Income Taxes

The effective tax rate in 2004 was 22.6% and reflects about a 1% reduction resulting from the deductibility of the BGM charges, and about a 1.5% reduction from the deductibility of the litigation settlement. See Note 7 of the Notes to Consolidated Financials Statements for additional discussion. In 2005, we expect our effective tax rate to be about 26%. The American Jobs Creation Act of 2004, which was signed into law on October 22, 2004, provides corporate taxpayers with an election to claim a deduction equal to 85% of cash dividends in excess of a base-period amount received from controlled foreign corporations if the dividends are invested in the United States under a properly approved domestic investment plan. As a result of the passage of the American Jobs Creation Act, during 2005 we will revisit our policy of indefinite reinvestment of foreign earnings. We expect that for every $100 million repatriated, our expected full year tax rate would increase by approximately .6 to .8 percentage points in 2005.

Income and Diluted Earnings per Share from Continuing Operations

Income from continuing operations and diluted earnings per share from continuing operations in 2004 were $583 million and $2.21, respectively, and included the impact of the BGM charges and litigation settlement in 2004, as discussed earlier, which reduced income from continuing operations in the aggregate by $90 million and diluted earnings per share from continuing operations in 2004 by 35 cents. Income from continuing operations and diluted earnings per share from continuing operations in 2003 were $555 million and $2.10, respectively. Non-cash charges in 2003, as discussed earlier, reduced income from continuing operations by $16 million and diluted earnings per share from continuing operations in 2003 by 6 cents.

Discontinued Operations

Loss and diluted earnings per share from discontinued operations in 2004 were $115 million and 44 cents, respectively. Loss from discontinued operations in 2004 reflected an after-tax charge of approximately $116 million in connection with the planned sale of Clontech, as further discussed in Note 18 of the Notes to Consolidated Financial Statements. This charge related to the write down of Clontech net assets to estimated fair value. Loss and diluted earnings per share from discontinued operations in 2003 were $8 million and 3 cents, respectively. The discontinued operations of Clontech in 2003 included an after-tax charge of $4 million relating to the write down of certain inventory and intellectual property.

Financial Instrument Market Risk

We selectively use financial instruments to manage the impact of foreign exchange rate and interest rate fluctuations on earnings. The counterparties to these contracts are highly rated financial institutions. We do not enter into financial instruments for trading or speculative purposes.

     We have foreign currency exposures throughout Western Europe, Asia Pacific, Japan and Latin America. We face transactional currency exposures that arise when we enter into transactions in non-hyperinflationary countries, generally on an intercompany basis, that are denominated in currencies other than our functional currency. We hedge substantially all such foreign exchange exposures primarily through the use of forward contracts and currency options. We also face currency exposure that arises from translating the results of our worldwide operations to the U.S. dollar at exchange rates that have fluctuated from the beginning of the period. We purchase option and forward contracts to partially protect against adverse foreign exchange rate movements. Gains or losses on our derivative instruments are largely offset by the gains or losses on the underlying hedged transactions. For foreign currency derivative instruments, market risk is determined by calculating the impact on fair value of an assumed change in foreign exchange rates relative to the U.S. dollar. Fair values were estimated based on market prices, when available, or dealer quotes. The reduction in fair value of our purchased option contracts is limited to the option’s fair value. With respect to the derivative instruments outstanding at September 30, 2004, a 10% appreciation of the U.S. dollar over a one-year period would increase pre-tax earnings by $39 million, while a 10% depreciation of the U.S. dollar would decrease pre-tax earnings by $6 million. Comparatively, considering our derivative instruments outstanding at September 30, 2003, a 10% appreciation of the U.S. dollar over a one-year period would have increased pre-tax earnings by $73 million, while a 10% depreciation of the U.S. dollar would have decreased pre-tax earnings by $37 million. These calculations do not reflect the impact of exchange gains or losses on the underlying positions that would substantially offset the results of the derivative instruments.

