Beckman Coulter Inc. Q3 20078 Earnings Call Transcript

Executives

Allan Harris - Investor Relations

Scott Garrett - President and Chief Executive Officer

Charles P. Slacik - Senior Vice President and Chief Financial Officer

Analysts

Matthew Notarianni - Robert W. Baird

Bill Quirk - Piper Jaffray

David Lewis - Morgan Stanley

Tycho Peterson - JPMorgan

Bruce Jackson - RBC Capital Markets

Peter Lawson - Thomas Weisel Partners

Jon Wood - Banc of America Securities

Jeffrey Frelick - Lazard Capital

Bruce Cranna - Leerink Swann

Beckman Coulter Inc. (BEC) Q3 2008 Earnings Call October 28, 2008 5:00 PM ET

Operator

Good afternoon. At this time I would like to welcome everyone to Beckman Coulter's third quarter results conference call. (Operator Instructions) .

Mr. Harris, you may begin your conference.

Allan Harris

Good afternoon, and welcome to the Beckman Coulter third quarter 2008 conference call. A full description of the company's third quarter and year-to-date results is provided in today's earnings release. Management's comments will be based on adjusted results, which are detailed in the release.

On our call today are Scott Garrett, Chairman, President and Chief Executive Officer, and Charlie Slacik, Senior Vice President and Chief Financial Officer.

Before we begin, I want to remind you that our comments today will include predictions, estimates or other information that may be considered forward-looking. These forward-looking statements are subject to risks and uncertainties that can cause results to differ materially. We direct you to today's earnings release, as well as our most recent Form 10-K and 10-Qs, particularly under the heading Risk Factors, on file with the SEC for information on these risks. These forward-looking statements reflect our current expectations only as of the date of this presentation, and we undertake no obligations to update or revise them. Also, this discussion will include certain financial measures that were not prepared in accordance with GAAP. A copy of the earnings release, which includes non-GAAP reconciliations, is posted on our website at beckman.com.

And now with our prepared comments, here's Scott.

Scott Garrett

Good afternoon. Thanks for joining us. I am pleased to report solid results for Beckman Coulter's third quarter, and first nine months of 2008. Third quarter trends and outcomes demonstrate the stability of our sector fundamentals and the strength of our position.

As I review our results, there are four key indicators that standout. Number one, strong revenue growth. All major product areas are increasing at double-digit rates, well above the market. In total, revenue was up 13.4% in the quarter, recurring revenue up 10.4%.

Number two, Immunoassay momentum. Share gains continue. Immunoassay revenue increased by 14.6%, twice the market rate.

Number three, rapid international expansion, with all major regions continuing double-digit growth in constant currency.

Number four, operating excellence. Lean initiatives and facility consolidation efforts continue to march along, yielding opportunities for improved efficiency throughout the company.

Before reviewing our third quarter results, I will briefly summarize our solid progress for the first nine months of 2008. Recurring revenue grew, as anticipated, at a steady rate, while cash instrument revenue growth exceeded our expectations. Total revenue increased 16%, 11.9% in constant currency. The flow cytometry acquisition added about 1% to the growth rate.

Recurring revenue increased 12%, 8% in constant currency. Cash instrument sales increased 28% in constant currency, and were especially strong in emerging markets where we continue to improve our penetration and scale. China, India and our other emerging markets operations were up 47%.

Operating income increased by 12.9%, demonstrating operating expense leverage, and overcoming adverse product mix and inflationary cost pressures. Pretax profit increased 11%. Net earnings per fully diluted share increased 8.4% to $2.35, while absorbing $0.09 of dilution from our flow cytometry acquisition.

Results are on pace for achievement of our full-year revenue and earnings growth goals. In addition, we continue to fully fund the key strategic investments, including our three additional chemistry Immunoassay work cells, our molecular diagnostics project, our next generation cellular system, the Unicel DxH 800, and expansion of our sales and service infrastructure in international markets.

Now a more detailed summary of third quarter revenue on an as-reported basis, unless otherwise noted. Total revenue was $759 million, up 13.4% over third quarter 2007, up 10.2% in constant currency. Our flow cytometry acquisition added 120 basis points to the growth rate.

Revenue from Clinical Diagnostics, which represents more than 80% of total revenue, increased 13.7% over prior year, and more than 10% in constant currency. Excluding the impact of our flow cytometry acquisition, Diagnostics' cash instrument sales increased 26%, still robust, but down from 39% in the first half, due to the previously announced clearing of the cellular instruments backlog.

