Becton Dickinson and Co (BDX) 2005 Q3 法說會逐字稿

Hello and welcome to BD's third fiscal quarter 2005 earnings release conference call. [OPERATOR INSTRUCTIONS.] Beginning today's meeting is Ms. Patricia Spinella, Director of Investor Relations. Ms. Spinella, you may begin.

Thank you. Good morning, everyone, and thank you for joining us to review our third fiscal quarter results. Today's call is being simultaneously webcast, and will be available for replay through Friday July 29th on the Investors page of the bd.com website, or by phone at 1-800-933-9609, for domestic calls, and 1-402-530-8098, for international calls.

During today's call, we will discuss some non-GAAP financial measures with respect to our performance. A reconciliation of these non-GAAP to GAAP measures can be found in our third quarter press release and its related financial tables. A copy of the release and the financial tables is posted on the Investors page of the bd.com website.

We will also make some forward-looking statements, and it's 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 sections of our recent SEC filings.

Leading the call this morning is John Considine, BD's 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 Biosciences. I will now turn the call over to John.

Thanks, Pat and good morning to everyone. I assume you've all have our earnings release and the attachments that we sent out this morning and have had an opportunity to review them. As usual, we'd like to devote as much time as possible to answering your questions. Therefore, my opening comments will be brief.

There are three primary topics we'd like to address. First, since there are certain items that affect the comparability of our diluted earnings per share from continuing operations for the third quarter and nine-month periods of fiscal 2005 and 2004, we want to review the analyses of these results as provided in the press release. Second, we'll describe some the key drivers of our revenue and earnings growth for the third quarter of 2005. And, third, we'll review our guidance for the fourth quarter and full year fiscal 2005 that we have provided in the press release.

Beginning with our earnings, I suggest that you turn to the first table we included in the press release that appears under the heading Analogies of Third Quarter and Nine-Month Periods of Fiscal Year 2005 and 2004 Earnings. As we have said at our prior calls, this table is provided to assist you in comparing the current year's diluted earnings per share from continuing operations to the prior year results. To accomplish this, we have excluded certain items which we believe are unique to the periods presented.

For the third quarter of 2005, we begin with reported diluted earnings per share from continuing operations of $0.73 and add back $0.01 relating to certain discreet tax events that caused the quarter's tax rate to vary from the underlying expected tax rate for the year of about 25.5%. We next add back $0.05 related to share-based compensation, which you will recall, relates to our adoption at the beginning of fiscal 2005 of FASB No. 123(R), which requires the expensing of stock options in addition to all equity-based compensation. We have, therefore, isolated this expense for comparative purposes, given that stock options were not expensed in fiscal 2004. After we take into account $0.01 of rounding, our diluted EPS from continuing operations, excluding specified items and share-based compensation expense, is $0.78 for the third quarter of fiscal 2005. For the third quarter of 2004, we begin with reported diluted earnings per share from continuing operations of $0.42 and add back $0.24 related to last year's litigation settlement with RTI. Therefore, on a comparative basis our third quarter diluted earnings per share from continuing operations, excluding specified items and share-based compensation expense, are $0.78 versus $0.66 in the prior year's period.

Moving to our nine-month results for fiscal 2005, we begin with reported diluted EPS from continued operations of $2.18. You may recall that in the first quarter we subtracted $0.04 of EPS related to the reversal of tax reserves that were no longer required as the result of favorable conclusions of certain international tax examination. We have also subtracted a net of $0.02 related to tax events that caused the first and third quarter's tax rates to vary from an expected effective tax rate for the year of 25.5%. The last adjustment we have included is to add back the total of $0.12 of share-based compensation expense recorded over the first three quarters. Again, this is being isolated since there is no comparable expense recorded in the fiscal 2004 results. This gives us diluted earnings per share from continuing operations, excluding specified items and share-based compensation expense, of $2.24 for the nine-month period of fiscal 2005.

For the nine-month period of 2004, we begin with reported diluted EPS from continuing operations of $1.51. We add back $0.11 per diluted share, recorded in connection to the voluntary recall and write off of Blood Glucose Strip inventory and other actions taken with respect to our blood glucose monitoring products last year. We also add back $0.24 related to the litigation settlement. After we take into account the rounding, you can see, on a comparative basis, our nine-month diluted earnings per share from continuing operations, excluding the specified items and share-based compensation expense is $2.24, versus $1.86 in the prior year's period -- period.

Moving to the second topic, that is, what drove our growth, we'll begin with our revenue growth of 11% for the quarter. This growth included an approximate 3.5% benefit from foreign currency translation, due primarily to the strong euro. Despite its weakening late in the quarter, the euro accounted for 2 percentage points of the 3.5 percentage benefit. Also contributing were a strong Australian dollar, yen, and Korean won, which drove favorable translations from Asia-Pacific; the Brazilian real, which favorably impacted Latin America; and a stronger Canadian dollar.

Our revenues for the nine months have also benefited by about 3% from positive foreign exchange. Again, this was due, in particular, to the strong euro for the first eight months of the year. Similar to the third quarter, the euro accounted for 2 percentage points of the 3 percentage-point benefit. Also contributing were currencies in Asia-Pacific, Latin America, and the Canadian dollar.