     Our primary interest rate exposure results from changes in short-term U.S. dollar interest rates. Our debt and interest-bearing investments at September 30, 2004, are substantially all U.S. dollar-denominated. Therefore, transaction and translation exposure relating to such instruments is minimal. When managing interest rate exposures, we strive to achieve an acceptable balance between fixed and floating rate instruments.

We may enter into interest rate swaps to help maintain this balance and manage debt and interest-bearing investments in tandem, since these items have an offsetting impact on interest rate exposure. For interest rate derivative instruments, market risk is determined by calculating the impact to fair value of an assumed change in interest rates across all maturities. Fair values are estimated based on dealer quotes. A change in interest rates on short-term debt and interest-bearing investments is assumed to impact earnings and cash flow but not fair value because of the short maturities of these instruments. A change in interest rates on long-term debt is assumed to impact fair value but not earnings or cash flow because the interest on such obligations is fixed. See Note 9 of the Notes to Consolidated Financial Statements for additional discussion of our debt portfolio. Based on our overall interest rate exposure at September 30, 2004 and 2003, a change of 10% in interest rates would not have a material effect on our earnings or cash flows over a one-year period. An increase of 10% in interest rates would decrease the fair value of our long-term debt and interest rate swaps at September 30, 2004 and 2003 by approximately $42 million and $33 million, respectively. A 10% decrease in interest rates would increase the fair value of our long-term debt and interest rate swaps at September 30, 2004 and 2003 by approximately $46 million and $41 million, respectively.

     See Note 10 of the Notes to Consolidated Financial Statements for additional discussion of our outstanding forward exchange contracts, currency options and interest rate swaps at September 30, 2004.

Liquidity and Capital Resources

Cash Flows from Continuing Operating Activities

Cash provided by continuing operations, which continues to be our primary source of funds to finance operating needs and capital expenditures, was $1.1 billion in 2004 compared to $903 million in 2003. Cash provided by continuing operations was reduced by $37 million and $112 million in cash contributions to BD pension plans during 2004 and 2003, respectively. Additional discretionary cash contributions of $68 million were made to BD pension plans in fiscal 2005 (October 2004). In 2005, we expect to generate in excess of $1.1 billion in cash flows from continuing operating activities.

Cash Flows from Continuing Investing Activities

Capital expenditures were $266 million in 2004, compared to $259 million in the prior year. Medical and Diagnostics capital spending, which totaled $159 million and $80 million, respectively in 2004, included spending for various capacity expansions as well as safety devices. Biosciences capital spending, which totaled $17 million in 2004, included spending on manufacturing capacity expansions. In 2005, capital expenditures are expected to be in the $300 to $325 million range and will include spending for new capacity expansion for push button blood collection sets.

     In the fourth quarter of 2004, we spent approximately $24 million, net of cash acquired to purchase Atto Bioscience, Inc. See Note 6 of the Notes to Consolidated Financial Statements for additional discussion.

Cash Flows from Continuing Financing Activities

Net cash used for continuing financing activities was $504 million in 2004 as compared to $289 million during 2003 and included the repurchase of shares of our common stock for approximately $450 million, compared to approximately $350 million in 2003. At September 30, 2004, 4.1 million common shares remained available for purchase under a January 2004 Board of Directors’ authorization to repurchase up to 10 million common shares. In 2005, we expect to continue to repurchase common shares of $400 to $450 million. Total debt at September 30, 2004, was $1.2 billion compared with $1.3 billion at September 30, 2003. Short-term debt declined to 4% of total debt at year-end, from 9% at the end of 2003. Floating rate debt was 55% of total debt at the end of both 2004 and 2003. Our weighted average cost of total debt at the end of 2004 was 4.3%, up from 3.8% at the end of 2003 due to higher short-term interest rates. Debt-to-capitalization at year-end improved to 28.1% from 30.4% last year. Cash and equivalents were $719 million and $520 million at September 30, 2004 and 2003, respectively.

     We have in place a commercial paper borrowing program that is available to meet our short-term financing needs, including working capital requirements. Borrowings outstanding under this program were $33 million at September 30, 2004. At the end of 2003, we had in place two syndicated credit facilities totaling $900 million. These consisted of a $450 million five-year credit agreement maturing in August 2004 and a $450 million 364-day credit agreement maturing in August 2006.