While we anticipate that further strengthening of the dollar may negatively impact the growth rate of cash instrument sales going forward, recurring revenue is expected to post steady growth in constant currency terms. Recurring revenue accounts for nearly 80% of our business, and continues to grow at steady rates, affording a predictable source for earnings expansion, cash flow, and investment capacity.

Clinical Diagnostics recurring revenue, the best indicator of the overall strength of our business, grew 10.8%, or 7.6% in constant currency, and expanding installed base and increasing test kit utilization drove steady gains in recurring revenue across all major product lines. Most importantly, Access Immunoassay was up nearly 18%.

Total revenue from life science customers was also up in the quarter, increasing nearly 12%, or 8.5% in constant currency. While we are pleased by the year-to-date growth of our life science business, we expect growth to moderate going forward in light of expected constraints in government-sponsored research and a stronger dollar.

I will summarize third quarter revenue results by geography. In the United States, laboratories continue to focus on quality and productivity as they contend with skilled labor shortages and rapidly growing outreach volumes. Beckman Coulter's broad product offering, automation leadership, responsive service, and deep process knowledge are especially attractive in this environment. Total revenue in the United States increased 6.8%.

Positive momentum in Clinical Diagnostics was broad based, up 7.1%, with above market growth in Access Immunoassay, autochemistry, and Cellular Analysis systems.

Outside the US, customers are facing a variety of challenges, including rapidly growing test volumes, laboratory consolidation, and shortages of skilled technicians, all of which drive demand for enhanced productivity and quality. Beckman Coulter's broad product line delivers substantial productivity improvements and bolsters laboratory quality. Customers recognize the advantages that we can uniquely create for them, as demonstrated by our continuing above market growth.

As I review international trends, revenue growth will be stated on a constant currency basis. International revenue was up nearly 14%. Revenue from Asia-Pacific was impressive, up more than 17%. Within the region, Immunoassay was the key driver of Diagnostics growth. Centrifugation was the primary contributor to life science gains.

Revenue in Europe increased by more than 10%. Growth in Clinical Diagnostics led the way, up over 11% versus prior year quarter. Within Diagnostics, Immunoassay and flow cytometry were again the greatest contributors to growth. Our leadership in clinical automation is now apparent in Europe, as evidenced by growth of more than 35%. Revenue in China, and other emerging markets, increased more than 17% in the quarter.

I will address revenue by product area. Worldwide Chemistry and Clinical Automation revenue increased 12% in the quarter, sustaining exceptionally strong growth in markets outside the US. Success in our DxC family of autochemistry systems has put us on pace for a fourth consecutive year of record placements.

We are growing our installed base in mid- to large-sized hospitals, and improving our share in international markets. Auto Chemistry revenue grew 14% on the strength of accelerating workcell placements and double-digit international growth.

In Immunoassay revenue was up 14.6% worldwide, more than twice the market rate. Immunoassay growth was especially impressive given that growth in the third quarter of 2007 was a remarkable 28%, which included a 5% contribution from our Lumigen acquisition.

Recurring revenue for our Access Immunoassay systems increased about 18%. Our Asia-Pacific, Latin America, and emerging markets operations all made impressive gains in Immunoassay. For the past several years Beckman Coulter has generated exceptional growth by selling immunoassay to our established chemistry customers. The integration of chemistry and immunoassay into workcell solutions enables even further immunoassay penetration of our chemistry base, taking maximum advantages of our industry-leading systems integration capability.

We commercialized the second workcell in our UniCel line, the DxC 880i in the first quarter of 2008. And we continue to make progress on three additional workcells, which should be released by year-end. These consolidated systems will give us great flexibility and capability in meeting customers' varied test volume and mix requirements, while providing five price points for customers versus the one or two typical of our competitors.

Further, our entire installed base of standalone DxI and DxC instruments placed in 2005 are field upgradable to workcells. Above market growth in Chemistry and Immunoassay over the last two years signals great demand for workcell solutions. In the quarter placements of workcells increased by more than 35%.

Revenue in the cellular products area increased more than 14%, with well above market growth in flow cytometry. As anticipated, cellular growth decelerated in the third quarter, as a result of clearing the instrument backlog in the first half of the year.

Sales of recently acquired flow cytometry products continued to pick up momentum, contributing 3.9% to overall growth for the cellular group of products in the third quarter.

In hematology, we remain on schedule for a fourth quarter controlled release of our next generation cellular system, the UniCel DxH 800. We expect growth rates in the Cellular Analysis segment to moderate over the remainder of 2008 and into 2009, until our DxH launch reaches full deployment, and we lap difficult comps from the first half of 2008.

