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Executives

Suketu Upadhyay - Acting Chief Financial Officer, Principal Accounting Officer, Senior Vice President and Controller

Analysts

Matthew Taylor - Barclays Capital, Research Division

Becton, Dickinson and Company (BDX) Barclays Global Healthcare Conference March 13, 2013 10:45 AM ET

Matthew Taylor - Barclays Capital, Research Division

Thanks for joining us for this morning session. I'm Matt Taylor. I'm joined by Becton, Dickinson this morning. Really pleased to have Suky, the CFO, here with us, as well as Monique from Investor Relations.

So maybe I'll just kick it off, and you want to give us a few opening comments in terms of how you're looking at growth this year. You recently had a pretty good quarter, and you've seen an uptick in trends in a number of your businesses. So maybe it would be helpful to give some context in terms of how you started the year and how you've seen trends going through the year and what we should expect for the rest of the year.

Suketu Upadhyay

Yes, great. So I think, Matt, before I get into that, just a little bit of background on BD and sort of the sector and the industry and where it's come from the last 5 years and sort of how we're placed opposite that.

So if you look at overall med tech sort of P multiples over the -- going back to 2007 to 2012, you would have seen compression of about 1/3 across the overall sector. And if you ask yourself why, I think the reasons are pretty well understood: developed markets, lower utilization, pricing pressure, regulatory hurdles, lack of innovation, et cetera. Right? And BD suffered from that sort of end-market environment in developed markets, as well as most of our peer group. And the management team went through a deliberate approach about 2 to 3 years ago to say this is not an environment that we think structurally is going to change in the near future or improve.

So how do we build ourselves and construct ourselves to actually grow our way out of this, to generate and accelerate top line growth in very sort of difficult, challenging end markets, as well as improve overall profitability and quality of earnings? So after the last 2, 3 years, BD has made several significant investments into acquisitions, new product opportunities, geographic expansion, efficiency plays, et cetera.

And the idea, again, was how do you grow yourself out of this in the backdrop of challenging end markets? Well, the other thing that's part of this, we were very transparent with the investment community, with analysts, with investors. And we said over this 2- to 3-year period, we're not likely to grow margins or expand margins. And in fact, revenue will also be somewhat compressed. But stay with us, we have a growth story. We have an investment story. And during that period, we rewarded the shareholders by recapitalizing the firm, taking on more debt and returning that cash back to shareholders to help maintain overall shareholder return at the upper end of our peer group.

Well, we're now at the point and just starting the runway of leveraging the benefits of those investments through accelerated top line, as well as margin expansion. And I think you start to see that, especially in the first quarter of our fiscal year, where you're seeing core underlying growth start to accelerate. You're beginning to see margin expansion. You would have saw the matriculation of our pipeline last year with 10 new products, and these are products that are less about line expansions, more about innovation. You're going to continue to see that into '13 and '14. So again, we think we're right at the front end of that new growth trajectory and that new profitability profile.

Within the first quarter, as you said, we had a really nice first quarter, 5% on the top line, 5.2%. We saw earnings per share grow at about 15%, maybe closer to 16%, well above our overall full year guidance range. And overall, that gave us the confidence to lift the bottom end of our guidance range for the full year. But there were several onetime items or onetime benefits, which we knew about and planned for, for the full year, which manifested into the first quarter.

Now we continue to see that strength. We did see some good durable gains in certain parts of our businesses that were upside surprises. If we continue to see that into the second quarter and beyond, of course, we'll recalibrate our earnings. But we're very pleased with where the first quarter came in. I think it's more about -- more than just the first quarter though, and it's really sort of a proof point around that entire investment strategy that I talked about over the last 2, 3 years that, that's really playing out. And we're at the beginning part of that runway.

Question-and-Answer Session

Matthew Taylor - Barclays Capital, Research Division

Okay. That's a great backdrop. Maybe just as a jumping-off point from there. Can you talk about, of those different factors, which we should view as more onetime and which you think are more durable that will continue to drive growth?

