as well as by competitive pressures.

Turning now to the P&L, our pro forma gross profit margin of 50.3%, which excludes the $45 million pretax charge for blood glucose products showed strong improvement over the first quarter of year. Contributing to this performance were benefits from the previously announced medical manufacturing restructuring, incremental higher margins from safety margins as well as Protec and flu products. More over we are beginning to see the positive impacts of Six Sigma lean efforts, which along with higher margin products gives us confidence of achieving a 75 to 100 basis point pro forma increase for the year.

SG&A expenses as a percentage of sales increased over last year by about 50 basis points. Core spending grew at a rate consistent with inflation and as expected the remainder was primarily due to incremental expenses related to blood glucose monitoring.

In terms of cash flow for the first three months of the year, we generated over 200 million in net cash from operations on track to our annual guidance of 1 billion. Capital expenditures of 45 million are in line with our budget and on track to the $300 million guidance we previously provided. We also repurchased about 1.9 million of common stock for about 75 million. By the way, you may have noticed that our board authorize as new 10 million shares repurchase program on Tuesday of this week. At present there are also about 1.7 million shares available under the prior 10 million-share authorization.

Finally before I open the call to questions, I want to speak to our guidance. The second quarter sales growth is expected to be in the 8% to 10% range for our total company revenues, and for the medical and diagnostic segments. The bioscience segment is slightly high we are a range of 10% to 12%. These ranges include the expected favorable benefit of positive foreign exchange. The EPS guidance for the second quarter is 10% to 12% over the prior year. Turning to the full year, November, we provided full year guidance on sales growth of 6% to 8% and diluted EPS of an approximate plat 10% to 12% increase over 2003 pro forma EPS of $2.15.

Assuming the year remains at approximate our current levels, our revenues should increase to the 8% to 10% range. Correspondingly we expected diluted EPS would remain in the range of 10% to 12% including the 11-cent BGM charge that we previously discussed. Excluding the charge pro forma EPS is expected to increase in the range of 15% to 17%. So in summary aside from the charge, Q1 was a very strong quarter with strong sales growth excellent improvement in gross margin and leverage which resulted in an EPS that was in the range of our guidance on a reported basis even with the charge and well beyond that on a pro forma basis. With that, we'd like to open up the Q&A and in order to allow for broad participation, we'd appreciate it if you would limit your questions to one plus a follow-up. Thank you, and with that, operator, please open the call for questions.

Thank you. [OPERATOR INSTRUCTIONS] Our first question comes from Danielle Demetri (ph) with Merrill Lynch. Go ahead.

OK. Good morning everybody. Just I want to follow up on a couple of items and I guess it's a little hard, John, for us to understand on the diagnostic side the flu test. Are you talking about some strength in the core microbiology business at -- or are that actually unit tests that are not microbiology test based?

Let me add Dan, rather than giving two answers, let me ask Bill Kozy who runs that business to respond to that.

OK.

There is a strategy center that runs out of the diagnostic systems business that is immuno-based or thinking about it is a rapid manual test group of product array. Flu lives in that product array of rapid manual test. It's not under the umbrella of traditional microbiology.

OK. Thank you, bill. And then John, the guidance for the second quarter would seem awfully conservative based on the run rate you had. I understand there are some one off things like the flu season and like in the first quarter and number and the like. But given the currency impact it would seem like the sales numbers could be quite a bit stronger and I'm a little confused at the lack of sequential earnings progress on a sales number that ought to be probably higher than -- or at least at the same level here as the first quarter. Can you go into that a little bit for us?

Well, you know, Dan, we have some estimate in there for foreign exchanges if it kind of remains in the level we have now. You know, we also think, you know, the flu for instance in the U.S. while it was very strong in first quarter kind of died and we probably had some buy-in in the first quarter from the second quarter. You know kind of when we looked at the euro, our second quarter euro last year, which is the biggest part of the currency side, was about 106. If it stays in and around 125, 126 ranges, we still feel comfortable with that guidance, although there may be some upside in that. But, you know, I'd rather, I'd rather be a little cautious on it than get too far ahead.

OK. Thanks.

All right.

Thank you. Our next question comes from Glenn Reicin with Morgan Stanley.

