Becton Dickinson and Co (BDX) 2004 Q3 法說會逐字稿

Hello and welcome to BD's third fiscal quarter earnings release teleconference. [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 us this morning. Today's call is also being simultaneously Web cast. During the call, we will discuss some non-GAAP financial measures with respect to our performance; reconciliation of this non-GAAP to GAAP measures can be found in our third quarter press release and the related financial tables. A copy of the release and the tables are posted on the investor's page of the BD.com web site.

We will also make some forward-looking statements and it is possible that actual results could differ from our expectations. Factors that could cause such differences appear in the third quarter press release and in the MD&A section of our recent SEC filings. Leading the call this morning is John Considine, our Executive Vice President and Chief Financial Officer and also joining us today are Gary Cohen, President of BD Medical, Bill Kozy, President of BD Diagnostics, and Vince Forlenza, President of BD Biosciences. 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 would like to devote as much time as possible to answering your questions, but before beginning we would like to make some brief comments regarding our third quarter results. Overall the third quarter was solid from an operating perspective with continued sales growth, improvement in gross profit and strong cash flow.

The settlement of the RTI litigation for 100 million or 63 million after taxes, which has been reflected in our quarterly results, was a prudent decision and one which allows us to move forward unencumbered by the obvious distractions that a potentially protracted and expensive battle in the courts would have caused.

We continue to maintain that the company always acted lawfully relative to allegations of this lawsuit and the quality of our products and our concern for the safety of health care workers speak for themselves. From a revenue standpoint, our quarterly sales increased by 8%, the currency translation contributing about 3 percentage points due to the most part to impact of the strong Euro versus the U.S. dollar in each of our segments.

Looking at our medical segment, we grew about 5% driven in part by an increase of 9% to 110 million in the sales of safety engineered devices in the U.S. Our company wide U.S. safety revenues, which you will recall include sales in the pre analytical systems unit of BD diagnostics, grew about 14% to $190 million. For the nine-month period, company wide safety sales revenues of 561 million increased 13%, which is in line with our fiscal 2004 guidance. You may have noticed that sales growth in the medical segment was somewhat lower than what we have seen in the first two quarters of this year.

This was primarily the result of a comparison to a particularly strong quarter in fiscal 2003. 2003 third quarter benefited in part from customer order patterns and backorder clearances, which were especially evident in the pharmaceutical systems unit, which increased 40% in fiscal '03 versus 3% this quarter. As we indicated last year, the 2003 third quarter also benefited from certain non-recurring items, namely SARS-related revenues in Asia, sales of specialty needles for smallpox vaccination administration and purchases in the U.K. that normally would have occurred in the fourth quarter.

We expect that medical segments growth in the fourth quarter will rebound from the third quarter rate and I'll provide guidance around that growth for all segments before closing my remarks. Included in the medical segment growth were BGM strip sales of about 11 million versus 4 million in fiscal '03. Although sales were flat when compared to the second quarter, they have in fact continued to grow at the end user level as confirmed by our share data. This anomaly reflects some channel inventory restocking that occurred at the distribution level during the second quarter, as a result of the voluntary product recall that we made.

On the outset of this fiscal year of 2004, full-year guidance for BGM was about 50 million. At this point our guidance is in the low, lower $40 million-plus range for the year. This is based on now having a fuller understanding of the short-term sales impact of the product recall. However, the recall is now fully behind us and both internal and customer data indicate that our BGM products are performing at the expected quality level and we are already seeing this reflected in the market share data.

Moving on to our diagnostics segment, overall sales increased by 11%. The pre analytical systems unit of the segment grew 12% led by 22% growth to $80 million of -- safety -- sales of safety products in the U.S. The diagnostics systems unit of the segment grew 9% supported by sales of the BD ProbeTec instrument platform, which again delivered solid double-digit growth in the quarter.

In the BD Biosciences segment, revenue for the quarter was 12% ahead of last year. Immunocytometry sales systems, as anticipated, were strong up 21%, reflecting very favorable broad market acceptance of the recently launched FACS Canto and FACS Array Analyzers and continued strong performance of the FACS Aria Cell Sorter. Also, contributing to growth of strong sales in Fluorocytometry Reagents in both the research and clinical markets. Reagent revenue continues to benefit from our increasingly, increasing installed instrument base as well as the introduction of new reagents.

Now turning to our gross margin, we achieved a 90 basis point improvement over the third quarter pro-forma results of last year, which exclude the write-down of certain tangible assets and inventory in the BD bio sciences segment. For the nine months our pro-forma '04 gross profit, which excludes the first quarter charge to write off BGM inventories related to the previously mentioned Voluntary Recall, increased by 140 basis points.

