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Becton, Dickinson and Company (NYSE:BDX)

Q2 FY08 Earnings Call

April 23, 2008, 10:00 AM ET

Executives

Patricia A. Spinella - IR

John R. Considine - Vice Chairman and CFO

William A. Kozy - EVP

William A. Tozzi - VP, Finance

Gary M. Cohen - EVP

Vincent A. Forlenza - EVP

Analysts

Frederick Wise - Bear Stearns

Michael Weinstein - JPMorgan

Peter Lawson - Thomas Weisel Partners

Bruce Cranna - Leerink Swann & Company

David Toung - Argus Research

Glenn Reicin - Morgan Stanley

Lawrence Keusch - Goldman Sachs

Jeffrey Frelick - Lazard Capital

Kristen Stewart - Credit Suisse

Operator

Hello and welcome to BD's Second Fiscal Quarter 2008 Earnings Call. At the request of BD, today's call is being recorded. It will be available for replay through Wednesday, April 30th, on the Investors page of the bd.com website or by phone at 800-388-6197, for domestic calls an area code 401-220-1115, for international calls using conference ID 7BDX. I would like to inform all parties that your lines have been placed in a listen-only mode until the question-and-answer segment.

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

Patricia A. Spinella - Investor Relations

Good morning, everyone, and thank you for joining us to review our second fiscal quarter results. During today's call, we will make some forward-looking statements and it's possible that actual results could differ from our expectations. Factors that could cause such differences appear in our second quarter press release and in the MD&A section of our recent SEC filings. We will also discuss some non-GAAP financial measures with respect to our performance. A reconciliation to GAAP measures can be found in our press release and the related financial tables. A copy of the release which includes the financial tables is posted on the bd.com website. Leading the call this morning is John Considine, Vice Chairman and Chief Financial Officer. I'll now turn the call over to John.

John R. Considine - Vice Chairman and Chief Financial Officer

Thank you, Pat, and good morning to everybody. As usual on the phone with me today is Vince Forlenza, Bill Kozy, and not in this room, but also on the phone is Gary Cohen. And Bill Kozy, who many of you know, our Vice President of Finance, is also joining us and he is going to take us through the results of the second quarter, after which we'll entertain your questions. So Bill?

William A. Tozzi - Vice President, Finance

Thanks, John, and good morning everyone. I assume you all have our earnings release and the attachments that we send out this morning and have had an opportunity to review them. Since we'd like to devote as much time as possible to answering your questions, my opening comments will be brief. We'd like to address three primary topics. First, since there is one significant item that affects the comparability of our diluted earnings per share from continuing operations for the six months ended March 31st, 2007 and 2008, we want to review the analysis of these results provided in the press release. Second, we'll describe some of the key drivers of our revenue and earnings growth for the second quarter. And third, we'll review our revised guidance for full fiscal year 2008.

Starting with our earnings, for the three-month period ending March 31st, 2008, reported diluted EPS from continuing operations were $1.09 and when compared to our fiscal year 2007 second quarter results of $0.92, our growth was 18%.

Moving to our six-month results, I would suggest you turn to table one in the press release. For the six months ended March 31st, 2008, reported diluted EPS from continuing operations were $2.16. There are no specific items in fiscal 2008 six-month results that impact comparability. For the first six months of fiscal year 2007, we are heading back to our reported diluted EPS from continuing operations of $1.44, a charge of $0.45 resulting from an in-process research and development charge related to the TriPath acquisition. This gives us EPS from continuing operations excluding the specified item of $1.89. Comparing the $2.16 in the fiscal year six-month period to the $1.89 in the prior year’s six-months period gives us an adjusted EPS increase of 14%.

Moving to our growth drivers for the second quarter, our revenue increased by 11%, which included a 5% favorable impact from foreign currency translation. The positive translation effect was primarily related to the euro and to a lesser extent, the Canadian dollar and certain Asia-Pacific and South American currencies. As you can see from the tables attached to the press release, all three segments benefit from positive foreign exchange of 46% for the quarter.

In the Medical segment, second quarter revenues grew about 9% led by sales of prefillable drug delivery devices and pharmaceutical systems and by diabetes care products. Global sales of safety-engineered products in this segment grew about 9% to $175 million.

Revenues in the BD Diagnostics segment grew about 12% in the second quarter. Sales of safety-engineered devices, TriPath products, and molecular testing systems, which include GeneOhm, ProbeTec, and Viper also contributed to the growth. Global sales of safety-engineered products in this segment grew 15% to $199 million, due for the most part the continued success of our Push Button Blood Collection Set. Looking at the combined medical and diagnostic global safety, sales grew about 12% to $374 million. The US growth was about 4% and ex-US was about 33%.

In the BD Biosciences segment, worldwide revenue grew 14% for the quarter. Research instruments as well as clinical and research reagents continued to be the primary growth contributors.

Turning to quarterly gross profit, our margin percentage for the second quarter was lower than that for the prior year by 40 basis points. As you may recall, in the fourth quarter of fiscal year 2007, we recorded the reclassification of certain expenses from SSG&A and R&D, cost of products sold for both quarters of the year have related to a newly integrated TriPath and GeneOhm platforms.

The reclassifications was recorded to conform the historical accounting classification practices to those filed by BD. About half or 20 basis points of that decrease in the second quarter's gross profit margin related to this reclassification. While this impacts the comparability of our quarterly gross margin to the prior year's period, it will have no impact on the comparability of the... our full fiscal year. The other half of the decrease relates to discrete inventory write-downs that totaled about $4 million, which were recorded in the quarter. Absent these items, our overall gross margin percentage would have been about the same as prior year.

SSG&A as a percentage of sales improved 200 basis points primarily due to disciplined expense management. R&D spending increased by about 11%. Our operating income margin was 160 basis points higher than prior year's adjusted margin due to the favorable SSG&A offset the slightly lower gross margin… profit margin impact that’s previously discussed.