In life sciences revenue increased about 12% worldwide, or 8.5% in constant currency. Double-digit growth in life science automation and centrifugation led the way, achieving high-teens constant currency growth in international markets. We expect the strengthening of the dollar and potential weakness in publicly funded research to moderate life science growth going forward.

Now I will turn it over to Charlie Slacik, who will comment on the P&L and other financial results and update our outlook. Charlie?

Charlie Slacik

Thanks Scott. Good afternoon. I will provide now some additional color on our results. As Scott has already discussed, we achieved excellent revenue growth in the quarter. Recurring revenue continued to expand at steady rates, growing at about 7% in constant currency.

The rate of recurring revenue growth was moderated by an unusually high prior year comparison. In the third quarter of 2007 recurring revenue as a proportion of total revenue was the second highest level over the last 15 quarters. Cash instrument sales grew 26% during the quarter.

The gross margin in Q3 was 46.4%, 20 basis points below the prior year, but we feel this is a reasonable margin for the period when taking into account three items. One, high cash instrument sales growth in the mix, two, 20% growth in international sales, and three, very high transportation costs experienced during the quarter, an increase of 20% versus prior year. As you know, these have been consistent themes all year long.

SG&A grew at 15% during the quarter, due in part to incremental expenses from the flow cytometry acquisition. On a constant currency basis, when excluding the incremental expenses from the acquisition, SG&A grew by 10.5%. Operating income margin was essentially on par with third quarter 2007, yielding operating income growth of 13%. This is in line with our internal expectations and objectives for the year.

Net earnings and EPS were $50 million and $0.78, respectively. Despite the healthy 13% Op income growth, net earnings were up only marginally versus the prior year due to higher non-Op expenses and higher tax rates. The non-Op expense increased $5.5 million, due primarily to higher foreign exchange related costs. The tax rate increased by 350 basis points, due to the impact of discrete items in the prior year.

I will turn briefly to discuss the balance sheet. Our accounts receivable DSO improved eight days to 83, providing good evidence that our customer base seems to be weathering the difficult credit conditions fairly well so far through the third quarter. Inventory turns have remained relatively steady at around 2.9 on a constant currency basis.

I would like to discuss our nine-month year-to-date results, together with our updated outlook for the full year. Revenue increased by 16%, or 11.9% in constant currency. Our revised outlook for the full year is for growth of between 12% and 13%. This reflects our expectation for decelerating growth in Q4 due to lower cash instrument sales growth. Year-to-date gross margin decreased 70 basis points to 46.2%, again adversely impacted by heavy instrument and international sales growth in the mix.

As I mentioned earlier, we have experienced higher than expected transportation costs this year. Freight costs are up almost $20 million versus prior year. Since the end of the quarter we have begun to see some easing in raw material and transportation costs, but neither has yet returned to prior year levels.

The total operating expense was 35.7% of revenue, compared to 36.1% for the first nine months of 2007. We expanded funding for key development programs, including our sample-to-result molecular diagnostic system. We absorbed additional operating expenses from the flow cytometry acquisition. And we extended the geographic reach and scale of our sales and service organizations.

SG&A expenses, after excluding the effects of currency and the incremental expenses from the flow cytometry acquisition, grew by approximately 11%. The improvement in the operating expense rate only partially offset the decline in gross margins, yielding a net 30 basis point decrease in operating margin to 10.5%.

Operating income was negatively impacted by a number of items, as cited in today's earnings release, including, first, continued dilution from the flow cytometry acquisition, second, a second quarter payment related to currency swap agreements embedded in the Company's facility leases, and third, incremental non-cash expenses related to changes in retirement vesting terms for our share-based compensation.

It is important to note that after absorbing an incremental $15.6 million for these expenses, our operating profit still grew 13%. This is consistent with our objectives, and in line with our plans and expectations for the year.

Non-operating expense was up versus prior year mostly due to currency related costs. We now expect non-operating expense for the full year to be approximately $45 million, a bit lower than our previous $48 million estimate, due primarily to the recent currency movements.

Pretax earnings grew 11%, again in line with our expectations. Our outlook for pretax profit growth for the full year should now be around 10%.

Turning to taxes, our nine-month rate was 27%. While this is up 130 basis points from last year's rate, it is much more favorable than our previous outlook. Our tax rate has been favorably impacted by some discrete items related to tax settlements, and also by a shift in geographic profit mix. We now expect the full year tax rate to be between 26% and 27%, slightly less than last year. This reduced tax rate also reflects the recent extension of the R&D tax credit by Congress.

