Becton Dickinson and Co (BDX) 2009 Q2 法說會逐字稿

Hello, and welcome to BD's second quarter 2009 earnings call.

At the request of BD, today's call is being recorded. It will be available for replay through Tuesday, May 5th on the Investors page of the BD.com website, or by phone 800-642-1687 for domestic calls, and area code 706-645-9291 for international calls, using conference ID, 92219921. I would like to inform all parties that your lines have been placed in a listen-only mode until the question and answer segment.

Beginning today's call is Ms. Patricia Spinella, Director of Investor Relations. Ms. Spinella, you may begin.

Good morning, everyone, thank you for joining us to review our second fiscal quarter results.

As a new practice and as we referenced in our news release this morning, we are presenting a set of slides to accompany our remarks on this call. The slide presentation is posted on the Investor Relations page of our website at www.bd.com. During today's call, we will 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 our second fiscal quarter press release and in the MDandA sections of our recent SEC filings.

We will also discuss some non-GAAP financial measures with respect to our performance. A reconciliation to GAAP measures can be found in our press release and the related financial schedules. A copy of the release, which includes the financial schedules is also posted on our website. Leading the call this morning is Vince Forlenza, President. Also joining us are David Elkins, Executive Vice President and Chief Financial Officer, and BD Executive Vice Presidents, Gary Cohen and Bill Kozy.

I will now turn the call over to Vince.

Thanks, Pat, and good morning, everyone.

I assume you have all 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; however, I would like to make some brief comments regarding our second quarter results and after David walks us through the financials, I will discuss our outlook for the second half. Now moving to Slide 4, Business Highlights. Before reviewing our highlights, I would like to point out that, as noted in our earnings release, we have reached an agreement to settle the claims of the direct-purchaser plaintiffs in the antitrust class action suit. Our comments today exclude the impact of the pretax $45 million charge, or $0.11 diluted EPS from continuing operations, relating to the settlement.

Now looking at our results for the second quarter, adjusted fully diluted earnings per share of $1.18 was in line with our expectations. The economic environment is impacting our customers in certain areas of our business, in particular, U.S. Biosciences, and foreign currency continues to negatively impact year-on-year reported growth. The Company's cost control programs, however, continue to drive operating margin expansion. We have reaffirmed guidance for full-year adjusted EPS growth of 9% to 11% in the face of approximately $500 million of projected lost gross revenues due to currency, before hedges, and even though we are expecting to experience much stronger headwinds from foreign currency in the second half of the year.

Now Slide 5, Financial Highlights. As you can see in Slide 5, we achieved underlying revenue growth of 3.7% in the first half. In the face of severe economic challenges, we expect to achieve underlying revenue growth of 4% to 5% for full-year 2009. I will visit this later to explain where the growth comes from.

Now, I would like to turn the call over to David to cover our financials.

Thank you, Vince, and good morning, everyone.

I would like to begin our financial review with revenue growth by segment. Medical's second quarter revenues declined about 3% after about 5 percentage points of unfavorable impact from foreign currency translation. On a currency neutral basis, underlying growth was about 2%. On a currency neutral basis, solid worldwide sales of Medical Surgical Systems products were offset in part by the expected decline in sales of prefillable devices in the U.S. For the first half, underlying growth was about 2% on a currency neutral basis.

Revenues in the BD Diagnostics segment grew about 2% after about a 3 percentage point unfavorable impact from foreign currency translation. On a currency neutral basis, underlying growth was 5%. Solid sales of safety engineered devices, cancer diagnostic products and infectious disease testing systems were partially offset by a decline in the sales of flu testing products due to a mild flu season in the U.S. For the first half, underlying growth increased about 6%.

In the Biosciences segment, worldwide revenues grew about 3% in the quarter. Strong international sales growth of research instruments and reagents, primarily in Western Europe and Japan, were offset in part by a slowdown in research-related capital spending in the U.S., particularly in the academic and biotech markets. So, for the first half, underlying growth increased about 6%.

Now moving to Slide 8, reported sales growth of our Safety products were about 5% in the quarter to $392 million. On a currency neutral basis, underlying growth was about 9%. This was comprised of a 3% growth rate in the U.S., and a strong underlying international growth rate of 19%. For the first half, underlying growth was about 8% on a currency neutral basis, which is a combination of a 2% growth rate in the U.S. and an underlying growth rate in International Safety of about 19% on a currency neutral basis.

On the next slide, we will look at revenue by region. In the second quarter, BD's U.S. reported revenue declined 1%. U.S. Medical revenues were flat year on year reflecting the anticipated decline in prefillable devices and distributor destocking of our insulin delivery devices. U.S. sales of diagnostic products increased 1% reflected in the light flu season and weaker-than-anticipated uptake of the new BACTEC System. Biosciences revenues in the U.S. declined 9%, reflecting weaker demand in the academic and biotech markets due to funding constraints, and lower sales of advanced bioprocessing products. As a result of these market dynamics, the first half U.S. reported revenues increased 1% in the U.S., with Medical and Biosciences revenues flat year-on-year and Diagnostics revenues increasing 2%.