In terms of cash flow on a year-to-year basis, we generated approximately $700 million of net cash from operations. $276 million was used to repurchase 3.3 million shares of common stock and we invested $266 million in capital expenditures.

The last topic we'd like to cover is our revised guidance for fiscal year 2008. We expect diluted earnings per share from continuing operations for fiscal year 2008 to increase approximately 13% to 14% last year's adjusted base of $3.84. This excludes $0.48 of in-process research and development charges related to the TriPath and Plasso acquisitions. This reflects an increase from our prior guidance of 11% to 13%.

Our full-year reported revenue growth is expected to be about 11%. We expect Medical to be about 10%; BD Diagnostics, about 11% to 12%; and BD Biosciences, about 12%. This would include about 3 to 4 percent point… percentage points of positive foreign currency benefits. Our global safety is expected to increase by 11% to 12%, US safety sales of... US sales of safety-engineered products are estimated to increase by about 6% and international safety should grow about… by about 25%.

We expect our gross profit margin percentage to climb by about 30 to 40 basis points below the prior year and about 10 to 20 basis points below our previous guidance. This reflects the inventory write-downs discussed earlier as well as the one-time items that impacted the first quarter. Year-on-year, we expect product mix to contribute about 70 basis points, which has more than offset the higher resin cost of about 60 basis points, start-up cost of 30 basis points, and all other one-time asset write-offs, about 10 to 20 basis points.

We would like to point out that in fiscal year 2007, BD spends for resins was about $250 million, which accounts for less than 10% of our total cost of sales of $3 billion, while resins prices do not immediately reflect an increase in oil prices, over time, the rise in oil prices has and continues to have an impact on resin prices. And although the weakening of the US dollar contributes to the increase in oil prices, the benefit to BD of weakening US dollar has outweighed the negative impact of higher resin cost since more than half of the company's revenues are derived from outside the US. And coupled with our expense control plans explains why we had been able to raise guidance even when confronted with higher resin costs.

Continuing with our guidance, SSG&A is expected to improve by about 80 basis points as a percentage of revenues. Our R&D spending is expected to increase by about 11%. Our overall income margin is expected to improve about 50 basis points over the adjusted 2007 operating income of 20.8%. Our effective tax rate is projected to be 27.5% for the year, and as you know, can vary by quarter. We expect to generate $1.6 billion of net cash from operations and invest about $650 million in capital expenditures. We expect share repurchases to be about $450 million and the average number of fully diluted shares outstanding to be about 253 million to 254 million.

I will now turn the call back to John.

John R. Considine - Vice Chairman and Chief Financial Officer

Thanks, Bill, and Operator, Kevin, you can open the call for questions and we'd appreciate it if you'd limit your questions to one plus a follow up.

Question and Answer

Operator

Thank you. [Operator Instructions]. And we'll take our first question from the line of Rick Wise with Bear Stearns. Your line is now open.

Frederick Wise - Bear Stearns

Good morning, John.

John R. Considine - Vice Chairman and Chief Financial Officer

Good morning, Rick.

Frederick Wise - Bear Stearns

Let me start with SG&A and its sustainability. You were saying that… you were suggesting that SG&A will be down 80 basis points on a full-year basis. Maybe, walk us through some of the factors, which were disciplined expense management, what have you eliminated and are we sort of in this 23% of sales range or 23.5%, 24% of sales range for the foreseeable future, even after things “get back to normal on the gross margin line?”

John R. Considine - Vice Chairman and Chief Financial Officer

Well, that's a long question, Rick.

Frederick Wise - Bear Stearns

Tried to squeeze a lot in there.

John R. Considine - Vice Chairman and Chief Financial Officer

But I don't want to get too much into the future because as you know, we'll guide for 2009 and beyond a little later. But, if you want to look at our total SSG&A, last year about $407 million, obviously some of that is European-based. So FX drives that up a bit. But what really has helped us is that when you look at our core spending, so take out investments in Immunocytometry, Pharmingen, Infusion Therapy, our core hypodermic SSG&A, and only... and core alone has only risen about 1.3%. So, we have placed these controls along... among all of our businesses within all three segments and we don't follow in any way a strategy of throwing the proverbial baby out with the bathwater, rather we are being very judicious in how we look at any increases around SSG&A, we're going to see the growing needs on a marketing and selling basis. But where cost can be discretionary, we are taking the opportunity to control them. I think without forecasting exactly what we would be, we're animating a kind of 24 or slightly lower relationship to sales for SSG&A for this year. I think certainly there is this sustainability of cost that will continue to exist and we should be able to leverage our future sales growth and do that. To be more explicit than that, we are going to have to wait till next... till the time we forecast for the '09 year.

Frederick Wise - Bear Stearns

Okay. Let me follow up on a slightly different topic. US growth this quarter was at 4%, if I'm looking at it correctly, was one of the slowest growth quarters we have seen in some time, and US Diabetes down a percent, US Med-Surg only up 1%, maybe you can give us some general perspective on the US business and maybe some of the more challenging segments? Thanks a lot.

John R. Considine - Vice Chairman and Chief Financial Officer

Okay, well, Gary, why don't you talk on Medical and then Vincent and Bill will join this.

Gary M. Cohen - Executive Vice President

Sure. Well, looking at the US specifically, there were a few things that occurred in the quarter that we're expecting to change in the balance of the year and a few things won't change. So to be very specific, on Diabetes, as you know, we were down about a point year to year, that was particularly impacted by the loss of a VA contract last year where we had a very favorable second quarter associated with that contract and didn't have any revenues from it this year. And then the good news there is that we won the contract back. There were some issues with the other supplier, and effective April 1st, we're going to be regaining business from that. So in fact in the second half of the year, we’re expecting US sales in diabetes care to be quite a bit higher, in fact even higher than they were in the first quarter, and they were up around 9% in the first quarter.