Suketu Upadhyay

Sure. So the onetime gains that we saw, just starting with the revenue top line for a moment. So we had about 50 basis points of flu upside in the quarter. Now we expected that to be in the full year forecast in our guidance range, but flu typically impacts our second fiscal quarter or the first quarter of the calendar year. We actually saw an earlier flu season, which came a little bit earlier than we expected, so in the first quarter. Again, 50 basis points. You've all seen the CDC website and how flu is playing out, and it's primarily a U.S. phenomenon this year. And you've seen a pretty precipitous decline in the second quarter. So we think that the flu was -- the biggest impact we saw was in the first quarter, and we think that, that's pretty much where it is. The other thing that we saw in the first quarter is really if you look at comparables versus last year, we had a very easy comp, so that also helped. So those 2 factors I sort of say are onetime in nature. But again, we're very excited about some of the durable gains that we saw in the underlying growth in the first quarter that we will continue into the rest of '13 and into '14. If you just sort of break it down by business and then I'll go into geography, from a business perspective, diabetes care continues to be a very, very big growth driver for us, in the pen needle market, conversion from syringes to pen needles. It's an epidemic that impacts just about every major economy out there. It's, we think, a market that still has a lot of runway to go yet. So a big growth driver for us is in diabetes care. Some other big growth drivers that sort of we're a little bit stronger than we expected were around safety growth. So safety growth outside of the U.S., particularly in Western Europe, but even more importantly and what's growing of more relevance is our safety growth in emerging markets, which is in the high teens. So that was a little bit better than expected, and we expect that to continue on through the rest of the year. We also saw some upside in the first quarter around stabilization in the U.S. So in '11 and '12, we really suffered, and I think our competitive set as well suffered from, again, declining utilization, higher pricing erosion, et cetera. So while I don't think things are maybe improving, let's say, in the U.S., we do see things stabilizing. So that got a little bit better for us. So those are just some examples of some of those durable gains I talk about that I think are really going to help propel and accelerate our core growth going forward.

Matthew Taylor - Barclays Capital, Research Division

Maybe let's talk a little bit more about the medical products gains that you had and how you see that growth over the next 12 to 18 months because there is a tailwind from safety conversion in Europe. And we saw that cycle in the U.S. several years ago. So how would you frame the 2 different opportunities, and how does that cadence look over the next couple of years?

Suketu Upadhyay

Yes. So in the Medical segment, you hit the nail on the head. One of the biggest drivers that we have is on our traditional safety products, specifically outside of the U.S., so this is our catheters and our syringes. But also, what's very exciting in our Medical business is we're going to what we call different forms of medical safety, as well as medication error. So from a medication safety perspective, moving beyond syringes and catheters, now into aerosol-based medical applications, so as we saw with the Carmel pharmaceutical product, which actually expands our safety offering but also offers us a new channel into the pharmacy sector of hospitals. I think the other area from a Medical segment perspective is really around medication error. And if you ask hospital CEOs, CFOs, what are some of the top things on their minds, obviously, cost pressures are on the top of their mind. And then you start to peel the onion back a little bit more and say what drives that cost pressure. Right? There's a host of variables. But 2 things, 2 common things that we hear across hospital CEOs, CFOs is around infection control. Because when infections become out of control in the hospital setting, you begin to increase your cost base. The other is around medication error, which is not only from a quality of health care perspective quite detrimental, but also from a cost perspective, this can be quite detrimental. So this is a new area that BD is starting to look at, medication error. We just recently announced the acquisition of Cato, which is a software-based application for the compounding of cancer drugs, which should actually improve medication error rates, which are very high in that type of setting. So in the Medical segment, I think it continues to be an expanded concept of safety. We are also continuing to evolve and generate new products that will start to penetrate what I'll call the middle tier of emerging markets. So these are syringes and catheters that are priced at a lower price point, which help us to move out of the sort of higher concentration, higher wealth segments in places like China and into those middle segments, which present a whole new and, quite frankly, much faster growing opportunity for us.

Matthew Taylor - Barclays Capital, Research Division

Maybe let's go to that point. You do have a lot of exposure in emerging markets, and they're growing faster in a number of your product areas. Can you talk about the overall opportunity for the company there and how you can continue to increase that penetration and how you're growing in your different businesses?