Given the recent weakening of the euro, we thought it would be helpful to give you some additional detail regarding where our international revenues are generated, which can serve as a framework for our overall foreign currency exposure on sales. As you know, international revenues make up a little more than 50% of our global revenues, with Europe, currently representing about 60% of that, and, therefore, 30% of our global revenues. Within Europe, about 70% of our revenues are euro based -- euro-currency based. Therefore, if you do the math, about 40% of international sales are euro-exposed, representing roughly 20% of our global sales. As a result, you can see that we are not solely impacted by the euro. In fact, if you grouped our other exposures by region, you would see the following with respect to international and total worldwide revenues -- Asia-Pacific and Japan, 25% and 13%; and the Americas, that is Latin America, Canada -- and Canada, but excluding the U.S., 16% and 7%.

I'll now turn to the fiscal third quarter results by business segment. In the Medical segment, revenues grew about 13%, driven in part by strong international sales of prefillable devices and strong sales of Diabetes Care. Sales of our BGM products totaled 20 million for the quarter, which is consistent with our guidance. We continue to expect full year BGM sales of about 75 million for fiscal 2005. U.S. sales of safety-engineered products grew 5%, to 119 million, while international safety sales grew about 37%, to 22 million.

Revenues in the BD by -- BD Diagnostics segment grew about 10%, with the Diagnostic Systems unit reporting revenue growth of 9% and the Preanalytical Systems unit reporting 10%. U.S. sales of safety-engineered products grew at 15%, which was positively impacted by early conversion activity for our Push Button Blood Collection Set. International safety sales grew about 41%, to 52 million. The combined Medical and Diagnostics U.S. safety sales grew about 9% for the quarter and nine-month period, to 211 million and 618 million, respectively. Combined Medical and Diagnostics international safety sales grew about 39% for the quarter, and about 37% for the nine-month period, to 74 million and 203 million, respectively, with about 7 to 8 percentage points of that increase related to foreign exchange rates. We expect combined Medical and Diagnostic U.S. safety sales growth of about 8 to 9% for the year, and international safety sales growth in the low-30% range.

In the BD -- BD Biosciences segment, worldwide revenues from continuing operations grew 8%. Research instrument and reagent growth continued to be the primary growth drivers, driven by increased demand for high-end research analyzers. Also contributing to the growth was increased sales in the Discovery Labware unit.

Moving next to earnings, the number I'm going to reference have been adjusted to exclude the impact of share-based compensation expense. Beginning with gross profit, even with the impact of oil-related cost increases for medical-grade resin and other raw materials, we were able to deliver another solid quarter. Among other things, increased worldwide safety revenues, incremental margin from the higher BGM sales, all combined with continued operational effectiveness to produce gross -- gross profit margin of 50.5%. Somewhat mitigating this was strong growth in Pharmaceutical Systems sales. Although the margin on our Pharm System products has improved, you may recall that it is lower than the Company's average by about 10 percentage points. On an overall contribution bases, however, as a result of lower SSG&A cost, Pharm Systems contributes strongly at the operating income line, which, by the way, improved 120 basis points from last year's Q3, and that would be 19% to 20.2%.

SSG&A expense as a percentage of sales improved over last year by about 130 basis points for the quarter. R&D spending increased about 12% in absolute terms over last year, and this reflects about 10% growth on new programs, which is consistent with our plans to accelerate R&D spending. And we expect our full year R&D growth to be about 11%. All of this led to strong cash flow for the nine-month period of about 778 million from operations, of which approximately 409 million was used to repurchase about 7.1 million shares of common stock and 175 million for capital expenditures. We are right on track to our full-year expectation of generating about a 1.1 billion of net cash from operations.

In relation to our prior guidance for the third quarter, our adjusted diluted earnings per share from continuing operations, excluding the specified items and share-based compensation expense of $0.78, was about $0.04 higher. Favorable foreign exchange contributed about a penny, along with about a penny from favorable net interest expense, and the other $0.02 came from the stronger revenues in the quarter, particularly, with double-digit growth with contributions from Pharmaceutical Systems, Diabetes Care, Preanalytical Systems, and Discovery Labware.

The last topic we'd like to cover is our guidance for the fourth quarter and full year 2005. Once again, I'd suggest you now turn to the second table we included in the press release, which is near the end and immediately precedes the conference call information paragraph. By the way, our fourth quarter estimate of diluted earnings per share from continuing operations, excluding specified items and share-based compensation expense has remained exactly the same, as indicated in our second quarter release.

That said, starting with our fourth quarter outlook, we have adjusted diluted earnings per share from continuing operations to exclude an anticipated $0.06 to $0.07 from expensing all share-based compensation and $0.02 from the timing of certain items that we expect to cause the fourth quarter's tax rate to be higher than the expected tax rate of 25.5% for the year. The share-based compensation estimate is somewhat higher than our previous guidance, due to the possibility that the outstanding performance-based restricted stock awards would increase, due to our results exceeding established three-year performance targets incorporated in the awards criteria. For the fourth quarter of 2004, there are no specified items that impact comparability. Therefore, our comparable adjusted diluted earnings per share from continuing operations are expected to increase 6 to 9% from a fourth fiscal quarter 2004 basis of $0.70.

Just to comment on that growth rate, this year's expected earnings growth rate for the fourth quarter faces a somewhat tough comparison to last year. In addition to lower revenue growth that we are expecting in Q4, compared to the prior three quarters of fiscal 2005, you may recall that our operating expenses and R&D were fairly low on the fourth quarter of last year. Importantly, this was before our R&D efforts on new programs started to ramp, and also is in contrast to the incremental R&D and selling efforts supporting BGM that are resident in the fourth quarter of fiscal 2005.

