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Beckman Coulter, Inc. (NYSE:BEC)

Q3 2007 Earnings Call

October 30, 2007, 8:30 AM ET

Executives

Robert Raynor - Director, Investor Relation

Scott Garrett - President and CEO

Charlie Slacik - CFO and Sr. VP, Information Technology

Analysts

Sara Michelmore - Cowen & Company

Quintin Lai - Robert W. Baird

Peter Lawson - Thomas Weisel

David Lewis - Morgan Stanley

Bill Quirk - US Bancorp Piper Jaffray

Bruce Jackson - RBC Capital Markets

Bruce Cranna - Leerink Swann

Rick Wise - Bear Stearns

Jon Wood - Banc of America Securities

Presentation

Operator

Good morning. My name Luan and I will be your conference operator today. At this time, I would like to welcome everyone to the Beckman Coulter Third Quarter Earnings Release 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. I will now turn the call over to Mr. Robert Raynor. Sir, you may begin your conference.

Robert Raynor - Director, Investor Relation

Good morning. Welcome to the Beckman Coulter third quarter 2007 conference call. On our call today are Scott Garrett, President and Chief Executive Officer; and Charlie Slacik, Senior Vice President and Chief Financial Officer. During the call, there would be forward-looking statements on a number of subjects. They are based on the company's current expectations and are subject to a number of risks and uncertainties. Actual results could differ materially. Today's press release, our 2006 annual report, and our SEC filings identify factors that could affect those results. I direct you to those documents.

This presentation also includes a number of non-GAAP financial measurements and explanation of these non-GAAP measures is provided in the company's earnings release which is posted on the company's website at beckmancoulter.com. And now with our prepared remarks, here's Scott.

Scott Garrett - President and Chief Executive Officer

Good morning and thanks for joining us. As we review the third quarter today, please keep in mind four key factors that shaped our results. First, overall revenue growth of 6% was less than anticipated. Strong performance in the sales of our clinical diagnostics products up more than more 9% was partially offset by lower than expected sales of life science products and a short-term supply disruption in cellular instrument production.

Second, laboratory automation continues to be a key differentiator for our company and is growing in importance to customers. Sales of clinical lab automation systems rose more than 40% in the quarter. And importantly, automation powered the growth of all clinical products.

Third, revenue growth in immunoassay continued to be robust, up 28% in the quarter. And fourth, we achieved 17% growth in adjusted diluted earnings per share, while continuing to expand our R&D investment, including our sample-to-result molecular diagnostics project and the UniCel, DxH 800, our next-generation cellular system.

Now, I will begin a more detailed summary of third quarter revenue on an as reported basis unless otherwise noted. Total revenue was $669 million, up 6% over third quarter 2006, in constant currency up 4.1%. Total revenue from clinical diagnostics products increased 9.4% over prior year or 7.5% in constant currency.

Clinical diagnostics includes chemistry, immunoassay, cellular and clinical automation products. The demand for Beckman Coulter's diagnostic systems continues to be strong although sales in the third quarter were lower than expected. We ended the quarter with cellular instrument backorders totaling about $10 million due to a combination of strong demand and a supply disruption caused by the consolidation of our printed circuit board operations. A shortage of critical parts for some of our hematology and flow cytometry instruments delayed delivery of some customer orders.

No urgent deliveries were missed and no customer operations were interrupted. We expect to work down much of the cellular instrument backorders in the fourth quarter and we remain on track to achieve our goals for the year.

Life science revenue declined 8.6% or 10.5% in constant currency on reduced demand in the academic research market. For the full year, we expect life science revenue to decrease to about 2%. Consumables growth in the third quarter was 8.7% or 6.8% in constant currency. The acquisition of Lumigen in the fourth quarter of 2006 contributed about 1.7% to this growth. Consumables for Access Immunoassay Systems continued to grow rapidly, up 23% in the quarter. Year-to-date, hardware revenue growth was up about 5%. The off trend spike in cash sales of hardware experienced in the second quarter did not reoccur.

Now I will summarize third quarter revenue results by geography in constant currency. In the United States, revenue increased 4.4%. Immunoassay sales were robust, up 24%, partially offset by modest declines in discovery and automation and cellular. Most of the cellular backorders occurred in the United States. We renewed and extended contracts with two of the largest group purchasing organizations in the US, Premier and Amerinet.

Outside of the US, revenue was up 3.8% in constant currency. Growth in Europe up 5.2%, Asia-Pacific up 3.7%, and Latin America up 10.9% was partially offset by a decline in Canada.

In Europe, growth was led by immunoassay products, up 19%, propelled by Beckman Coulter's competitive offering and a full range of instrument systems. Our products thoroughly cover small to mid to high volume market segments, highly appropriate for both developed and emerging markets. Importantly, clinical automation continues to drive our success in Europe, as we place our highly productive chemistry and immunoassay systems and work cells in combination with our new AutoMate 800 sample processor. Sales of clinical automation products more than doubled in the third quarter and we expect this trend to continue at least through the balance of the year.

In Asia-Pacific, sales in China continued to grow rapidly, up more than 20%. We expect excellent overall results in China for the full year. Otherwise robust performance in Asia-Pacific was offset by considerable weakness in Japan, down 18% in the quarter. After three quarters of steady improvement, the life science markets in Japan turned down. The abrupt resignation of the Prime Minister and consequent government changes are delaying research spending.

Now I'll address revenue by product area. Chemistry revenue increased 6.3% in the quarter. Placements of autochemistry systems were up 16% compared to the third quarter of 2006. We remain on pace to achieve a third consecutive record year of autochemistry placements, growing our installed base in mid to large size hospitals and driving increased utilization of chemistry consumables.

Immunoassay revenue was up 28% worldwide with strong performance across all geographies. Revenue from the Lumigen acquisition added about 5% to this growth rate. Access Immunoassay consumables not impacted by Lumigen increased by about 23%. New and improved tests continued to add value to our highly competitive menu of immunoassays.

