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Beckman Coulter, Inc. (NYSE:BEC)

Q4 2008 Earnings Call Transcript

February 9, 2009 5:00 pm ET

Executives

Allan D. Harris – Director, Investor Relations

Scott Garrett – President & Chief Executive Officer

Charles P. Slacik – Senior Vice President & Chief Financial Officer

Analysts

David Lewis – Morgan Stanley

Tycho Peterson – JPMorgan

Sara Michelmore – Cowen & Co.

John Wood – Banc of America Securities

William Quirk – Piper Jaffray

Quintin J. Lai – Robert W. Baird

Eric Criscuolo – Thomas Weisel Partners

Operator

Good afternoon. My name is Christian and I’ll be your conference operator today. At this time, I would like to welcome everyone to the Beckman Coulter’s fourth quarter and year-end results conference call. All lines have been placed on mute to prevent any background noise. After the speakers’ remarks, there will be a question-and-answer session. (Operator Instructions).

Thank you. Mr. Allan Harris, you may begin your conference.

Allan Harris

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

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 could 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 a non-GAAP reconciliation, is posted on our website at beckmancoulter.com.

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

Scott Garrett

Good afternoon and thanks for joining us. As we review our results today, please keep in mind four key factors that characterize our performance in the fourth quarter and for the year.

First, solid revenue growth. Constant currency revenue growth was 6.6% for the quarter and 10.4% for the year. On a constant currency basis clinical diagnostics grew 9% in the quarter and the 11.6% for the year. Second, sustained above market growth in Diagnostics. Immunoassay continues to lead the way. Access Immunoassay revenue was up more than 20%, nearly 3 times the market rate in the quarter and in the year. And Diagnostics recurring revenue growth continued increasing by 9.6% for the quarter and 9% for the year on a constant currency basis.

Third, another year of significant new product introductions. The five major system launches and significant progress on our sample-to-result molecular diagnostics instrument. We demonstrated the unrivaled productivity of our pipeline and positioned the company for continued above market growth.

And fourth, significant expansion of cash flow and earnings. For the full year, operating cash flow grew more than $75 million. Adjusted EBITDA increased more than 14% and adjusted fully diluted earnings per share grew 11.7%, well within our 2008 outlook range.

Now, I’ll begin a more detailed summary of fourth quarter and full year revenue on an as reported basis.

For the full year, revenue was $3.1 billion up 12.2% over 2007, or about 10% in constant currency. Our flow cytometry acquisition added 140 basis points to the growth rate. Also for the full year, recurring revenue, the best indicator of the overall strength of our business grew 8% in constant currency to $2.4 billion or approximately 78% of total revenue.

The continued buildup of lease payments and growth of highly profitable consumable sales delivered consistent recurring revenue gains in the 7% to 9% range all year. In constant currency, Clinical Diagnostics recurring revenue was up 9% and Life Sciences up just 1%.

In the fourth quarter, Clinical Diagnostics recurring revenue growth was up 9.6% in constant currency. Total cash instrument sales declined as expected. On a reported basis, cash instrument sales grew more than 30% through the first nine months then declined about 4% in the fourth quarter largely due to a challenging comparison to Q4 ’07 and softness in Life Sciences demand.

We are preparing for continued declines in cash instrument sales in the first half of 2009, due to a stronger dollar, difficult comps and an uncertain outlook for the economy in general. However, steady gains in recurring revenue, which account for approximately 78% of total revenue, should continue to provide a predictable source for earnings expansion, cash flow and investment capacity.

Now I will summarize revenue performance by geography. In the United States, laboratories continue to focus on overall process efficiency in their operations, favoring our broad product offering, expanding work cells portfolio, and progressive automation solutions. For the full year, U.S. revenue was up 8.2%, driven by growth of approximately 9% in Diagnostics.

In the fourth quarter, strong U.S. revenue gains continued increasing 7.4%. Clinical Diagnostics was up 9% while Life Sciences revenue was flat. Diagnostics growth was lead by steady strong performance in Access Immunoassay., up more than 22% and clinical automation up more than 35%.

Now I will discuss international revenue in constant currency. For the full year, revenue from international operations grew 12.7% lead by strong sales of Clinical Diagnostics products up 15% over prior year. International Life Sciences revenue was up 3% lead by gains in centrifugation in Life Sciences automation. Europe was up nearly 9% on 12% Diagnostics growth. Asia Pacific was especially strong up 16% lead by China with growth of approximately 25%. Exceptional cash instrument sales in developing countries, especially in the first half of 2008 are expected to drive recurring revenue gains going forward.

In the fourth quarter, international revenue was up 5.8%, with sales of Diagnostics products up 9.7%, partially offset by 6% decrease in Life Sciences revenue. Europe was up 8% on sustained immunoassay strength. Asia Pacific revenue was flat with strong contributions from immunoassay and flow cytometry offset by continued weakness in Japan and a 15% decrease in Life Sciences revenue. The comparative downturn in Life Sciences was partially the result of an effort to more evenly pace revenue throughout the year.

Now I will address revenue by product area on an as reported basis unless otherwise stated. For the Chemistry and Clinical Automation product area, revenue for the full year was up 10.2% driven by the continued success of the UniCel DxC, Auto Chemistry instruments and sustained gains in Clinical Automation. Auto Chemistry maintained its above market growth posting double-digit revenue gains on the year.

Clinical Automation, long a leadership position, enjoyed continued success growing at about 25% for the year. For the fourth quarter, Chemistry and Clinical Automation revenue was flat, increasing 3.5% in constant currency. International placements of new Auto Chemistry systems were especially strong in the fourth quarter leading to a fourth straight record year of Unicel DxC instrument placements. Approximately 30% of Unicel DxC Auto Chemistry units displaced competitors.