Revenue growth for the fourth quarter is expected to be about 6 to 7%, with revenue growth for BD Medical and BD Diagnostics being between 6 and 7% and BD Bioscience being about 8%. These revenue estimates include the impact of foreign exchange at their present rates. Thus far, the euro has been about flat with last year's fourth quarter average. Therefore, if the euro stays at the current rates, we do not anticipate any significant up or down impact for the fourth quarter. Overall, current rates would suggest about a 1% FX pickup in Q4, driven by our other international rates that we previously discussed.

Look to the full year, I have already described all of the named specified items you will note in the table. For the full-year diluted earnings per share from continuing operations, adjusted for specified items, are expected to increase in the 16 to 17% range from last year's adjusted base of 256. Full-year revenue growth for the Company is expected to be about 8 to 9%, with revenue growth for BD Medical being at 8 to 9, BD Diagnostics being in the 7 to 8% range, and BD Biosciences being about 9 to 10%. As previously mentioned, we look for U.S. sales of safety-engineered products to increase by about 8 to 9% over 2004.

We anticipate percentage growth of international sales will be in the low-30% range, or about 270 million. We expect gross profit margin of about 50.7%, adjusted for share-based compensation, which is and improvement of about 50 basis points. On a reported basis, the gross profit margin is expected to be about 50.5%.

SSG&A as a percentage of revenues, adjusted for share-based compensation is expected to improve by about 80 basis points. On a reported basis SSG&A is expected to be about flat with 2004. Again, excluding the $0.04 benefit from revise -- reversing certain tax reserves and the tax impact related to share-based compensation expense, our effective tax rate is projected to be 25.5% for the year. On a reported basis, the effective rate is expected to be about 24%. Now in each case, this excludes the tax impact of any repatriation of undistributed earnings from foreign subs under the American Jobs Creation Act of 2004, which we continue to review. Our capital expenditures are expected to be in the range of 300 million to 325 million. And we expect to continue share repurchases and spend about 450 million for the entire fiscal year.

So in summary, we had another solid quarter and are raising our guidance for the full year diluted earnings per share from continuing operations, excluding specified items and share-based compensation to the 16 to 17% range, as I previously said. Lastly, while we're still in the process of finalizing our 2006 budget, and, therefore, will issue our guidance for fiscal 2006 in our fourth quarter conference call, we currently expect our EPS growth to be about 10% from the estimated fiscal 2005 base of 279 to 281, which is the EPS from continuing operations, excluding the $0.04 of tax examination. This can be found in the press release table labeled Fiscal 2005 Outlook For Fourth Quarter and Full Year.

On that basis, our underlying performance, that is, our results, excluding estimated -- the estimated impact of foreign exchange, will have increased by 13 to 14%. The variation between this range and the 10% I've noted would be due, primarily, to a comparatively lower euro in the first three quarters of fiscal 2006 versus 2005. This early expectation also assumes that all other foreign currencies, including the euro, remain at about the current levels.

With all that said, we can begin the Q&A. And in order to allow for the broadest participation, we'd appreciate it if you would limit your questions to one plus a follow-up. I thank you. And, Operator, please open the call for questions.

Thank you. [OPERATOR INSTRUCTIONS.] First question comes from Glenn Reicin from Morgan Stanley. You may ask your question.

Good morning, folks.

Good morning, Glenn.

Couple questions here. First, could you talk a little bit -- little bit about the third quarter and how that relates to the fourth? And I can't help but notice that Pharmaceutical Systems was incredibly strong in the third. Are you assuming that some sales got pushed from fourth to third quarter and that's why we have a dramatic slow down in Medical in Q4? I guess what I'm looking for is a little bit on the guidance of 6 to 7%, how -- how you get there as opposed to upper single digits?

Gary, why don't you -- you know Pharmaceutical better than anyone.

We are expecting Pharmaceutical Systems to be slower in the fourth quarter. There are timing-related factors, based on when our customers, the pharmaceutical companies, bring in products for their own production. And we did have a very strong third quarter, as you noted, which was a combination of strength in the heparin market; strength in the prefill market; to our flu vaccine, which is in anticipation of next year's flu season. We also have in the European Pharm Systems, which we mentioned in previous calls, there was a transfer in supply from one of our U.S. facilities to our European facilities. So that favored Europe -- favored the international number, vis-a-vis the U.S., although it nets out overall. But we are expecting fourth quarter Pharm Systems to be slower than what we've seen.

Okay. And what about diabetes? You had another really good quarter overseas as well. Is there a story there?

Well, diabetes, we are seeing a lot of strength in the pen needle market, and we anticipate that'll continue. There are a number of factors that are driving that, not only around insulin, but other drugs that are being introduced for people with diabetes, so, such as Byetta. And, in general, we're seeing good growth in the pen needle market. And that's in addition to the BGM growth, which John already stated, that's helping drive the overall diabetes number.

Glenn, Glenn --

So let me just take a step back, how do you get to 6 to 7 from 13 in the third? In other words, what else changes besides just the Pharmaceutical Systems?

Obviously, part of it is currency, since that is euro-based currency exposure. So there's going to be some of that. And, also, as Gary said, some of these sales probably do mismatch in one quarter versus another, just based on the ordering patterns of the different customers.

A little bit relates to last year also.

Right.

That we had a comparatively softer third quarter in Medical last year, although that was based on a much tougher comparison for the third quarter of '03, where we had small pox needle sales that were one-time stockpiling sales. But you get the quarter-quarter variation also based on what happened last year, and last year we had a pretty solid fourth.