Inhibin A is part of a four test panel used as an aid in the diagnosis and monitoring of various reproductive hormonal disorders. Our new Inhibin A test commercialized on out automated immunoassay systems this spring is already well on its way to becoming one of our top 10 immunoassays. Additionally in the third quarter, we introduced improved assays for hepatitis B surface antigen and rubella.

Beckman Coulter continues to be the leader in work cell solutions. Our work cells combine our full menu of more than 150 chemistry and immunoassay tests into consolidated systems that bring higher levels of productivity, quality, and safety to the laboratory.

Third quarter placements of our DxC 600i work cells more than doubled versus the prior year quarter. And development continues on additional work cells. Our next work cell, the DxC 880i, should begin shipping in the first quarter of 2008. The DxC 880i combines Beckman Coulter's highest volume chemistry system with our highest throughput immunoassay instrument, and will be a significant driver of productivity improvement in larger hospital laboratories.

Late next year, we anticipate commercializing three additional work cells, including two that incorporate our new DxI 600 immunoassay instrument. Beckman Coulter's family of work cells is expected to be the most complete and flexible in the market, uniquely able to meet multiple customer price points and throughput requirements.

In addition, all the DxC and DxI instruments placed since 2005 are field upgradeable to work cells. Many existing Beckman Coulter customers anticipate taking advantage of this flexible approach to managing their work flow, acquiring DxCs and DxIs now and upgrading to work cells in the future.

Revenue in the cellular products area was about flat with prior year, due to a slight decline in sales of hematology and flow cytometry instruments. As I mentioned earlier, while customer demand for cellular products was strong, a supply disruption caused by the consolidation of our printed circuit board operations impacted our ability to meet the demand in the quarter. Again, we do not expect this disruption to impact our ability to achieve full year goals. We remain on track for commercialization of our next-generation hematology system, the UniCel DxH 800, targeted for introduction late next year. This new system is designed to enhance productivity in mid to large size laboratories.

In discovery and automation, revenue declined 4.5% on softness in the academic research market for our life science products. The decline was partially offset by strong demand for Beckman Coulter's clinical laboratory automation systems, up 40% worldwide in the quarter. Through the first nine months of 2007, we have grown our worldwide clinical automation revenue by more than 60%. Increasingly, customers recognize that Beckman Coulter automation systems can transform their laboratories into the highly productive and cost-effective operations. Automation is proving to be an effective and reliable growth engine pulling through sales of all other clinical products.

In molecular diagnostics, our project to design a simple sample-to-result molecular testing system for hospitals is on schedule for commercialization in 2010. We are making excellent progress toward our first working model. By the end of the year, we expect to have design and build working subsystems for all the critical functions. In addition, progress continues on test menu development. We have targeted an initial menu of nine infectious disease tests to be available at launch.

Looking ahead, we will be adding tests for cancer, genetic diseases, and pharmacogenomics. In this regard, as announced earlier today, we signed agreements with John Hopkins University, a leader in cancer genomics research. These agreements will provide Beckman Coulter exclusive rights to intellectual property that may arise from Hopkins studies of multiple types of cancers, including breast, colon, and six other cancers.

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

Charlie Slacik - Chief Financial Officer and Senior Vice President, Information Technology

Thank you Scott and good morning. A full description of the company's third quarter and year-to-date results is provided in today's earnings release. Scott has already discussed revenue performance in the quarter, but looking further at the P&L, gross profit margin declined about 70 basis points to 46.6% compared to the third quarter of 2006 after adjustments.

Higher distribution costs and a decline in margin from life science products were responsible for pushing margins down. The increased distribution costs are attributable to fuel surcharges in a higher number of smaller expedited shipments needed to maintain customer service levels. It is important to recognize that the diagnostic product margins were flat with prior year quarter reflecting overall stable pricing trends.

As a measure of our progress towards full year objectives, I'll focus more closely on the adjusted year-to-date results. Through the first nine months, revenue increased by 8.6% or 6.8% in constant currency. Our full year outlook for revenue growth remains at 7% to 9%. Year-to-date gross margins were 46.9%, 70 basis points below the first three quarters for 2006. This was largely due to the higher distribution costs and lower life science product sales and margins, which I mentioned earlier.

Product margins for our clinical diagnostic products through the first nine months are in line with 2006 margins. Savings from our one company restructuring completed in 2006 continue to deliver good leverage and SG&A spending. Through September year-to-date SG&A as a percentage of sales is about 80 basis points lower than the same period last year.

Turning to R&D, as we planned, the investment in R&D through the first nine months of 2007 is about $16 million higher than comparable R&D investment for the same period last year. We remain committed to our funding of our high growth opportunities for success. Molecular diagnostics and our next-generation hematology system, the DxH are among our top priorities.

Despite the higher R&D spend, year-to-date operating expense was 36.1% of revenue compared to 36.9% for the first nine months of 2006, reflecting good leverage and expense management.

Adjusting for special items, operating income for the first nine months was $213 million, up 10% versus prior year. And this is consistent with our full year outlook. Adjusted operating income margin expanded by 20 basis points to 10.8% through the first nine months versus 10.6% last year. Our full year outlook for operating margin remains at approximately 12% on a comparable basis.

Reported non-operating income in the third quarter included a $26 million gain on the sale of vacant land in Miami. From the proceeds of this gain, the company made a contribution of $9 million to establish the Beckman Coulter Foundation to fund non-profit research. The foundation will benefit research and educational institutions and programs.

Through the first nine months, adjusted non-operating expense was $26.4 million, pretty much in line with the prior year. $130 million of higher debt levels versus last year is offset by the lower coupon rate on convertible notes. As we expected, the company's EBITDA performance has been improving steadily since we shifted to operating type leases from sales type of leases. As OTL assets are built over the last two years, depreciation and amortization have been closing the gap with our OTL CapEx levels.

In the cash flow report for the first nine months, you will see that our 2007 D&A has expanded by 32% versus 2006 to $157 million. During the same period, our CapEx level has grown by only 8% to $223 million.