Reported international revenues in the second quarter were flat year-on-year reflecting the 6 percentage point unfavorable impact in foreign currency translation. On a currency neutral basis, the underlying growth was about 6%, driven by the strong performance in Western Europe and emerging markets. Second quarter revenue on a currency neutral basis resulted in underlying growth of 3% for Medical, 9% for Diagnostics and 10% for Biosciences. For the first half, reported international revenues were flat year-on-year reflecting the 6 percentage point unfavorable impact from foreign currency translation. On a currency neutral basis, international revenues increased 6% in the first half, with Medical increasing 3% and Diagnostics and Biosciences each increasing 10%.

Now looking at second quarter revenue on the next slide, and the growth year-on-year. These gains came from the underlying performance and our hedging program, and were more than offset by currency reflecting approximate $90 million of lost revenue due to the strengthening dollar.

On the following slide (#11), I will go through gross margin. As you can see from the slide, gross margin improved 80 basis points in the second quarter to 51.9%. This was primarily driven by hedge gains and by foreign currency translation, which actually had a positive impact on the gross margin percentage in the quarter. The currency and hedge gains were offset in part by start-up costs and product mix. The first half gross margin further improved over the prior year to 52.7% due to the translation gains in the first quarter, which we discussed on our first quarter earnings call.

Slide 12 now examines SSG&A and R&D expenses in the second quarter. SSG&A spending decreased by $20 million in the quarter primarily driven by foreign exchange. On a currency neutral basis, underlying expenses are flat year-on-year after absorbing inflation. Therefore, in real terms, our expenses are down as a result of our disciplined expense management. R&D spending increased 3% reflecting the increase in our total R&D as a percent of sales to 5.7%. In addition to our total R&D increase, we are also focusing more of our spend on our key growth initiatives.

Now moving on to operating income, Slide 13. Our second quarter operating income increased 7% to $408 million. As a percent of sales, operating income increased 170 basis points to 23.5%. This was a result of the positive impact that the hedge gains and foreign currency translation had on our gross margins and the margin expansion we get from our continued focus on expense management. Slide 14 looks at operating income year-to-date. Year-to-date, our operating income increased by 11.6%, or to 23.9% of sales, for the reasons I mentioned earlier.

Now I would like to switch to guidance for the year. On Slide 15, I would like to discuss the full-year guidance for revenues. Beginning with BD's underlying growth for the first half was about 4%. Underlying growth for the second half is expected to be about 5% to 6%, which is primarily driven by the expected improvement in our Diabetes Care and Pharm Systems business units. Our actual underlying growth of 4% in the first half, coupled with the expected underlying growth improvement in the second half of 5% to 6% will result in an expected full-year underlying growth rate of 4% to 5%.

Now moving to slide 16, I'll walk you through our guidance for operating margins. We expect gross profit margins to improve -- gross profit margin to improve from 51.2% to a range of 52.5% to 53%. SSG&A is expected to improve from 24% to a range of 22.9% to 23%. R&D spending is expected to increase from 5.5% to a range of 5.6% to 5.8%. So, our overall operating margin is expected to improve from 21.7% to a range of 23.5% to 24%, which is an approximate 180 basis point improvement year-over-year. Three other items I would like to cover with you prior to moving on is, first, operating cash flows are expected to be between $1.6 billion to $1.8 billion for the full year. Our capital expenditure guidance is unchanged at $650 million for the full year. And we continue to guide share repurchases of $450 million for the year.

Now, I would like to move on to EPS guidance, Slide 17. Since we have unusual swings in currency and hedges on a quarterly basis, I would like to walk you through the components that make up our earnings guidance for the full year. For the first half, we start with our 2008 base earnings per share of $2.16 from the prior year's first half. To this, we add $0.09, or 4.2% of underlying performance, plus the positive impacts of $0.01 from currency and $0.17 from the hedge gain. This gives us an adjusted first half earnings per share of $2.43, or an increase of 12.5%. For the second half of 2009, we are building on a 2008 base of $2.30. Increased revenue growth, coupled with improved operating efficiencies, are expected to drive underlying performance increase of 10% to 13%. In addition, a negative currency impact of $0.28 is expected to result from the dollar's appreciation to the Euro when compared to the second half of last year. This is illustrated in Slide 18.

The positive impact of $0.17 from the hedge gain in the first half is expected to be repeated in the second half based upon today's exchange rates. Please note that currency and hedge impacts are estimates only and will vary according to the actual exchange rate fluctuations. So, this results in adjusted second half earnings per share estimate of $2.43 to $2.52, or an increase of 6% to 10%. In summary, I would like to highlight our underlying performance on adjusted earnings per share basis. As I mentioned earlier, in the first half we experienced two market factors that impacted our underlying performance. The first is the impact of wholesaler destocking in Diabetes Care products and the macroeconomic factors impacting our Eastern European operations. The second is the impact reduced research funding had on our U.S. Biosciences business in the second quarter.