In August 2004, we amended and restated the five-year credit agreement, increasing the amount available from $450 million to $900 million and extending the expiration date from August 2006 to August 2009. At the same time, we terminated the $450 million 364-day credit agreement due to expire in August 2004. These changes did not impact the total amount of syndicated credit facilities, which remain at $900 million. The amended and restated facility contains a single financial covenant that requires BD to maintain an interest expense coverage ratio (ratio of earnings before income taxes, depreciation and amortization to interest expense) of not less than 5-to-1 for the most recent four consecutive fiscal quarters. On the last eight measurement dates, this ratio has ranged from 18-to-1 to 21-to-1. The facility, under which there were no borrowings outstanding at September 30, 2004, can be used to support the commercial paper program or for general corporate purposes. In addition, we have informal lines of credit outside the United States.

     At September 30, 2004, our long-term debt was rated “A2” by Moody’s and “A+” by Standard and Poor’s and our commercial paper ratings were “P-1” by Moody’s and “A-1” by Standard and Poor’s. Given the availability of the various credit facilities and our strong credit ratings, we continue to have a high degree of confidence in our ability to refinance maturing short-term and long-term debt, as well as to incur substantial additional debt, if required.

Contractual Obligations

In the normal course of business, we enter into contracts and commitments, which obligate us to make payments in the future. The table below sets forth BD’s significant contracted obligations and related scheduled payments:

							2006			2008			2010 and
(in millions)	Total			2005			to 2007			to 2009			Thereafter
Short-term debt	$	49		$	49		$	—		$	—		$	—
Long-term debt	$	1,172		$	—		$	103		$	1		$	1,068
Operating leases	$	163		$	43		$	68		$	31		$	21
Purchase obligations(A)	$	175		$	115		$	56		$	4		$	—
Total(B)	$	1,559		$	207		$	227		$	36		$	1,089

Use of Non-GAAP Financial Measures

We prepare BD’s financial statements in accordance with U.S. generally accepted accounting principals (GAAP). When discussing our financial performance, we at times will present certain non-GAAP financial measures, as follows:

• We present revenue growth rates at constant foreign exchange rates. We believe that presenting growth rates at constant foreign exchange rates allows investors to view the actual operating results of BD and of its segments without the impact of fluctuations in foreign currency exchange rates, thereby facilitating comparisons to prior periods.
  
• We present earnings per share and other financial measures after excluding the impact of significant charges, and the impact of unusual or non-recurring items. We believe that excluding such impact from these financial measures allows investors to more easily compare BD’s financial performance to prior periods and to understand the operating results of BD without the effects of these significant charges and unusual or non-recurring items.
  BD’s management considers these non-GAAP financial
  

measures internally in evaluating BD’s performance. Investors should consider these non-GAAP measures in addition to, not as a substitute for or as superior to, measures of financial performance prepared in accordance with GAAP.

Litigation–Other Than Environmental

In 1986, we acquired a business that manufactured, among other things, latex surgical gloves. In 1995, we divested this glove business. We, along with a number of other manufacturers, have been named as a defendant in approximately 523 product liability lawsuits related to natural rubber latex that have been filed in various state and Federal courts. Cases pending in Federal court are being coordinated under the matter In re Latex Gloves Products Liability Litigation (MDL Docket

Reconciliations to pro forma amounts (in millions)		2004			2003
Gross profit	$	2,434		$	2,167
BGM charges		45			—
Non-cash charges		—			27
Gross profit–pro forma	$	2,479		$	2,194
as a % of revenues		50.2%			49.2%
Operating margin	$	787		$	761
BGM charges		45			—
Litigation settlement		100			—
Non-cash charges		—			27
Operating margin–pro forma	$	932		$	788
as a % of revenues		19%			18%
Income from continuing operations	$	583		$	555
BGM charges		28			—
Litigation settlement		63			—
Non-cash charges		—			16
Income from continuing operations–pro forma	$	673		$	571