Net earnings were $151.4 million, up 9.2%. EPS was $2.35 per fully diluted share, an increase of approximately 8%. This EPS result reflects a slightly higher average share account versus prior year. But as noted in today's release, we did purchase 300,000 shares during the quarter. We are still on track to achieve our EPS objective of $3.55 to $3.65 for the full year, with a share count of approximately 64.5 million.

Although we are maintaining our 2008 EPS outlook for the year, I would like to point out some major factors which have been incorporated since we last updated our outlook in July. The dollar has strengthened significantly, negatively impacting operating income for the full year by approximately $0.12. This negative impact in operating income was completely offset by currency hedging and the lower tax rate.

Turning to EBITDA and cash flow. The company's EBITDA performance has been improving steadily since we shifted to operating type leases and phased out sales type leases. As the OTL assets have built over the last three years, depreciation and amortization have been closing the gap with our OTL CapEx. EBITDA grew by $60 million or 16%. This represents solid progress toward our full year goals.

In our cash flow statement, you'll see that in our nine-month 2008 D&A has expanded by 30% versus 2007, yet during the same period CapEx has been flat.

Our updated full year outlook has depreciation and amortization at about $260 million, and CapEx of approximately $300 million. So we expect further EBITDA improvement as we continue to close this gap.

Free cash flow was $40.7 million, approximately $20 million below 2007, which included the receipt of the $40 million breakup fee from the termination of the Biosite acquisition agreement.

Now I would like to turn things back to Scott.

Scott Garrett

Thank you, Charlie. We have managed to overcome inflationary cost pressures and a mix favoring lower margin products to achieve our earnings goals for the first nine months of 2008. At the same time, we expanded our installed base, improved our penetration and scale in emerging markets, and ramped up investments in key product development areas. And operationally we achieved important milestones associated with our supply chain improvements and flow cytometry acquisition integration, further positioning our company for long-term profitability improvements.

As we improve our operations, we continue to build our lead in Clinical Diagnostics markets. The stability of these markets, and the strength of our position, give us confidence in our ability to deliver on both our annual and long-term objectives, even in an increasingly uncertain economic climate.

While no company is fully insulated from vulnerable and volatile world markets, keep these factors in mind. Nearly 80% of all revenue is derived from relatively stable hospital-based demand. Our leasing model mitigates capital expenditure cycle risk. We have a healthy balance sheet, with minimal exposure to variable rate debt, and an active hedging program to offset some of the effects of big swings in currency exchange rates. We believe these factors position us well to weather current economic risks.

We remain focused on creating shareholder value through growth, quality and operating excellence. Our priorities include sustaining the rapid growth of Immunoassay, extending our Automation leadership, developing our sample-to-result molecular diagnostics system, commercializing three additional workcells and our next generation cellular system, and achieving still greater efficiencies in operating excellence throughout our supply chain and business operations.

Charlie and I are now prepared to take your questions.

Question-and-Answer Session

Operator

(Operator Instructions) Your first question is from the line of Matthew Notarianni with Robert W. Baird.

Matthew Notarianni - Robert W. Baird

Good afternoon. Thanks for taking my questions here.

Scott Garret

Good afternoon.

Matthew Notarianni - Robert W. Baird

Scott, could you just give us a little bit more color in terms of what you are seeing in the US hospital market? Any changes here, particularly with the labs that were maybe driving towards getting towards more of an automated workcell approach? Are you seeing anything on that side?

Scott Garret

Sure. We continue to see a lot of interest in automation. The better managed hospitals around the country are focused on outreach as a way to do more testing, utilizing the fixed assets in the lab around the clock, rather than just during the morning shift where they are doing the in-patient testing. The overall interest in automation continues to be very strong.

Remember our operating type leases really insulate the customer from capital constraints. If they are interested in automation, we can get them the automation by providing the leasing with our own financing. So nothing so far to suggest that our hospital customers in the US, or anywhere in the world right now, have been slowing down in their need for improved quality and automation.

Matthew Notarianni - Robert W. Baird

Thanks for that. Then maybe, Charlie, just really quick, with the share repurchase in the quarter, could you help remind us how much is left on that authorization? How we should be thinking about, given where the stock is at, going forward your strategy on the cash deployment?

Charlie Slacik

Obviously, with the current market, we are obviously rethinking how we use our cash, but we originated authorization for $2.5 million. We have acquired $1.3 million of that to date, so we have $1.2 million remaining. Clearly, we have a strong balance sheet. We have lots of liquidity. We have cash and a lot of unused facility capacity at this point, but we want to be fairly cautious until we see where the markets play out, and so we are not actively purchasing right now. We will just watch the market and liquidity situation before we go any further.

Operator

Your next question is from the line of Bill Quirk with Piper Jaffray.