As Vince will discuss in a moment, the underlying performance in the second half is expected to improve to 10% to 13%. This is driven by the expected revenue improvements in Diabetes Care and Pharm Systems and our planned efficiency gains through expense management. The net result is a full-year underlying performance of 7% to 9% and adjusted earnings per share of 9% to 11%. This gives us confidence in delivering this year and providing a strong platform for growth moving forward.

I will now turn the call over to Vince, who will walk you through our plan for the second half of the year.

Thanks, David.

Before we open the call to questions, I would like to review the currency neutral growth outlook for each of our segments in the second half; it's on Slide 20. BD Medical's growth rate is expected to improve from 1.9% in the first half to approximately 4% for the full-year, which implies a 6% growth rate in the second half. All Medical business units are expected to improve in the second half. In particular, Pharmaceutical Systems is expected to show strong revenue growth in the fourth quarter and Diabetes Care is expected to return to its normalized growth rate having absorbed inventory reductions and distributor restocking in the second quarter. Diagnostics growth rate is expected to show slight improvement from 5.6% in the first half to 6% for the full year, reflecting a 6% to 7% growth rate in the second half of the year, absent the negative impact of a light flu season and weaker-than-anticipated sales of the new BACTEC System in the first half.

Since I know you are going to ask, GeneOhm revenues increased to $14 million in the quarter and TriPath revenues increased about 9% on a reported basis and include the first installations of the FocalPoint GS in the U.S. We are reaffirming full year revenue guidance for both GeneOhm and TriPath. Moving on, our Bioscience segment is expected to face continuing challenges in the U.S. in FY 2009. The U.S. academic market has been hit by endowment funds that have, on average, declined 40%. We are also seeing a large increase of biotech companies with less than six months of cash, and the clinical market is economizing on their use of reagents. While we are seeing a large increase in request for quotations for our instruments, we are not forecasting a positive impact from the stimulus package until 2010. We expect international sales growth to remain in the 9% range for the balance of FY 2009.

Now to Slide 21. I would like to leave with you these key takeaways today. Our underlying revenue growth for 2009 is expected to be in the 4% to 5% range in the face of economic challenges and wholesaler destocking. We are reaffirming guidance and expect to deliver 9% to 11% adjusted EPS growth by continuously driving efficiency. Our spending controls are helping to drive operating margins. We are accelerating expanding our efficiency and effectiveness programs in 2010, including flat salaries for 2010, and reducing executive compensation, among other initiatives and considerations. We are driving investment and growth opportunities to ensure a strong platform for growth in 2010 and beyond.

BD is committed to driving shareholder value by increasing cash flow to enable dividend growth and share repurchases. Biosciences faces near-term challenges, especially in the U.S. Medical is recovering and Diagnostics is solid. This is another example of benefiting from our diversification. Suffice it to say, these are extraordinary times and we cannot predict the length or severity of the global economic crisis, but what we said last November in our Annual Report to Shareholders is still true today, and that is, we have reviewed our financial position and credit market exposures, and we believe we are well prepared for these economic times. Our balance sheet is strong. Our cash flow is healthy and we see little risk to our ability to fund our operations or plan for future growth.

We will continue to respond to the current economic conditions with the same commitment, responsibility, prudence and transparency as we have done for many years. We are confident that with hard work and discipline, BD will emerge even stronger while continuing to reward our shareholders. Thank you. With that, operator, we will open the call for q&a.

The floor is now open for questions. (Operator Instructions) Thank you. Our first question is coming from David Lewis with Morgan Stanley.

Hello. Good morning.

Good morning, David.

Vince, given your comments on sort of the second-half of your outlook and obviously how critical it is to guidance, I wonder if you can give us some more clarity on a few specific buckets. I guess, number one, looking at the prefill business, obviously given what we saw from Guardasil and Enbrel in the quarter, I wonder if you can comment on the outlook there, as well as emerging weakness off of last quarter and sort of your confidence in the outlook in emerging markets. And then lastly, on destocking and your comfortability that the inventory levels are set at manageable points. Maybe those three issues on outlook and then I have a follow-up.

Okay. So, David, I will make a brief introductory comment and then I'm going to ask Bill Kozy to talk a little bit more about the Medical business and, in particular, Pharm Systems, and Gary will pick up the emerging market piece of the question. As I mentioned, we are expecting a higher growth rate in Medical in the second half, and all of the businesses are going to participate, and Bill can give you a little bit more color there. But to remind you specifically on Pharm Systems, if you went back and you looked at last year in Pharm Systems, the growth was very heavily skewed to the front half of the year as we had launches with a couple of new major products by our pharmaceutical partners and then we actually had a significant decrease in the second half of the year, so in terms of the comps, they are completely flipping around from first half of the year to second half of the year. And Bill and the team have been analyzing the orders coming in for the second half of the year and I think they have a high degree of confidence what is going on there. So, maybe I will ask Bill to make a few more comments on that and then we'll go to Gary on emerging markets.