Hi, actually I have a follow-up to Dan's question and then a second question. Maybe you look at the upside this quarter, you know, without the one-time charge it was somewhere in the 10% to 12% range and it's clearly because of currency in the flu season. Do you think maybe you can speculate and break down those two factors and maybe quantify them in terms of say the 11 cents or the 12 cents of upside?

Well, why don't I do it versus kind of last year for you Glenn, I think it might be easier to understand. I think if you started with our 43 cents that we had last year in the first quarter, currency versus that first quarter gives us about 6 cents because our euro then was about 99. For first quarter, it averaged about 118. So we have that. Diagnostics overall including, you know, the very strong flu season probably gives us about 7 cents. And then we have improvements in BDB. You know, Vince is running now of a couple pennies and med surge is stronger by about 3 cents. Offsetting that is probably a couple pennies of BGM spend as we continue to support that new brand. And this kind of gets you up --kind -- you're trying to get to the 59 cents and that would do it.

Yeah, and I'm thinking of the second quarter. Conceptionally you're saying if you probably have another nickel upside in the second quarter, but you want to offset that or potentially could be offset by purchasing on the flu season, etc?

There's a little of that, that's a very good question, Glenn. There is a little of that and then, you know, we're going to -- you know, our assumption -- this is kind of one-time event on BGM. Notwithstanding which, you know, we have to go out and really support that brand, and there's some additional spending as we go through the remainder of the year that is above and beyond what was in our original expectation and some of that in the second quarter and the third quarter and the fourth. And, you know, that could be about as much as a nickel of spending throughout the year.

OK. Using FX to fund that essentially. On the BGM front, just conceptually, you know, I was thinking your estimates for the year of 60 million; I think that was your estimate -

No. It was 50.

50 million.

50, yeah.

OK. So actually -- you're right, it was 50 million. I was thinking you would start off the year with like a nine number, an eight number and then go to low teens in the second, mid teens in third and fourth and you get there. How -- if this is according to ramp of $6 million number in the first quarter, how do you expect the ramp in the second, third and fourth quarter this year to get to that $50 million plus number?

Let me have Gary talk to you about that. But remember, a big part of this strategy was based on the Medtronic Paradigm link, which only began shipping in October. So we don't start to get that uptick until then. But Gary you can fill in the blanks here.

I think, you know, the ramp is heavily tilted toward the back end of the year. As I mentioned and John mentioned as well, the first quarter results were actually just marginally above what we had expected. So we probably had built into our projections more of a ramp up, more of a higher curb on that ramp than you may have had built into yours, particularly in the latter two quarters.

Right. OK. So what kind of sales are you looking at in the second quarter? For BGM?

Well, you know, we kind of set a policy of not giving you explicit guidance on that, but needless to say, you won't see the big jump in the second quarter. You will start to see it in the third.

OK. Thank you.

All right, Glenn.

Thank you. Our next question comes from David Lewis from Thomas Weisel Partners. Go ahead with the question.

Good morning, John. Just a quick financial question. You mentioned a break down on EPS and the two sources of upside. I wonder you mentioned gross margin as a highlight. Can you walk us through the components of the gross margin upside and what might be sustainable and more granularity there?

Well, overall we continue to believe on a pro forma basis we'll get, you know, about 75 to 100 basis points of increase this year. Last year we had the same thing and we had guided around 80 and I think we got close to 100. And, you know, there are some unusual things that happened this year like flu. But we continue to get you know benefit from safety. We get benefit from pre analytical solutions, which margin has overall gone up. Over 50% now, you know, our bioscience division has a gross margin that is, you know, beyond just --just beyond mid 50's. So that is contributing.

We get a little benefit from FX, but that hasn't, you know, that hasn't been the sole part of this. The manufacturing structuring continues to give us benefit and then, you know, we've really spent a lot of time on -- with our new system and with driving through good procurement and driving through lean manufacturing and Six Sigma efforts. And you know, David, as you can appreciate, there was many things in there when we add them all up and we add up all the lines of business that we have, that that's what we think will drive it and should be sustainable for us.

But John you would characterize more than half of the gross margin benefit being linked to organic drivers as opposed to FQ?

Yes. I would.

Excuse me?

Yes, I would.