Scott Garret

Good afternoon, Bill

Bill Quirk - Piper Jaffray

Good afternoon, Scott.

Scott Garret

You are not used of doing this in the afternoon

Bill Quirk - Piper Jaffray

Fair enough, Scott. You are right; I think its first time. I have a quick question on FX and the implied fourth quarter guidance. Obviously foreign exchange is pretty volatile right now, particularly a lot of the emerging market currencies, but, Scott, if we look at the overall constant currency growth, year-to-date it has been quite impressive. This quarter obviously 12%. Now if I am doing the math correctly here, given the average for the quarter, we are looking at constant currency guidance in the 4% to 6% range for the fourth quarter. What I am trying to get to is, so essentially we are in an environment where cash sales were growing 30%, and now we are expecting them to be off something in the neighborhood of 20% to 25% in the fourth quarter. Am I doing the math correctly on those sums?

Charlie Slacik

We have a FX headwind in the fourth quarter. We are certainly expecting to. Although, as you know bill, things have been very volatile in currency markets. We want to be prudent about setting expectations in the fourth quarter, given the economic climate that we are in today.

Remember also that our fourth quarter in 2007 was aided by the backlog that we had in cellular. So we had a very big cellular instrument quarter in the fourth quarter in '07. Adding all those things together, we think it is prudent for us to just stay on track, and that is what we are predicting.

Bill Quirk - Piper Jaffray

Okay. Then Charlie, just to make sure I get things locked in on this side, what are you assuming in terms of euro and yen exchange rates? Are you assuming today's spot rate, or what should we be dialing?

Charlie Slacik

Bill, we are roughly using rates that you see today for our expectations for the rest of the year. The only thing I would add to Scott's comments is given that, we would see reported results in the fourth quarter that would probably the below the constant currency levels, given this year's fourth quarter versus last year and that is how that headwind would manifest itself in the results for Q4. So we are assuming, I think, as I said in the comments, that the rates roughly that we see today will carry out through the rest of the fourth quarter.

Bill Quirk - Piper Jaffray

Okay. Great. Then Scott, just one last question from me. Would you mind expanding on your comments about government research? Were there any specific geography where you are starting to see some pressures? Is this predominately in Asia? Are you seeing anything in Europe, and I am thinking maybe perhaps in the UK?

Scott Garret

We do not have a lot of specifics, but just given the pressure that governments are under, bailing out banking systems in most of the developed world, we are being cautious and assuming that the flow of money into the research area is not likely to be robust.

Bill Quirk - Piper Jaffray

Okay. So it is more of an assumption, if you will Scott?.

Scott Garret

Yes, it is a conservative assumption rather than an observation.

Bill Quirk - Piper Jaffray

Okay. All right. Very good. Thanks for the clarification. Appreciate it.

Charlie Slacik

Bill, this is Charlie. I just wanted to reiterate something on the fourth quarter expectations. That is maybe to reiterate something we just did in the script, which was from midyear till now, we have held our guidance on EPS, but importantly this change in the rates and the dollar strengthening took about $0.12 out of what had been in our expectations at midyear out of the Op income. So as we look at that little bit of pressure on the Op margins for the full year, that we are showing today, that does reflect that compression of the Op margin line, but offset at the non-Op and the tax rate to get back to where we were with the original guidance range.

Bill Quirk - Piper Jaffray

Is that a complete $0.12 offset on the non-Operator, Charlie?

Charlie Slacik

Yes. The non-Op plus tax.

Operator

Your next question is from the line of David Lewis with Morgan Stanley.

Scott Garret

Hi, David.

David Lewis - Morgan Stanley

How are doing?

Scott Garret

Good.

David Lewis - Morgan Stanley

Well as a westcoaster I appreciate you moving the call to the afternoon. I am on the same boat that you are on. So just to leave off here, Charlie, where we finished off, if we take that $0.12 of FX, how much of it, frankly, was tied to the tax rate? How much was offset by tax rate and how much was offset by hedging?

Charlie Slacik

It is a little of each. The passage of the R&D tax credit is probably good for maybe about $0.06. We get some of it back in tax, I mean, in the hedging. The important thing to note is that $0.12 did come out of the operating income line. At this point, given all the movement of rates, it is a little bit hard to figure out how much is going to be attributable to those two offsets, but we do feel comfortable, that is roughly about $12 million in Op income that we will get back in those two lines before we get to the net income line.

David Lewis - Morgan Stanley

Intra-quarter did you do anything different in your hedging practices?

Charlie Slacik

No, we essentially hedge a year in advance. So, this is essentially our option contracts going from negative to positive as the dollar went from weak to strong.