Suketu Upadhyay

Yes. So emerging markets has continued to be a very strong growth driver for us, that we posted 13% growth in the last quarter foreign currency neutral. It was over the last 8 to 9 quarters, we posted somewhere between 10% and 13%, so it continues to be a very nice growth driver for us. China, in particular, growing over 25%. We've increased our investments, $60 million incremental in 2012, $40 million incremental this year. We're launching new products specifically for the markets in which we operate. And really, the opportunities are beyond China. They extend into India, into Brazil, into Eastern Europe and even into we're now looking at the next tranche of countries that we might go into, in Asia Pacific, like Indonesia. You may not know that there's over 100 million people in Indonesia with a very fragmented health care system and a big government push to actually expand infrastructure and health care spending. So we think that there's a lot of runway at these markets. Health care -- overall health care spending is still growing roughly about double digits, depending on what market you're looking at. And then if you peeled it back even a little bit further, there are submarkets within that, that are growing in the high teens to double digit -- or excuse me, low 20s around medical, around safety, which we operate in, in diagnostic testing, in life science testing, around cell sorting and in flow cytometry. So we think we're well positioned from a product position. We think these markets still have opportunity to grow, and it's primarily at that value premium where they're growing right now. And then we're going to continue to see growth in that middle segment that we're going to start to penetrate.

Matthew Taylor - Barclays Capital, Research Division

We haven't talked much about diagnostics yet. Do you want to give us a view into the core growth and some of the new products you're launching? BD MAX is one that you've talked about being really excited about, with a number of new assays coming online. Can you give us a preview of what to expect there?

Suketu Upadhyay

Yes, absolutely. So we're very excited about our MAX opportunity. We just recently launched in the U.S. We're starting to put boxes out in place and get placements in the U.S. We're expanding our overall menu. We've got a couple of key anchor assays, which were really helping us start the early days of placements. But as that assay pipeline really begins to matriculate, we expect to see a lot of runway and ramp-up in the overall MAX system. The reason we're so excited about that opportunity is it's the first open architecture system out in the marketplace. It enables -- if you think about one of the mega-trends out in the health care environment, it's how do you make the health care system more cost-efficient. There's not a single health care system out there, whether it's U.S., Europe, emerging markets, that's sustainable over the long term, just when you look at the economics of the demand for care versus the supply of funding. So your ability to drive efficiencies in the health care market will set you apart as a differentiator, and you will be rewarded for that, we believe, in the long term. MAX is one of those plays that offers not only, we think, improved clinical efficacy in the turnaround time, which becomes very important in the hospital setting when you're trying to identify MRSA before you have widespread -- time to diagnosis is very quick or needs to be very quick. The other thing from an efficiency standpoint, the ability to run multiple tests at any given time instead of just, let's say, one batch of one type of assay is very important to what we're seeing in hospitals and our customer base. Also, the ability to automate that whole process, so in other words, put your assays into a machine, push a button and you've got your results in 2 hours versus a lot of manual intervention and run time between the lab technician and the instrument is very important to our customers. So we're excited about MAX because it's open architecture, its efficiency and the turnaround times that it can provide. So we've characterized that as we expect to see more ramp-up in the second quarter -- excuse me, second half of 2013, so you're going to see the most notable gains into 2014.

Matthew Taylor - Barclays Capital, Research Division

Great. I guess we haven't talked about Bioscience yet so maybe touch on that. Could you talk about the changing dynamics that you've seen and how you expect the government regulations to impact growth there?

Suketu Upadhyay

Yes. So it's been a problematic area for BD over the last -- and I think everyone in the sector, really since late 2011 into '12. The whole notion of uncertainty around research spending has created an overhang beyond just NIH-funded accounts to sort of pull back and sort of take a wait-and-see approach on capital equipment purchases. And it really impacted us in '11 and '12, primarily because accounts really didn't have the time to react to these spending reductions. Now that they've had a little bit of runway and saw that the sequestration was coming, they've had time to adjust their infrastructure, adjust their purchasing cycles. So we're cautiously optimistic that while sequestration in the U.S. still could present a headwind for us, that it won't be as much of a shock as what we saw in '11 and '12. And we accordingly took our guidance up in that business from 1% to about 2% for the full year. So again, we're cautiously optimistic there. The other thing I should say, so that's really about a market play and less about our products and our ability to differentiate in the value proposition. Because when you look at our segment Biosciences outside of the U.S., we had a slight anomaly in the first quarter. But over the last 4 to 5 quarters, that's a business that's been growing about 7% to 8% for us. So when we see that the markets are actually relatively healthy, our products are winning in that space.