And then in Med-Surg, there is a combination of factors, some of which are going to be ongoing factors, some of which are not. One is, we are seeing some inventory adjustments at the distribution level, and we know that because we compare our sales through distributors to our tracking of end-user sales. And our end-user sales are up in the normal range for Medical Surgical US which is say 4% to 5% range. So there is some inventory adjustments going on. We also had a stronger than usual quarter with safety devices last year in the second quarter. It was by far the strongest quarter of the year on a year-to-year growth rate. So that was up against a little bit of a tough comparison. We have one safety device, it's been in the product line for a long time, that is declining and was expected to be declining, that’s the Interlink product line. That will continue.

On the other hand, Nexiva is doing very well. It's just not large enough yet to it show up in a demonstrable way but our Nexiva sales doubled year-to-year, and that also will continue.

So, on the whole, Med-Surg, we're expecting better growth in the second half of the year than we saw in the quarter, probably something closer on average to what we saw in the first quarter in that range. The other one I might as well mention is Pharmaceutical Systems, we are expecting much lower growth from the US in the second half of the year. On the other hand, we are expecting quite a bit faster growth internationally in Pharma Systems in the second half of the year. So those two should more or less offset each other relative to the Pharma Systems growth rate.

Frederick Wise - Bear Stearns

Thanks very much.

Vincent A. Forlenza - Executive Vice President

So, in Diagnostics, our US growth was pretty consistent, we were approaching 7%. On the safety line in PAS, PAS safety grew 6.2% and we have been averaging closer to eight and that's in the US I'm talking about, to be clear. International safety was 27.1% for an overall worldwide of 14.5%. So, US safety was slightly lower, but not all that much and that was just a mix of smaller Push Button conversion accounts.

William A. Kozy - Executive Vice President

On the Bioscience side, as you saw from the release, the Cell Analysis business was right in line and actually had a pretty good quarter. Most of our events that we're anticipating came in the Discovery Labware side. Three factors, number one, our dealer inventory management particularly of the core plasticware products, very similar to the comments that Gary made, has impacted us in the second quarter. Number two, some timing on the Bioimaging instrument placements was a factor, and then some regular demand from advanced bioprocessing, one major customer. Those three things happened all at the same time and really is what's impacting that Discovery Labware second quarter performance. We don't expect that to continue.

Frederick Wise - Bear Stearns

Very helpful. Thank you.

Operator

We will take our next question from the line of Mike Weinstein with JPMorgan. Your line is now open.

Michael Weinstein - JPMorgan

Thank you for taking the questions. Gary, spending a minute on the inventory draw down you saw at the customer level in the quarter. There has actually been some... we have seen this in a bunch of different businesses in the US as the company has been reporting that it has been instrument in what's going on there?

Gary M. Cohen - Executive Vice President

Well, it's not uncustomary to have changes in inventory patterns periods during the year depending on how they are doing their only inventory management. And what we saw... the best way we can measure that is by comparing end-user sales and we can track end-user sales through the rebating system that essentially is the mechanism that we transact by where we sell to distributors and they resell and then we rebate to them and through that we get reporting on end-users sales. And they were up more or less 5% in Medical Surgical in the second quarter. So this would reflect that inventories had been taken down, although more than we would have anticipated in the quarter. There were some... also some recently entered into distributor agreements that we believe may, on our side, that would… should be a positive for the long term but may have cost distributors to take down their inventory a little bit in the quarter. The other factor is the more efficient we become with our supply chain, the more rational distributors have to take their inventory levels down. That's not a long-term effect but when they take it down it does affect that quarter.

Michael Weinstein - JPMorgan

Understood. And John, this… the $4 million of inventory write-downs you entered the cost of goods sold line, would be any expectations on that for the back half of the year, that cost you a penny this quarter?

John R. Considine - Vice Chairman and Chief Financial Officer

That's it. It's a one-time discrete item to this quarter.

Michael Weinstein - JPMorgan

Okay. Perfect. And then, let me… If I taken a quick update, if you don't mind on TriPath, how that’s doing competitively and if you could just talk about the progress in the pipeline?

Vincent A. Forlenza - Executive Vice President

Yes. So this is Vince. On TriPath, sales were up around 5% for the quarter which was lower than we've been but it’s about 9.5% for the six months. And that's pretty much our expectation as we look forward towards the back half of the year that that's where it's going to be. And there's just some fluctuation in instrument orders on a quarter-to-quarter basis. So if...

Michael Weinstein - JPMorgan

The market issues, the market might have been a little faster this quarter? Inventory, any thoughts?

Vincent A. Forlenza - Executive Vice President

I don't think there is... we sell direct, haven't seen a lot of change in customer ordering patterns. We are fully implemented a quest. So there is not a lot of upside there. We think we are gaining about a 0.5 point a share a quarter, somewhere around there and we expect to see some more growth coming out of international in the back half of the year. In terms of updating on the programs, the focal point GS as we've talked about has been... that submission for the guided screening claim on the instrument has been at the FDA. They have finished their site inspections. So the manufacturing site inspections is what I'm talking about, they're done. We're into our second round of questions, so I hope we expect one more round of questions in May. I can't say whether that will be the last or not, but hopefully that will be. So that appears to be on track at this point. The HPV trial is, we are finishing that up and expect to be finished with that in September time frame, actually this summer than submitting in around the September or October time frame. That's for the HPV claim on short path. Now the one actually significant change from where we were before is that on the molecular path trial, we did suspend that trial. We had some sites that we're doing extremely well with that. Other sites there, I would just call them less sophisticated in their abilities to stain cells, and so we've had to go back and kind of change the workflow, the upfront workflow on that trial with an automated stainer and we expect to restart that trial probably September, October time frame.

Michael Weinstein - JPMorgan

But what do you hint as your time line?

John R. Considine - Vice Chairman and Chief Financial Officer

Probably pushes it back nine months, at least.

Michael Weinstein - JPMorgan

Okay. Great. Thanks for taking the questions.