Our year-to-date performance coupled with fourth quarter estimate suggests that we should be at the high end of our original guidance of 75 to 100 basis points improvement for fiscal '04. SSG&A as percentage of sales increased by about 40 basis points over the last year, core spending grew at a rate consistent with inflation and as expected, the remainder of the increase was primarily due to incremental expenses related to investment spending on blood glucose monitoring and the impact of foreign exchange translation. R&D spending grew at about 1% over the prior year and is inline with our internal investment plan. Net interest expense was favorable to last year's third quarter. This was primarily due to the interest of about 4 million received in connection with the conclusion of certain IRS tax examinations.

In terms of cash flow for the third quarter, we generated about 300 million in net cash from operations. This does not include the 100 million for the litigation settlement recorded in the third quarter, since that transaction actually occurred on July 2 and from a cash flow standpoint only will be reflected in the fourth quarter cash flow statement. For the nine-month period of fiscal 2004, we have generated over 800 million and we remain on track to our annual guidance of 1 billion, which I might add includes the litigation settlement.

Capital expenditures were 62 million in the third quarter, and 170 for the nine-month period. We expect fourth quarter Capex to be a bit higher as a result of certain projects such as the capacity expansion of our new push button collection set. All that said, our Capex will likely be at the lower end of the range of our guidance, which as you will recall was 275 to 300 million.

During the quarter we repurchased about 3.5 million shares of common stock for about $175 million. At present we have 6.2 million shares available under the 10 million-share repurchase authorization that was announced in January of this year. For the nine months, we have purchased about 350 million in stock and given our strong cash flow we will likely continue purchases in quarter four.

Finally before I open the call to questions, I want to speak to our guidance. We are expecting sales growth for the fourth quarter of 2004 to be in the 8 to 9% range for the total company. Medical segment is expected to increase by about 9%. The diagnostics and Biosciences segments are expected to increase in the range of 6 to 7%.

EPS guidance for the fourth quarter is about a 10% increase over the prior year's quarter. And turning to the full year, revenues based on sales guidance for Q4, our total company revenues should be about 10%, BD medical revenues are expected to increase about between 9 and 10%, and revenues in the diagnostics segment should grow in the 10 to 11% range and BD Biosciences revenues growing in the 11 to 12% range. Favorable foreign currency again is estimated to account for about 4 to 5 percentage points for all segments in the company.

In summary, the third quarter reflected good sales growth, continued year over year improvement in gross margin, again strong cash flow and pro forma earnings per share that once again were inline with our guidance. With, that we would like to open up the call to Q&A and in order to allow for broad participation we would appreciate it if you limit your questions to one plus a follow-up. And I thank you and with that, operator, would you please open the call for questions.

Thank you. At this time we will begin the question and answer portion of the call. [OPERATOR INSTRUCTIONS] Question comes from Mike Weinstein of JP Morgan.

Hi, there. It's actually Taylor Harris (ph) here for Mike. Two questions. One is just specific to this quarter and on the interest expense line. Can you just explain a little bit more the $4 million reduction on the, from the released IRS payment, I suppose? And then second, is that just a one-time quarterly event? What should we expect next quarter, for example? And then secondly on gross margins, it was, you know, a great gross margin quarter. And just wondering, you know, is there a business mix -- mix shift -- going on that's going to continue to propel gross margins? How should we think about that line for next fiscal year? Thanks.

Let me just quickly do those. With respect to the interest expense, as you probably recognize, the IRS reviews a number of years at the same time. This was three years that they were looking at. There were some items where we had actually made tax payments that were refunded to us; that did not create a P&L event. But because of the time that had passed they pay us interest on that and to your point, you're right, that's one-time event and it was right around $4 million. And you know, that obviously gets taxed and would have contributed about a penny to these results.

And with respect to the gross margin, we're not going to yet guide for next year or beyond that, although I would say we believe there is continued opportunity for gross margin improvement, but you are seeing a number of things. You're seeing the effects of the manufacturing restructuring we did primarily in medical back in 2002. You're seeing a higher, a better mix in terms of products, as we continue to increase safety sales, which are higher margin products. And then just overall efficiency throughout our whole supply chain, obviously there is some benefit there, also from foreign exchange. So I hope that answers the question for you.

Yes it is Mike. If I can just follow-up just briefly here, as currency dissipates in terms of the benefit you have seen over the next couple quarters, can you just walk through the impact that will have down the income statement, as we look at the other lines?