Matthew Taylor - Barclays Capital, Research Division

Great. And maybe we could just touch on overall dynamics and talk a little bit about what you're seeing, both on the utilization side and on the pricing side, and specifically whether you've seen any recent pressures. There's been some commentary that Europe has looked a little bit weaker. I don't know if you've seen that in your business at all.

Suketu Upadhyay

Yes. So we've gotten that question quite a number of times. Medtronic was out there talking, I think, specifically about Germany and sort of a very big downturn or slowdown in that economy. Europe continues to probably be the biggest headwind or downside risk that we're seeing across the company. And we still continue to see a sort of a tale of 2 regions. Northern Europe still growing relatively well for us. I wouldn't say that we're seeing couple-digit growth by any means in those regions, probably somewhere in the mid-single digits. Our key areas of focus there from a headwind perspective are really around Southern Europe, Italy and Spain, where we -- the government has mandated pricing concessions across the health care industry. How that ultimately manifests itself back to med tech, back to BD and supplies, et cetera, still to be seen, and the type of enforcement they put behind is still to be seen. But broadly, Europe we see growing at about the 2% to 3% range for 2013, and we're not seeing anything as acute as what sort of Medtronic came out with.

Matthew Taylor - Barclays Capital, Research Division

Can we move to margins and cash flow? Can you talk about some of the improvement programs that you've put in place, the ReLoCo programs, and how you could see margins evolving over the next couple of years in either taking costs out or through mix shift?

Suketu Upadhyay

Right. So in my preamble, I talked a little bit about margins not expanding in the last couple of years as we invested. One of those major investments that we made was into efficiency programs. And the company is very committed to generating 50 basis points of operating margin improvement over the mid-term, which, let's call it for now, about the next 3 to 4 years. And that margin expansion is going to come primarily from our gross margin. And so your next question will be, what's going to drive that? Well, there's really one major program beyond the continuous improvement that the company has always sought to generate and being the lowest cost provider in the marketplace. It's around our ReLoCo program, which is an initiative that started in our Medical segment, and it was around better plant utilization, plant rationalization, producing at -- with lower material costs, redesigning our products to be more efficient from a production standpoint. That initiative was so successful we called it ReLoCo. We then started ReLoCo II. So we moved beyond our Medical segment into our Diagnostics segment. ReLoCo I and II should generate about $40 million to $50 million of incremental gross margin year-over-year this year. Going into '14, as we move out of the investment mode, we expect that to even accelerate. Okay? So we expect that to be a tailwind for us into '14. Those programs are so successful that we're now looking at initiatives to go deeper into Diagnostics and now expand the program into our Biosciences segment. So we still see a lot of runway over the next 3 to 4 years to continue to drive that, but it doesn't end there. We've got -- when you think about our innovation pipeline and I talked a little bit about moving beyond line extensions into more innovative-type products that are adjacent, that hit mega-trends, we believe that innovation and that mix of business, of moving away from sort of, again, next-generation medical supplies to more innovative offerings in diagnostics and life sciences will provide a mix benefit from a pricing perspective. We think that's going to be another positive gross margin play. From an SSG&A perspective -- so again, most of our -- we see the operating margin improvement coming from gross margin. From an SSG&A perspective, we expect that to grow broadly in line with sales, some years maybe a little over the index, some years a little under index. We're going to continue to invest the acquisitions we've made over the last 3 years. We're going to continue to invest expansion in emerging markets. All of our new products, this is not the time to be sort of penny wise and pound foolish on these types of things. So we're going to continue to grow that in line with sales. But there's -- if you peel back a little bit, there's an undercurrent there, which is we're really looking at strategies and initiatives to move spending out of G&A into selling. So while overall SSGA is growing at the rate of sales, the actual movement of dollars into selling and promotion and expansion is going to grow at faster rate than sales, while G&A grows at a slower rate than sales. And then from an R&D perspective, we see that growing broadly in line with the rate of revenue growth over the next 2 years, perhaps a little bit higher over the next 2 years where we're looking at one of the richest pipelines that we've had in history, again, moving sort of out of our home court into more innovative-type offerings that address major mega-trends. So again, very committed to 50 basis points, primarily driven by gross margin as we continue to invest behind some of these new product and new geography opportunities.