And, then, lastly, John, we've been, I think, for comparative reasons, we're using that 279 to 281 as the apples-for-apples estimate using a 25.5% tax rate. Why does the tax rate bounce around? I mean, Q4 it looks like the tax rate's going to go to over 27%, or even higher. Maybe talk a little bit about why there is such volatility in that tax rate.

Okay. I'll do that. I want to make one more point, though, on the diabetes. You guys, some of you, have asked about our capital. And while we, certainly, had our capital lower the last few years, and it's slightly edged up this year and it may edge up a little bit more next year. The good news behind a lot -- a non-insignificant piece of that is additional pen needle lines that we're actually putting into Ireland to be able to meet the need that Gary's expressing in pen needles. In addition, we've had more capital requests for Pharm Systems as that business has peaked up. So I just wanted to make sure that we tied that relationship in.

To that tax rate, Glenn, it, in a sense, it frustrates us as much as you. We've had that, as you remember, in the first quarter we had $0.02 that we said caused the tax rate to differ from the underlying effective tax rate. We kept -- we thought that would hit in the second and the third, and now it looks like it won't reverse itself until the -- until the fourth quarter. In prior -- under prior accounting scrutiny, effective tax rates were booked equally throughout the year. Now the guidance from the public accounting world is that there are certain discreet items, they may be foreign tax credit-type items and others, are to be reflected discretely in the quarter in which they reside. And so that's -- that's caused that.

We still are confident when we give you an underlying tax rate, as we did this year, with the 25.5, which, obviously, excluded the share-based and that $0.04 reversal, since we won those tax cases. But there's nothing we can do about that. We'll just try to be as explicit as possible, and hopefully, this thing does clear in the fourth quarter.

Great. I'll get back in line. Thank you.

Next question comes from Mr. Mike Weinstein from JPMorgan. You may ask your question.

Hi, guys. It's Kim Weeks here for Mike. My first question is on guidance and your FX expectations for the second half of the calendar year. Your fourth quarter comments were very helpful, and it sounds to us like you're looking for a 1% top-line benefit, which should probably be pretty neutral to your EPS line. Do you have any thoughts of what current exchange rates would mean for the December quarter? I think on the last quarter call you were able to kind of look out two quarters for us, just in terms of what the top- and bottom-line growth might look like.

Well, thanks, Kim. We -- I may, but at this point in time, other than that broad, early expectation guidance we've given you for our '06 results, which, obviously, begin in October. So that's really our first quarter. And I don't want to, kind of, get into that right now. So we'll just -- we're just going to, kind of, stay with the first -- with our fourth quarter. And your 1% is exactly right there.

I would just say to you that, obviously, next year and it's inherent in that broad guidance that I provided, the headwind that we'll feel if rates stay where they are, are certainly with respect mostly to the euro, even that I hope I've allayed some of the fears with how euro-exposed we are. Because the first three quarters of -- our first three quarters, which began in 2004, had much higher euro -- a much higher euro than we have right now. I believe it was about 1.27, 1.28 in the first quarter 1.32 in the second quarter, and probably back to about 1.27 or 8 in the third quarter. So we've had that. And then in the -- then if it stays where it is right now, it's right around 120 or 121. We'll see. So, I -- that's about as far I can go on that right now.

Okay. That's fair enough. And actually, we just have one follow-up. With regard to your safety sales, which were, obviously, a strong point in the quarter. I'm wondering, just in that number, if there were any one-time factors at all on the distributor side or what have you? And whether we should think about just a modest decline in the fourth quarter? It sounds like your guidance is implying that. Thanks.

Well, there were no one-time items at all. Some of the decline that we see -- if you think about safety, an interesting thing happens is, obviously, the U.S. safety has been tremendously successful. And as we said early on, we would start to see ex-U.S. safety start to take its place in some respects. But within the U.S., you see the -- what allowed us to bring the safety estimates up in terms of the whole market occurring in our PAS business, as the upswing there can be attributed in large part to the success of a new product, being the Push Button Blood Collection Set.

Some of what you've seen in the U.S. Medical side relates to somewhat of a delay in the introduction of a safety product, which we think is revolutionary, called Nexiva, which is the catheter, which now has been launched, but is in its early stages. So over time we believe that will take up the slack, and, then, certainly the ex-U.S. safety is doing very well. And -- albeit that it also have -- it also has been impacted favorably by the euro, because so much of it is euro-based. But even if you took the euro back, its growth is, certainly, in the 30% range. So no one-time items and no gradual slow down, really. It's just that these new big products come in and it takes time to move them through.

Our next question comes from Rick Wise from Bear, Stearns. You may ask your question.

Good morning, John.

Hi, Rick.

Starting off with, maybe, follow-up on the safety question. The U.S. business, obviously, continues to slow for a variety of reasons, not looking at it, but it was 5% this quarter. What should we expect from U.S. safety growth going forward? Is it sort of mid-single-digits growth? Just in general, looking out over the next few quarters, does something cause it to reaccelerate from here? Again, how do we think about it?

Maybe Gary can say it better than I did.

Hi, Rick.

Hi.