Sure. As Vince mentioned, we are guiding for the total year on Pharm Systems on an FX neutral basis of about 5%. The U.S. decline continues, and for the year, we think it will be down about 8%, but we are expecting international growth in the 8% to 9% range driven by some contribution from Western Europe, probably in the 9% range. And then on some smaller geographic basis, some solid growth in Asia-Pacific and Latin America are both well into double digits over the second half of the year. In terms of the timing of the growth, Pharm Systems business in the third quarter will look relatively flat and that reflects a pretty tough comp we've got to a real strong FY 2008, where we had international growth well above 20%.

Fourth quarter, though, will be about the same in dollar terms as third quarter, but we are up against a weaker comp in that fourth quarter and we are anticipating growth right around 20% for the worldwide business as we start to see both the U.S. and the international pieces grow as compared to an FY 2008 Q4 that decreased. Now, in terms of order management, as you know with Big Pharma, we get projections that tend to run into five to six-months advance notification of pending orders. Those orders get confirmed in the two to three-month period prior. Based on our work with our major pharma customers, that kind of is the basis for these projections that we are discussing today.

Great. Gary?

Just to comment on emerging markets. I know in the last call we talked a little bit about the issues that we had experienced in Russia and a little bit about Africa, and I will mention those again, but I also want to share the broader picture that broadly in emerging markets when you look at markets like China and India, in particular, we are doing extremely well and has a very different feel. You don't factor in an economic crisis when you visit those regions. We are getting very strong double-digit growth in China, better than teen's growth in China and we are expecting that to continue in the second half, as well as strong double-digit growth in India.

In Russia, the negative impact was really confined to two businesses, Medical-Surgical, and PAS, both of which are using a large part of the distribution is coming from outside Russia into Russia so the distributors are paying in dollars and reselling in rubles and that was the source of the impact there and we couldn't just place some response program to price more competitively to enable them to restore some of that business and in Africa where -- totally out of our control, India pulled out of UNICEF's tendering process for immunization syringes. That and a little bit of a slowdown in the CD4 business, particularly in Western Africa, but the overall picture for the emerging markets is a positive one. And just looking broadly for the moment at international, Europe is growing solidly, EMA, which is Eastern Europe, Middle East and Africa, we expect to recover in the back half based on the items I just mentioned and lessening of effect from Russia and Africa. Asia-Pacific is growing in double-digits. The northern part of Latin America is growing in double digits and we're also getting good growth in southern Latin America, so the overall feel is very good in the international markets and including the emerging markets.

David, the last part of your question was around distributor destocking, and we have all -- and that was primarily in Diabetes Care, and we have already seen that stabilize.

Okay. I obviously asked a monster, though, so I'll ask two more quick ones and I'll jump back in queue. The first was if someone could just comment on, you said flu weakness this quarter, obviously, we're obviously concerned about global pandemic, Swine Flu, maybe your outlook there or expectations there. And then secondarily for David, in terms of margins heading into this year, obviously the top line's proven to be weaker than we expected. If you look at the things that are going to drive positive margin expansion this year, largely lower input cost, cost cutting, can you just basically describe just maybe on a qualitative basis whether you're -- how far we have had to cut into that cushion this year already, and if there is still further cushion to go or are we starting to get a little maxed out? Thank you.

All right. Well, let's take the question on the flu first. We were talking about the fact that there was virtually no flu in the United States during this quarter and obviously there is major concern what might happen with the flu going forward. It is too early to really predict where that may go, but I will turn it over to Gary to make a couple of comments, who has been very involved in our own pandemic planning.

Yes. So, just to reinforce Vince's comments, we're referring to the nonpandemic non-outbreak season that we had experienced prior to the more recent news starting in Mexico and which has now spread to most regions of the world and I am sure you are following the news as we are that there are over 150 deaths reported in Mexico. The -- the strain seems to be less severe in other parts of the world, but it's spreading very rapidly. We have been planning around pandemic, more so based on H5N1 AVIAN strain, but it applies here as well. Over the past 18 months with this type of occurrence as part of our enterprise risk management process, and associated with that, there were two main constructs. One is internal planning around workforce policies and how we respond and ensure continuing operations, but the other part was to ensure that we would be able to produce in equivalent or larger quantities the products that may be most in demand during the flu outbreaks.