In 2008, we introduced four new chemistry-immunoassay work cells completing the broadest, most capable work cell lineup in the industry by far. Our variety of new systems uniquely positions us to match customers needs, based on their specific test mix and volume requirements at multiple price points. Looking forward to 2009, we should sustain our momentum in chemistry as we fully commercialize the three work cells introduced in late December 2008.

In immunoassay, revenue increased about 19% for the full year with double-digit growth across all major geographies. Access immunoassay sales for the year grew 22% worldwide accelerating from 2007 growth rates, which were already well above market rates.

Unit placements were up considerably, driven by solid demand from mid-to-high volume hospital laboratories. For the fourth quarter, immunoassay revenue increased 15%, about 19% in constant currency with growth of twice the market rate or more in all major geographies. Growth of access recurring revenue was especially encouraging, up more than 20% on a constant currency basis.

Our success in immunoassay has been greatly facilitated by selling immunoassay products to our broad base of loyal chemistry customers. Accelerating placements of work cells in the quarter provide confidence that we can sustain penetration of our chemistry base.

In the fourth quarter, work cell placements increased by more than 65%. We’re meeting strong demand for labor saving instruments with the most capable combination of immunoassay and chemistry systems in the industry.

In molecular diagnostics, our DxN project remains on track. Our goal is delivery of a sample-to-result molecular testing system for the central lab in the next few years. As stated in December at our Annual Business Review, we are making excellent progress. Our 2008 goals were achieved as we performed extensive testing and fully functioning prototype systems.

High growth of total and recurring revenue yielded increased investment capacity and allowed us to reach a stable run rate for molecular diagnostics R&D investment in 2008. We expect to maintain this level in 2009.

In our cellular products area, revenue for the full year was up 13.5% led by above market growth flow cytometry. Our flow cytometry acquisition added 470 basis points to the overall cellular growth rate.

Cellular Analysis growth in the first half of the year was more than 18% due to heightened cash instrument sales as we eliminated a backlog carried forward from 2007. With no backlog entering 2009, we have lower expectations for cellular cash instrument sales. In the fourth quarter, cellular revenue increased 4.2% or 8% in constant currency led by strength in international markets and accelerating sales of flow cytometry products.

Placements of the industry leading high performance cell sorter and a highly capable nine-color research analyzer nearly doubled versus third quarter. Increased sales and placements turned the acquisition accretive in the quarter as expected. We added breadth and we are building momentum. Our flow cytometry business is positioned to extend these gains in 2009.

In December, we introduced our next generation cellular analysis system, the UniCel DxH 800. The DxH features improved optics and algorithms as well as enhanced automation and remote service capabilities. Much more than a hematology analyzer, the DxH is the first in a series of several innovative products, targeted for introduction over the next three years. We intend to transform cellular analysis, significantly improving laboratory workflow, extending the test menu and enhancing the value of the cellular business.

In the Life Sciences product area, revenue for the full year increased 6%, driven by gains and centrifugation at Life Sciences automation. While growth moderated in the second half as the dollar strengthened, low teens growth in the first half drove higher than anticipated full year growth in Life Sciences. In the fourth quarter, Life Sciences sales were half, more than 7% or down approximately 4% in constant currency impacted by declines in international markets. We’re pleased with the overall performance of our Life Sciences business. Sustainable leadership positions continued to contribute profit with modest levels of investment.

Now I’ll turn the call over the Charlie Slacik, who will comment on the P&L and other financial results. Charlie?

Charles Slacik

Thank you, Scott. A full description of today's fourth quarter and full year results is provided in today's earnings release. I'll provide some additional color now on our adjusted results unless otherwise stated. To start, I will make some brief comments on the fourth quarter and then more extensive comments on the full year results.

In the last quarter, despite a considerable currency headwind in the fourth quarter, gross margin improved by about 70 basis points to 47.5%, compared to 2007. SG&A grew modestly up 2.2%, which resulted in flat operating expenses as a percentage of sales versus the prior year quarter.

We've been very active in expense management this effort together with the improving gross margins, yielded an operating margin of 15.2% and gives us good momentum as we implement our plan to achieve zero overhead growth in 2009.

Non-operating expense increased about $4 million, primarily due to additional interest expense associated with tax liabilities. This resulted in pretax profit growth of about 5%. Our tax rate decreased from 33% to 24.4% due primarily to R&E tax credits. This is inline with our previous outlook. Net earnings grew 18%, to $82.3 million, or $1.29 per fully diluted share. This result was also right on track with our full year outlook.

I’ll now focus more extensively on our full year results. Overall, I would like to say that the management is very satisfied to have delivered on our earnings projections for the year. These results are the outcome of two things: one, a resilient recurring revenue base together with, two, a conservative cost control effort in the phase of a strong dollar in the second half and high transportation costs all year.

Reported revenue grew at a robust pace 12%, or 10.4% in constant currency. Growth was driven in part by very strong cash instrument sales in the first nine months. On a constant currency basis, recurring revenue grew consistently in the 7% to 9% range throughout the year. As you know, this is our most closely watched business parameter, especially as we look forward to 2009.

For the full year, gross margin was 46.6%, about 30 basis points below the 2007 levels. This was largely due to higher transportation cost and very strong sales of cash instruments internationally during the first nine months of the year. During the period of the weak dollar, we used this opportunity to expand our business overseas especially in developing countries. Although this will be a great long-term benefit, in the 2008 year, the high level of international instrument sales did depress overall margins for the company.

This is a good time for me to point out some new P&L disclosures introduced in today's earnings release. I think this new data will underscore our razor blade business model. We are now breaking out revenue in cost of sales for both recurring revenue and cash instruments sales in the P&L. With this new information, you can see that while recurring revenue grew at a steady rate this year, the cash instrument sales grew by almost 20%. As you can also observe from the geographic schedule, this was largely driven by growth in the developing countries.