Well, yes. You know, obviously it effects, you know, all lines and, you know, with the favorable currency obviously we have gotten a benefit on the sales line, we take the opposite effect on any of the cost lines as those costs go up. And then some part of it falls down into P&L, you know, I for one will tell you I never know which way it's going. That's why we employ a hedging strategy to make sure that we're not overly exposed and we try to hedge about 60% of our Euro exposure, the whole European block exposure. So we feel like we can pretty much protect most of that. And that is limited by what under the accounting would be called hedge able transactions. And then we look at the other currencies that we can also hedge effectively, which would be primarily the Japanese Yen and the Canadian Dollar. I think that currency still will be positive based on present rates for us in the fourth quarter as we have indicated, and we're just going to have to wait to see what it will do for next year. If you took currency completely out of this year, we would still, our profits would still be up double-digits on a pure performance basis.

Okay, thank you.

You're welcome.

Our next question comes from Dan Lemaitre of Merrill Lynch.

Good morning, John.

Hi, Dan.

You know, again, obviously you guys are knocking the cover off the ball in terms of you know hitting reported numbers and the like and I guess I still come down on the side of trying to understand the upside in earnings and frankly the share buybacks in the context of a group where I think a lot of your long-term compensation plans have been reoriented towards sales growth and return on invested capital and when I see R&D up 1% going down as a percent of sales and I don't have a whole lot of companies where R&D is coming down as a percent of sales, when I see you spending the kind of money you are on share buybacks and I know, you know, is obviously assertive to earnings, but just it's hard to believe there aren't things that could you do with that money that would perhaps do some things longer term to help facilitate sales growth. So can you just talk about kind of how this year has unfolded and the spending plan and the acquisition plan relative to those long-term goals?

Yes, had you a bunch of things, there Dan, but let me see if I can address them. First of all, some of what you see in terms of R&D is reflective of programs that we have that have concluded during the year and we're always in the plan. There is no plan to try to bring down R&D as a percentage of sales as such. In fact, there has been a major effort led by Vince, along with the business Presidents and our R&D head, to really look at where our core dollars should be spent.

If you think about, I know just jumping over first, I am going to come back to R&D to the buyback of shares, you know, we have the kind of nice issue of having over a billion dollars of cash flow and spending anywhere between 250 and 300 million in Capex and 150 kind of million on the dividend, which leaves us with free cash flow of about 600 million that recurs year in and year out so. So we certainly have the room to do share repurchases and we can certainly cut them off if we have to or increase them or decrease them slightly. And that's a nice luxury to have.

The company, as we have said before, is dependent on internal growth but obviously we also look outside at things as we said consistently, you know, we don't comment on future acquisitions nor do we try to indicate that we won't do them, if the right things, you know, came to us or we discovered them, then obviously we would consider making investments in that.

I think when you, as much as we are not going to guide for next year and beyond, I can tell you with some reasonable certainty that you'll see the increases that you have seen resident in SG&A, which were higher than what our sales were increasing at, move over to double-digit increases in R&D spending rather, since the kind of incremental level of spending to support some of the other products will have mitigated greatly.

So I think you're going to see when you sum all that up, we'll still have room to do share repurchasing, I think you will see a move up in the spend of R&D. I think that you'll see some mitigation in terms of the spending on SSG&A and you will see us looking to develop and continue to develop new products and hopefully we'll be able to share some of that with you as we move along.

Okay, John and if I may, just one follow-up and I apologize if you've already said this because we're juggling a few calls this morning. But it looks like diabetes care in total in the U.S. was flat to down sequentially. Can you specifically talk about what happened on the glucose monitoring side and what the prospects for sequential growth are in the fourth quarter?

Yes, I did touch on it. But Gary is here. Let's have Gary really respond to that.

Sure. Well, John had mentioned that the glucose monitoring sales in the quarter were $11 million and, you know, as we have the opportunity to assess the impact of the recall, which was executed in the second quarter, in looking back we did see there was a short-term loss in sales momentum in the second quarter, which was offset by some restocking that occurred following the recall.

And the data we have, including share data, indicates that the sales momentum did then pick up again in the third quarter when the recall was completed and we're very satisfied with the performance of the products in the marketplace based on customer data as well as internal testing data. And on the basis of all this, we have re-guided the full year to the low 40s, 40 million-plus range based on you know what occurred now in retrospect in the second quarter.

Diabetes overall in the U.S., if you deduct out BGM was fairly flat and in digging into that what we identified, that was actually a result of insulin sales into the hospital channel, not into the retail channel, which are also recorded in the diabetes care unit. And apparently what occurred was that there were two of our large distributors had both stocked up in anticipation of a large VA order and they actually got to a court dispute over who was really entitled to that order, it went in favor of one of the two and the one that it didn't go in favor of actually de-stocked because they had that stocked up in anticipation of getting that business, they didn't get it. That caused sort of a one-quarter disruption on the inventory side in the hospital channel. So, that's really what affected our reported revenues in the U.S. for diabetes in the quarter.

Thanks, Gary. So, again we should not look for any sequential growth then in glucose monitoring in the fourth quarter?