The year-to-date gap between CapEx and D&A was $66 million, which shows a market improvement versus the gap in 2006 year-to-date which was almost $90 million. We expect this positive trend to continue positively impacting cash flow.

At the end of the most recent quarter, the 12-month trailing EBITDA was $572 million on a reported basis and $532 million after adjusting for special items. By comparison for all of 2006, EBITDA was $437 million on a reported basis and $470 million excluding special items. We also expect this positive EBITDA trend to continue.

Turning to taxes, the adjusted tax rate for the first nine months was 25.6%, lower than anticipated due to a number of discrete items including a tax settlement, reductions of certain foreign tax rates, and additional R&D tax credits. Excluding any unanticipated items, we expect the Q4 rate to be approximately 33%. Overall, the tax rate for the full year 2007 should be between 28% and 29%, which is lower than our original estimate, but in line with the prior year actual tax rate.

Adjusted net earnings for the first nine months were $139 million or $2.17 per fully diluted share, an increase of 17% over the same period of 2006. Having completed the first three quarters of the year, we are now narrowing our full year outlook for EPS to be between $3.15 and $3.22.

Our fourth quarter outlook anticipates positive pre-tax earnings growth; however, the higher tax rate will have a negative effect on the after tax earnings growth.

Turning briefly to the balance sheet, CapEx for the first nine months was $223 million. The full year outlook for CapEx remains at between $325 million and $350 million. Depreciation and amortization for the first three quarters was $157 million versus our full year outlook of $210 million to $230 million. The company strengthened its balance sheet with a reduction of $20 million of debt and increased the cash balances by $23 million during the quarter.

In addition, our accounts receivable DSO is about flat with the prior year, inventory levels improved from 2.5 turns last year to 2.7 turns this year. In addition, we repurchased approximately 270,000 shares of company stock at an average price of about $69.55. That leaves about 0.5 million shares remaining under our existing share repurchase authorization.

The company's revolving credit facility was un-drawn at the end of the quarter. And finally, free cash flow for the first nine months was $61 million, up $56 million from the prior year.

Our supply chain initiatives are continuing across many parts of the company complemented by our focus on Lean Six Sigma. Lean initiatives work at the grassroots level from the bottom up, producing incremental changes over time that result in consistently improved margins and operations. As a result of our training programs, the lean culture is taking hold on us across the company. Productivity savings from lean initiatives in this first year of the program are on target for the full year, and efforts to consolidate operations and exit buildings has allowed us to reduce our footprint by about 75,000 square feet.

The previously announced relocation of our Palo Alto operations to Indianapolis is right on plan and on budget. Upon full implementation in 2009, this relocation is targeted to provide an annual benefit of about $7.5 million. And we will continue to share additional details on our lean program and supply chain improvements with you as we progress toward our goal of operating excellence.

And now I would like to turn things back to Scott.

Scott Garrett - President and Chief Executive Officer

Thank you Charlie. Given our solid progress through the first nine months of the year, we remain confident regarding achievement of our 2007 performance objectives. We do not expect the third quarter supply disruptions in cellular instruments to impact our ability to achieve our full year goals. We continue to outperform the market in clinical diagnostics with a broad portfolio of instrument systems, high quality assays, a comprehensive lineup of work cell solutions, and leadership in lab automation.

We are focused on creating shareholder value through growth, quality, and operating excellence. Our priorities remain, first, sustain the rapid growth of immunoassay, progressive automation, and work cells products. Second, develop and launch our next-generation hematology system. Third, develop a sample-to-result molecular diagnostic system. And finally, improve productivity and achieve operating excellence throughout our supply chain and business operations.

Charlie and I are now prepared to take your questions

Question And Answer

Operator

[Operator Instructions]. Your first question comes from Sara Michelmore with Cowen.

Scott Garrett - President and Chief Executive Officer

Good morning Sara

Sara Michelmore - Cowen & Company

Hey, good morning. I guess just two questions, Scott. First on the gross margin. I understand you have got a couple of positive dynamics as well as some negative dynamics in the next year. But at some point here at least on diagnostic product margins, I would think that the immunoassay consumable sales would allow you guys to start to show some gross margin expansion there and again I understand that you have got kind of a tough comp here in terms of the instrument revenues. But if you could just kind of give us an update in terms of where you think you are in terms of the mix shift there and the potential for the immunoassay to drive some additional gross margin expansion, at least in the diagnostic products piece of the business?

Scott Garrett - President and Chief Executive Officer

We certainly agree that immunoassay will be a positive influence on our gross margin going forward. Immunoassay is becoming a bigger and bigger part of our business. And as you know, Sara, the gross margins in immunoassay are certainly among the highest in our business. In the third quarter, we also had some offsetting downward pressure from freight costs and also some declines in some very matured products, which we have been harvesting for years now. these are not important projects strategically, but because they are old and have been in harvest mode for a while, the margins were quite high and that decline in the third quarter offset some of our gains in immunoassay.

Sara Michelmore - Cowen & Company

So you are still in transition there? I mean, is there a timeframe in which you will be coming out of that?

Scott Garrett - President and Chief Executive Officer

We are on track in the year-to-date and we expect to achieve our goals for the full. We are close to 47% this year and we are going to be moving that up quarter by quarter and year by year over the next few years. And I think this transition is really in the stage where immunoassay is going to start shining through in a stronger and stronger way because it is getting to be such a big part of our business now.

Sara Michelmore - Cowen & Company

Okay. And then in terms of consumable growth, it looks like excluding the favorable impact of foreign exchange and excluding the Lumigen addition there, that it was 5% growth year-over-year in the quarter. And I know the immunoassay was greater than 20. So, I was just hoping your could kind of comment on what was going on with the non-immunoassay piece of the consumable stream, it seems like it might have been a little lower than expected.