John R. Considine - Vice Chairman and Chief Financial Officer

Sure.

Operator

We'll take our next question from the line of Peter Lawson with Thomas Weisel Partners. Your line is now open.

Peter Lawson - Thomas Weisel Partners

Maybe this is probably a question for Gary or John on the weakness from hospital markets, have you seen any weakness there for capital spending?

John R. Considine - Vice Chairman and Chief Financial Officer

Gary?

.

Gary M. Cohen - Executive Vice President

This is Gary. I don't think we have a lot of visibility to it, since on our hospital sales, we really don't do much in terms of capital. I don't know if anyone else on our team would have some visibility to that.

John R. Considine - Vice Chairman and Chief Financial Officer

Bill, have you seen anything on--?

William A. Kozy - Executive Vice President

To have much visibility, the only thing we'd place is, one of the canter [ph] for clinical applications and we have not seen that in that theories [ph]. That's a very narrow area there, specialized area.

Vincent A. Forlenza - Executive Vice President

No, we haven't seen any impact on the Diagnostics side.

John R. Considine - Vice Chairman and Chief Financial Officer

Okay?

Peter Lawson - Thomas Weisel Partners

Okay, that's great. And then, maybe some color on the end markets, the life science, there has been weakness from large pharma from some of your peers on the life science business. I wonder if you're seeing that as well or --?

William A. Kozy - Executive Vice President

Well, I think if you took my earlier comment, this is Bill, we have seen some, what I call some destabilization in the pharma market. There is lots of things going on, people are reevaluating their discovery development process, some people are relocating to other parts of the world. All these factors simultaneously do have some impact on ordering patterns. We do think that's a situation we're working our way through in the next few months and we are... most of our customers pretty good by sharing their plans about where they are going in-depth going forward. So I think we'll work our way through this in the next couple of months. But I think it has slowed some orders of some key product categories and instruments. We hope to see that bounce back.

Peter Lawson - Thomas Weisel Partners

Okay. Thank you for taking my questions.

Operator

We'll take our next question from the line of Bruce Cranna with Leerink Swann. Your line is now open.

Bruce Cranna - Leerink Swann & Company

Hi, thank you. I don't know, John or maybe Vince, can you perhaps part what the actual number for GeneOhm in the quarter?

Vincent A. Forlenza - Executive Vice President

GeneOhm was around $10 million in the quarter. It was up just over $10 million, and we have been saying that for the year, our expectation is about $40 million.

Bruce Cranna - Leerink Swann & Company

Yes. And then what's up with VRE? Was it submitted, I missed that, or is it still sort of later in the spring timing?

John R. Considine - Vice Chairman and Chief Financial Officer

No, VRE has been submitted to the FDA, and has been... it was just cleared in Europe.

Bruce Cranna - Leerink Swann & Company

So, submitted... the data was submitted?

John R. Considine - Vice Chairman and Chief Financial Officer

Yes.

Bruce Cranna - Leerink Swann & Company

I'm sorry, the data was submitted in US as well?

John R. Considine - Vice Chairman and Chief Financial Officer

I'm sorry, what I said was, VRE was cleared in Europe.

Bruce Cranna - Leerink Swann & Company

Right.

John R. Considine - Vice Chairman and Chief Financial Officer

We’re just in the process of making the submission in the United States.

Bruce Cranna - Leerink Swann & Company

But not formally submitted yet in the US?

John R. Considine - Vice Chairman and Chief Financial Officer

Not formally submitted, by the next couple of weeks.

Bruce Cranna - Leerink Swann & Company

Okay, and any change in your thinking about CDEF [ph] timing in the US?

John R. Considine - Vice Chairman and Chief Financial Officer

We're just... we expect the EU technical files or the filing in the EU to be in June. Okay? And then FDA filing in July.

Bruce Cranna - Leerink Swann & Company

Okay.

John R. Considine - Vice Chairman and Chief Financial Officer

No change really.

Bruce Cranna - Leerink Swann & Company

All right, and thank you for that. And I'm just curious also in the quarter, did you have a big rapid flu season, can you spare any details about that in the quarter?

John R. Considine - Vice Chairman and Chief Financial Officer

Yes. It's pretty much a non-event is the way I would describe it. US flu season kind of returned to normal, was a little bit stronger than the previous year. And the Japanese flu season was absolute non-existent. In the quarter, we are talking about worldwide sales of like $5 million. So it's not real material at this point.

Bruce Cranna - Leerink Swann & Company

Okay. And last from me, just, can anyone there comment about the announcement from Excelerate? I don't know earlier this month, what it means to you guys that agreement, where is it going to fed or potentially fed that technology in BD?

Vincent A. Forlenza - Executive Vice President

Yes, this is Vince again. So, what we have right now is a standstill to negotiate an agreement. And so we do not have an agreement in place, it will fit in the microbiology business in certain targeted applications in identification.

Bruce Cranna - Leerink Swann & Company

So is that really a blood culture technology?

Vincent A. Forlenza - Executive Vice President

Is it a blood culture technology? It's not going to replace our blood culture. We are targeting at another application which I really don't want to put on the table right now.

Bruce Cranna - Leerink Swann & Company

Okay. That sounds right. All right, thank you.

John R. Considine - Vice Chairman and Chief Financial Officer

Okay.

Operator

We'll take our next question from the line of David Toung with Argus Research. Your line is now open.

David Toung - Argus Research

Yes, good morning. Thank you for taking the call. I want to follow up the reference you made to the dynamic in the pharmaceutical industry as some of the operation may move overseas and some operations are outsourced to CROs. Can you talk about your penetration into the CROs and how those market share... how the market dynamic and how you are adjusting to that? And then I have a follow-up.