From this new P&L breakout, you can now see that the cash instrument gross margin in 2008 was 18%, compared to 55% for recurring revenue. This new data makes it pretty clear that our recent overseas expansion has had the upfront impact of reducing gross margins as we place more razor handles. You can also determine from the new P&L data that the gross margin on the recurring revenue stream, the razor blades is very stable. The slight reduction you'll see in 2008 from 56% to 55% gross margin was primarily driven by the higher growth rate in developing countries.

Now turning to operating expenses. SG&A expense excluding the effects of currency and incremental expense from our flow cytometry acquisition grew approximately 10% as we ramped up infrastructure investments in developing markets. As I noted earlier, the fourth quarter results demonstrate our intended slowing rate of growth for these expenses.

Growth in R&D investments slowed slightly in the second half, resulting in a 30 basis point decline in operating expenses as a percentage of revenue for the full year. We funded significant R&D programs for the success during the year delivering four new work cells as well as the next generation cellular analysis system. Also spending in our molecular diagnostics program was ramped up significantly over the 2007 run rate.

Operating leverage and expense management in the second half allowed us to deliver an operating income growth of 11%, and an operating margin on par with 2007. This is a positive outcome given the significant growth in overseas cash instrument sales as well as international infrastructure expansion. Non-operating expenses were $47.9 million. They increased this year by $11 million driven by higher currency related expenses.

Turning now to taxes. The lower tax rate in the fourth quarter yielded a full year adjusted tax rate of 26% at the low end of our outlook range and 230 basis points lower than 2007. Additional R&E tax credits and a shift in the geographic profit mix were the primary factors bringing the rate down. You will see in our outlook that we expect to maintain a similar rate of 26% to 27% in 2009.

Adjusted net earnings for 2008 were approximately $234 million, or $3.63 per fully diluted share, an increase of 12% over 2007. So, despite elevated sales of cash instruments, international business expansion, fluctuations in currency and higher transportation costs, we were able to deliver an EPS near the top of our outlook range. This profit growth is very much inline with our company objectives.

Now turning to cash flow and the balance sheet. This year's earnings performance was complemented by equally positive results from cash flow and EBITDA. Operating cash flow grew more than $75 million, or 19.6% to $475 million and free cash flow increased by more than $50 million to $175 million. These were especially good comparisons considering 2007 included a $41 million breakup fee related to the Biosite transaction.

As noted in prior periods, the company's EBITDA performance has been growing at a rate faster than net earnings since we shifted to operating-type leases from sales-type leases in 2005. As OTL assets have built over the last three years, depreciation and amortization have been closing the gap with OTL CapEx.

In the cash flow report, you'll see that the gap between CapEx and depreciation and amortization continues to narrow. The GAAP in 2008 was $44 million, which was down from $72 million in 2007. One another important point on CapEx. Our CapEx associated with OTL instrument placements increased to approximately $208 million this year.

This one shows that increased cash instrument sales did not slow OTL placements, and two, it also gives us confidence that our positive momentum in recurring revenue is supported by an expanding OTL asset base. As a result, 2008 adjusted EBITDA increased more than 14% to $619 million. We expect this EBITDA growth trend to continue in 2009.

The company’s year-end balance sheet should also be a good indicator of our focus on fundamentals. This significant improvement in cash flow allowed us to reduce debt by $70 million while also improving cash balances by almost $40 million.

Our accounts receivable DSO improved from 96 to 83 days demonstrating two things, one that our customers are managing difficult credit market conditions pretty well and two our active management of receivables particularly given the expansion in developing countries. An aggressive management of inventory levels resulted in a reduction of $28 million and improved turns from 3 to 3.4 on a constant currency basis. The inventory reduction was partially the outcome of intentionally lowered production volume in the fourth quarter. One negative outcome will be higher product cost in the first four months of 2009.

The higher product cost should negatively impact gross profit by approximately $7 million mostly in the first quarter of 2009. We continue to emphasize operating excellence and complement this with our focus on Lean Six-Sigma.

In 2008, we successfully completed the consolidation and closure of several facilities and we are now turning our attention in 2009 to the consolidation of our Southern California facilities. We are also committed to zero overhead growth in 2009. We've prioritized investments, eliminated pay increases across the company and we are managing head count, all directed to limit growth and operating expenses.

Because we are planning for slowed revenue growth in 2009, especially for cash instruments sales, strict expense management will be essential to deliver on our earnings outlook. We will continue to share additional details of our Lean program to supply chain improvements and the other cost control initiatives throughout the year.

And now I’ll turn things back to Scott who will provide full year 2009 outlook, but I would like to just mention and keep in mind that our 2009 outlook has not yet been adjusted for changes related to the accounting of convertible debt securities under APB 14-1. The details are provided in the earnings release today.

Thanks and I will turn the things back to Scott.

Scott Garrett

Thank you, Charlie. Our 2008 results confirm the ongoing strength of our Clinical Diagnostics business. Double-digit constant currency sales growth was above market growth across all major geographies, demonstrating the positive momentum of our current position, and extensive gains in emerging markets providing scale and a foundation for future recurring revenue growth. Steady diagnostics recurring revenue growth up 9% in 2008 generates predictable future growth and revenue earnings and investment capacity.

Introduction of five major systems and sustained progress on our molecular diagnostics sample-to-result system proves our development pipelines’ unrivaled productivity. Acquisition and integration of new products and technologies was positive as we demonstrated feasibility of breakthrough immunoassay technology, acquired higher value tests in immunoassay molecular diagnostics, and bolstered our position in flow cytometry effectively integrating our 2007 acquisition.

But most importantly, we managed through difficult credit markets, volatile currency swings and escalating commodity prices, to deliver our 2008 earrings goals on target.

Turning our attention to 2009, we will continue our progress. Please be aware that we have taken the uncertain economic environment into consideration in our planning. We believe that our revenue outlook is prudently cautious and our spending appropriately gauge to this conservative forecast. At currently prevailing exchange rates, we expect reported revenue to be flat. On a constant currency basis, our outlook for revenue growth is 46% driven by recurring revenue growth in the 6% to 7% range.