Yes, just building on what John had mentioned that what we're seeing -- the 5% you mentioned was around Medical side, and then we had real solid growth on the Diagnostic side. And what's driving not all of, but a good part of the growth on the Diagnostic side now in the U.S. has -- is the Push Button Blood Collection Set, which was introduced originally about 18 months ago. And typically, with new devices, we track them when we bring them to market, these types of devices, it's usually around 18 to 24 months when they start to hit their real growth stride, because you have to go through a process of introduction and product evaluations at the hospital level. We usually start out with a lower volume production and build it up as demand builds up.

And this year, we had anticipated the BD Nexiva to launch earlier. We had a few things we needed to continue to work on, which delayed the launch. And, therefore, the U.S. Medical safety number, our original anticipation for the year would have had Nexiva kicking in a little bit earlier. And as you look forward for safety in the U.S. we do expect it and see the growth will kick in, both next year, and maybe even more so in the following year, in that 18- to 24-month period. And that will restore the U.S. medical safety growth closer to, let's say, the upper-single-digit level, between mid- and upper-single-digits is what we think will be sustained in the U.S., supplemented by the international growth, which is picking up nicely.

When I think about the third quarter BD Bioscience growth overall, up 8%. That's -- it's a shade less than your guidance last quarter, John. Again, I just want to make sure I understand what's driving -- I think you were looking for something more like 10%, if I recall, and you came in up 8%.

I'll let Vince talk about that.

Yes, there was -- let me -- it's all really focused in Japan, Rick. And there are two events that occurred this quarter. One is that we are ending our distributor relationship in Japan for our reagents, and we're going to take them direct. And that's a really good thing, it gets us closer to the customer on the IS side. We can do reagent rentals. We haven't been able to do that, and we're actually going to pick up some good sales people from our distributor, who is a pharma company, who was acquired and merged with another pharma company. It's not -- it's not strategic to them any more.

But the financial impact in the short run is that because we will be selling and then buying back inventory, we did not record those sales. So there was -- and some inventory cutting by the distributor. You look at that, that's a $2.5 million impact in this quarter, Rick. On the instrument side in Japan, the government there -- there's been a wave of changes in that marketplace over the last 18 months. This latest one that impacted was putting in a new administrative or tender process on the buying side. So what we saw happen was instruments that were queued up to be purchased were basically delayed 90 days, this process takes about an extra 90 days. So instead of our sales being up about 10% or so, that we would expect in Japan, they were actually down, and down about 2.7 million because those instruments all got pushed back 90 days.

We expect that that's going to improve in the fourth quarter. We see that the instruments starting to move through the tender process. The question's going to be, the ones that were scheduled for the fourth quarter, do they happen in the fourth quarter? So we're tracking them very carefully. But the process now seems to be working. So it's really those two big impacts. We had good growth in the U.S., good growth in Europe.

So you hope for, maybe, a little better than normal in the fourth quarter, or something?

In Japan.

We're hoping.

Yes, in Japan.

And just last, John --

Oh, wait a minute, let me finish off, because -- because one other thing, Rick. There is going to be an impact -- so the instruments are going to improve and we're going to see better growth there. But on the -- as we acquire this distributor, there's going to be another impact in the fourth quarter of 4 million on the sales slide from this same issue. Okay? And then in fiscal year '06, it's about an 8 to $10 million positive.

I see. Sort of add back again?

Yes, because we'll be going direct and we'll pick up the margin that the distributor was making, yes.

And my last question is to John. Just in general, John, as you look out at, whatever, the next two, four, six quarters, and thinking about cost pressures, implications for gross margins, do you think you're still going to be able to see the kind of gross margin improvement, just directionally, that you've had this year, given whether it's oil or transportation or resin or mix or, just, are you as optimistic, more optimistic, less optimistic? Just any color would be appreciated.

Okay. Well, I won't be too explicit, again, since we haven't finished all our plans, but I will be explicit on this, is that I think the way we overcame resin this year with the oil based was phenomenal. It probably cost us $0.08 in our P&L through three quarters. And I think the resiliency of our -- the way we've been -- the businesses have been attacking the operational effectiveness, which is a term unto itself, but you should read, getting after any waste that we can have -- that we may have resident in the cost of goods sold line. And we believe, it's early right now, that the lion's share of that is behind us, apples-to-apples. We'll probably see some more in the fourth quarter, but we should be reasonably in good shape next year.

I can't say as to how much growth is there, but I am confident that there is growth in the gross margin line as we go forward. We have -- we have and continue to do an awful lot of work around that area, as well as the other operating areas of the Company. And that -- those programs were not one-off programs. They're -- you should read them as being more into the DNA of the Company than anything else. So we feel pretty good about that going forward, and we'll guide more explicitly when we get to the November call.

Thank you.

Our next question comes from Bruce Cranna from Leerink Swann. You may ask your question.

Hi, good morning, everyone.

Hi, Bruce.

John, just to follow up on ProbeTec for a second. So, the strength mentioned in the press release, that was a U.S. and then a EU dynamic?

Yes, I'll have to -- Billy wants to talk to that. I think you have it -- Bill, why don't you just talk?

And, Bruce, the question is around the contribution internationally, or what exactly is the question around the growth of ProbeTec?

Well, yes, I'm sorry. I kind of missed what you were saying. I didn't know if there -- if some of the strength in ProbeTec was related to the Japanese launch, or, based upon what you were saying, it sounds like that was not the case. But, what I'm trying to get at is whether or not you had some success in the U.S., let's just say, with large, commercial lab partner, and whether or not that was added into the quarter?