Scott Garrett - President and Chief Executive Officer

Yes, again we had some things offsetting. The third quarter tends to be a weak quarter just due to seasonality. So, we've had a bit of a slowdown in some of the other categories and even affected immunoassay to some degree. But again, we had declines in plasma proteins and declines in some of the miscellaneous categories that we group under the chemistry business that offset some of the big gains that we had in immunoassay. And you remember, we do have a fairly tough comparable because last year in constant currency we were up about 11%.

Sara Michelmore - Cowen & Company

Right. And so nothing in terms of going on with the chemistry stream that's notable?

Scott Garrett - President and Chief Executive Officer

Sara, I think what you are going to see, chemistry growth in consumables emerge very strong in coming periods. Again, the decline of some of these harvested products is really pretty much going to be out of the way as we finish up the year. We expect to finish the year close to double digit in overall consumables growth and we expect fourth quarter to be right in there around 10% for consumables growth.

Sara Michelmore - Cowen & Company

Great. Thank you.

Scott Garrett - President and Chief Executive Officer

Thank you

Operator

Your next question comes from Quintin Lai with Robert W. Baird.

Scott Garrett - President and Chief Executive Officer

Good morning, Quintin.

Quintin Lai - Robert W. Baird

Good morning. Turning to life sciences, several of the life sciences companies have reported here in the third quarter and no one seem to have... the market seem to have not changed that much. Could you kind of address your product positioning right now? When you are talking about all your different strategies, I didn't hear increased R&D to reinvest in that side of the business.

Scott Garrett - President and Chief Executive Officer

Well, we've got so many very compelling opportunities in the clinical diagnostics area that just by virtue of priorities we have not been spending as much in life science. Two things to keep in mind when think about our life science business, Quintin -- our product line is divided in two parts to make it pretty simple. We've got a lot of tools products that are most appropriate for the academic research market. And we've got some automation products that are very appropriate for big pharma. The automation tends to come in big chunks and so we get some lumpiness quarter-to-quarter. And the life science tools, that market in academic research is really affected by government funding, which, as you know, has been pretty soft around the world and just recently really took a turndown in Japan.

Quintin Lai - Robert W. Baird

Okay. Thanks for that color. And then with respect to molecular diagnostics, diving a little bit deeper into that area.

Scott Garrett - President and Chief Executive Officer

Sure.

Quintin Lai - Robert W. Baird

You said that when you go commercial in 2010 you expect to have nine infectious diseases at launch?

Scott Garrett - President and Chief Executive Officer

Right, that's our target menu right now.

Quintin Lai - Robert W. Baird

All right and then I guess when do you think that you will begin some of the clinical trials for some of those, and when do you think that you will able to give a little color on what diseases you will be looking at?

Scott Garrett - President and Chief Executive Officer

I think we will be able to roll out a pretty clear picture of what we have in mind when we have our... we will have an Investor Day coming up in the fourth quarter. We'll be talking about it next year. Right now, our focus is on getting started on the mandatory menu of the nine assays, and also getting a hand on where we go from there. The John Hopkins announcement earlier today gives you a good indication that cancer is going to be a very important part of that overall test menu.

We also think the pharmacogenomics will be an important part. And we think there are a lot of pharmaceutical companies out there that will see us as a very appropriate partner for those pharmacogenomics. So, we'll be rolling out more details on the implied menu as we move through the rest of this year and throughout next year, Quintin.

Quintin Lai - Robert W. Baird

Right. Thanks.

Scott Garrett - President and Chief Executive Officer

You are welcome.

Operator

Your next question comes from Peter Lawson with Thomas Weisel.

Scott Garrett - President and Chief Executive Officer

Good morning Peter

Peter Lawson - Thomas Weisel

Good morning. I wondered if you could just go through that supply interruption for cellular. Is that fixed now and --

Scott Garrett - President and Chief Executive Officer

Sure. It's really a supply issue, it's not a quality issue. It only affects instrumentation. So no clinical shipments of reagents are affected whatsoever. We had two large printed circuit board operations for many, many years, one in Miami and one in California, and in the process of consolidating those two, quite frankly, we had some planning errors that made some components that we need... made them unavailable for a short period of time. We're catching up on that and we've got some significant backorders. But again, they are for cellular instruments for the most part and not much else. And we expect to work those backorders off in the fourth quarter in a way that will allow us to meet our full year goals. So, this not a... this certainly had an impact on our third quarter results, we don't expect it to affect our full year.

Peter Lawson - Thomas Weisel

When was it fixed, that issue, and are the parts available now?

Scott Garrett - President and Chief Executive Officer

The parts are becoming more and more available. And they... as far as being fixed, yes, we know exactly what we need and we've got the orders in and as the components come in, we are building the boards, and as the boards come in we are building the instruments.

Peter Lawson - Thomas Weisel

Okay. Thanks.

Scott Garrett - President and Chief Executive Officer

I want to emphasize that our customers are not affected, no customer operations were interrupted.

Peter Lawson - Thomas Weisel

And then I am wondering if you could talk through the incremental cost in R&D. How much of that is going to molecular?

Scott Garrett - President and Chief Executive Officer

I think you can... just to sum it up simply, virtually all of the incremental R&D is going into molecular. It's the lion's share of the increase that has been ramping up throughout the year.

Peter Lawson - Thomas Weisel

And then finally on the gross margins, I am wondering if you could break out the impact between the distribution costs and the life science hit?

Charlie Slacik - Chief Financial Officer and Senior Vice President, Information Technology

Sure. Peter, this is Charlie. On the gross margin impact, about 50 basis points would be as a result of the higher distribution costs. And about 20 basis points on the mix represented by the lower margins on the life science products.

Peter Lawson - Thomas Weisel

Okay. Thank you so much, Charlie.

Charlie Slacik - Chief Financial Officer and Senior Vice President, Information Technology

Sure.

Operator

Your next question comes from David Lewis with Morgan Stanley.

Scott Garrett - President and Chief Executive Officer

Hi David.

David Lewis - Morgan Stanley

Good morning.

Scott Garrett - President and Chief Executive Officer

Good morning.