In an uncertain economic climate, we anticipate that cash instrument sales should decline on the year especially in the first half relative to 2007 when cash instrument sales grew over 30%.

Operating margin for the year should be in the 11.7% to 12% range after absorbing about $25 million of increased pension expense and a considerable currency headwind. At current rates, non-operating expenses expected to be around $22 million, decreasing from 2008 levels due to anticipated gains on hedging contracts. Based on an expected tax rate of 26% to 27% in a flat share count, earnings per diluted share should be $3.85 to $4.05.

Pacing of net earnings are planned to be uneven, with as much as 65% of net earnings expected to come in the second half of the year, due to currency shifts and slowed growth in cash instrument sales, largely impacting the first half. Capital expenditures are expected to be $350 million to $375 million including roughly $50 million for the Orange County consolidation project and depreciation and amortization should be between $270 million and $290 million.

We remain focused on creating shareholder value through growth, quality and operating excellence. The operating environment in 2009 will no doubt present challenge. However we are confident that by focusing our team on continued recurring revenue growth and holding operating expenses to 2008 levels, we should be able to deliver on our earnings goals this year. We have a solid foundation for recurring revenue growth including an expanding base in emerging markets, long standing above market growth in immunoassay and an enhanced product lineup throughout our Diagnostics business.

Also we have well established cost management initiatives including reducing employment to 2007 levels mostly through attrition, suspending pay increases for 2009 and carefully reprioritizing investments in R&D and business initiatives.

We demonstrated solid expense control in the fourth quarter of 2008 while maintaining high levels of recurring revenue growth. We will maintain this focus in 2009 and are committed to deliver on our earnings goals for the year.

Charlie and I are now prepared to take your questions.

Question-and-Answer Session

Operator

(Operator Instructions) Our first question comes from the line of David Lewis with Morgan Stanley. Please go ahead with your question.

David Lewis – Morgan Stanley

Hi good afternoon.

Scott Garret

Hi David.

David Lewis – Morgan Stanley

Few quick questions here Scott. I guess first talking about the environment. Historically you had been very aggressive on certain competitors whether it be Abbott and others. At last year were seen kind of two different changes in the competitive environment: one being, a lot of senior management changes at Siemens, a lot of disruptions at Siemens and of course Abbott has been very public in talking about their ability to hold, desire to be focused on profit and not growth. Can you talk about the implications for those two competitors stated changes to their business will have in ’09 and perhaps 2010 results?

Scott Garrett

I would expect that in ’09 we will see a continuation of the approach that Siemens and Abbott took in 2008. I think Siemens is very much focused on the overall consolidation of the many product lines that they have acquired and Abbott appears to be very intent on moving clinical testing outside the Central Lab with patient self-testing and some near patients initiatives. I wouldn’t expect that to change in a material way in ’09.

David Lewis – Morgan Stanley

Okay, that’s helpful, and Scott help us. You made a interesting comment about the number of your placement that actually were competitive wins. I think the number was 43% or 46%. Help us to think about how you expect that number to trend in 2009 and what should we think about in terms of the downstream implications to recurring revenue or essentially assay growth if you are not able to place as many boxes in 2009. I’m thinking more sort of over the next 18 to 24 months. What implications would this change have on your ability place boxes having in your core business or recurring business?

Scott Garrett

Okay just a couple, you got a lot of information into that question. Let me try to answer it completely. First of all, we quoted a number of 30% in terms of competitive displacements in our chemistry product line. And that’s the historical number since we launched the DxC series and it continues and we expect it to continue. So, that’s number one. Number two, I think we can sustain our recurring revenue and it's important to note David that there is big difference between the slowdown in cash sales of instruments and the slow down of competitive wins and expansion of our market share. Remember our leasing program has also been accelerating and we think in an environment as we see it today, we'll see more and more customers who might have been using cash in the past opt for leases in the future. So, we have tremendous momentum in virtually all of our product lines in Diagnostics and we expect to continue to win and expand our market share across the board and continue our recurring revenue growth. However we've moderated the expectation to about 6% to 7% in constant currency going into next year for recurring revenue down from the 7% to 9% that we've been quoting in recent years. Just to be prudent about the impact of the global economy on all industry sectors and to some degree on healthcare.

David Lewis – Morgan Stanley

Okay. That’s a great answer to my confusing question. Sorry Scott. Two more quick ones for Charlie and I'll jump back in queue. Charlie I may have missed it but your outlook for gross margins and free cash flow for 2009?

Charles Slacik

We didn't give one for gross margin, David. We gave one for operating margin, which was 11.7 to 12. And one of the reasons, we specifically didn’t given in for gross margin as you can see it when you digest today's earnings release and if you look at P&L in the attachments and you'll see that the gross margin on hardware moves around a lot where the margin for recurring revenue is pretty stable. So as we talked about on the last few calls, we've been really focused on the operating margin as opposed to the gross margin, just due to fact that we’ve got a lot of growth going on in both hardware as well as the geographic mix. As I know, Scott has talked about on a couple calls, we’ve had a lot of growth in developing markets around the world. And as a the general rule, we're going to take a hit on those hardware places. It's not only because it’s hardware but because if those markets and we have distributors in many of those markets too. So, even those markets might have real positive operating margin impact. It does depress the gross margin upfront and we have also said sometimes, which is kind of a deserve is that the gross margin is kind of reversely a leading indicator when it goes down because that does signal large placements of hardware particularly in new markets overseas. So that’s why our focus has been more on building the operating margin and the gross margin todate. That’s was the first question there, next one?

David Lewis – Morgan Stanley

Yeah, just free cash flow.

Charles Slacik

Free cash flow we haven’t and I’m giving but you can pretty much discern it from the data we gave you. I think we gave the operating cash flow number and a range on CapEx, didn’t we?