Well there should be sequential growth. If you go from where we are year-to-date, which I believe is 28 million to the 40-plus ranges, we're expecting over 40, there will be sequential growth in the fourth quarter, we're anticipating anyway.

Okay, thank you.

Our next question comes from Rick Wise of Bear Stearns.

Good morning everybody. Several questions, first is on the topic of BGM, maybe we can continue there for a minute. The sort of launch in the BGM, I think fairly characterizes a little more frustrating in this year than you would have hoped. Are you confident that the, you know, that the outlook here is the same as when you invested in the business, number one and number two, our channel checks, you know, seem to indicate and I'm not offering this up as a statistical sample but just our channel checks indicate that investors are still concerned about the recall. And also continue to mention the lack of the alternate site approval where does that stand as well, Gary?

Okay let me take the last one first. We have submitted to the FDA on June 1 on the alternate site approval. Under normal circumstances we would expect clearance in roughly 75 days. So, we're looking for clearance within that time frame, we don't anticipate any issues there. Relative to the overall sense of satisfaction since the launch, I mean, certainly it would be correct to say things did not go as well as we had anticipated and that's primarily in our view due to the fact that we had to do a small scale recall in Canada in the fall and then a more significant recall in the U.S., which was executed in the second quarter and we really believe had it not been for that we would have been on our initial trajectory.

The strategy that we went into the market with, which was primarily based on marketing to BD's existing insulin syringe and pen needle customer base as well as with Medtronic and particularly associated with the integrated system, the paradigm system, we believe those strategies were sound. However, they were interrupted by the recall. I can say with a great degree of confidence that all the data that we have, both customer and internal, indicates that the products are now performing exceptionally well. The issues associated with the recall have been resolved and we're finding that the customer retention rates, which were interrupted by the recall are now rebuilding again.

All that being said, we did have a loss of momentum as a result of the recall. We believe we're back on the track that we were on prior to the recall and that probably pushes out our growth expectations more or less by the period of time that was represented by the recall. And as we look forward, we're going to be further stepping up our direct marketing efforts to our existing customer base, which during the time of the recall lost a little bit of focus because our team here was involved in executing the recall successfully.

John, just in terms of your, looking at your fourth quarter top-line guidance, can you help me understand a little better? Up 8% or 9%, I think is what you said. Two things, one that would suggest it's one of the slowest growth quarters of the year is up against the slowest growth comp a year ago. You know, are you just being, trying to be conservative? Is this currency? Help us understand a little better, just the consolidated number.

Well, there's a little bit. I mean your math is okay, our reported growth in the first quarter was around 14% and then we had 12% and about 8% in this quarter. So, now the fourth quarter, our current guidance would get you a little bit higher than that, the third quarter in terms of total growth. And currency actually will have less of an impact this quarter than others. So, it's not as weak a quarter as, you know, that quick analysis you did might have said. Obviously the first quarter was, as we had discussed at some length, abnormally high or positive because we had the flu situation particularly in Japan. So, I mean I think we tend to try to be just, you know, just dead honest on this stuff, Rick. The other thing that Vince just reminded me of is obviously we start running up against full Aria sales and then begin in this quarter end and we will also in the fourth quarter.

We just had a very strong finish to the year. Last year with Aria we had pent-up demand because we just introduced the product, which I'm not forecasting. Where in turn the product is doing great, continuing to do great but that one bump, I had in the fourth quarter, I'm not projecting.

And that was actually my final, I'm glad you were there Vince. Maybe just, I don't know who wants to do it, but just expand a little bit, Canto, Array, Aria sounds like they are doing great, new Reagents being approved and the largest install base and all that. Can you help us quantify the impact of all this in some kind of way in terms of incremental sales, growth drivers or potential for accelerating divisional growth over the next year or so? And maybe comment, John, on in this part of the margin improvement story as well?

Well, why don't we let Vince start with, kind of, we don't want to get so granular on this stuff. Rick, as you depreciate for many reasons that we talk about every unit that goes out. But I think broadly speaking Vince can react to that.

Right and Rick, it's really on the instrument piece, it's really a mix change with the new analyzers taking over as the growth driver versus the Aria. The Aria will be in for a whole year next year and of course we had it for a full year this year. So, and as I said, it continues to do well. But the growth on the instrumentation piece, I think the main driver, Rick, is going to be the Canto and then it will be the FACS Array and about equal to that will actually be some international growth in our lower priced product for CD 4 testing, the FACS count and that's going to be driven by the amount of money that's going in to the developing world on CD 4 testing as these aids therapy programs gear up.

So, it's kind of a shift from being sorter driven to analyzer driven with those three instruments. I would say, you know, over the course of this year going from the first quarter to the fourth quarter, we have seen improvement of a couple percentage points if you look back on the Pharmingen growth and that has been really the market coming back after, you know that whole kind of downturn in biotech and pharmaceutical spending.