Yes, the growth was actually pretty solid. We actually used in the press release the word, solid, because it was solid pretty much all the way around the world. Think about ProbeTec, is we told you last year, we were hoping to get through '06, given the pending product platforms that would follow with somewhere in the high-single-digit or low-double-digit category, and we're in that respectable, double-digit category at this stage in time on a global basis. And the quarter was very characteristic of that.

So you did well in the U.S.?

Yes, we did fine in the U.S., we did, yes. We had a nice, solid quarter in the U.S. again in this -- we're calling, at this stage of the product life, anything that's double digit for us, we're pleased with. So that's where we are at.

Just in, I guess, in general terms, do you -- would you describe your pricing strategy in the U.S. with respect to ProbeTec to be a little more aggressive than it was, potentially, last year or equal or, perhaps -- or, perhaps, less going forward?

I think it's a good question. It depends on the platform. I think as you see major customers move to higher throughput, very-high-volume platforms, we will, for major customers, utilize effective pricing to gain business. But there is nothing dramatic going on there. We're real pleased with where the prices in the margins are with ProbeTec.

Okay. And, then, just, quickly, can you tell us what percent in the U.S. you think Logic is on formulary? And my last question would be if someone could just touch on, quickly, where you are in terms safety products and production capacity currently? Thank you.

Just real quick, we'd say 50 to 70% formula -- formulary coverage, depending on the region of the country. And safety product capacity, sufficient to meet current and anticipated demands. We have scale up occurring mostly around new platforms.

Thank you.

Our next question comes from Sara Michelmore from SG Cowen. You may ask your question.

Yes, thank you. I was wondering if we could get an update on the Phoenix rollout, and also where we are in terms of the BGM product rolling out in international markets? Thank you.

Bill, why don't you go first?

Sara, this is Bill. We had a nice, solid quarter on Phoenix. I know you know we have a small base, given where we're at. We had a very strong quarter in Europe, particularly, around the consumables, where we -- we actually crested into seven-digit sales for the first time in Europe. We're pleased with that.

And our U.S. launch, which is really the focal point right now continues to go along pretty well. We've got, at this very early stage, we've got about 15 contracted customers at this point. Now these are people who are committed, and we've got another 34 that are in that, what we'd call the back end, almost ready to go piece of the funnel. So we're fairly encouraged at this stage. Again, we don't see any of that, probably this year in any U.S. impact of revenues. But these are important contracts for us to secure to help us perform next year.

BGM, as you know, has been launched, first in Canada, shortly thereafter, U.S. And we launched last quarter in Germany. We're going one large country at a time. We're choosing markets where the market characteristics are attractive and concentrating in those markets. There is quite a bit of investment associated with any new introduction in a new country. So that's our plan for now. And future markets will be communicated as we get closer to.

And, Gary, are you still -- are you guys still going direct in the main country markets?

Yes. Well, we're going direct, in terms of our selling effort. The actual sales flow, either through the drug wholesaler channel or direct to retail chain, depending on who the buyer is.

Great. Understood. Thank you.

Next question comes from Aaron Geist from Robert W. Baird. You may ask your question.

Good morning. If you could put a little bit more color on the growth internationally that you're seeing for the safety-engineered devices, that would be helpful, particularly, I'm curious to know, is it the first generation of safety-engineered devices that were put in place years ago in the U.S. and the Europeans are just following a couple years behind the U.S.? And do you think, step-wise, we'll see the same conversion to second and third generation in Europe? And did a new geography come online there that supported the 30% growth?

Well, I'll comment on that for Medical, and Bill may want to comment for Diagnostics. First, we're seeing the growth is being fairly well-balanced. It's not just Europe. Of the international safety growth that we attained in the third quarter in Medical, a little bit less than half was Europe, and a little bit more was rest of the world. And that doesn't mean that growth in Europe isn't important but, some people might have the perception it's only happening in Europe, and it's not. The primary places we're seeing, in addition to Europe, are Canada, also some growth in Japan, and in Asia. There is progress on regulatory, legislative, and government guidance side. Canada has a number of provinces now that are -- that have regulations in place that are similar to the U.S. regulations. We were pleased to see in Spain, in a major province in Spain, the first requirement in Europe, as opposed to guidance, the first requirement in Europe was recently passed in Spain. We would anticipate that will spread further in Spain.

And in terms of your question of which generation of product, it varies. It's not so much generationally based. We did do some product development specifically for the European market, given that there are some medical -- minor, I would call -- minor medical practice differences in product configurations that lend themselves to some variation in design. As far as I know, we're the only one doing that, that are tailoring the devices to specific markets. We've been content to continue doing that.

Nexiva has been launched in the U.S. and Europe. We believe there's a lot of potential for that product in both of those major markets, as well as other areas of the world.. So we're not necessarily going through the generational sequence. More so, we're trying to put our focus on the devices we think that are best suited to each market. And even with the growth we're getting in Europe, it's still fairly early stage, but it's moving along nicely.

I guess I could just add that our story is similar. There is good strength in Europe. We also have had some good success in Canada, as well as Japan. We are primarily focused, in Diagnostics, on the first-generation platforms, and it's the Sharps products, the safety-engineered products that are particularly associated with blood collection, that are very key contributors to the growth.

If you were to look into your crystal ball, how long do you think it would take for some of these new geographies, territories to convert to U.S.-style conversion?

It's a very -- it's a question that involves a lot of speculation, because there's a lot of factors, obviously, the most of which most are beyond our control. But it will be a number of years to get to U.S.-level transition, because, particularly in Europe, even though there's an EU, it goes country by country. That being said, we would anticipate that the growth will remain attractive for many years as a result.