David Lewis - Morgan Stanley

Charlie, I wondered if you could give us some more detail here on revenue mix and margins. You gave different components, one being obviously the revenue mix; you also talked about distribution costs. In the past, when you've talked about higher freight cost, that actually has been tied to some of your large equipment in automation sales. So, I guess number one, could you just give us the breakdown between the hit to EBIT in basis points of margin as it relates to the revenue mix and then as it relates to the distribution of freight costs and were those freight cost linked to large automation shipments?

Charlie Slacik - Chief Financial Officer and Senior Vice President, Information Technology

On a year-to-date basis, there is some of that's going to be mixed in to the higher automation shipments and clearly given the mix you can see that the diagnostic products are growing faster than the life science products. But the exponents that are really affecting the distribution costs this year would be surcharges... fuel surcharges were also one of the other aspects this year that has been affecting us and less so in the third quarter, but throughout the year is more expedited smaller, less consolidated shipments around the world, partly due to our ERP conversion and some product and inventory availabilities. And so, when you combine the higher fuel charges and a higher number of smaller shipments together with our inability to pass on these incremental costs to customers, it leaks out as about a 50 basis point increase in gross margin, not only for the quarter, but for year-to-date. So, I would say, less impacted by mix as opposed to some extraneous impacts from the outside.

David Lewis - Morgan Stanley

So, Charlie, if we add back that 50 bps, you're still sort of down below where you were two quarters ago on gross margin. So, what I am trying to guess or ascertain here is what is the sustainable gross margin or the target for the business you can get back to? Should we be talking about the company is trying to get back to 48%, the company is trying to get back to 50%, what's the number we should be thinking about?

Charlie Slacik - Chief Financial Officer and Senior Vice President, Information Technology

If you remember last quarter, we had a rate below 47% for the quarter, but for the first half it blended at about 47% and for the quarter, we've got about 47% in the third quarter for a year-to-date run rate of 47%. So, that's what it is. And in the fourth quarter, we'd expect that to bubble up a little bit above 47% just because of the nature of our fourth quarter shipments with life science hardware. So, I would say that it should place us north of 47%, but south of 48% on a full year basis.

And probably the other thing I would just want to reemphasize from prepared comments is that the margins for diagnostic products have not changed in terms of what we call our standard margins. So, to the extent that our unit costs go up each year, when you give the mix within the diagnostic products, as I think Sara pointed out with higher immunoassay in the mix, our overall margin for diagnostics has remained in tact and constant with prior years. So, it's obviously immunoassay pulling up the average and then costs would bring it down a little bit to get to a neutral point.

Scott Garrett - President and Chief Executive Officer

And David, as Charlie said in the prepared comments, we do expect to get to approximately 12% operating margin for the full year. So, a lot of these efficiencies that had a little bit of downward impact in the third quarter I think are going to be turned around and you will us hitting out full year goals for operating margin.

David Lewis - Morgan Stanley

Okay. And then Scott, could you comment on... hemostasis was obviously... some comments you made last quarter, you just from clinical doses this quarter still seems like you have a competitor who's getting more aggressive in the marketplace over the last couple of quarters. Can you talk about the competitive dynamics within hemostasis and when you see those improving?

Scott Garrett - President and Chief Executive Officer

David, were you talking hemostasis or hematology?

David Lewis - Morgan Stanley

I am sorry, I am talking hematology.

Scott Garrett - President and Chief Executive Officer

Okay, that's what I thought. We continue to see some pressure from Sysmex; that's our most important strategic competitor in hematology. But we believe we are holding our own in share, the concessions on price are not at all severe. We are working hard to get our next-generation system out. And our margins remain solid. Remember, the life cycle of an instrument is going to be at least five and in hematology often six, seven, or even eight years. And we have very, very strong relationships with these customers, and the margins for the reagents that go to our hematology customers are very, very solid and really quite high.

David Lewis - Morgan Stanley

Okay. And then Scott you mentioned the goal of hitting 12% for the year in 2007. Any sort of updated thoughts in terms of your sort of two to three-year goals of where operating margin can get to?

Scott Garrett - President and Chief Executive Officer

Well, we certainly expect that the numerous supply chain initiatives and business operations initiatives we have around the company will continue to give us leverage in operating expanses and in our overall costs. So we expect steady improvement and we should get back to historical levels within the next couple of years. If you remember, we were up in the 14% plus range before we made the change in our leasing policy.

David Lewis - Morgan Stanley

Okay. Thank you very much

Scott Garrett - President and Chief Executive Officer

You're welcome David

Operator

[Operator Instructions]. Your next question comes from Bill Quirk with Piper Jaffray.

Scott Garrett - President and Chief Executive Officer

Good morning Bill.

Operator

Sir, your line is open.

Bill Quirk - US Bancorp Piper Jaffray

Good morning, thank you. Quick question for you on R&D spending trends, Scott, we've had a nice series in new instruments launches, particularly in immunochemistry, one coming up actually as well, but chemistry and obviously we have our expenses dialed in for the new hematology launch. Should we be thinking in terms of R&D trends of continuing to expect these kind of $6 million to $7 million year-over-year increases in that for the molecular business or should we think about perhaps harvesting some of the existing R&D and transitioning that, say, away from the traditional clinical chemistry business or central lab business, I should say, into molecular? Could you just talk maybe kind of next couple of year trends on that?

Scott Garrett - President and Chief Executive Officer

Yes, I think we have an enviable list of opportunities to work on in R&D because of our breadth and because we have been able to leverage our instrument engineering capabilities across product lines, we've got a long list of very compelling projects. So we'll continue to ramp up, we expect to be consistently spending 9% plus as a ratio to sales and would be moving that investment around. Hematology, the new system will be launched late next year. We are already seeing some of the engineering resources that we are dedicated to that project to become available. As you know, we are finishing off a long list of very capable work cells. We've just introduce new automation. So we are rotating some of those engineering and software resources off to other projects. Molecular will continue to be funded for success and we have a number of very attractive throughput automation speed and sensitivity oriented improvements available to us that we can apply across several of our product lines. So, we have got plenty of compelling projects in mind and I think you are going to see us spending at a 9% plus rate pretty consistently over the next couple of years.