David Lewis - Morgan Stanley

Okay. So if we think about next year, in terms of the tax rate given the movement from the third to fourth quarter, what is a reasonable number to assume for '09 tax?

Charlie Slacik

It is still a little early, but I think what I would be comfortable telling you right now is I think our tax rate for next year should be below 30%. That ought to be a conservative number for next year.

David Lewis - Morgan Stanley

Okay. Just taking the same argument Charlie, and trying to save through margins, because obviously we are going very fast on the topline, we are not seeing a lot of it drop through to the EBIT line. Give us a sense of adjusting for currency, what operating income could have looked like here, or what you lost in terms of operating income margin here in the back half of the year because of OpEx, either gross or operating?

Charlie Slacik

Well that is the $0.12 I was referring to. If rates had stayed where they were, and the dollar hadn't gone from where it was, then that $0.12 would have ended up on the Op income line. It would have been slightly offset in the non-Op, but the other point is, you think about next year, and this is important, we managed to get the Op income up 13%. I know you might be disappointed in the actual margin itself, but we do feel good that we were able to grow the Op income year-to-date 13%, and when Scott talks about expanding the business and investing in it, and think about Dako as being an acquisition, very strategic, building up our flow cytometry business, and yet we have absorbed $0.09 of dilution on that, almost all of that Op income dilution, year-to-date.

We do not expect that to continue next year. As we look forward into Q4 and next year, we are feeling that is going be neutral. So we will not see that carry into the future periods. Also in the first nine months we had that $5 million yen swap hedge payment. That will not continue next year. We also will not have the cost of the FAS 123R expense from the changes in vesting of our stock plans. As you think about those puts and takes, currency, if it stays where it is, will be negative. It is hard to figure out exactly what that will be next year at this point, but these other items that we just went through will go a long way to offset any negative impact of a strong dollar next year.

David Lewis - Morgan Stanley

Okay. That is very helpful. Do you feel comfortable with your 12% to 12.5% EBIT margin that you had given, if it was not for currency you still would have been on the upper end of that range?

Charlie Slacik

For this year?

Scott Garret

For currency, yes…

David Lewis - Morgan Stanley

Okay. That is helpful. Scott, on molecular plans for next year in terms of filing, you still feel comfortable the number of assays, which I think you pegged as nine, getting through the clinic?

Scott Garret

We expect that in 2009 we will be completing the development of preproduction prototypes, so that we can enter 2010 in a good position to do the clinical trials that will get us on to the market late in the year in 2010. So, yes, we are still looking at a launch menu of 9 to 10 assays, that we will be adding to continuously after the launch.

David Lewis - Morgan Stanley

Okay. Thank you very much.

Scott Garret

Welcome.

Operator

Your next question is from the line of Tycho Peterson with JPMorgan.

Scott Garret

Hello Tycho.

Tycho Peterson - JPMorgan

Hi, good afternoon. Scott, maybe just picking up on one of the questions earlier about your outlook on the government and life science market, can you give us a sense as to here in the US, maybe roughly what your breakdown is in terms of academic NIH funded versus other life science customers? Are you predicting the US government funding to get worse?

Scott Garret

We are not necessarily predicting, but we are preparing ourselves for a tough academic market. While the academic market in the US is probably no more than third or so of our total sales, that is a big chunk, Tycho. If that is not growing, it is hard to grow the total. As you might know, our life sciences business is bigger outside the US than inside the US, so we still have opportunities for growth, but many of the developed countries are going to be in a similar situation to the US, where they are going to be looking for ways to save money. At least that is going to be our conservative view as we plan for 2009 and the fourth quarter of 2008. Therefore we can not really expect these robust growth rates of 12% plus to continue.

Tycho Peterson - JPMorgan.

That is helpful. I am wondering if you can comment just a little bit on the competitive landscape and whether there has been any material change in the past quarter here vis-à-vis Abbott or anybody else?

Scott Garret

We continue to believe that we are winning customers, and literally product line by product line taking them from different competitors. We have not seen any significant changes in the competitive landscape in terms of new products, new capabilities, and new promotions. More or less a similar climate to what we experienced over the last couple of years.

Tycho Peterson - JPMorgan.

Okay. As we think about the coming year and some of the levers you can pull in terms of facility closures and consolidation, can you just remind us the timing of some of the potential milestones here in the coming year in terms of going from five to two distribution centers?

Scott Garret

Sure, we are in the process of completing our US distribution consolidation. We should have that done by year end. We are in the process of completing our US distribution consolidation. We should have that done by year-end. We are closing in on the end of the Palo Alto to Indianapolis project that moves our centrifugation operations from Palo Alto to Indy and we believe that will be done by year end. Those are a couple of big ones.