David Lewis – Morgan Stanley

I was just coming out with free cash flow numbers that were flat to maybe slightly down from 2008. Is that close or am I doing the math wrong?

Charles Slacik

The variable that you are picking up is on the CapEx. It’s important to note that while this year’s CapEx is pretty much down that you would expect. We do have a one-time event coming up in 2009 and that’s going to be the reconstruction if you will of our (inaudible) campus. We expect to invest $50 million to $60 million to renovate that campus and probably also important to note that although that will pop up in the CapEx in '09, we would expect that we're going to probably recoup most if not - all of that investment in 2010 or '11 when we sell the Fullerton Campus. So, that will probably lag by a year or two after we vacate, but net–net we expect that the net proceeds will offset the investment in the new site. But that doesn’t ramp up the CapEx number to a number that’s about $50 million to $75 million more than we would normally spend.

David Lewis – Morgan Stanley

Great, very helpful thank you very much.

Scott Garret

You are welcome.

Charles Slacik

Okay.

Operator

Our next question comes from the line of Tycho Peterson with JPMorgan. Please go ahead with your question.

Tycho Peterson – JPMorgan

Hey good afternoon.

Scott Garret

Good afternoon.

Tycho Peterson – JPMorgan

Scott, in your comment you talked a little bit about Japan. Can you talk more specifically about what some of the issues were there and then what are your thoughts on generally on Asia for this year. I mean I think you also called that Life Sciences has been particularly problematic in Asia. So if you could comment on that too.

Scott Garret

Japan continues to be a problematic market. I think it’s not at all unique to us. We've had historically a fairly strong Life Sciences business. Life Sciences has slowed down around the world and Japan is no exception. In addition the reimbursement and just the outlook in Clinical Diagnostics in Japan is pretty flat. So we weren't able to really grow that business much in the fourth quarter nor did it growth a lot in the year. Overall in Asia though we had an outstanding year with terrific growth in just about every country except Japan, a great start in Korea where we have a direct organization now for a good part of our business and continuing big gains in China. And the fourth quarter flattened out a bit based on comparisons to the prior year and also pacing Life Sciences primarily in Asia where we had been seeing a very big spikes in the fourth quarter historically and we put in some incentive plans to even that out throughout the year.

Tycho Peterson – JPMorgan

Okay, that’s helpful. In terms of some of the cost levers that you talked about pulling and going back to Analyst Day in December when you also talked about potentially being able to reprioritize some of the R&D investments. Has anything meaningfully changed there in terms of what you laid out for your R&D strategy over the coming year-end and some of those projects that were highlighted?

Scott Garrett

No we were very consistent. We highlighted the most prominent and the most impactful projects and those are the ones that are still at the top of the priority list. We deferred some of the longer-term and lesser projects in order to keep our spending inline with 2008.

Tycho Peterson – JPMorgan

And in terms of the introduction this year, you have talked about the meta flow maybe midyear, is that still on track for a media launch?

Scott Garrett

Yes it is.

Tycho Peterson – JPMorgan

Okay. And then just one last one. I think you had talked in the past around the share gains going back to David's question versus Siemens and Abbott about maybe 2% or so in competitive wins, is that still reasonable to think about for the share?

Scott Garrett

I don’t think we’ve quoted a number like that. We've consistently talked about the competitive wins in Auto Chemistry and that continues at a very predictable 30% clip and I expect that’s going to continue.

Tycho Peterson – JPMorgan

Okay. I guess one last one on M&A. Are you seeing anything interesting there, given the price of deals these days?

Scott Garrett

As you know Tycho, we were always screening opportunities. We have done four significant acquisitions over the last three or four years. Spent probably close to $0.5 billion and we're very pleased with the way we've been able to integrate those four acquisitions. We continue to be actively screening and of course we can’t comment on any specific situation.

Tycho Peterson – JPMorgan

Okay, fair enough. Thank you.

Scott Garrett

Thanks Tycho.

Operator

Our next question comes from the line of Sara Michelmore with Cowen & Co. Please go ahead with your question.

Sara Michelmore – Cowen & Co.

Thank you.

Scott Garrett

Hi Sara.

Sara Michelmore – Cowen & Co.

Hi, how are you?

Scott Garrett

Good, how are you?

Sara Michelmore – Cowen & Co.

Good. Scott I think I know you are going to say and I'm sorry to split hairs but in terms of the detailed outlook you guys commented, there are a few differences versus the preliminary outlook, you guys provided back at the Investor Day. And one specifically was I think back then you talked about cash instrument sales being flat to down and today you were clearly talking about the cash instrument portion of the sales being down. So I was wondering if you could just comment on that and then secondarily just kind of running through the math here. It does look like organic revenue growth if I guess constant currency growth, did you guys call it, is probably going to be flat. Maybe even down on one of the first quarters of the year. So I’m just hoping that you could give us little more color on how that revenue is going to trend in terms of the variety around that 4% to 6% constant currency revenue growth target?

Scott Garrett

The constant currency recurring revenue growth is going to be pretty consistent and predictable all year. And that’s the nice thing about recurring revenue is that it’s very predictable, gets into a slot and then gives us an opportunity to plan our business around it. It’s the cash hardware sales that are going to be down in terms of what we expect to be the percentage of systems that go out on a cash basis versus a lease basis. And also the currency in the first half is going to have a significant downward impact. So, those are the factors there and I don’t think anything has really changed in our feelings about what to expect, since we gave that preliminary outlook in December.

Sara Michelmore – Cowen & Co.

Okay. Well in terms of the first half of the year though, in terms of constant currency growth, are we going to be flat down low single-digit? What exactly is that comparison there. How bad is that cash instrument comparison going to be in the first half of the year?

Scott Garrett

The cash instruments will be down compared to the prior year in the first half.

Sara Michelmore – Cowen & Co.

Right but I mean total revenue that you guys reported. I just want to model this well Scott, make sure we are doing the models right on the revenue.