Bill Quirk - US Bancorp Piper Jaffray

Okay. So in other words we should not expect any significant bolus above that, above that 9% on, call it, a full year basis, Scott, in '08?

Scott Garrett - President and Chief Executive Officer

No, I think we can pace these projects in a way that that 9% or so will give us an opportunity to really fully fund these projects in a way that we would quite successful. So, you'll see R&D growing a little bit faster than sales. But we will have I think a tremendous impact with a number of these new projects over the next couple of years.

Bill Quirk - US Bancorp Piper Jaffray

Okay, understood. And then Charlie, just a housekeeping question. Any change to the percentage of CapEx related operating leases in the quarter?

Charlie Slacik - Chief Financial Officer and Senior Vice President, Information Technology

No, I think, Bill, we kind of recalibrate or recheck as we go along and it's still about two-thirds of our CapEx would be represented by OTL assets.

Bill Quirk - US Bancorp Piper Jaffray

Okay. Thank you.

Scott Garrett - President and Chief Executive Officer

Okay. Thanks Bill.

Operator

Your next question comes from Bruce Jackson with RBC Capital Markets.

Scott Garrett - President and Chief Executive Officer

Good morning, Bruce.

Bruce Jackson - RBC Capital Markets

Good morning guys. To follow-up on Quintin's question about the launch menu, so it's going to be nine assays, can you tell us a bit more about which areas they are going to be in?

Scott Garrett - President and Chief Executive Officer

They will be... we will have an MRSA assay, we will have an AIDS and hepatitis assay, sexually transmitted disease. I think, Bruce, we will have a competitive list of tests for infectious diseases that will make our system immediately competitive. And then we will build out from there. I'd call that the minimum launch menu for now and if in fact we have some cancer tests available at launch, which we very likely will, we would include those. So I think this is kind of a moving target and kind of a minimum expectation for now. And as we move through the next year, we will have a far better idea of exactly what the launch menu is going to be like. And then we are going to be adding I think new tests literally quarter by quarter as we have in immunoassay over last five or six years.

Bruce Jackson - RBC Capital Markets

Okay. And then speaking of cancer, could you tell us a bit more about your commercialization plans for the Johns Hopkins assays?

Scott Garrett - President and Chief Executive Officer

Well, we will --

Bruce Jackson - RBC Capital Markets

Hope for any assays that are derived from the Johns Hopkins agreement?

Scott Garrett - President and Chief Executive Officer

Well, there could be dozens. Literally we have rights to the IP associated with all the new genetic markers that are coming out of this research at Hopkins. We have been working with them via our Agencourt subsidiary for several years. We've been doing the sequencing for them in all their work that's been identifying new genetic markers. So we are going to continue to do the sequencing, we will be their partner in their research, and then we will have... we have negotiated to secure rights for the diagnostic applications of these new genetic markers that they discover.

Bruce Jackson - RBC Capital Markets

Okay. And then one housekeeping question for Charlie with the tax rate, is that something that's going to carry you through to 2008?

Charlie Slacik - Chief Financial Officer and Senior Vice President, Information Technology

It's probably a little early to talk about the 2008 tax rate now. But with the FIN 48, the quarter-to-quarter tax rates become a little volatile. But net-net for the full year what we see is a tax rate that's at the end of the day pretty comparable to last year, between 28% and 29%. So it's kind of been hard to blend that in on a full year rate, but at this point it looks like it's going to be very close to what last year's was for '07. And '08, it's still a little too early to tell.

Bruce Jackson - RBC Capital Markets

All right. Thank you.

Scott Garrett - President and Chief Executive Officer

Thank you, Bruce.

Operator

Your next question comes from Bruce Cranna with Leerink Swann.

Bruce Cranna - Leerink Swann

Hi, good morning everyone.

Scott Garrett - President and Chief Executive Officer

Good morning.

Bruce Cranna - Leerink Swann

Scott, I guess the toughest question first. Just I am trying to get to your $0.77 number on the bottom line. Can you give me some sense as to the impact from the one-time gain on the quarter? I can't tell if it's... it looks like by your commentary in the press release it's $0.14 give or take?

Scott Garrett - President and Chief Executive Officer

In our adjusted results, there is no impact from the land sales, if that's what you are referring to, Bruce.

Charlie Slacik - Chief Financial Officer and Senior Vice President, Information Technology

Bruce, this is Charlie. I don't know if you have the reconciliation page in front of you, it's page 11 of the press release.

Bruce Cranna - Leerink Swann

Yes.

Charlie Slacik - Chief Financial Officer and Senior Vice President, Information Technology

What essentially you should do is take out the $26 million gain on the sale and also extract $9 million, which was the amount of the gain that we contributed to our foundation.

Bruce Cranna - Leerink Swann

So the contribution is the difference there?

Charlie Slacik - Chief Financial Officer and Senior Vice President, Information Technology

Yes, exactly. That's probably what you're not seeing.

Bruce Cranna - Leerink Swann

Okay.

Charlie Slacik - Chief Financial Officer and Senior Vice President, Information Technology

That's why we'd net down to 17.

Bruce Cranna - Leerink Swann

Got it. And then, I guess, my... I guess the next most important question, just on the supply distribution or disruption in the quarter.

Scott Garrett - President and Chief Executive Officer

Yes.

Bruce Cranna - Leerink Swann

Was it specific to hematology or did it also affect flows, Scott?

Scott Garrett - President and Chief Executive Officer

It was cellular. So it did affect flow and hematology. Again, we moved... we're moving the printed circuit board operation in Miami that were dedicated to cellular flow and hematology to California, and the planning was not... did not include enough buffer stock to make sure that the transition was smooth and we just got caught in the transition during the third quarter. It's not a long-term issue and it's something that we think we can work our way out of easily over the next period.