So those activities are now engaged. They are engaged in a very serious way in Mexico, which we would consider to be in a serious situation, and we have two significant facilities there. And as well, we are engaging to a lesser degree around the world. We have coordinators located in every location of the world that have been assigned over the past 18 months for an event such as that. The types of products that you can expect to be potentially in higher demand, although we are not necessarily seeing much of it yet, would be rapid flu test where there's already an increased order demand as you might expect from Mexico, that's not a large business for us, but the demand is already going up. And also, immunization devices that would accompany either injectable, anti-virals or immunizations for the flu strain as injectables are developed, as flu vaccine is developed around these strains. So, we are very well prepared for this and all the planning that can be put into place is being put to good use now. We should know soon whether or not it has any impact on product demand.

Okay. Okay. So, David is going to handle the gross margin question.

So, David, on the gross margin, if you remember on Slide 16, year-to-date we're sitting at about 52.7%. What we are guiding for the full year is 52.5% to 53%. So, there's a lot of moving parts in there as we talked about before between mix, start-up, purchase price variances. And you put all of those things together, we think that guidance is really our best view at this point in time. So, I wouldn't articulate it as cushion. I would say what we are giving you is our best view of where we think we will land for the full year.

Thank you very much.

Yes, thanks. Next question.

Our next question comes from Jon Wood with Bank of America - Merrill Lynch.

This is for Bill Kozy. If I look at the cell analysis business down 8% -- U.S. cell analysis down 8% for the quarter. First of all, what did the instrumentation do versus the consumables?

Well, this is Vince Forlenza. Bill's got Medical now. So, let me just talk a little bit about the business. There were declines in both the consumables and the instrumentation piece. And with both being off somewhat, and let me just take a quick look for you. In the quarter, the Pharmingen piece was down on a performance basis about 7% and the overall IS business, the flow Cytometry business was about 8% -- down 8%. Both of those are U.S. numbers. And that's where we saw the decrease. The international pieces we mentioned for Biosciences were up 11% in the second quarter.

And by customer group, just -- the breakout -- I guess qualitatively between Commercial R&D, academic, government and then clinical, were there any disparities between those three customer groups?

Well, we did see growth go down in the research market to the greatest extent, but -- but both research and Pharma were off more than the clinical market place. The clinical market was down slightly, as well. So you saw it in all three segments and you would say, well, why in the clinical marketplace? Well, in clinical, we have had very aggressive growth in some of the developing world countries. And while they still grew, they did not grow as fast. And then some of the large labs economized on reagents. But as a percentage drop, the biggest was in biotech where I mentioned in my comments the number of companies with less than six months of cash.

Okay. And then just given the level of quoting activity, I would imagine that a lot of the government academic was just a deferral because of the stimulus coming down the pipe. Why not -- is it just a timing of when you think those grants are released, not hitting your fiscal year? But I am trying to understand why you don't anticipate more of a rebound in the back half in Biosciences.

Well, here is our understanding of the grant process, because we do expect to see a benefit from it, but we expect that to occur starting in first quarter of FY 2010. And the grants -- there is a challenge grant program out there, and the money is going to be allocated, or the grant is going to be decided upon in September which, of course, is right at the end of our fiscal year. And to your point, we are seeing a very large increase in requests for quotation. So we do think that people are putting off their orders, and there is a significant timing issue going on here.

Okay. Thanks. Last one for David. Can you just comment broadly on the M&A pipeline. If the conditions of valuation or size have changed at all in the last three months?

I think, generally speaking, what's happened with valuations, I think there could be opportunities as we talked about before, if people become cash constrained and we see new technologies that are aligned with our strategic drivers, we're going to capitalize on that. We continue to actively look in the marketplace for those opportunities, so we will keep you guys abreast if anything comes about.

Thank you.

Your next question comes from Bruce Cranna with Leerink Swann.

Hi, good morning, everyone.

Good morning.

Couple of things. Just on Diagnostics, can anyone -- or can you guys give us an actual -- quantify the flu impact on a dollar basis in the quarter?

$4 million to $5 million, 1%.

Okay. And you mentioned BACTEC maybe being, I guess, not meeting your expectations. Any color there? Is it just hospitals being a little tighter on the purse strings or are you guys seeing other issues?

No, we saw a longer selling process. As this hit, we were getting a lot of requests for quotations. The process took longer and the sales didn't start to come in until March. So it was very back-end loaded. That was what the issue was.

Okay. And then you guys were talking about Biosciences. I guess -- in OUS trends versus U.S. I'm curious, just looking at the numbers, OUS. Clearly, there's no FX going on there. Is that just overwhelmingly the effect of sales into China? What's going on such that reported growth is a point above FX neutral?

Why -- well, the growth is fairly strong across the board in Biosciences internationally with just a couple of very minor exceptions, but are you asking an FX question?

Well, I'm just looking at it by segment.

Yes.

Yes, if you look at your international business, obviously, you are losing 6 or 7 points of top line in Medical and Diagnostics, yet in Bioscience, you're actually picking up some growth?