We also have a long list of smaller facilities that we have accumulated throughout the last several years through acquisitions. They we are in the process of reviewing. We are going to be challenging our management team to come up with a good strategic reason to have them, or to look for a way to consolidate them as well.

Tycho Peterson - JPMorgan

Then, in terms of the ERP spend, I know you have done a big slug of that, but is there material spend in the ERP rollout for '09 planned or no?

Scott Garrett

Well, not significant. We are always going to be investing in smaller pieces to maintain state-of-the-art and extend capabilities, but that should be seen as routine.

Tycho Peterson - JPMorgan

Okay. Thank you very much.

Scott Garrett

You are welcome. Tycho.

Operator

Your next question is from the line of Bruce Jackson with RBC Capital Markets.

Scott Garrett

Hi, Bruce.

Bruce Jackson - RBC Capital Markets

First, just a macro question. There has been some concerns about capital availability in the hospital market and I was wondering if you had noticed anything like that with your customers and if it was having any impact on the demand for capital equipment?

Scott Garrett

We have not noticed it in our business but that may very well be due to the fact that we have a leasing model and not many of our customers are confined to using their own cash or capital. Our DSO is actually down, which I think is a good sign that, at least through September 30, our customers are not behaving any differently due to the current economic conditions. Although, as I said in my opening comments, no company can be totally insulated from what is going on in world markets, we think that our segment, and literally our business model, is probably in one of the better positions to be in during these kinds of difficult times.

Bruce Jackson - RBC Capital Markets

Okay, and then a follow-up to that. Can you give us just some general guidance on top line growth for 2009 in constant currency terms?

Scott Garrett

Bruce, we are going to give you that in February when we talk about our full year results.

Bruce Jackson - RBC Capital Markets

Okay. Thank you.

Scott Garrett

Thanks, Bruce.

Operator

Your next question is from the line of Peter Lawson with Thomas Weisel Partners.

Scott Garrett

Hello, Peter.

Peter Lawson - Thomas Weisel Partners

This is actually Patrick in for Peter.

Scott Garrett

Hi, Patrick.

Peter Lawson - Thomas Weisel Partners

How are you?

Scott Garrett

Good.

Peter Lawson - Thomas Weisel Partners

Can you just talk to the emerging market opportunity, and how that will limit margins if you keep expanding into them?

Scott Garrett

Well, it is an interesting phenomenon. We see two factors that tend to have downward pressure on gross margins when we expand in these emerging markets. Number one, they usually lead with more hardware. As we have rapid growth, we stay well out ahead of the ultimate equilibrium ratio of hardware to consumables and then secondly, we do make use of distributors in many of these countries, either as secondary distributors that work with our own employees on the ground, or in some cases as the primary customer facing organization.

So although we have lower gross margins, we often find that we also, due to labor rates and other favorable expenses, we have better operating income margins in those countries. So that is why we have been really focusing on improving our operating income ratio and letting the gross margin fall where it may, because we do not want to limit the growth in emerging markets, even though it will tend to put downward pressure on gross margin.

Peter Lawson - Thomas Weisel Partners

All right, great. Thank you. Could you add some color on the market in China? Is it getting more competitive over there? What are you manufacturing there?

Scott Garrett

We are manufacturing many of our chemistry reagents. We are manufacturing our bulk hematology reagents. We are looking to do more and more of that and we find the market to continue to be competitive, but also very attractive. High growth rates and the demand for literally high-end products in the many absolutely first-rate hospitals in the many large cities of China. So we tend to focus our sales efforts on the most sophisticated hospitals in China and to some peoples' surprise, there are a lot of those hospitals in China, and more of them being built every day. We believe that the government in China is following through on its commitment to the people of China to provide better and better health care for more and more of the population.

Peter Lawson - Thomas Weisel Partners

Okay, great. Thank you very much.

Scott Garrett

You are welcome.

Operator

Your next question is from the line of Jon Wood with Banc of America Securities.

Scott Garrett

Hi, Jon.

Jon Wood - Banc of America Securities

Hi, Scott. It is early. Good afternoon. So just to be clear, have you bought foreign exchange hedges for next year already?

Charlie Slacik

Yes. Generally what we do is, each quarter we go out and we buy about 12 months out, and we layer in hedges throughout the year. So at this point I think we have about 70% of our hedges placed for next year already and they are all in the form of options agreements.

Jon Wood - Banc of America Securities

Okay. So Charlie, when you say $0.12 in currency, that is basically above the operating line, and then if I look at your non-operating expense reduction of $3 million, that is about $0.03. Is that the offset on the currency?