Great A couple of quick questions on diagnostics I guess the first of which is you ended the 2003 market share and going to give us less detail in 2004 but market share was 35% for Protec. I guess a couple questions. Is the growth accelerating in Europe for just the U.S. or is the U.S. slowing? And what was your updated market share assumption after the first quarter?

Let Bill Kozy take that.

OK, David, our sales ramp up includes two things. We're obviously continuing to gain some competitive business, but at the same time, we continue to focus on converting if you would the non-amplified users. So in some ways some of the growth that we're getting is expanding the market. We believe that our share has improved in the last two quarters. Somewhere in the range 2% to 3%, but that is inclusive of whether we're describing as a larger amplified market. We continue to look at Protec in a context of the amplified market. I don't have a number for you on the total market. I just don't have that one.

But is Europe growing faster than the U.S. now or not necessarily?

No, not necessarily. Both are doing pretty well, but we're really driving our success out of the U.S. primarily.

Great one real quick one just an update on Phoenix approval time line?

We're still hopeful. We are into the critical stage with the FDA trying to get all the data complete by the end of this quarter so that we can get pilot launch. And I suspect we'll either just make the end of this quarter or we'll make early in the next quarter is my guess.

Great. Thanks so much.

Thank you. Our next question comes from Bruce Cranna with Leerink Swann. Go ahead with the question.

Good morning.

Good morning.

John, just want to kind of follow through on your margin commented a little bit. It's a big uptick on the gross margin side, so I'm kind of - very concerned of mine model and stick to guidance. So, you know, am I missing something with respect to the way this should trend, gross margin should trend for the year? I mean, if I kind of --obviously, flow this through I'm getting a little bit of a higher number. I guess on balance for the year, where do you think the gross margin would come in for fiscal '04?

I think we'll be versus last year's year end we should be in that 75 to 100 basis points. If we stay where we are on gross margin, I feel more confident with the upper range. Remember, that -- particularly the Euro was quite low in the first quarter and our gross margin was at its lowest in the first quarter at just under 48% and then it began to move up during the year. So whatever benefit we do get from the Euro starts to narrow as we go forward.

The other thing that's a limiting factor on it you have to remember, Bruce, is my earlier comments we continued to support BGM. And we're going to spend a little bit more money on BGM, as we go forward and probably a nickel. Some of that is SG&A for the good portion of it hits on our gross margin line and so that's somewhat of -- of a mitigating factor that's keeping it from being a bit higher as you would interpolate the growth.

I kind of wanted to get to that. So I know that there was a sense before that you were -- you're kind of walking a fine line between showing the earnings and spending the earnings and so do you think that's changed somewhat today with what we have seen in this quarter? In other words, can you put the pedal down a little more on whole blood glucose and maybe, you know, maybe that includes more aggressively giving away meters? Do you think you can be more aggressive on that spin going forward?

Well we clearly have -- there are two parts to the answer. One is do we have the financial resources to be able to do that and the answer is yes. I mean, indeed, we were going to spend probably this extra nickel I'm talking about anyway and we'd go out and push our divisions, all of them because everybody contributes, to allowing I. We have had this first quarter and that's great. But we'll continue to put the pedal to the metal in terms of operating efficiency. But I don't want to leave it at that. I want to let Gary comment because it's not a matter with this strategy of just seeding more meters especially given the importance of Medtronic who is our key partner in this on the marketing side.

The only thing I would add is I would say, you know, it's all relative in this sense. I mean, one can make the argument we could be spending much, much more on BGM than we are given the size of the market and the given the size of the competitors. So we do try to keep this all in balance and given that the company is performing well and we're getting the benefits of FX upside, it gives us a little build more Leeway for more investment.

Now, that investment will be committed only as the quarters go by the way so we're not going to lock in more spending in advance of the actual performance of the company. And we do our best to come to a reasonable conclusion as to what's the right amount of investment to put in relative to performance of the company. And there's also a need to insure given that we're doing a recall in first quarter that we're treating our customers as best as possible.