I add to it that coming back to instruments, Adoe (ph) I'm expecting at 1 or 2% to the top-line growth over the next couple of years as well. Clontech is, you know, you saw was down 8%, you know, versus 15% last year. So, we're making progress there, some of the initial new products we're starting to see the first orders in. So, we want to see some continued improvement in Clontech, kind of (inaudible) on the status quo.

Yes, just to add to that, by the way just to put Clontech into perspective, the dollar change year-on-year is less than a million dollars. So, 8% sometimes sounds a little bit worse than it is. But due to the other question that you asked, you know, clearly bio sciences in general and specific to this area that you questioned, had higher gross margins than the average of BD and as we -- and the reagents that follow the instrument installed base have much higher margins. So, that it is, Rick, you are correct, a part of the mix growth story that we have in terms of gross margin.

Thank you very much, John.

You are welcome.

Our next question comes from John Calcagnini from CIBC.

Hi, good morning everybody. Just a quick question on the, can you give us the profitability of the BGM business in the quarter?

The profitability of it? Well, still investment spending but just let me give you an idea of where we were. Again, you know, we had about -- well we had positive gross margin, you know, somewhat less than a couple million bucks. But our investment spending was 17 or 18 million, so on a net basis it had a pre-tax cost of 16ish, kind of million dollar.

Okay. And how should we -- we look to 2005; I know you're not giving guidance but should we think of the base medical business without diabetes as growing 2%? I mean it just looks like you're bumping up against, you know, safety maturing and -- so how should we think of that core growth without diabetes? You know, should it not play out the way that you anticipate?

Let's let Gary, you want to start with that.

Sure, we would anticipate that the base growth in medical, without diabetes or without press BGM, would be above 2%, underlying neutral of currency. As we have stated in previous calls, we anticipate that the safety growth will continue both as a result of new product introductions, which we're in the midst of now, I think we'll be talking more about on the next call, but we have some significant new safety devices that are coming to market, that we believe will represent substantial improvements over existing devices in the area of surgical procedures, in IV Therapy in particular. We are also seeing good growth coming from the international markets, which we'll probably talk about more in future calls. So, we don't see the safety growth going away or dissipating. And on an overall basis the pharmaceutical systems growth is being seen this year, has moderated quite a bit and we would expect that to continue to next year with perhaps some pickup in growth going in to '06 and '07 based on anticipated growth in the vaccine and biotech areas and within diabetes care, excepting BGM, we would expect that to be fairly steady and that has been sort of a low single-digit FX-neutral grower and we would expect that to continue. But on the whole, excluding BGM, growth would be above what you indicated.

Well what can we expect from BGM in '05, roughly? You have been 11 million run rates now and what are the challenges there you're encountering?

Gary can talk to the challenges. Again, we're not going the guide on BGM right now, but just so that there's no inference taken on what Gary said, I don't want somebody to come away thinking well it's going to be, you know, 2.1% either. We have pretty clearly said that we think of ourselves as a kind of upper mid single digit grower and I think to be consistent with that, whether it's, even if it's 6% kind of growth, you can't have our biggest business being at 2% and achieve that kind of growth. So, without giving you an exact number, there's no way it can be that. I don't want to get in to BGM right now in terms of that John, only because we want to be consistent with how we're going to guide for next year. But a lot of what, you know, that will be dependent on what we see in the fourth quarter because there is an earlier question indicated. Well I think at the end and as it's really going to be sequential growth and for us to hit the number that we now feel much more comfortable with, we were going to have to be in the low teens.

Okay.

So, let Gary, Gary might talk about some of the challenges.

Yes, just to refer to challenges there, they are probably the ones that are obvious, that the market is well established and there are a number of very strong leading players, J&J and Roche, in particular, and Abbott has strengthened its position through the acquisition of Ferrocene. And then our goal at this stage is to establish an initial stable position from which we would continue to grow on in the future based on introduction of more advanced technologies. So, now that gets in to the longer-term strategy. We believe that we will be able to achieve that goal and even if the first, let's say year and few months, because we really were in the market around late February or early March of last year, was our initial entry, and as I stated earlier it had been momentum, it had been interrupted by the recalls, but other than that we are moving along essentially as we expected to, we knew going in to this that we were going in to a market where the existing players were strong and well established. We do believe we'll be able to establish this initial position over the coming years, which will then be a launching pad for further technology development. And just to return back to the overall question of medical growth, I didn't mean to imply that above 2, it's going to be 2.1 or 2.2. We would be well above 2% in our outlook in the coming years, next year.

If you don't have the BGM growth, though, what else is going to drive it? Because it sounds like, you know, the pharmaceutical systems business, it sounds like you were thinking '06, '07. So, what would, what else would drive growth in '05 if you didn't get the kind of BGM kick that you expect?