Thank you, very much.

Our next question comes from Lee Brown from Merrill Lynch. You may ask your question.

Yes, I'd like to address the o-U.S. Pharma Systems sales. I realize that you said Q4 is going to be a step down. But in terms of the year-over-year growth rates, it's up against a tough comp. But would you expect that to be high teens or greater?

We would not anticipate it to be greater. It would likely be less. Of course, we do get a currency benefit in the European sales in Pharm Systems, and Europe is the biggest market for that. In fact, that business is actually headquartered in Europe. So we are expecting a slower fourth, but a solid finish for the year. And we do think some of what occurred in the third may represent some buying by our customers that could impact the fourth. It's not stocking. It's buying for their production plant.

Okay. And, then, just in terms of the U.S. Pharma, again, up against a tough comp, obviously, a much smaller base, though. Where do you see growth going in that business? And then also going forward in '06 just in terms of Pharma growth, given the exceptional strength in the U.S. -- o-U.S. numbers this year?

I would say, in general, we're expecting the U.S. to be softer relative to the European business in Pharm Systems. That will likely continue into '06. We had some stellar growth going back '03, '04. Some of that leveled out over the long term. It should pick up again. But I think into next year we would be looking for Europe as being a stronger driver.

Super. And, then, just moving forward, I know there's been quite a few questions here on safety. But one clarification here, it seems like the Med-Surgical international business should be growing -- I mean, it's growing at a phenomenal rate, granted -- but it should -- you would think the pace would be much faster than the Preanalytical -- o-U.S. Preanalytical side because, one, the smaller base, and it seems like you have a broader product line, just given that the U.S. numbers in Med-Surg versus the U.S. Preanalytical. Can you address this point?

Well, I want to make sure I understand it. Let me come at it and let me know if I've understood the question correctly. First, I would say that in Europe today, most of the growth in Med-Surg is coming from safety. In general, when markets are transitioning to safety, blood drawing needles is one of the first areas they put their focus on because the needles are filled with blood. So, therefore, you would expect to see some faster growth in the early transition period to blood-filled needles, which is, in part, what's driving the Diagnostics growth. Not sure if there's anything else I can help -- I can answer on that.

Well, perhaps I didn't ask it clear enough. The -- given the U.S. safety product numbers, obviously, a bit larger than the Preanalytical U.S. safety numbers. I was just wondering are there future introductions that have yet to occur in o-U.S. safety products?

I understand what you're saying. So you're saying that the proportion of total safety represented by Medical in the U.S. is higher than Diagnostic and vice versa in Europe?

Exactly, and you had Preanalyticals growth as stronger. It just seems counterintuitive.

Yes, well, part of that, I think, was driven by product mix in Europe. Europe started with a higher percentage transition on plastic evacuated tubes than the U.S. had, and, therefore, had a higher base, in fact, in safety going back a number of years. And the growth, again, is being driven more so by the needle-based platform, which are the blood-filled needles. We would anticipate over the coming years that will get -- I can't say that type of growth, that'd be too specific. But the growth in Medical will pick up as customers move through their natural priorities on transition.

Okay. And just to push you a bit more on the gross margins being flat year-over-year, I mean, you did have a 70 basis point improvement in the year -- I mean, in Q2. In what -- and I know you're driving initiatives here to improve that. But what's a realistic improvement here in '06 on a year-over-year basis?

Well, I'm not going to go to '06, specifically, as I said. But just to give you a little color, this quarter was flat with last quarter. But immediately the mind comes to mind a write off that we took on some intellectual property no longer being used by the business. That charge goes to cost of goods sold. It was about $3.5 million. It could have moved us about 30 or 40 basis points. So we face those things as soon as we see them. The event happened this quarter, we put it in there. So, I think that I'll stand by my earlier statements that there's growth going forward. I don't know how much it's going to be. It's been very solid over the last few years. I consider -- I continue to believe it will be solid, especially when you see what we've been able to do in spite of $0.08 worth of resin for three quarters.

Our next question comes from Mayer Tipness from Goldman Sachs. You may ask your question.

Hi, guys. Could you provide us some update on international safety regulation? And I guess the second question is, as John in your prepared comments, you said that 10% of the 12% growth in R&D was dedicated to new R&D initiatives. So could you kind of provide us some color on some of these -- some of these initiatives, and what kind of incremental investment we expect to see in the coming quarters?

Gary will take the first part of that. And then I'll just touch on that. And then we'll take one more call and wrap the -- wrap this up. Gary, why don't you first -- ?

Sure. I don't know if I have much to add from what I said before regarding international safety regulations. The places where things have been happening have been Canada and Europe, in particular, and the most recent item of note occurred in Spain. And there's some anticipation that was started in one large area of Spain. Will -- will ultimately spread to the rest of Spain, and then possibly take hold more broadly in other countries in EU, but that's still left to be determined.

Outside of those areas, there is some, in fact, safety regulations, which I haven't mentioned before, occurring in other countries that is oriented around prevention of reuse, which is another category that we participate, in devices that prevent reuse. And there's been a policy activity in a number of countries in Africa, as well as in Brazil. So it's a little bit of a different product category, but similar trend. Those are the places where things are happening from a policy standpoint.

And when you -- just to give you a couple broad strokes on R&D, we had announced that, obviously, we wanted to take the leverage that we were gaining in other parts of the income statement and start to put more into R&D. I won't be specific, because we haven't talked specifically about a number of these things. We've mentioned that we continue to work on, advanced drug-delivery-type item. But I would leave you with the thought that the research programs are judged among the three businesses. They are all high impact. Every single business has programs going forward.