The best way we know how to, which means we'll probably do --forgive the term a little more hand holding to make sure that their transition to the replacement strips is done very smoothly, that we can sustain a high rate of customer satisfaction or in some cases increase the level of customer satisfaction if they have been experiencing this issue. So that requires a little bit of an investment going forward as well. To make sure we're going through this in an effective manner. This is a conservative move that we're making. I think it's fair to say that when it comes to issues of product quality we have approached the issues very conservatively. If there's a question we pull the product back and replace it. And over the long term that should put us in a better position with the customers.

And Gary on the E3 message what sort of normal percent or percentage of seeing that message normally in the field and how much of a higher percentage reading were you getting?

To give you a general sense, normal should be probably in the 1% to 2% range, and we're -- and, you know, roughly the criteria we establish is when it got over 7% in any particular lot. It was too high. So as I said, a pretty conservative way of looking at this, but we established a health hazard analysis even before going back and testing all the lots to determine at what point the effort to retest would, you know, become a problem. That they went through several strips and didn't get a result would they then not test?

Most circumstances we think they will continue to test by the way but in that -- on that circumstance we said there's a potential that somebody cannot get a reading and therefore not have the information they need for injecting insulin. And that's the order of magnitude. Some lots were above that. That was sort of the criteria that that we had established and also will be reviewed with the FDA.

OK. That's helpful. And then John, in quarters past I think you had mentioned the cost and the quarter for BGM broken out by cogs and sales marketing. Did I miss that number? Did you give that already?

No, you didn't miss it because I didn't give it.

OK.

But let me see if we can give you a little bit something. I'm not going to forecast going forward, but let me just look at couple of numbers. There's the bad -- about 6 million -- a little over 6 million in cost of goods sold. And there's about 12 million in SG&A.

Those are quarterly numbers?

That's in this quarter alone and then R&D also has about a couple of million bucks in there which -

So that's a substantial uptick sequentially?

Right.

Then last question I promise. Just on the tax rate. I think the guidance last quarter for the year was 25% seems a little lower. Has what changed?

Just that write-off is all in the U.S. So it would attract a higher benefit rate of about 38% if you took -- if you take -- take that number out, you come right back to the 25%.

So that's right with the model going forward?

That's right.

I appreciate it.

Thank you. Our next question comes from Rick Wise with Bear Stearns. Go ahead with your question.

Good morning. A couple of things. First, maybe Gary you could talk about two other aspects of BGM issues. One, your non-Medtronic-related issues in terms of or initiatives in promoting your blood glucose monitor. Second, why are you getting rid of the latitude and what's the impact on the Lilly relationship? Third, just generally, does this strip quality issue make you rethink your current suppliers? Should you be taking this inside and manufacturing it yourself? Why are you so confident that the issue is resolved now? Thanks.

OK. They're all good questions. If you don't mind I'm going to start with the second and do the third and ask you to ask the first one again, because I can use more clarity on that one. The latitude and the issue with Lilly, we don't have any -- that doesn't have any impact on our relationship with Lilly even though it's accurate to ask the question because that was one of the focuses of what other product they were helping us to promote. The reason we decided to discontinue sales of latitude in the U.S. is that -- it's really a meter system established for pen users, and there may have been some assumptions at the time of the speed of the development of the pen market in the U.S. that led us to believe that there would be a higher potential than ultimately came about within the U.S. for latitude.

As we look to the future, there's still very likely the opportunity to look at that type of integrated product downstream as the pen needle develops, but it would be a more advanced version of it and it didn't make sense to hold on to that inventory in view of the low market potential for latitude in the U.S. The situation is different in Canada. The pen market is developed. There are a lot of customers now in Canada using latitude and will continue to support that product there. The relationship with Lilly is a very solid one and it's broader than just any one particular catalog item, and we don't believe it will have -- this decision will have any-is more than -- this decision is not going to have any effect on our relationship with Lilly.