William A. Kozy - Executive Vice President

Sure, this is Bill. We are of course looking at our go-to-market model, particularly in both the Cell Analysis as well as the Discovery Labware business. We've seen this… some of this activity may be moving a little quicker in Europe, and we of course created kind of a virtual sales organization focused exclusively calling on pharma and bringing the broader array of bioscience products to the pharma customers. As we see other geographic markets evolving this kind of way, we will react accordingly. We're using the European model right now, it's probably our proving ground to say that this is indeed the right way for us to react to this type of research migration.

David Toung - Argus Research

Okay. And it was a news item about your second facility in Suzhou, the Diagnostics facility, can you talk about... is that selling into China, Asia, is it exported into other regions? And would there be some plan where you would break out your international growth into regions beyond just whole US and maybe breaking down to Asia, and Europe, and maybe you can just give me some color now on that?

William A. Kozy - Executive Vice President

I'll comment on the plant, and John can comment on how we think about breaking things out publicly going forward. So we just announced the opening of our second plant. We have a medical device plant in Suzhou. This is about 30 minutes away, and it's a diagnostics plant, and it’s for rapid diagnostics, and we expect to start... we're just starting to make product there. This is the flu product and those sorts of things. It's in the export zone. So we do expect to do worldwide distribution for that product line out of that plant.

John R. Considine - Vice Chairman and Chief Financial Officer

Yeah. And as far as giving you a little bit more in-depth look at Asia Pacific, as we call it in the region, we would consider doing that in the future. These things have a historical basis with us and the five regions, if you will, have existed at this for some time. So rather than try to give you anything just off the top of my head right now, I think in '09 we would probably consider breaking that out a little bit more finer in detail.

David Toung - Argus Research

Okay. Great. Thank you.

Operator

We will take our next question from the line of Glenn Reicin with Morgan Stanley. Your line is now open.

Glenn Reicin - Morgan Stanley

Good morning, folks. Thanks for taking my call. A couple of follow-up questions. Can you just break down the safety US or US by business, you did... you said total safety US was 4 and 33, can we just feel and hear a little bit and just go through Medical and Diagnostics, what those numbers look like?

John R. Considine - Vice Chairman and Chief Financial Officer

Hi, Bill.

Gary M. Cohen - Executive Vice President

I don’t know when you get that, I got that here, you might do it.

John R. Considine - Vice Chairman and Chief Financial Officer

Bill has got it right here, Gary.

Gary M. Cohen - Executive Vice President

Okay. That's fine.

William A. Kozy - Executive Vice President

So, Glenn, US safety, Medical is about $135 million, Diagnostics was about $112 million, international Medical was $39 million and Diagnostics, $87 million.

Glenn Reicin - Morgan Stanley

Very helpful. Okay. Another follow-up question is on the issue of foreign exchange, maybe, really two issues. Can you give us maybe the total bottom line contribution from FX in the quarter and maybe how it compared with the last? And I'm a little bit confused about gross margins. It was my understanding that last quarter, gross margins were hurt by FX because, essentially inventory is valued at one specific point in time towards the end of the quarter, while sales obviously are on an average. And at some point in time, that catches up and your gross margins actually get better from that. Can you talk specifically why you didn't mention FX in the gross margin discussion and why that won't help you later in the year?

William A. Kozy - Executive Vice President

Glenn, this is Bill. In the second quarter, we didn't keep all the details to it, but FX contributed about 30 basis points improvement. So, it is starting to turn, I think the first quarter, we had about a 70 basis point reduction, so consistent with what our experience has been and over time it’s euros out. So on a full-year guidance, we don't believe FX will have much of an impact.

Glenn Reicin - Morgan Stanley

Okay. But it was 30 basis point improvement in the second versus the first?

William A. Kozy - Executive Vice President

Versus the first quarter being about 70 basis point reduction.

Glenn Reicin - Morgan Stanley

Right. Okay. That's helpful. And what about the whole bottom-line contribution?

John R. Considine - Vice Chairman and Chief Financial Officer

Well --.

Glenn Reicin - Morgan Stanley

I think you know that.

John R. Considine - Vice Chairman and Chief Financial Officer

There is a little… or yes, we haven't gone there. But I mean, if you really think about it, we have about... for the year about 20% of our sales are euro based. That's the biggest... or euro exposed, that's the biggest piece of the entire foreign exchange side. So that's like $1.5 million... $1.5 billion in sales and it depends on a lot of things, but we can drop 25% of an increase down on… depending on how the FX falls. So if we got a benefit of 5%, about 20% or 1% of that could hit the bottom line. All that said though, it depends on certain things get rolled up into inventories and the timing is different. But, I think if you think about it broadly, the weakness in the US dollar is strengthening of, in particular, the euro has more than offset the resin side because we… as Bill said in his opening remarks, last year we spent about $250 million in resins, we think that additional resins are going to cost us about 60 basis points this year, the benefits we get in foreign exchange have offset that. The resin is kind of our… if you watch oil and euro, they kind of dance together very closely over time. Our resins aren't exactly one for one, a proxy with oil. And so there is a lot of things that kind of get into that line, that's why I'm being a little hesitant, Glenn, because I wouldn't want to give you something to model that didn't work.

Glenn Reicin - Morgan Stanley

Okay. I will go offline on that one. And then, I promise this will be my last question here. I'm a little bit confused about the other income line and the interest expense line. If I just take your cash balances and I take your debt balances, the numbers don't seem to work. There is obviously something else happening, can you give us any sort of guidance how one would model for that to take into account those other issues?

John R. Considine - Vice Chairman and Chief Financial Officer

I’ll have Bill Kozy take you through those numbers. And I know you are only kidding about going offline since we couldn't do that, but I'll let Bill just do that, just for publication purposes.

William A. Kozy - Executive Vice President

Glenn, on the other income expense year-on-year, we’re... it was about a $5 million reduction. Last year we had small gains on two small businesses worth about $3 million; in this quarter, we had a small investment that we wrote down. So year-on-year, that's... those are the three components, we had a $3 million gain last year and $1 million loss this year. As far as interest income, our income is unfavorable to last year by about $1 million. The accounting for some of our deferred comp, not to get too specific but when you have a reduction in returns on those investments, actually hits our interest income, few offsets in our SSG&A and year-on-year there was actually a under $5 million hit we took in interest income, that's probably the single biggest item why year-on-year looks like it's down versus you might think it would have been up.