Yes.

So, I'm trying to figure out from a currency, where geographically are you so strong that you are not being affected by the Euro and Yen?

Bruce, this is David. This phenomenon happened last quarter, as well, and you are talking to the Biosciences business international, correct? And why you are not seeing the comparable impact of the foreign currency?

Yes.

The reason for that is our hedge and it's the way from our accounting perspective that our hedge has to be allocated and the hedge, in order to be accounted the way we are accounting for it, you have to -- it is on U.S.-based sales abroad. So in more of our -- almost 100% of our international sales within the Biosciences business is from the U.S., so, therefore, a greater portion of the hedge gets applied to the Biosciences businesses.

Okay. Okay, I got it. Sorry.

There's nothing unique about the Biosciences business from where the product is sold.

Okay. And lastly for me on GeneOhm. Vince, thanks for the dollar number there.

Yes.

I am kind of curious listening to your competitor talk about this space. They claim to be taking share, et cetera. And I look at your quarter and the $14 million number, it doesn't seem to really jive with that kind of commentary. So, I'm curious. Do you think that -- as such that the market is growing faster that you can lose accounts and still show this kind of growth? Or would you say that their commentary that they are taking accounts from you is inaccurate?

Well, I think a couple of things. One is that there is a royalty payment in our sales for this quarter of $2 million. So, you have to look at it on a continuing basis as $12 million. That is the first thing. The second thing is we are continuing to increase the number of our accounts. So, I don't think they are taking our accounts -- that is not what is going on, but I think if you look at market share from a dollar value, they are now slightly ahead of us.

Okay. It was that royalty payment I was missing. All right. Thank you.

Okay.

Our next question comes from Sara Michelmore with Cowen and Company.

Great, thank you for taking a question. Just a question back on Pharmaceutical Systems. I know it's a bit early to talk about fiscal 2010, but I'm kind of just curious here if we have gotten most of the negative comparisons at least behind us and should we think about this being a growth business in fiscal 2010, if you can comment there? Thanks.

Sure. We are not going to guide for the business yet for 2010. We are going to see how the balance of this year goes. We are confident we are seeing returning growth in this business in the second half of the year. And as that unfolds, then we will get back to you later in the year with that.

Okay. But, Vince, maybe just on the pipeline there, this -- this growth rate that you're talking about for the second half of the year. You are not depending on any kind of new products or anything like that to hit those numbers; is that correct?

These are core customer, core product areas.

Okay. That's helpful. And can we get just a quick update on ProbeTec and Phoenix?

Sure. So Phoenix, on a performance basis, was up just about 10% versus for the first half -- I am sorry, one second. Year-to-date, it's up 18% and 10% for the quarter. I was right. And you want also ProbeTec.

Yes.

Okay. So, ProbeTec was up -- the molecular business up 10.8%.

Thank you.

Your next question comes from Keay Nakea with Collins Stewart.

Yes, good morning. Would you talk to the wholesaler destocking in Diabetes, is that more specific to a strategy of a specific distributor and why should we think that you are not vulnerable to destocking, either by wholesalers or by hospitals in other product categories?

Okay. So, I will make a first overall comment. As the last couple of quarters have unfolded, we have seen destocking in other businesses during the last six months or so and we have seen that stabilize in the other businesses, so as we track the number of inventory days we see out there, it gets to the point where they start to have service problems and then they start to back away from that. So that's the overall trend that we are seeing and I will ask Bill to make a comment on the Diabetes Care situation.

No, I think that covers the primary message. The second message as it relates to the timing of the second quarter is that we did have some large restocking orders that took place in the second quarter of 2008 that created an inventory build and an unfavorable comp. And they were at one of the major U.S. chains, and also there was a home health care loss that took place. So those were also factors in the timing of the second quarter.

Okay. With respect to SSG&A, you have demonstrated good expense management. As we think about that longer term, moving into next year, you talked about pulling back some incentive comps. So, as we think about that in longer term where you might reinstitute that, do you have other specific initiatives that can offset that so we can see continued expense management and the leverage from that?

Yes, we do. We think that we have multiple levers that we can pull in terms of expense management and compensation isn't the core of our strategy. We've -- we have a number of programs that we have, we have started looking for leverage across our expense base. And, I can point to such areas as our transportation networks and rationalizing them. We can look at such things as shared services, and we look at our -- we will look at shared services in G&A. We look at our functions of how they are delivering those services, what we can do to share on a worldwide basis. So, we will go after reducing overhead. In the meantime, we have started an upgrade of our ERP system, and this is going to enable a lot of this sort of work where we can get this leverage, so it's not primarily a compensation-driven strategy.

Okay. Very good, thanks.

Your next question comes from Mike Weinstein from JPMorgan.