Relative to our supply relationship, as you can imagine we have been working very closely over the past weeks with our supplier to ensure that we're not placed back in this type of situation. The majority cause of this issue had been identified and corrected. That gives us confidence-moving forward. Relative to the long term it wouldn't be appropriate for us to comment about what our long-term options are because there are several options, but on a go-forward basis given that we're in the market with products that we have a lot of confidence in, save for this situation that we're now going through, it makes the most sense to vest our efforts with our supplier to ensure we're getting a high-quality product that meets our expectations. So that's where we have been putting our effort. On first question, it related to the marketing and sort of the general

Exactly. You know, the diabetes nurse educators we have talked to, love Becton, love your sales force, like the product and think it's competitive, but don't really see you actively promoting it in the way that some of the other consumer-focused companies are. Is that going to change? Are you going to market the product more aggressively separate from the described (inaudible)

Gary Cohen This does go back even in a way to the prior question. Whether someone thinks we're investing too much or not enough in BGM. We're doing our best to strike a balance between putting sufficient investment in to build a sustainable position although long term. We think that will take some time without -- without betting the farm so to speak. Without disrupting the performance of the overall company. And that has caused us to make some choices and potentially some trade-offs.

I would say to date, one of the most key elements was making sure there was a high degree of customer satisfaction with the product that it worked as which expected and events like the one where we're announcing today relative to the recall certainly take precedents over the discussion of whether to put even more money behind us. More simply said, we want to make sure that the level of customer satisfaction very high as we ramp up spending from the outset we said we have a targeted approach. We're not going after the entire market, and we're not going after the pump market either.

We're going after frequent injector, insulin injectors who inject more than two or three times a day and pump users because they're the highest frequency test strip users. That's a fairly defined segment of the customer base that we can reach without having to make the very substantial investments in consumer mass marketing. Which would put this into a different investment category. That's our premise and we're trying to reach about 3 million people across the U.S, if with do that, that represents about 62% of the strip market. And we don't believe we need to be at this stage in television advertising.

In fact, our view would be a lot of the advertising being done is really reinforcement of brand loyalty among those leading manufacturers who have a strong existing position. As we build the business, we wouldn't tend to put more into it so we would expand the types of activities going forward in a manner we consider appropriate and affordable.

Just another follow-up or so. Maybe John could address the weak U.S. home healthcare business and the outlook there and what might change. And last question for Gary, safety. Safety was strong, stronger than many people had I think expected or had been worried about. What's targeting as new products new accounts and maybe an update on international. Thanks so much.

Sure. I think I'll take those as well. First on home health, it was a very sad quarter for home health. No other way of saying it in fact, the core diabetes business in the first quarter did very well. It's masked by the home health outcome. Penegles (ph) had particularly strong quarter in Europe and Japan. The base (inaudible) business defined and home health was way down year to year. My own view is this is a little bit of a lingering effect from the time that we had planned to sell the business, as might be expected during that time.

We pulled back a little bit in terms of our focus. That had some impact that took some time to manifest itself and clearly now we're working to stabilize that. So that type of year-to-year sales decline we wouldn't expect to repeat itself. Although in this business by the nature of the contractual relationships you do lose business in Chunks rather than in small increments. That's what we experienced in first quarter. And then relative to safety your observation is correct.

We did have a very solid first quarter in safety both in the diagnostic segment and the medical segment. Here we had been saying that the safety growth was not going away yet, so this is consistent with what we have been saying. And the strength in the U.S. we're seeing strength now on the injection side, whereas in the past we had said that the strength was more on the infusion therapy and on the blood collection side and that was due to the level of prioritization where hospitals were dealing first with blood-filled needles which actually makes a lot of sense. So we are seeing some good strength now, behind injection devices as accounts are turning their attention to the safety conversion process.

We do continue to grow in Europe. And the political or legislative side of activities in Europe is moving forward more or less as we had talked about in previous calls. Germany has issued a guidance It's actually a regulation, it doesn't require the use of safety devices but strongly suggests the use for higher-risk settings. We are expecting the U.K. to issue a guidance document, which carries, a quiet a bit of force in the U.K. some time in the second quarter. There's progress in Spain. More in the direction towards bringing attention to this issue and recommending use not mandating use. So that not necessarily with the same degree of teeth that was put into the U.S. legislation. But this is cribbing to some sales growth outside the U.S. as well.

Thank you.

Thank you. Our next question comes from Mike Winestad (ph) with J.P. Morgan. Please go a head.

Thank you. Fine quarter by the way. I wanted to get the chance to have you comment a little bit about cash flow over the balance of the year and thoughts about use of that cash flow. We saw the announcement the other day relative to the dividend and the 10 million share repurchase. Can you give us your thoughts above that 10 million share repurchase relative to use of the cash towards acquisitions and is there a point in time with your cash you may consider once again raising your dividend pay out ratio as you did a few months back? Thanks.