Charlie Slacik

Yes, the benefit of the hedges offsetting the downside of the op income. So maybe just to be clear on the $0.12. From where rates were at midyear to where they are now, that $0.12 will show up as reduced margin, and that is primarily Q4, because if you realize lot of that rate did not change until October. So it is mostly a Q4 phenomenon in terms of the reduction in op margin. As you just point out, some of the offset will be the value of the hedge agreements offsetting that, again in Q4, and then the balance of that would be the tax rate improvement to get us back in the range.

Jon Wood - Banc of America Securities

Okay. So, if I look at fourth quarter, you said a lot of that currency will be manifested in the operating margin. If I take the high end, so the 13% revenue growth to get to the 355 at the bottom, I have got roughly 14% operating margin. Is that close?

Charlie Slacik

Yes. If you remember, I can not give you have specific number but if you remember, our Q4 operating margin is always strong because we have a very heavy sales quarter due to the Life Science Q4. So, last year I think it was 14.5% last year. So you are on track in terms of your trending there.

Jon Wood - Banc of America Securities

Okay. Last one, flow cytometry, if you take Dako out, is that business growing ahead of Clinical Diagnostics constant currency currently?

Scott Garrett

Yes, it is.

Jon Wood - Banc of America Securities

Scott is there any Life Science exposure in that business, meaning pharma and academic, or is it all clinical?

Scott Garrett

It is clinical and research. A lot of the research is done in labs adjacent to the hospital lab. So big university, teaching hospitals would have a flow cytometry lab that would do clinical testing and research testing. So it is not a pharma R&D sale, so much as it is a clinical research or clinical diagnostics application. So, I think it is pretty well insulated from some of the academic funding risk that I referred to earlier.

Jon Wood - Banc of America Securities

Okay. Qualitatively, I mean is the outlook there still very robust, or do you sense that what I am asking is flow cytometry more or less sensitive than the core clinical business in your opinion?

Scott Garrett

I like flow cytometry a lot. I think we have a lot to look forward to in the many applications that are yet to be introduced. So, overall I am pretty bullish on flow cytometry as a market and as a business for us.

Jon Wood - Banc of America Securities

Okay. Thanks a lot.

Scott Garrett

You are welcome.

Operator

Your final question is from the line of Jeffrey Frelick with Lazard Capital.

Scott Garrett

Hello Jeff.

Jeffrey Frelick - Lazard Capital

Hey Scott. Can you give us some sense, what product line contribute most to cash sales in the quarter?

Scott Garrett

Let me think. Charlie, what do you think?

Charlie Slacik

Well, obviously Life Sciences, chemistry has been…

Scott Garrett

We have got Life Science cash sales. We have…

Charlie Slacik

Chemistry and automation has been strong in terms of cash sales as well.

Scott Garrett

Then, hematology has always got a high component of cash.

Charlie Slacik

Right. That is right. Those would be the three, Life Science, chemistry, automation and Hematology.

Jeffrey Frelick - Lazard Capital

Okay. Then what was the installed base growth for emerging markets in the quarter?

Scott Garrett

We have never disclosed that number, so I do not even have a good feel for it. It is certainly significant, we are adding customers. We have got significant sales of instruments in emerging markets, but we have not ever disclosed the installed base.

Jeffrey Frelick - Lazard Capital

Okay. Maybe just to help us understand the customer there; how would you characterize, maybe if you equate them to a US hospital lab sizewise, is it a small lab or is it…?

Scott Garrett

It varies country by country. As I was saying in China, the big hospitals in the coastal cities tend to be very sophisticated, very large. We have total lab automation customers in several of those hospitals throughout China. In India, we see a similar, if not exactly the same trend, where although labor is relatively inexpensive, trained medical technologists are still in short supply. So there is an interest in work cells. There is an interest in highly productive automated systems, and even total lab automation in India.

Jeffrey Frelick - Lazard Capital

Okay. Just to get a sense of when we start recognizing some benefit in emerging markets from the consumable trail how do the systems and the platforms lag the US market as far as methods or assays on the…?

Scott Garrett

Yes. I see what you mean. The utilization in emerging markets tends to be somewhat less in immunoassay. It tends to be a little bit less in chemistry, and tends to be pretty much spot on in hematology. So, those are the three big categories. That is the way I see it.

Jeffrey Frelick - Lazard Capital

Okay. Thank you.

Scott Garrett

Welcome.

Operator

Your next question is from the line of Bruce Cranna with Leerink Swann.

Scott Garrett

Hey Bruce.