Bruce Cranna - Leerink Swann

No, I understand, but it's always sort of equally affecting flow and hematology?

Scott Garrett - President and Chief Executive Officer

Yes, although we have a lot more varieties of hematology instruments and a lot higher volume of hematology instruments than we do flow.

Bruce Cranna - Leerink Swann

Yes. And then so, the $10 million backorder, would it be fair to think that would drop into Q4 or do you think that's not representative of kind of the extent of the miss in cellular for the quarter?

Scott Garrett - President and Chief Executive Officer

I think that is a good way to look at cellular for the third quarter and we'll make up the majority of that in the fourth quarter. But in any case, we don't expect to have that prevent us from achieving our full year goals because even as we hit this short-term disruption in supply, demand for all of our cellular products has been increasing. So, we're kind of chasing the backorder and we're chasing increasing demand in the fourth quarter, which is good news.

Bruce Cranna - Leerink Swann

Yes. And then immunoassay, you guys continue to do very well there and you mentioned you are clearly performing above market growth rates. Did you... I am sorry if I missed it, did you actually mention what you think current market growth rates are in immunoassay?

Scott Garrett - President and Chief Executive Officer

No, we didn't and that's a tough number to pin-point. The market growth rates worldwide, I think, are rough estimates at best today, Bruce.

Bruce Cranna - Leerink Swann

Okay. And then last from me, Charlie, I am sorry, I missed your commentary on what's left on the buyback authorization.

Charlie Slacik - Chief Financial Officer and Senior Vice President, Information Technology

Oh, yes. We have about 500,000 shares left on that Bruce.

Bruce Cranna - Leerink Swann

Okay, great. Thank you.

Scott Garrett - President and Chief Executive Officer

You're welcome.

Charlie Slacik - Chief Financial Officer and Senior Vice President, Information Technology

You're welcome.

Operator

Your next question comes from Rick Wise with Bear Stearns.

Rick Wise - Bear Stearns

Good morning everybody.

Scott Garrett - President and Chief Executive Officer

Hi Rick.

Rick Wise - Bear Stearns

How are you doing? Just pickup on the immunoassay first, can you give us a little more color, you clearly seem to be gaining share; you've been hard at peg at market growth. I was impressed to see that immunoassay was up sequentially even what I assume is normally a sequentially weak quarter. Can we see this kind if a sequential dollar growth continue for a while?

Scott Garrett - President and Chief Executive Officer

I think it can. We get growth in immunoassay in a number of ways and it's just getting to be better and better story. We better utilize our existing installed base with new tests. We've just introduced a new kind of mid to high throughput analyzer in the 600. Our work cells are kicking in, which gives us additional immunoassay customers and we're seeing rapid growth in some of the international markets that we serve, specifically, China. So, lots of ways to grow and I think we can continue to see very good positive momentum in immunoassay for the next few quarters and probably into the next couple of years given the number of new ways that we can sell immunoassay, not only through the work cells, but also through automation. As we continue to utilize our leading position in immunoassay, we virtually always pull through chemistry with automation and more and more, we're pulling through immunoassay and even hematology as well.

Rick Wise - Bear Stearns

Did I hear you correctly, you were going sort of quick with your initial comments, Scott, that there's a delay in the work cells to the first quarter of '08 versus late '07? Did I hear it correctly and maybe just help us understand what's going on?

Scott Garrett - President and Chief Executive Officer

We will be introducing and shipping the new work cell in the first quarter of 2008. We have been positioning both the DxC 800 and the DxI 800 as upgradeable to work cells for some time, especially in Europe. And we will be introducing the additional three work cells in the UniCel family by year-end in 2008.

Rick Wise - Bear Stearns

Okay. Two other quick ones, Charlie, other... I mean, I realize there were some unusual things there. If we're doing our math right, it would seem like other was positive by maybe $2.5 million in the quarter. Is my math right? And is that going to continue... will the other line continue positive in the fourth quarter?

Charlie Slacik - Chief Financial Officer and Senior Vice President, Information Technology

Rick, yes, on the non-op, there's a flip turnaround on foreign exchange gains versus losses last year. So, your read on the turnaround is, yes, was about $5 million flip versus last year. And that's because of foreign exchange on un-hedged currencies, primarily the Turkish lira. But I think as we said, if you are modeling the full year for total non-op expenses, it would be fairly flat with the prior year.

Rick Wise - Bear Stearns

Okay. And just last, you narrowed your EPS range, but you brought the upper end down slightly and despite obviously a very good EPS quarter in the third quarter, I mean, just trying to understand what changed versus the upper end of your thinking. Japan is a factor, seems like cellular is going to come back in the fourth quarter. Gross margins could better in the fourth quarter, I am just a little confused about the upper end and just a clarification will be appreciated. Thanks.

Scott Garrett - President and Chief Executive Officer

Sure, Rick. Obviously we want as we get closer to the end of the year get a little bit more concise on what we are projecting. But as you thought...if you think about what we've showed for the quarter, we are real happy with the diagnostics business, it's going great, life science has currently underperformed. And so, I think we are trying to take a little bit of the luster up just because life science has underperformance at this point. I think that you might attribute that to if we are bringing down the top end of the range.

Rick Wise - Bear Stearns

Okay. That's very helpful, thanks so much.

Scott Garrett - President and Chief Executive Officer

Sure.

Operator

Your next question comes from Jon Wood with Banc of America Securities.

Scott Garrett - President and Chief Executive Officer

Hi Jon.

Jon Wood - Banc of America Securities

Hello. Good morning.

Scott Garrett - President and Chief Executive Officer

Good morning.

Jon Wood - Banc of America Securities

Scott, is the life science business accounted for the divestiture?

Scott Garrett - President and Chief Executive Officer

Well, you know we don't comment on acquisitions or divestitures. I can tell you that we have been looking at our product portfolio over the last couple of years and looking at some of the more mature products and looking at harvest possibilities. Divestiture would be a big step and not something we would take lightly. So, I don't think it's something that I would speculate on a call.