OK. You know, overall, kind of the cash provide by the operations should be in the range of a billion dollars perhaps a bit ahead of that, but about a billion dollars. Capital expenditures we think are around $300 million, and at the current rate, which would imply a 60-cent dividend that was a 50% increase over the 40 dividends we had. That would imply a pay-out ratio on prior year earnings of about 28% to 30%. So you kind of have -- even though it's in the purview of the board in terms of its declaration, you know, you use a 450 between CAPEX and the dividend.

In terms of acquisitions, the position we find our place in --ourselves in rather is the kind of enviable place of having certainly the financial cash ability to do that. With that said, that's the preponderance of our strategy tends to be internally driven right now. Which is not to say that we don't look at things on the outside, we do. But the focus tends to be more internal now organic growth. In terms of the cash use for share repurchases, last year we bought back over 9 million shares. We spent about $350 million. You know, somewhat depends on the number of things, but we've already purchased 75 million in first quarter, dollars worth of shares. I would not expect us to back away.

We continue to think that the intrinsic value of the stock is undervalued. And then your last question was on the likelihood of the dividend being increased again. We actually increased the dividend, you know, for as long as anyone can remember, albeit it was at a lower rate as we kind of moved on to 20% pay-out ratio. At 28% we feel pretty comfortably and while it still does reside with the board, if we were to maintain at least that ratio on our earnings on a pro forma basis rose 15%, one could argue that we might have to be in that range in terms of an increase. But I just caveat that it is always at the board's discretion. So if that's helpful -

That's very helpful and very fair. So as we look at the experience you're having with the glucose monitoring business and maybe we look back with a bigger history of the company in the last half a dozen years and some of the experiences with some of the acquisitions and some of the kind of higher risk reward programs. Does that make you philosophically more inclined to keep focusing internally on just blocking and tackling as you're doing and generating cash flow and returning that cash flow to investors?

I think you have to do kind of all three. You know, you have to focus this company for 106 years has been focusing on different names like lean and Six Sigma and every thing else, because it resides in industries where you don't get a whole lot of price increases so you have to keep taking costs out of the system. We have to keep doing that stuff. I think you have to stay near your sweet spots for the most part.

You know, we are tremendous in terms of engineering, billions of sharp point things in creating diagnostics and all that. But we also have proven ourselves to be able to get kind of outside the box with the creation if you will of our bio-sciences business, which in no small part was a result of a Chairman, you know, staying with his plan of making sure that the (inaudible) entered the Mark place. So I think you got to do a little of that. Acquisitions, you know, are always hard to do. Again, that doesn't say you don't do them but you really have to make sure that you have something that really fits within your business because you get too far afield in my experience is generally problematic. But that's kind of -- so we still got to do the blocking and tackling, we still got to look for new products.

We have to put, you know, overall we'd like to put more into research and development. If you looked at our R&D, which is -- and no small number, at almost a quarter of a billion dollars, there's a lot more D than there is R and we would like to see that move up over time. I'm not going to tell you exactly how fast it's going to move up over time, but clearly that's where we want to, you know, put some of what we drive out of increased operating margin into that R&D.

Great. Thank you.

Thank you. And our next question comes from David Zimbalist of Blaylock & Partners. Go ahead with your question.

Hi. Can you talk a little more about the balance sheet and how you did in quarter and sort of what kind of targets we should be using as you implement the SAP system?

Well, you know, we're still -- you know, we are locked down fairly well on the balance sheet. You know, our ratios as you would expect early are pretty consistent with where we have been in the past. You know, our return on assets is a little bit ahead of last year. However, it's way ahead of it if you think on a pro forma basis, as reported last year. It was 14.2 and it's 15.8% this quarter. Return on equity is 21.5. You know, our future date supply of inventories is about 155, but our turns are moving up.

You know, our debt to cap is at 27%. So we're certainly in great shape there. You know our asset turnover is moving up slightly, and so we're in very good shape there. There's obviously some increase in, you know, in kind of the working capital use. And that's why our first quarter cash flow isn't quite at $250 million but it's about a 50 odd million use of capital --working capital there.