Matthew Taylor - Barclays Capital, Research Division

And maybe we'll transition from that to use of cash.

Suketu Upadhyay

Sure.

Matthew Taylor - Barclays Capital, Research Division

So the last couple of years, you've done big buybacks and you're funding another one this year with a divestiture. Can you talk about the plans going forward? You also have a dividend that you've raised for ever.

Suketu Upadhyay

That's right.

Matthew Taylor - Barclays Capital, Research Division

So you have kind of a diversified strategy, but how do M&A, dividends and buybacks look in terms of first call and cash going forward?

Suketu Upadhyay

Yes. So the first thing I was -- key question is around capital allocation strategy. How do you come up with that? I should say the first thing I look at is to see if the company is to say, broadly, we're looking for total shareholder return at the upper end of our peer group over the mid-term and 3 years. And the way I'm sort of kind of recharacterizing total shareholder return, taking a different lens on it and saying, as a composite of earnings per share growth plus dividend yield. So let's say earnings per share growth is at 10%, dividend yield is at 3%, I look at that as roughly as 3% total shareholder return in the year. Now I'm assuming that multiples go in line and stock price goes in line with the overall earnings per share growth. But if you sort of -- if you bought into that, the capital allocation across that, obviously, our dividend yield becomes very important to us. And currently, we are at the upper end of our peer group at our payout ratio of somewhere between 30%, 35%, as you said, double-digit increases for the last 10 years, 40 years of increases overall. So it's a very important lever for us. When I think about capital allocation, first, it's about funding the business because we think we've got -- we can win in the marketplace through innovation, through acquisitions. Second, it's around maintaining that very healthy dividend profile. We know that's important to our investors. It's something we're going to maintain. Our philosophy around that is to increase dividends at the trailing 12-months earnings per share performance. Now actually, for 2013, we announced a 10% increase when '12 only grew by about 5% on earnings per share. So we're making a very positive forward-looking statement about how optimistic we are about the future of the company. So then after funding the organic business, funding dividends, we then look at the trade-offs between acquisitions and then share buybacks, and both of them being very important levers. When I talked about the EPS composite, you really got 3 levers there. You've got revenue growth, margin expansion and then share buybacks. So it's a very important part of that 4-pronged piece that I talked about in shareholder return. When I'm asked about my preference of share buybacks versus acquisitions, I tend to lean towards acquisitions, things that are growth-driven, that drive top line, that are cash-driven. But again, when those opportunities aren't there and we don't see opportunities there in the near term, we look to fill that overall total shareholder return profile through share buybacks.

Matthew Taylor - Barclays Capital, Research Division

We still got a minute left. Maybe we'll do a question from the audience. We have an audience response system, if you haven't been in the room, you can click on the answer that you like. The question is how do you believe BDX's long-term earnings growth will compare to peers above, slightly above, in line, slightly below or below?

[Voting]

Matthew Taylor - Barclays Capital, Research Division

So looks like you have a positive skew there.

Suketu Upadhyay

Yes, that's where I'd have called it. I would have probably called it at more on above. Actually, if you look at the forward-looking consensus, we're pretty much in line with where the respondents came out. So it's good to see that the positive proof points that we've been able to generate, really, not even in the first quarter, if you look at the back half of last year, we really started this margin expansion profile, this revenue acceleration profile. I think that's starting to play through in some of the results you're seeing here in addition to some stabilization in end markets and developed markets, as well as, I think, a firm belief that emerging markets, there is room to continue to grow there. So it's right in line with where I'd see it as well.

Matthew Taylor - Barclays Capital, Research Division

Okay. Great. Well, thanks. I think we should end there, but thanks a lot for your time.

Suketu Upadhyay

Okay, great. Thank you, Matt.

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