With success in them comes the need for more money, so that's a good sign. And we believe that we are moving closer to a point where we'll be able to talk more specifically about some of this research. But you'll start to see -- you'll continue to see the spend go up. I mean, if just -- just stay within the parameters that we've guided in R&D, we'll be putting an extra $30-plus million a year into R&D, which, for us is a, certainly, a meaningful number. So I would guess that we're probably about a year away from talking a little bit more specifically about R&D, and -- but we'll just keep you apprised of that.

Thanks. And, John, just to follow-up onto that. So broadly speaking is there any business you feel you are kind of under-invested in over-invested in at this stage? Or how should we think about that?

I may not, but probably two of the Presidents here would jump on me and say we are. But, I think -- I think right now we are certainly adequately funded in our projects. But as we gain more and more traction and as we have more and more successes, it's going to call for more and more money. And that has been -- that certainly is something that we have baked into our numbers. Actually, I'll let -- Vince can probably comment on this.

Well, the only other comment that I would make is that our strategy is to continue to invest in our core -- in our core businesses and layer on new growth initiatives. So I think we all feel pretty good about where we are at from an R&D standpoint. So we're not sacrificing investing in our core as we move ahead. We're going to add to, in logical areas, we're adding new programs.

And just to add one further thing, we're doing this while continuing to gain leverage on the top line through productivity improvements and through careful spending on the SG&A line, so that we can fund these new initiatives, while still getting leverage on the top line.

Our last question for today comes from Glenn Reicin from Morgan Stanley. You may ask your question.

Just two follow-ups. I'm sorry. Can you go through the issue of Bioscience in the fourth quarter having to do with Japan? If you can just revisit that again. That was the question that Rick had asked. And, then, just a bigger picture question, John. When I look at the story of the Company, it's changing a little bit in the sense that you're much more reliant on Pharmaceutical Systems and on safety. And it seems like you're de-emphasizing ProbeTec, BD Gene, and Phoenix. Correct me if I'm wrong. Maybe you can address some of that stuff?

Let me do that up first, that we don't mean -- we write quotes and things like that and talk about the Company. In no way, shape, or form are we more reliant on safety. For instance on safety, I think we have said, and I say it again here, is we're less reliant on safety. What we are is a -- an accumulation of three businesses with businesses within them. And every one of them is contributing to growth. It's no one story any more. And we just didn't talk a whole lot about ProbeTec, but as Bill said, when we have low teens growth quarter-on-quarter in ProbeTec, we feel pretty good about it. The starts in Phoenix are good. The analyzers where, in Vince's business and the pull through with the reagents are excellent. He'll expand on the question on Japan, because I know that --

But just to interrupt you there, when we think about ProbeTec going forward, if you remain, really primarily on sexually-transmitted diseases, there's no reason we're going to see a re-acceleration of that business. In other words, this isn't going to be -- it doesn't sound like it's a -- unless you have a major new platform that you haven't talked about, it sounds like we're sort of constrained on growth on that product line?

Well, I would just say that if all that were true, I might agree with you, but there are other things there. There are opportunities for expansion of business with existing clients. And, Bill, you might want to make a comment --

Will we see that at the ACC this year?

Bill?

Glenn, I had just one quick comment. The one thing that is, I think, some cause for optimism is that this amplified market, now this is just the general use of amplified technology in the sexually-transmitted disease category, continues to grow. And remember that market, it's hard to say, it's a moving target, but a fast 60, 65% converted to Amplified. We're really focused on helping major, high-throughput customers with the new technology migrate over to Amplified. So there's still a pretty nice growth opportunity we think in that Amplified space.

Okay.

Vince will follow-up on that --

What I was saying was that we -- as we terminate this relationship, or end this relationship with our distributor and go direct, sales that we are making to the distributor, we would not be booking in the fourth quarter because at the end of the relationship, we buy back the inventory, we will be reversing the sale. That's a $4 million negative at the top line in the fourth quarter, that I was talking about, Glenn.

Okay. And then you said another 2.7 million of government sales that would push from Q3 to Q4?

Yes, and what I was saying there was that the issue is going to be how much of the ones that were originally scheduled in Q4 will happen in Q4? That -- what I was saying was that, so far, things are going well. That tender process seems to come in place. It's going to be -- the ones that got pushed from 3 to 4 seem to be queuing up. Will we get the ones that were originally scheduled in 4 in 4? Time will tell on that.

Okay. And just to look at this, again, the ballpark way, it was $80 million business last year, internationally. I'm just looking at the total reagent, immunocytometry business, you're saying the impact from buying back the inventory is 5% right there. So if we start off with a normalized growth rate of around 10%, we subtract 5%, and then Japan sales to the government are the difference, in terms of the year-over-year growth?

Yes, Japan is the biggest -- far and away, the biggest part. Got good growth in Europe and in the United States. And so Japan, for the quarter, was down, between the accounting adjustment and the 2.7 million in instrument sales -- figure I was going to get 10% growth, so it's closer to 4 -- it's down -- it was down 5.1 million versus last year. Okay?

Yes. I got it. Thank you, very much.

Sure.

Okay. Well, it's nice to have the first be last, and thank Glenn for that last call. And thank you for your attention. And we'll talk to you next quarter.

This concludes today's conference. Thank you for joining.