Glenn Reicin - Morgan Stanley

So for the year, for net interest expense or I mean for income I was talking about $10 million or $15 million, is that the number that you’re thinking of?

William A. Kozy - Executive Vice President

Net interest expense for the year, I think we have it around a net $4 million benefit and other... I'm not really out but give me a minute, I’ll take a look at that. Other, actually we have it about flat year-on-year. Again there is a lot of ins and outs there, so we're just assuming it's about the same as last year.

Glenn Reicin - Morgan Stanley

Okay. Thank you very much.

Operator

We'll take our next question from the line of Kristen Stewart with Credit Suisse. Your line is now open. And we'll take our next question from the line of Larry Keusch with Goldman Sachs. Your line is now open.

Lawrence Keusch - Goldman Sachs

Yeah, hi. John, I think if I caught this correctly, you were talking about or in the prepared comments, there was an 80 basis point reduction in SG&A for the year. And if I just run that off of last year, that gets me to 24.4. And then I think John, you had sort of said something that may be that could be lower than 24 for the year. So I just wanted to just make sure I was understanding this correctly?

John R. Considine - Vice Chairman and Chief Financial Officer

I was talking about the quarter that it’s slightly lower, it was 23.8, I believe but could it be a little lower for the year, yeah. We will have to see how it comes in, but we have not relinquished the spending controls that we've instituted across the company. So I... what I was trying to get across is we're confident that we can continue those controls this year and beyond. So, therefore, as sales go up and our leverage of these costs continues, we should get some more benefit in that line, Larry.

Lawrence Keusch - Goldman Sachs

Okay, got you. And then, just help me think about this. So, as I think forward from here and obviously not trying to predict where FX is going to go. But, if we sort of just straight line the euro as you move across, obviously the comparisons get less pronounced. So the positive benefit starts to wane some here. Where are the levers as you think about the entire business, given that you had 5% FX benefit, clearly some of that fell to the bottom line, and let's just assume that oil continues to march up every day, so presumably costs... your commodity costs continue to rise?

John R. Considine - Vice Chairman and Chief Financial Officer

Well, you are right. I mean… I’m worst at forecasting FX. But certainly at this base, you wouldn't expect it to be incrementally as large as it had been, but it's still a… if it stays at these levels, there would still be some built in benefit next year, all other things remaining equal because our average euro this year is probably going to be in the low 150s and it stays at 159, we are going to get the benefit. When you think about the levers we can pull, we've already talked at some length at... on SSG&A and again as I said, as we continue to get leverage. So, if you think about us spending overall a 24-ish percent of SSG&A on sales and we continue to maintain the leverage that we have to spending controls that that's one of the levers we can pull.

Within gross margin, as you know, we have talked about it at the end of last year and all through this year that we have a number of discrete projects going on within the all three segments that are start-up projects. They don’t all end at once but they all have an end date and that has... so that was about 30 basis points of impact on us which will eventually go away as we finish things like the Hungary plant which is going to take some time and other things.

And then as Bill Kozy said on resins, while that relationship with oil is certainly significant, it… last year it was... we spent $250 million of over $3 billion in cost of goods sold on resins, we think it’s going to cost us like 60 basis points this year, so that's like 40-odd million dollars. So I mean, that number should be for '08, $290 million, $300 million, something like that. So it still is... while it's significant to us and it does hit the gross margin line, we have other things that we fully expect to be able to, as you said, pull levers against to stave off any increase. And again, you made one other comment, Larry, that the kind of oil marches ahead and indeed it does but there… the risen costs don't go one for one. The oil is a reasonable proxy in directionally, and as I said, the euro kind of tracks it explicitly, but when you look at the resins, there is a lag there, and a lot of that gets around supply and other buying patterns that exist on resins. So right now, our resin costs haven’t caught up with the more recent last few quarters increase in oils.

Lawrence Keusch - Goldman Sachs

Understood. Okay. And then just lastly, I know that you guys said that in the US Pharma Systems was a bit tough in the quarter. Just any comments as to kind of what went on specifically in that business?

John R. Considine - Vice Chairman and Chief Financial Officer

On Pharm --.

William A. Kozy - Executive Vice President

Well, do you want me to... yes, actually the quarter for US Pharm Systems, the second quarter was pretty strong, grew about 18% overall. We're anticipating… it grew 19% overall. We are anticipating that's going to slow down in the US in the back half of the year, and that's really based on a series of factors, one of which is some customers ordering from us in Europe rather than the US now, there is also a few customer trends in the US that are impacting our... will impact our revenues for the balance of the year.

And on the other hand, international Pharm Systems which had a very slow quarter in the second quarter is expected to bounce back pretty considerably in the back half of the year. This business is bumpy by its nature when there is new market launches or conversion from vials to prefills, we'll see a boost and we get pretty good visibility to that and we anticipate those will continue in the future. They weren't really happening that much now in the second quarter and there is a few customers in the US whose business is impacting our business. So that's the outlook.

Lawrence Keusch - Goldman Sachs

But you expect that to come back?

William A. Kozy - Executive Vice President

Expect it to come back. I think the US will probably... will be low through this year and through '09 and then strong again in '10, that's our outlook to take things out a little further. International looks like it's going to remain strong for most of this year.

Lawrence Keusch - Goldman Sachs

Great. Thanks very much guys.

Operator

We'll take our next question from the line of Jeffrey Frelick with Lazard Capital. Your line is now open.

Jeffrey Frelick - Lazard Capital

Oh, great. Thanks. First question for Bill. If I look at the clinical segment only for Immunocytometry, what percent of revenues are the reagents, and is that growing significantly?