Thank you for taking the question. Good afternoon, everybody. Let's, if we can, circle back to the Biosciences business. If we looked at the first quarter, the flow of business was very, very strong, and -- and on the first quarter call, the confidence level that Bill had at the time in terms of the sustainability of the business seemed high, and now we fast forward to a quarter later and obviously it's a very weak quarter given what is happening with your customers' base. So, let's just talk about the dynamics of how quickly the business turned over the course of this quarter, your visibility into this business. A quarter ago, you were guiding to 9% growth for Biosciences. Now you are at 3%. So that is obviously a huge change in the dynamics for that segment of the Company. Talk about how quickly it changed, what your visibility is from here, and then let's follow up, if we can, with just getting into a little bit more into your customer base. Thanks.

Well, it's quick. It changed very, very rapidly. So, as you mentioned, we had a very strong first quarter, and we had a nice backlog of orders going into the second quarter, and then as the stock market went down and we saw these endowments decrease, what we saw happening with both hospitals but even more so academic centers was even if they had a grant, they were putting their order on hold. So it changed very, very rapidly. We still continued to get some requests for quotations, but they were not moving through the system. And then what we did see was after the Obama stimulus plan was announced and they started to figure out how they would spend the money, towards the second half of the second quarter, we saw requests for quotations moving up. So, it was a significant difference.

The U.S., of course, is where that significant difference was. In the first quarter, it was up 10%. And then, down 9% in the second quarter. So, those kind of swings are unprecedented. So what we are looking at. We have taken that into account, and as I said, we are being conservative. We are seeing a large increase in requests for quotations but we're not building them into our guidance for the year. We are assuming that's going to hit in 2010.

Vince, when I think about the business, I always think of the flow business as being about two-thirds research. That is the right mix in your customer base?

Yes.

That's right?

Yes.

Okay. And --

On the --

I think about trying to -- get our arms around it. If I think about the different issues that your customers are facing, can you just separate the research, the issues that your research customers are seeing from -- I want to separate out the biotech issue of emerging biotech not having funding, because that has been an issue but that probably does not get better in the short term. If we separate out that, the rest of the business is where you are seeing the -- the pickup, if you would, in quotations? I assume you are not seeing it from the biotech side?

Yes. It is coming from the research side. I will be real precise. The research piece of the business was about 75% in the second quarter, 21% was clinical and about 4% was other. The research would include the biotech guys, okay? Now, part of that U.S. downturn was not in the flow Cytometry business. It was actually in Labware and it was a $3 million decrease in advanced bioprocessing. And what happened there was we had a large customer, which I will not name, but who had a large drug where they changed the dosing regimen and they changed it down, and this left us and the customer with a large amount of inventory that was going to take them the entire year to work off of. So if you look at about a $10 million decrease in the U.S., $3 million of it, about 30% was that specific issue. And then, in terms of softening from quarter-to-quarter, the growth went down in the research segment by about $10 million worldwide.

Just for that one time -- that one-time specific customer, Labware bounces back next quarter?

Hang on one second.

Forget the flow, but the Labware --

No, it's going to continue in the second half of the year and not bounce back until 2010.

Okay. And last question, a finance question. We just want to make sure we're understanding the hedging programs that the Company has in place, because I think this is the first time we have seen where the hedges had an impact on the sales line so that the -- what looked like the currency impact that we would have seen this quarter was different, just optically on the sales line because of the hedges and we want to make sure we are thinking about it right for the back half of the year. So, in this quarter in particular, why did you have that hedging offset on the sales line, but you won't have it in the third and fourth quarters, just based on your guidance? I just want to understand the mechanics a little better. Thanks.

Mike, I need to understand your question. The hedge impact on the sales line was the same in the first quarter as well as in the second quarter; it was around $35 million.

So -- I am sorry. The hedge impacts from the hedges, you're saying was $35 million in the first quarter, $35 million in the second quarter, and then for the back half of the year, what is it supposed to be?

It will be roughly the same.

Okay.

That will fluctuate based on currency rates.

And -- I am sorry, I missed that.

I said it will fluctuate based upon actual currency movements.

But as of right now, you are saying the same for the back half of the year?

Yes, that's correct.

Okay. All right. That is helpful, thank you.

Okay

Your next question comes from Kristen Stewart with Credit Suisse.

Thank you for taking my question. I was just wondering with Biosciences, obviously outside the U.S., business has held up real nicely. I guess, what gives you confidence that we could see a potential slowdown in international markets within those businesses?

Okay. So there's really two pieces, one of which is -- let's call "the research market," and what the organization is telling us is that they see the funds already allocated for these instruments. They were in the budgets as they were put together going into this fiscal year and then, they are taking into account some risk in the emerging markets. They saw a little bit of that in the first half. I guess if there was any more exposure, it would be -- if any of those government programs slow down. Do you have anything else to add to that?