Scott Garrett

Well we're talking about on a reported basis being flat for the full year Sara. And we are talking about later the currency being a big factor especially in the first half. So, we know we don’t give quarterly guidance anymore. We are giving you the full year outlook. And I think the pacing as I referred to it in the call just now we expect fully 65% of our net earnings to come in the second half of the year. So, hopefully that helps you a little bit.

Sara Michelmore – Cowen & Co.

Okay, that’s needless to say that cellular systems and the clinical chemistry is where we should think about the comparison as being most difficult?

Scott Garrett

Especially, in the cellular systems, yes.

Sara Michelmore – Cowen & Co.

Okay. All right. And I guess Charlie in terms of operating margins too it seems like you guys are going to get stronger benefit clearly in the back half of the year versus the first half of the year?

Charles Slacik

Yeah as the currency will have more effect in the first half - downward effect in the first half versus the second half because the dollar did most of its strengthening in the second half this past year. The things that affected that are changing, the pension expenses we talked about really has a kind that affect that are changing, the pension expenses we talked about really has a kind of a flat effect all year. But the currency and the hardware really do effect the total revenue and therefore the operating margin pretty heavily in the first half.

Sara Michelmore – Cowen & Co.

Okay, and then just to clarify your comment on the gross margins in Q4 and then the ongoing drag. It’s not a I guess a huge revenue number but should we think about that you sort of offsetting that totally in Q1?

Charles Slacik

No, that…

Sara Michelmore – Cowen & Co.

And I’m not sure what the exact quantification was of the impact in Q1?

Charles Slacik

Let me clarify that. It wasn’t a revenue impact at all. What it represents is we’ve really been working on improving our cash flow. As we got towards the back half of 2008 we worked down production levels gradually in our plants. And so that’s what gave us some of the benefit of improved cash flow for the year. So it’s just really ramping down production to get more inline with things like built to install. So as a result in the fourth quarter of '08 we produced fewer instruments and as a result of that lower volume of production, as a result the unit cost of production goes up and those instruments that were produced in the fourth quarter gets sold primarily in the first quarter of '09, and so as a result those unit costs go up, isn’t just pure accounting at this point. So, the first quarter will show depressed margin primarily because of that. I recall almost one-time action of reducing our production volumes to get the inventories down. So, that will wash through in the first quarter and again exacerbate some of those other issues we talked about both currency and the hardware volumes, so to push down our first quarter results.

Sara Michelmore – Cowen & Co.

Okay.

Charles Slacik

As Scott said earlier in terms of model building you recognized the fact that we are going to hit 65% of our total income in the second half. It should be calibrate around that 35% in the first half.

Operator

Our next question comes from the line of Jon Wood with Banc of America Securities, please go ahead with your question, sir.

Charles Slacik

Hello Jon.

Jon Wood – Banc of America

Hey, thanks, afternoon.

Charles Slacik

Good afternoon.

Jon Wood – Banc of America

Hey so Charlie, it looks like the midpoint of the EPS growth guidance is 9% or so. So a little bit below the outlook at the Investor Day, but it looks like the pension, the incremental pension costs are 4% worse if you will from the $0.10 to $0.15 that you gave at the Investor Day. So what's the offset basically? It is just a better-cost experience than originally planned?

Charles Slacik

Yeah, if I think about the things that changed in December, Jon, pension would be one of them. We have that range and you are pretty right. You got that 9% as the midpoint of the range. We would love to make it 10 to 12 but, we recognize between the pension increase and the currency just going to be hard to try to deliver, at 12% after a good '08. One of the things I did change since our Investor Day was the discount rate for pension assets got solidified in the back half of December. And there is a lot of people who go through this now and I think somebody's have rode up. The discount rate dropped I think we had anticipate being 7.5% down to 6.25%. And so as a result the pension expense bubbled up, my guess I think about $10 million more than we estimated when we talked to you in December. So, that put a little pressure on our objectives at hitting 10% growth. But we've done a lot of things since then two, which is as Scott talked about a length, which was managing the priorities, basically eliminating pay increases this year and the Izog initiative. So it allowed us to get real close back to that objective and you recognize there is a still lot of variables in ’09, whether its currencies or hardware mix, that’s why we have that midpoint that you've obviously computed well at 9% at the midpoint of the range.

Jon Wood – Banc of America

So, the incremental pension cost of 25 that's said at this point, I mean the discount rate is it doesn’t change again through ’09. I mean should we view that as a hard figure at this point?

Charles Slacik

Yeah, if there is anything we do know about 2009 sitting here in January or February that’s what our pension expense will be.

Jon Wood – Banc of America

Okay.

Charles Slacik

So, it's not something we have much chance to change at this point but, I think if you can imagine if the market does and when and if the market does come back in the equities, our pension assets will climb back up and I shall one we hope that in 2010, ‘11 and ‘12 that our pension expense will come back down and give us that $25 million back.

Jon Wood – Banc of America

Okay.

Charles Slacik

That hopefully will be not something that we'll see for a long period of time.

Jon Wood – Banc of America

Right. So did you give operating cash flow for ‘09? I didn’t catch that it if you did?

Charles Slacik

No, we didn’t. We gave a bunch of components that should allow you to get close and it sounds like someone else on the call got pretty close to it. But I think when you calibrate around the numbers we gave you, you can get pretty close to where we are pointing to but suffice it to say that continuing them into balance sheet and you know I'm always talking about the EBITDA, with the fact that it’s driven to accelerate more than earnings because of the D&A component. One of the things we didn’t mention I think it was in my piece is that the gap between D&A and CapEx will shrink again next year. Or in other words since the CapEx numbers, it's fairly steady at around 300 million. What you can interpolate from that is that the D&A is going to continue to grow at that rate that we’ve talked about a number of times. So, with all other things being equal and earnings growing a little bit, you'll see EBITDA and therefore operating cash flow grow at a fairly healthy rate again in ’09 even above the earnings growth rate.