Well, as I mentioned, we have a series of new product introductions that fall within the boundaries of safety, but a number of which offer benefits for patient safety as well as health care worker safety and we'll begin to talk more about those introductions next quarter. They're now coming to market in limited release in various locations. I think next quarter will be the right time to talk about those in more detail and that will give us momentum, continued momentum for safety growth, that would be one of the key areas. And we believe our BGM numbers that we will project for next year, which we will talk about next quarter, will be realistic and achievable and will compliment the growth of the segment.

Okay, thank you.

Our next question comes from Glenn Reicin of Morgan Stanley.

Hello, just a couple clarifications. John, you did roughly 11 million in BGM this quarter, is that the right number?

That's right, Glenn.

Okay. And you have said in the past that you were going to lose around 60 million for the year, I think that was the number and you said what 16 million in the quarter? How will you narrow the losses next year, especially with this latest setback?

Just for my clarification, what latest setback?

In terms of the recall and the fact now that your run rates are sort of at a lower starting point.

The first quarter recall?

Yes.

Okay. Well first of all, the number that we gave you hadn't changed in terms of the loss, if there was any question on that it's still just out of 60 million in terms of investment spending and without pushing myself into trying to guide for the year, next year, it becomes less onerous to us as our sales go up. I mean it's kind of a simple equation and we are getting margin on that and it's contributing to our gross margin, although not, you know, dollar wise this year. And the investment spending, as a percentage of those sales, will be less. I mean we're going to spend more dollars, but that will be less. So, I think you will see when we guide that the impact on the bottom line will be less costly next year.

You don't want to quantify just yet?

I don't.

Then the guidance you gave for the fourth quarter, what did that include? What's built into the assumption on FX?

I think we said for the year it was going to be 4 to 5% and in the fourth quarter, it's probably two-ish kind of percent.

2%?

Yes.

So I'm looking at these numbers. In the fourth quarter you do have some fairly tough comps on several of your businesses?

Right.

So I would love for you to characterize this sales growth number at 8 or 9%, do you think that's a stretch? Or something that's in the bag, maybe just qualitatively talk to that because I was looking at more than 5%, just I was thinking "hey you wouldn't have much of a benefit of FX" which is probably now wrong. But now two, just the comparisons are very difficult, especially like on Bioscience.

They are. But if the Euro in particular, stays where it is, which is north of, just a little north of 122, I think that the FX number you I gave you is probably about right, because it's, you know, last year it was about 113, which is, you know, a low teens kind of increase in Euro. I never think anything is in the bag until we've unwrapped the entire quarter and I can put it in the bag. I think that this is reasonable, you know, it's not a low-blow estimate by any stretch of the imagination. But it's one in which the team has spent a lot of time looking at. We're right in our budget and our three-year plan season so, we're really looking hard also at the fourth quarter. So I think it's realistic,although as you say without getting into everyone of them, it has certain challenges.

And then, the only business that sort of came up short relative to my expectations in a big way was the International Med-Search business and obviously you had some very tough comps. Is there anything else happening in that business?

Gary, you want to talk to that?

Sure. There was the impact of the U.K. NHS orders last year, which shifted some sales based on their order patterns that we anticipated in the fourth quarter to the third quarter. There were sales last year, both in the medical surgical unit and in the pharmaceutical systems unit of smallpox, bifurcating needles for smallpox delivery, which we characterized as sales that would not recur this year and if you add up two business that had a significant impact year-to-year. Last year we actually had a stronger than anticipated third quarter internationally because immunization device sales that had been expected in the second quarter actually occurred in the third rather than the second and that made the comparison a little bit tougher. And also in Japan last year they were about to go live on SAP in the third quarter last year and they had some buy-in last year for that. So on the whole, all that added up to a tough comparison for International Med-Search but the underlying characteristics were fine.

Glenn I would add you were -- remember -- because I think you were the one who asked the question last year in the third quarter, we did have those one-time items I referred to in my opening remarks in particularly the bifurcated needles and stuff. And, you know, when we added the things that I talked to in my opening remarks, it was about 10 or $12 million anyway. So that would have certainly been meaningful if you look at $190-ish million running against the $180 million quarter last year.

Sure, you got a good memory.

Well, when you talk, Glenn, I always listen.

Thank you.

Our next question comes from Quinten Lay (ph) of Robert W Baird.

Good morning. As the flu season comes near, could you give an update on some of the products that you'll have and some insights on customer demand?

Bill Kozy would be best to respond to that.

Sure. Just to your comment, we will continue to focus our flu offering in the markets of Japan and the U.S., those products fundamentally for this upcoming season will be the array that we had offered last year in both markets. And the only thing that we're continuing to work closely on, we're aware that the timing of this flu season and the stocking is always different each year, and we're right now working through our planning to understand when that's all going to take place.