Do you have the numbers for accounts receivable momentary yet?

I don't have that one yet. I'm afraid you have to wait for the Queue, which will -- it will be filed on the 13 of February.

Thank you. And now targets for like year-end, or what kind of reductions in the DSO's momentary that you can get with SAP over the course of this year into next year?

Well, our DSO's are in such good shape I'm not so sure that that it's that meaningful there. Worth about 55 on DSO's last year 52 actual at the end of the year-end, Our U.S.-based business is in the 30's -- mid 30's and it really is the overseas companies that do that to you. In terms of inventory turns though, you know, when we started the programs we were about 2.5 and this year I think you're going to be looking at 3.25 to 3.30 probably in terms of where we're going to get to an inventory turn so we're starting to move that up nicely.

Thanks. Most of my other questions have been answered.

Thank you.

Thank you. Our next question comes from Erin Guits (ph) with Robert W. Baird.

Good morning Can you talk a little bit about Abbott's acquisition of Fresense (ph) in terms of your long tomorrow goal of capturing 10% of the BGM market?

We can. Gary, why don't you take

Sure. I think that with time we'll get a better sense of this. But we're -- we weren't surprised to seer this Fresense get acquired and we weren't surprised that our Addott was the one to acquire Fersense because it would strengthen the technology position. and the competitive position. It's a little bit of a matter of opinion whether -at least over the next several years a small five XT 100% focused competitor who survives on the results in BGM versus a large, very well respected, very capable, among the largest players in the industry, you know, which will provide say stronger competition. We still believe that our goal that we have set is a reasonable goal, and not necessarily even the long-term goal but as a midpoint goal, we don't believe that the acquisition of this Fersense should interfere with that. Over the next year or so we'll get a better sense of the extent to which this Fersense results in the markets will be strengthened as a result of the Abbott acquisition.

Thank you very much.

Thank you. [OPERATOR INSTRUCTIONS] Our next question comes from Sarah Muchal Moore (ph) of SG. Go ahead with the question.

Great. Moss of my -- most of my questions have been answered. But just a quick question for Gary on the diabetes you can you give us an idea on how much of the revenue that you're expecting this year comes from your direct efforts with logic versus with what comes through the Medtronic product that you're doing there? I'm trying to figure out how dependent you are on the success of the new Medtronic insulin pumps?

I'm always a little reluctant to give out a number sitting in front of me. I don't have that sitting in front of me. But I would say it's more than half of our sales will come from just general marketplace, and less than half through the relationship with Medtronic.

OK. Just a question for John to the R&D growth was a little bit lower than I had modeled in the quarter. Just wondering if there was anything one time in nature and what your expectations are for R&D spending fiscal '04?

You know it gets bumpy because of the deals we are reimbursed on and some of things like that. But if you modeled out kind of in the mid 5% range you'd be about right for the year

Great, thank you.

Operator, why don't we take one more question because it's getting near 11:00 right now.

Thank you. Our final question comes from David Zimbalist of Blaylock & Partners. Please go a head.

One follow-up actually on Protec. Can you talk about if you're seeing the base there accelerate in terms of expansion because you had been getting a good kick from instrument placements for that business over the course of last year and, you know, your sales have held up sequentially so I'm curious to know if you're still seeing the same rate of placement your actually or just increasing the reagent flow through on the instrument placements you already have?

Sure. I think as we mentioned last year we had had a significant peak in the end of our year in terms of instrument placements as we capitalize on the competitive opportunities it there very specifically the Abbott opportunity. At this stage, the replacement rate is starting to level out. it's back to a more normalized pace of growth that we would have anticipated in our plan from the prior period when we were not capturing unanticipated competitive opportunity. So we are right on the pace that we thought we'd be on at this point and we're leveling off to a more natural growth rate

Is that a couple hundred placement per year, incremental replacements?

No. I think the couple hundred would fit much more with what we have experienced last year around both market growth and significant competitive gain. So I think the more normalizer rate would be well below that.

All right.

OK, thank you very much for calling in and provided we can stay within the four corners of FD, I'm sure Pat is -- will be able to take any other questions you may have. Thank you.