Jon Wood – Banc of America

Understood. And then is there any capital redeployment assumption built into the ’09 outlook. I know you said share base flat but it was down in the fourth quarter?

Charles Slacik

Our share base, no as a matter of fact we’ve assumed when we talk about cash flow and share repurchases that we're just trying to keep our share count flat at about $64.5 million.

Jon Wood – Banc of America

So, to see you, you only built in what debt reduction from the cash flow into the ’09 outlook?

Charles Slacik

Recognizing, we also have a fair amount more CapEx next year. There would be basically just additional cash coming out of that.

Jon Wood – Banc of America

Okay, understood, thank you.

Charles Slacik

Okay, thanks Jon.

Operator

Our next question comes from the line of Bill Quirk with Piper Jaffray, please go ahead with your question.

William Quirk – Piper Jaffray

Thanks good afternoon.

Scott Garrett

Hi Bill.

William Quirk – Piper Jaffray

Hey Scott. First, I have a quick question for you. I hate to go back to ’09 guidance again, but I just wanted to I guess tease this out a little bit further. How much of the back half recovery in both the top and bottom line is essentially currency and comps versus you guys feeling better about the overall market as it relates to cash instrument sale?

Scott Garrett

The vast majority is currency and comp stock.

William Quirk – Piper Jaffray

Okay, fair enough. And then Charlie, just a couple of questions for you as well. In terms of the I think with the 18% gross margin on the cash instrument sales that was up pretty substantially versus the '07 number? Can you help us think a little about the currency impact. Obviously you guys are manufacturing just about everything in the states?

Charles Slacik

That’s correct. The currency impacts a little bit but there is a number of things that will bounce that around. First of all I’ll give that to the mind that probably the most impactful. One will be the mix of Life Sciences instrument in there, and we recognized that we do hope to make more than 18% on Life Sciences instruments since there is no recurring revenue stream. So, movement of Life Sciences instruments will bring the average up or down and in '08 Life Sciences instruments had a decent rate of growth. So that would bring it out versus '07. And the other impact that makes that all the less predictable is large instrument placements particularly overseas where we might place those instruments literally like a razor handle, which might be very close to zero margins. In '07 I know, we've talked about in the past we had a very large installation in Queensland, Australia. We replaced a large number of DxI's at a very low gross margin. Keeping in mind that once we get outside the United States and Western Europe, when we are building these new installations, the hardware tends to get sold as opposed to leased. And so in Australia, here is a really good example of this. Even though that margin that you mentioned Bill was really low in '07 partially driven by that Queensland delivery. The benefit is that in '08 the recurring revenue that comes out of that contract is even better than what it has been because there is no hardware component in the follow-on revenue stream. And so you'll see a little bit of movement around year-to-year on that hardware gross margin, which is one of the reasons if you want to break it out. So that in the process even you'll see some volatility on hardware, which can be explained by a lot of the different movements. The most important think we wanted to demonstrate is that the recurring revenue margins stays pretty steady.

William Quirk – Piper Jaffray

Okay understood, and so presumably Charlie, if we go back a few years. When you guys bring up somewhat probably ancient history, when you guys initiated the shift from STLs to OTLs? You guys disclosed I think it was in the 2Q of 2005 that the gross margin for this business were something like 30% or 35% and have we've seen material changes in the overall structure here or is this simply mix and back then obviously we just were not doing as many cash deals because they were smaller. Can you help us think about that, dust of the history books and help us think about that.

Scott Garret

Well, I really don’t think it’s prudent or valuable to think about cash instrument, gross margins as if there isn't something else going along with it in Diagnostics. We look at the profitability customer-by-customer over the life of that customer relationship. Typically when there is a lease, we get a five-year agreement but even when it’s a cash sale, it’s a long-term commitment by that customer to buy all the things from us that make up recurring revenue other than the lease payment. So the overall gross profit of that customer relationship is what we really find most important but we think it's also because of the way we have to report our results. It's also important for us to give you some clarification, and exactly what that cash sale generates in terms of gross profit. Keeping in mind that Diagnostics has a lot of recurring revenue associated with it and Life Sciences does not.

William Quirk – Piper Jaffray

Okay I understood. Thanks for the response, Scott. And Charlie, just one last quick one. And if you mentioned it, I apologize. But did you say exactly what the overall dollar and the cash contribution for the pension is going to be here in the first quarter? Or rather for '09.

Charles Slacik

You wanted to know about the total cash contribution?

William Quirk – Piper Jaffray

Yes, I looked at the fourth quarter cash flow statement. It doesn’t look you guys made a big contribution?

Charles Slacik

No, we didn’t. The contribution increase won’t be as much as the P&L charge that you can imagine. If you are doing cash flow projections you would probably only increase the contributions in '09 by about $10 million or $15 million versus the '08 contributions.

William Quirk – Piper Jaffray

Okay thanks very much.

Charles Slacik

Okay.

Operator

Our next question comes from the line of Quintin Lai with Robert W. Baird, please go ahead with your question.

Quintin Lai – Robert W. Baird

Hi, good afternoon.

Scott Garret

Hi, Quintin.

Quintin Lai – Robert W. Baird Co

Question with respect to kind of what you’re seeing now in terms of the testing volumes. Are you seeing stable volumes? Are you seeing kind of any impact from expanded test menu? And then kind of looking at the operating type leases, are you seeing people that normally would have done cash leases coming to you with operating-type lease request, but maybe looking for different terms like maybe longer leases than that you normally do?

Scott Garret

By the way, We are trying to stay very close to our customers all around the world and we are very sensitive to any changes in behavior that we might pickup. All we picked up so far is that many hospitals especially in the United States have capital expenditure restrictions or freezes. However, we've not seen any big change in the number of tests being done, even in-patient days although they are reported to be down in a few areas, overall aren't down in any big way or considerably down. So, right now although we are being prudent about expectations in '09, we haven't seen anything in the historical trends to suggest any significant drop off.