Jon Wood - Banc of America Securities

Okay. And is the operating margin in that life science business, is it higher than the core Beckman operating margin?

Scott Garrett - President and Chief Executive Officer

It's slightly lower. It's... we get very good returns in life sciences. It's a profitable business. Margins, because it's so heavily weighted to instruments, is a little bit lower than diagnostics.

Jon Wood - Banc of America Securities

Okay. And then you mentioned a 2% decline in the revenue for the year in that division. Can you remind us what does that imply for the fourth quarter on a constant currency basis?

Scott Garrett - President and Chief Executive Officer

We are not giving out that detailed guidance for the quarter. I am sorry.

Jon Wood - Banc of America Securities

Okay. And then one quick one, the D&A expense about 8.5% of revenue, what have you modeled for that line item once it reaches a steady state?

Charlie Slacik - Chief Financial Officer and Senior Vice President, Information Technology

Once it reaches a steady state, if I remember, it should close the gap in another year and a half, by the middle of 2010. So, it still has, I would say, another between $50 million and $100 million to grow per year. And then it should grow comparable to CapEx after that point, maybe with a small gap, but growing consistently with CapEx at an inflation rate or a business growth rate of maybe 7% to 8%.

Jon Wood - Banc of America Securities

Okay. And so is it reasonable to assume that's about 10% of sales or so on an ongoing basis once you are at a steady state?

Charlie Slacik - Chief Financial Officer and Senior Vice President, Information Technology

That's probably a good number. I have never thought of it in terms of sales. But if you just look at the... this year's numbers, we have a CapEx number that's in the $300 million and a D&A number that's, say, in the below $200 million range. So, you have got $100 million spread. And I think it was $66 million through three quarters. What should happen is you might see that close to a gap of maybe $75 million by the time we are, I'd say, $50 million by 2010. And then grow 7% or 8% from there. It shouldn't grow necessary with sales. It should grow more like I would say maybe more in the 7% to 8% range. Just like you are seeing the CapEx growing right now.

Jon Wood - Banc of America Securities

Okay. Thanks a lot.

Charlie Slacik - Chief Financial Officer and Senior Vice President, Information Technology

Okay.

Scott Garrett - President and Chief Executive Officer

You're welcome.

Operator

Your next question comes from Sungji Naam [ph] with JP Morgan

Unidentified Analyst

Hi, this is Sungji sitting in for Tycho Peterson. I just had a quick question; as far as Agencourt, your Agencourt business, I know that's a small part of your business. But what's your long-term strategy for that business in light of the fact that there is the emergence of next-generation sequencing technology?

Scott Garrett - President and Chief Executive Officer

We are continuing to be committed to doing our sequencing service business. We are evaluating new technologies in sequencing and the team that we have at Agencourt is being expanded and built upon as the kit development capability for our new molecular diagnostics project.

Unidentified Analyst

Okay. Thank you.

Scott Garrett - President and Chief Executive Officer

You're welcome.

Operator

Your next question is a follow-up from Quintin Lai with Robert W. Baird.

Quintin Lai - Robert W. Baird

Hi, thank you for taking the follow-up.

Scott Garrett - President and Chief Executive Officer

Hey Quintin.

Quintin Lai - Robert W. Baird

It wouldn't be a conference call without an M&A question.

Scott Garrett - President and Chief Executive Officer

Yes.

Quintin Lai - Robert W. Baird

So, first as the industry has had a lot of shake up here over the last 12 months, have you seen any changes with respect to... as some of the existing players... some of their customers' contracts come up, are there more chances for you to take market share or is it still too early to tell? And then, Scott, just in general, any update on your view on industry consolidations?

Scott Garrett - President and Chief Executive Officer

Sure. As we look at the emerging Siemens position, clearly it's going to be our most important strategic competitor going forward, but certainly we still have to pay attention to Roche, to Abbott, to J&J. These are all very capable companies with what appears to be strong commitments to their diagnostics franchises.

In the short term, as Siemens begins to integrate three rather disparate companies in terms of geography, locations, management teams, sales forces, we see some real opportunities to continue to gain market share. Clearly, it's going to take them some time to decide which platforms they want to standardize on and until they do standardize, they are not going to be able to drive much in the way of economic advantage by virtue of their scale. They really have to consolidate their plans; they have to pick what platform to use, which tests format to use before they really drive any significant economies.

So that's going to take some time and it's going to give us some opportunities. We still believe that we are the most capable broadly based diagnostic supplier to hospital laboratories in the world. When you look at our positions, Quintin, we are number one or number two in chemistry, hematology, flow cytometry, proteins and in immunoassay, we are the fastest growing and I believe we are already close to being number two in many of the important markets around the world in immunoassay.

Our automation, our work cells capabilities give me great confidence that we can continue to win even after a consolidator really does get its integrations act together. So we will be on the lookout for the tuck-in and content acquisitions that have typified our acquisition pattern in recent years. Certainly if there is a consolidation opportunity that makes sense, we have the capabilities of carefully... to carefully review and analyze that, but we don't believe that we need to do a consolidating acquisition to be successful.

Quintin Lai - Robert W. Baird

Thank you.

Scott Garrett - President and Chief Executive Officer

Thanks Quintin.

Operator

There are no further questions at this time. I'd now like to turn the call back over to Mr. Raynor for any closing remarks.

Robert Raynor - Director, Investor Relation

Thank you. A reply of this call can be accessed on our website at beckmancoulter.com. As for upcoming Investor Relations activities, we will participating in the following events which will be webcast. In Phoenix, the CSFB conference and in New York the Lazard Capital Markets; Piper Jaffray, and RBC Healthcare conferences. Also pleased to note that Beckman Coulter will host its annual business review in New York on Tuesday, December 11. For more information, please contact Investor Relations. Our website also provides more details on all these events. This concludes our call this morning. Thank you for joining us.

Operator

Thank you for participating in today's conference call. You may now disconnect.

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Source: Beckman Coulter, Inc. Q3 2007 Earnings Call Transcript
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