The only thing I would add is that you have the growth in the clinical side of Biosciences continuing in the emerging markets. China is expanding its health programs. They recently made an announcement they are planning to expand health access to 90% of the population, including rural populations, over the next three years. They are investing over the next three years the equivalent of a full-year's additional investment in the health system to allow for that access, and as that expands, particularly around areas like HIV, also areas outside of Biosciences like TB, we are in a position to benefit from those investments. We are also getting very good growth in Biosciences in Latin America and again, a lot of that is clinical applications, which are less prone to the funding factors that would impact the research applications.

And then, I guess along the lines of destocking. You addressed it within the Pharmaceutical Systems. Did you see anything notable across any of the other businesses whether it be Medical-Surgical within BD Medical and even Preanalytical Systems?

Well, in Preanalytical during the quarter, we did initially see some destocking, but it was a mistake by the distributor and it bounced back so it neutralized itself in the quarter. But other than that -- one second, Bill has got a comment.

Medical, it was a Q1 impact. Less of an impact in the Medical-Surgical business, but Medical-Surgical impacted in Q1.

And we have seen some in microbiology in Q1 as well.

Okay. And then, I guess on the gross margin. Would you help us just kind of understand the year-to-year change specifically? What would you allocate toward the impact of foreign currency? What was kind of raw material costs plus or minus in the quarter, and kind of how should we think about raw material costs for the balance of the year?

Yes. I think, Kristen, the best way to think about that is for the half year, there was 230 basis points improvement based upon FX, the hedge and the FX translation we had in the first quarter, that inventory impact I talked about in the first quarter. That was offset in the first half by raw materials, some writedowns and some start-up costs that we had, as well as product mix. And within that is productivity improvements. So that gets you to the 150 basis point change in the first half results. What we are saying going into the second half is that that 52.7% that we had, we gave a range of where we think we'll be in the second half of the year. And as I said earlier, there's going to be more of a currency impact in the second half of the year so there will be less favorability there, but as we look at purchase price variances and our continued productivity improvements, we have confidence in the gross margins that we guided on.

Okay. Were raw materials positive or negative this quarter?

Raw materials were slightly negative when you threw everything in.

Okay. And then, anything else with other expenses? Can you break that out a little bit?

Any other expenses?

Yes.

For margin or --

Any other expense line item.

The other expense line. Oh, in other income?

Yes. Other expense.

Yes, the other interest income -- I think there was really no major movement year-on-year for the full year -- sorry, for the half-year results, the biggest driver there is our executive deferred compensation, which has an offset up in SSG&A, which we talked about in the previous quarter and other expenses, there wasn't much of a movement there.

Okay. Thanks very much

Your next question comes from Peter Lawson with Thomas Weisel Partners.

From the molecular diagnostic business, I wonder if you can give us an indication of the traction of C. difficile and the appetite for capital spending in that environment?

Sure. So, C. difficile, we had our first orders in this quarter. We are running quite a few evaluations at this point in time, and the way those evaluations work is that they compare to the traditional methodology, the EIA. They run the molecular and then they run a gold standard and look for where you get discordance results and we are seeing excellent performance out of the C. difficle product we're seeing a lot of enthusiasm from the customers, so we are very encouraged with what we are seeing out of these evaluations. So, it's kind of a typical procedure for a lab to go through.

Then on the appetite for capital spending?

Oh, the appetite on capital spending. Well, what we have seen is, while we only had a small amount of instruments that were being sold, everything has moved to reagent rental in that segment of the marketplace. So, highly reagent rental at this point in time. So, backed away from just buying it themselves.

And then into TriPath, what is the traction like for that and testing volume and any changes in competitive dynamics?

No changes in competitive dynamics. It grew about the same as it did in the first quarter, so really not much else to say about it at this point in time. So we will take one more question.

Our last question comes from James Baker with Neuberger Berman.

Good morning. I wanted to repeat that question on other expenses, because those are -- that was negative $5.7 million in this quarter which is actually the largest "other expense" item for a quarter we have seen in many years. So, could you give us some color on that?

Yes, I think the biggest thing there is the lack of $3 million from GeneOhm last year in 2008. So, it's a year-on-year comparison versus last year.

Well, but I mean, sequentially -- I mean, in general, was it a write-off of an investment. Was there a write-off of something or other -- because that's very, very rare that it is that large.

It is interest income on the GeneOhm escrow.

Well, interest income, isn't that accounted for in interest income, as in other expense? Is that what you are saying?

Yes, for that transaction, it was.

Okay. So -- but -- normally, it isn't a big negative number. That's what I am trying to drive at here.

James, what I can do is I can go through that one. I mean, it's just such a small number in the overall of things. I will follow up with you in detail after the call.

Okay, but that will not recur in future quarters; is what you are saying. We don't expect to see --

That's correct. You will not see that in future quarters.

Okay, thank you.

All right. Well, thank you all very much for joining the call and we will talk to you again soon.

Thank you. This does conclude today's teleconference. Please disconnect your lines at this time and have a wonderful day.