Quintin Lai – Robert W. Baird

Super. And then with respect to operating-type leases, when a customer is at the end of the lease is there any reason for them to not, upgrade to the next instrument cycle or some customers just coming to you and saying hey could you add another year to as we work through our issues and if that happens is that favorable to you?

Scott Garrett

Yes it is and we often extend leases, when we retain a customer we can do it with a new instrument especially if they're expanding their business with more outreach, with more outpatient testing, but we often will add a few years to at least for a customer who might be a chemistry customer, we might bring a workcell and upgrade the DxC to workcell and extend the lease that way. Lots of ways to accomplish that and lots of ways for us accommodate customers who have growing needs for productivity improvements and higher throughput, but are faced with an institutionally wide capital expenditure freeze. So, we've got tremendous flexibility by virtue of the broad product line and by virtue of the operating lease model.

Quintin Lai – Robert W. Baird

Last question, Bill brought up an interesting point, kind of the when you started to switch over to in 2005. So, as we look out to 2010, some of those five year leases are up as we began anniversarying the shift OTLs, how does that impact organic revenue growth?

Scott Garrett

As we reach the fifth year we'll see, I think a slowdown to some degree in the amount of operating-type lease payment on a monthly basis. They've been building very steadily over the five years we’ll reach a bit of equilibrium, but we will continue to see growth in that category as we literally continue to expand our business. So, we expect it to continue to grow, and I expect that we'll see substantial improvements in cash flow as we cross over and reach equilibrium and see our depreciation and amortization really catching up with the capital expenditures for operating type leases something that Charlie elaborated on in the discussion today.

Quintin Lai – Robert W. Baird

Super, thanks.

Scott Garrett

Thank you, Quintin.

Operator

Our final question comes from the line of Eric Criscuolo with Thomas Weisel Partners. Please go ahead with your question.

Eric Criscuolo – Thomas Weisel Partners

Hi, guys. Just filling in for Peter Lawson today.

Scott Garrett

Hi Eric.

Eric Criscuolo – Thomas Weisel Partners

I guessed, I am sorry, if I missed this previously, but did you breakout the product and the service revenue for the quarter?

Scott Garrett

No, we did not.

Charles Slacik

Now, Eric what you see is that our hope of this is more helpful for you. What we done is we have replaced the service revenue with the recurring revenue and breakout cash instrument sales now recognizing that the service is a component of the recurring revenue. We think that wrapping it up with the total recurring revenue stream and providing the cost on that is a little bit more relevant than just service.

Eric Criscuolo – Thomas Weisel Partners

Okay, gotcha. And then as far as the contribution from acquisitions in the quarter, did you mention that?

Scott Garrett

Yeah, we talked about 140 basis points of growth being added from our December 2007 acquisition in flow cytometry. And that also that same acquisition added about 440 basis points to the growth of our cellular group of products.

Eric Criscuolo – Thomas Weisel Partners

Okay, great thanks. And then as far as I guess the clinical chemistry and the Immunoassay market, can you talk about how pricing trends have held up and how you see them going forward in '09?

Scott Garrett

We track our pricing on a local basis, literally country-by-country and product line-by-product line we've seen, although it can be very competitive, we have seen a lot of stability over the last few years in those prices around the world. In the U.S. specifically we think, we might even get a little bit of lift in 2009, due to the fact that the reimbursement for Medicare reimbursed testing has gone up by 4.5%, the lab fee reimbursement schedule is up 4.5% the biggest increase and I think close to 20 years and the biggest increase, the only increase of any kind in the last five. So, that’s going to give our customers even more incentive to go out and do more outreach and outpatient testing, by increasing the number of tests they perform and increasing their needs for productivity improvements, which plays right through our suite spot.

Eric Criscuolo – Thomas Weisel Partners

Okay, great. And then just as far as hedging goes, when do you recognize the gains and losses there, is there a specific time period where you have to recognize those changes in prices in the contracts and then how exactly does that flow through the income statement?

Scott Garrett

First of all, these are treated as hedge accounting.. So, when you see our balance sheet at the end of the year, you will see some deferred gains on those hedges sitting down in the equity section of the P&L. And then what happens is as those hedges, we would usually waive them throughout the year. So, what we did was a year in advance, we created hedge contracts that match-up the projected cash flows for ’09. So, as those contracts come due or expire on a quarterly basis, we will recognize the gains for those hedges as the, in the course if they eventually offset a certain portion of the currency headwinds that shows up in operating income, but those gains will show up down in non-op.

Eric Criscuolo - Thomas Weisel Partners

Okay, great. And then just one last question, sorry, with the as far as revenues in 2009, can we kind of expect the same kind of trends as far as the quarterly contribution to the full year in 2009 that we've seen in ’08 and ’07 just far as the percentage wise contributions?

Charles Slacik

We’ve given you some indication of why expectations for the pacing of net earnings, and I think that’s about as far as we are willing to go in terms of guidance other than the full year.

Eric Criscuolo - Thomas Weisel Partners

Fair enough. Thanks guys.

Charles Slacik

Okay, thank you.

Scott Garrett

Thank you.

Operator

That is all the time we have for questions today. Mr. Allan Harris. Do you have any closing remarks?

Allan Harris

Yes, thank you. A replay of this call can be accessed on our website at beckmancoulter.com. As for our upcoming Investor Relations activities, we will be participating in the following March events, which will be webcast in Miami, the Barclays Healthcare Conference, and in Boston, the Cowen Conference. Our website provides more detail on these events. This concludes our call for this afternoon. Thanks for joining us.

Operator

Ladies and gentlemen this concludes the Beckman Coulter's fourth quarter and year-end results conference call. You may now disconnect.

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Source: Beckman Coulter, Inc. Q4 2008 Earnings Call Transcript
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