I think we'll have a better sense when we get to the fourth quarter we can probably talk to you a little bit more specifically at that time. But like any of the flu seasons, you know, the pharma guys have had to try to guess on the strains and we're trying to guess on whether it's coming and where it's coming. So we'll get back to you.

Thank you very much. .

Our next question comes from Bruce Cranna of Leerink Swann.

Good morning, guys.

Hi Bruce.

John, I guess a couple things on the safety side. What's your best guess as to how much of your business you've converted at this point across all product lines? And then I know, I don't want you - you probably don't want to get into guidance in any way, shape or form for next year and I got that message. But thinking about safety kind of going forward, you know do you think, you know, 900 million or so in safety sales next year is still kind of a reasonable way to look at it? Or do you get the sense the conversion is getting a little bit tired?

Gary and certainly Bill can talk to it specifically. But just to kind of remind everybody, I remember back when we first got into this, we were guiding that kind of $800 million in total safety, you know, this quarter we did 190. So our run rate is getting right near the 800 now. We had upped that since then and since this is more opportunity and moved it up over a billion dollars of safety opportunity and frankly we think it's going to go beyond there, and that was just dealing in the U.S. In terms of the conversion numbers, Gary, you want to talk to it?

Sure. Yes. I would be glad to speak to it. I also want to point out that I think it's important in looking at the continued safety growth opportunity that we have, that to get past the notion that the growth is only going to come from market transition, because as we move forward upgraded safety devices are going to play an increasingly important role, things like the push button blood collection set in the diagnostic segment which has gotten fantastic customer response.

New products that I referenced earlier, one of which is going to have a price point double what, in the IV catheter market, the existing price point which we believe we will be able to gain based on the very demonstrable both healthcare worker safety and patient safety benefits of this new device and as we move forward, the growth will rely less on market transition, which in some categories as I will mention is at a fairly high level already, and more on continued innovation.

In addition international safety growth, which I guess we will start to talk more about in future calls, is at a higher rate than U.S. growth and we're making some progress there. Relative to transition rates, the IV catheter product category and blood collection product categories are in the low 90s, I would say low 90s for catheters, high 80s to low 90s for blood collection needles, injection devices continue to transition primarily in the hospital market, they would probably be in the 65 to 70% transition range in hospitals and probably 35 to 40% in alternate site facilities which have lagged.

By the way, some of the growth in medical for safety this quarter could be a little deceptive in that the safety injection devices continue to grow well. We had a little bit of moderation in a safety product category that transitioned in the early 90s, needleless IV access site, which were fairly flat year-to-year and that offset the growth of safety syringes, above the overall growth rate for medical safety devices.

I think on the whole we have been in this area, particularly accurate to-date over the last several years in our assessment of the growth characteristics of the safety device market. And you know if that carries forward what we have said in the past is we expect safety sales for the company to continue to grow in the low double-digit range for the next several years and there's nothing that's occurring that would cause us to think otherwise.

Okay. Thank you. And then John, I know -- the $11 million strip number in the quarter, can you just take a stab at quantifying what that number would have been net of the inventory -- inventory movement, if you will?

What you're saying is had we not had the recall, I think we lost about a quarter in terms of time delay. So probably what you're going to see in the fourth quarter is about what we would have seen in the third quarter, so probably would have been low teens.

Do you have any sense as to what's going on with strip use per meter? I know you probably don't want to, you know, quantify that in terms of dollars and cents, but when you look at the trend, when you take your installed base if you will and look at strip use, what's your sense as to strip use per meter trend as this year has gone forward?

I would say that -- this is Gary. The strip use per meter is very much influenced by the customer segment that we're marketing to and is adopting the system. On the whole, the pump user segment and in particular the paradigm users, the strip use per meter because we do do post market surveillance on this. It's pretty consistent with what we had anticipated in the six-plus per day range.

We also have specific programs targeted at the DME segment and that tends to be at a lower level, those tend to be people who are type 2 and may be testing one or two times per day and therefore there is less return on those meters, but that's been part of our early market entry strategy, is to go in to DME. And then the high frequency injectors, people who are not on pumps, we estimate are in the 2 to 4 test per day range and some of, as I mentioned earlier, some of our direct marketing efforts to that segment were interrupted for a few months based on the attention we have to pay to the recall.

So, on the whole, the average is probably a little bit lower than we would have originally projected for the year in part because the mix of DME sales was a little bit higher, though within each customer segments, strip use is just consistent with what we had projected.

And you had mentioned last quarter, I think the percent of sales from Medtronic base.

Yes, around 40%.