William A. Kozy - Executive Vice President

Yes, we make sure I got it. Just the clinical piece of the reagent portion of Immunocytometry as a percentage of the total company, total business.

Jeffrey Frelick - Lazard Capital

Just the clinicals segment of flow [ph], leaving out the research business.

William A. Kozy - Executive Vice President

Yes, reagents?

Jeffrey Frelick - Lazard Capital

Yes, what percent of the total revenues?

William A. Kozy - Executive Vice President

Okay, give me a second here. Just looking at the IS business on a worldwide basis, it's about a third.

Jeffrey Frelick - Lazard Capital

Okay. And growing well or slow?

William A. Kozy - Executive Vice President

The clinical reagent was a strong double-digit contributor for the quarter, the combination of the HIV and the CD4 reagents as well as the leukemia and lymphoma reagents, the combination of those two things that are setting up that double-digit growth.

Jeffrey Frelick - Lazard Capital

Okay, thanks. And then for Vince, with respect to Preanalyticals, two quarters in a row now growing double digits, what's driving this? Volume, price?

Vincent A. Forlenza - Executive Vice President

Well, what's driving the growth in Preanalytical is two things as we've been talking about, one is safety and that's US and international that we talked about before, and the other is geographic expansion that continues especially in Asia Pacific. Now, remember that there is some FX in that PAS number too. So PAS was on a performance basis 7.3 for the quarter. It’s pretty much in line with where it has been.

Jeffrey Frelick - Lazard Capital

Okay. Thanks, guys.

John R. Considine - Vice Chairman and Chief Financial Officer

Okay.

Operator

We'll take our next question from the line of Kristen Stewart with Credit Suisse. Your line is now open.

Kristen Stewart - Credit Suisse

Hi, sorry about that before. Could you guys remove it?

John R. Considine - Vice Chairman and Chief Financial Officer

Yes.

Kristen Stewart - Credit Suisse

Perfect. I just was wondering, you mentioned a little bit about on the cost of goods sold line, there being a write-off and I know there was one also in the previous quarter. What exactly is that related to and are those expected to continue?

John R. Considine - Vice Chairman and Chief Financial Officer

No, the one this quarter was about $4 million discrete on a product that we had to --.

William A. Kozy - Executive Vice President

Two products.

John R. Considine - Vice Chairman and Chief Financial Officer

Two products, yes, where we had found an issue with a product in our quality efforts and there was… was it not retrievable, so it was a one-time item that we wrote off. The first quarter, Bill, remind me how much that was?

William A. Kozy - Executive Vice President

First quarter was around $7 million to $8 million. And again there were some asset write-offs, again very, very small numbers. And again there were a couple of inventories now, individually they were all under probably $2 million.

Kristen Stewart - Credit Suisse

And there is nothing to signal that there is any issues from kind of quality systems perspective or anything like that?

John R. Considine - Vice Chairman and Chief Financial Officer

No.

William A. Kozy - Executive Vice President

No.

Kristen Stewart - Credit Suisse

Okay.

John R. Considine - Vice Chairman and Chief Financial Officer

So it’s actually positive, actually the system worked, we got the issues before these products ever hit the market.

Kristen Stewart - Credit Suisse

Very true. I was wondering if you could just comment a little more broadly speaking following Medicare’s proposed reimbursement plans, specifically for the hospital-acquired infections, what are your thoughts on those, has it changed your view at all on the MRSA opportunity or just kind of broader hospital adoption of a molecular diagnostic testing?

John R. Considine - Vice Chairman and Chief Financial Officer

Well, I don't think that the recent conversations have changed our view on the market. If you go back to conversations that we were having on this subject six months ago, I think I was indicating at the time that Jaco was saying that they were not going to include MRSA in the first six categories that they were going after. I know there is a lot of conversation out there around the issue that, well, you have this catch-all clause for not reimbursing for a healthcare-acquired infection that MRSA will be part of that. So I just see this as another area where there is continued pressure. I see the hospitals taking this issue more and more seriously, which I think is the right thing. I think the other thing that there is a lot of conversation about is, it’s not just MRSA, that MRSA is actually from a diagnose perspective right now a small percentage. C.difficile is also important, VRE is important. So I think from our standpoint, moving ahead with the menu is the right thing to be doing because I think hospitals will be going after this broadly but I do think to add to your question that it does push people towards the direction of molecular and getting more rapid answers.

Kristen Stewart - Credit Suisse

And when do you think you will be able to provide us with an update on what [inaudible] is going to be running on from an instrument platform perspective? I know your agreement with [inaudible] does end and you are working with a partner, any updates there or when can we hear?

John R. Considine - Vice Chairman and Chief Financial Officer

I don't have anything new to tell you. The program remains on track and we are going to be showing the product to customers and we’ve got a whole list of them in about couple of months from now at the ASM.

Kristen Stewart - Credit Suisse

Thanks very much.

John R. Considine - Vice Chairman and Chief Financial Officer

Welcome.

Operator

We'll take our next question from the line of James Baker with Neuberger Berman [ph]. Your line is now open.

Unidentified Analyst

Yes, good morning, everyone. I just have three quick questions. One, about operating margins in the three segments. Were they high in all three segments and could you comment on gross margins in the segments as well? That's the first question. Also, those two write-offs that the other caller referenced of $7 million in the first quarter and the $4 million in the second quarter, which business segments did those pertain to? And then finally, can you give us some thoughts on your thinking for where CapEx may be going in fiscal '09 and '10 compared to what we've seen in the last couple of years?

John R. Considine - Vice Chairman and Chief Financial Officer

Let's see. What… Bill, why don’t--.

William A. Kozy - Executive Vice President

I'll take the easy one. The ones that… the $4 million that hit this were both in Medical... the $4 million that was in the Medical--.

John R. Considine - Vice Chairman and Chief Financial Officer

That’s this quarter, Jim [ph].

William A. Kozy - Executive Vice President

That’s this quarter. In the first quarter, it’s probably split 50-50 between Medical and Diagnostics.

Unidentified Analyst

Okay, that's helpful.

William A. Kozy - Executive Vice President

And operating --.

John R. Considine - Vice Chairman and Chief Financial Officer

Yes, CapEx as we kind of under spent our budget last year, we think we will be about 650 this year. We haven’t rolled up next year but next year I would expect to be around... in the $600 million range again, Jim, as we finish off these major projects. But we will be more definitive with that and beyond that when we do the end of the year guidance.

Unidentified Analyst

Okay. And would you see a sort of front-end loaded and that was most of that in the first half and then maybe tailing off in the second half, fiscal '09, is that how that might work?

John R. Considine - Vice Chairman and Chief Financial Officer

I'm reluctant only because of the timing of the Hungary plant, it may actually, some of it may be more towards the back end and we historically tend to be back ended. But when we do that, I'll give you an idea how that will look.

Unidentified Analyst

Okay. And then the last question was just on the margin, I mean, I know in the 10-Q, I'm sure you'll discuss all those matters but if you could give us some sense of how the operating and gross margins went within the segments this quarter, that will be great?

John R. Considine - Vice Chairman and Chief Financial Officer

Yeah, I'm trying to get it from around the table here to see if we have it. Bill… while Bill Kozy can start.

William A. Kozy - Executive Vice President

Yeah, we had a quarter, Jim [ph], that had very favorable reagent mix. So if you looked at Biosciences broadly, the margins for the quarter year-on-year would have been up and just modestly ahead of expectations.

Unidentified Analyst

Okay. What about the other two?

John R. Considine - Vice Chairman and Chief Financial Officer

Well. I'll give you some… without putting these guys through heck, Biosciences is definitely positive, a little over 1% plus, Medical is slightly below about a percentage point down and that mainly reflects the write-off that we talked about in the first and second quarter which were a bit over $10 million in the aggregate.

Unidentified Analyst

Okay.

John R. Considine - Vice Chairman and Chief Financial Officer

So, that's where you come up with the 51.1.

Unidentified Analyst

Okay. And then Diagnostics, which really should have an easier comp by now that you had TriPath in there last year?

John R. Considine - Vice Chairman and Chief Financial Officer

Yes, they were slightly under last year, and part of that is that classification that Bill talked about where we took cost of a resin and tracked that and recorded and to a lesser extent, GeneOhm in SSG&A and in R&D. We caught it up at the end of the year and put them all in the fourth quarter. So now you have this quarter running against a vacant quarter, if you will, last year, because this is the fourth, so we'll get up, I know this sounds convoluted, but it will hit us this quarter, next quarter and then it would be a benefit in the fourth.

Unidentified Analyst

Okay. I think I got that. Thank you very much, gentlemen.

John R. Considine - Vice Chairman and Chief Financial Officer

All right.

Operator

[Operator Instructions]. And we'll take a follow-up question from Glenn Reicin with Morgan Stanley. Your line is now open.

Glenn Reicin - Morgan Stanley

Thanks, folks. A quick follow-up on the share repurchase line, the $460 million, is that gross or a net number?

John R. Considine - Vice Chairman and Chief Financial Officer

That's gross number, it doesn't net out anything against it.

Glenn Reicin - Morgan Stanley

Okay. Very good. And then, we've had some conflicting data on MRSA this past quarter. I am very confused whether this is going to be used for universal testing or really active surveillance. Can you give us your perspective what you built your models on, what do you think is a realistic outcome here?

John R. Considine - Vice Chairman and Chief Financial Officer

So Glenn, we haven’t changed in terms of the percentage. We have been building our models on the 100 million admissions and in the range of 30%, 35% adoption. So some people are going to do universal, some people are doing targeted and you're seeing as we're seeing that debate continue to go on.

Glenn Reicin - Morgan Stanley

When do you think we’re going to get some clarity here? I thought… I mean I didn't know… I thought the Evanston study was probably a little bit more meaningful this time around. But is there a set of studies that we should be looking at that will give us a definitive answer here?

John R. Considine - Vice Chairman and Chief Financial Officer

Well, I think some of the studies that I can point you to is, [inaudible] in the British Journal of Surgery, they are talking about the benefits, [inaudible] the Journal of Infection Control, [inaudible], The New England Journal of Medicine, those are some of the studies. But there was this other article… there is some people who still are arguing for targeted. We continue to say this is only a piece of the bundle that you can't do this in isolation. But Glenn, I think they are going to continue to argue over this for at least another 12 months.

Glenn Reicin - Morgan Stanley

If it's 12 months, that's great. So that does mean then there is going to be some sort of additional publication?

John R. Considine - Vice Chairman and Chief Financial Officer

Lot of people are working on this. I can’t say anymore than that.

Glenn Reicin - Morgan Stanley

Okay. And then can you talk a little bit about the new platform in terms of whether it's random access or batch, and how that compares with the existing platform?

John R. Considine - Vice Chairman and Chief Financial Officer

So Glenn, as I said, the biggest change in what we're doing is going to be in the sample processing piece of this and if you walk through the workflow, it's going... so that's where the major improvements are going to be and it will be more of a batch instrument than a random access.

Glenn Reicin - Morgan Stanley

Okay, and that's because you think customers prefer batch?

John R. Considine - Vice Chairman and Chief Financial Officer

It's because we think when you do the overall work flow, you can get to a more cost-effective solution by doing it that way.

Glenn Reicin - Morgan Stanley

Perfect. Okay. Thank you.

John R. Considine - Vice Chairman and Chief Financial Officer

Well, thanks for that last call… question, Glenn and everyone else and we've kind of just gone a little bit over our time. So I know we have some other calls that are competing with this. So we're going to thank you and look forward to your questions next quarter. Thank you, operator.

Operator

This does conclude today's teleconference. You may disconnect at any time. Thank you and have a great day.

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