About 40. And just a couple of quick on housekeeping items, Bill can we possibly pry a ProbeTec number out of you for the quarter?

Which one would you like to hear from me this morning?

I'd like to hear, ideally all of them, what the base is and at least the sales number, I guess.

Well, let me just give you a good sense of where we are. We have had a respectable third quarter and we're encouraged, we have had three consecutive quarters now that have been over $20 million in revenue. So, we're pleased with that. We think that's a little bit of a milestone for us and our third quarter, though these increases on a quarter-to-quarter basis at this stage are modest, it still is, you know, in terms of basic revenue, it is the strongest ProbeTec quarter we had, you know, in terms of launch to date. So, I think we're solid; we're pleased that we're hanging in there on a global basis with a respectable double-digit growth rate.

Okay, that's helpful. And lastly on Phoenix, still launching this quarter and when you talk about the diagnostics business looking at sort of 6 to 7% for Q4, does that contemplate then some help from Phoenix or is that not in that number?

There's really not anything in there in fairness with Phoenix because we're still working closely with the FDA. Let me tell you where we're at. We've got 50 of the drug indications now completely cleared. We've got two that are in with the FDA, that are pending and of course we're working very closely with them to get those completed. And we've got one final submission that we're working closely with on how to ensure a quality submission with the FDA. They're actually giving us some appropriate guidance. And we will submit that over the next month or so. So, we're still anticipating a best-case pilot launch late fourth quarter and pending the FDA approval obviously, we'd be in a one Q '05 full-blown launch in the U.S. as well as in Japan.

Thank you.

Our next question comes from Sara Michelmore from SG Cowen.

Thanks. Most of my questions have been answered at this point. But just running back on ProbeTec, wondering how sustainable you think the double-digit growth is there and if there's any additional Assay work that you have done to come up with some additional products, Assay products for that platform. And on pharm-systems, for Gary, I know you do have some tough comparisons here in the next couple of quarters. Wondering, if you think that business in a normalized growth rate, what it would be?

Let me take the ProbeTec question first. I'm not sure I can guide you all the way through '05 as John already mentioned. We're right now wrapping up our detailed planning around the instrument as we look at '05. But in terms of menu, as we have talked about over the last couple months, we're continuing to work on the atypical pneumonia panel, which is the three-panel, three-test panel around Legionella, mycoplasma and chlamydia based pneumonias.

We have just launched Legionella only. I'm going to have to give you these one at a time; I'll give them quickly here. We launched Legionella in Europe and with a launch that's underway in Australia. We are cleared by the FDA on Legionella in the U.S. and we're expecting to launch that late in the quarter so, think about the August, September time frame for Legionella. On myco and chlamydia, the FDA has asked us for some more data and we're going to be compiling that data and I have at this time, the best I can do is guess on when that'll happen. But we will probably want to collect, you know, real time samples during the pneumonia season. So, we're right now tentatively thinking about myco and chlamydia in probably later '05.

And then relative to pharma systems, I think you'll see the fourth quarter will look a lot better than the third because we have a little bit of the reverse situation where we had a very tough comp in the third and a better comp in the fourth. In general the pharma systems business, it tends to have a little different patterns than some of our other businesses because the quarterly sales growth can be very influenced by order patterns for new product releases, if a new drug is being released in one of our devices, whether be a pre-filled syringe or pen device and therefore you'll see a little bit less quarter-to-quarter continuity in pharma systems.

As you look out to the future, as I mentioned earlier, we believe based on what we're seeing today, that growth will be picking up again '06, '07, '05 at this point, I don't think we're really guiding next year by unit. But we would like to be more consistent with some of the patterns we've seen this year, which will be below last year's level.

Great, thank you.

Why don't we take two more questions, operator, and then since we're getting near the top of the hour.

Thank you. Our next question comes from John Chris (ph) of European Investors.

Thank you. The question has been answered.

Well that was easy. We'll take one more.

Our next question comes from Glenn Novarro.

Thanks, guys. A question for Gary, your safety sales outlook, you're saying is low double-digit. Is that a global number? And maybe can you split up the outlook between U.S. and international and potentially quantify the opportunity that you have in Europe? Thanks.

Yes, today all the guidance we have given and all the reports we have given on safety have been U.S. only. So, that low double-digit is a U.S. number and the sales outside the U.S. are growing at a faster rate off of a considerably smaller base. And we're seeing, you know, some continued progress and acceleration of sales growth in the international markets and we would expect that would continue going forward. So, that should, if we look at from the global basis, which we haven't guided to date, it would give us a little bit of a boost to the U.S. number.

Okay, great, thanks.

At this time I assure no further questions. I would like to turn the meeting back over to the leaders for any final statements or closing remarks.

None other than thank you and we'll talk to you again in the fourth quarter. Bye.