Financial Review

Company Overview

Becton, Dickinson and Company (“BD”) is a medical technology company that serves healthcare institutions, life science researchers, clinical laboratories, industry and the general public. BD manufactures and sells a broad range of medical supplies, devices, laboratory equipment and diagnostic products. We focus strategically on achieving growth in three worldwide business segments–BD Medical (“Medical”), formerly BD Medical Systems; BD Diagnostics (“Diagnostics”), formerly BD Clinical Laboratory Solutions; and BD Biosciences (“Biosciences”). Our products are marketed in the United States and internationally through independent distribution channels, directly to end users and by sales representatives. The following references to years relate to our fiscal year, which ends on September 30.

Accounting Change

During the fourth quarter, we changed our method of determining cost for inventory previously determined under the last-in, first-out (“LIFO”) method to the first-in, first-out (“FIFO”) method. As further discussed in Note 2 of the Notes to Consolidated Financial Statements, the change to the FIFO method has been retroactively applied by restating the accompanying financial statements.

Revenues and Earnings

Worldwide revenues in 2003 were $4.5 billion, an increase of 12% over 2002. Underlying revenue growth of 8%, which excludes the estimated favorable impact of foreign currency translation of 4%, resulted primarily from volume increases in all segments.

     Medical revenues in 2003 of $2.5 billion increased 14% over 2002 or 10%, excluding the estimated impact of favorable foreign currency translation of 4%. Revenue growth in the Medical Surgical Systems unit of this segment accounted for approximately 4 points of the underlying growth and included U.S. safety-engineered product sales of $407 million compared with $353 million in the prior year. This growth was partly offset by reduced sales of conventional devices in the United States. Revenue growth in the Pharmaceutical Systems unit contributed approximately 3 points of the underlying growth rate. Sales of BD Bifurcated Needles used in the administration of smallpox vaccines and auto-disable devices to non-U.S. governments also contributed to the growth rate of these units, representing approximately 1 point of the overall underlying growth rate of the Medical segment. Revenue growth in the Diabetes Care unit, which accounted for approximately 2 points of the underlying growth, benefited from a favorable comparison with the prior year. Prior year revenues reflected the unfavorable effects of redirecting promotional efforts towards branded insulin syringe sales at the retail level for U.S. Diabetes Care products and revisions to sales and inventory estimates provided to us from distribution channel partners. See additional discussion on revenue recognition in “Critical Accounting Policies” below. Revenue growth in this unit included sales of $15 million related to the launch of blood glucose monitoring meters, test strips, and related disposables, in the United States and Canada.

     Medical operating income was $556 million in 2003 compared with $470 million in 2002. The increase in Medical operating income reflected gross profit margin improvement resulting from continued conversion to safety-engineered devices from conventional products. The Medical operating income growth rate also benefited from a favorable comparison to the prior year, which included $23 million of special charges, net of reversals, and $7 million of other manufacturing restructuring costs, as discussed below, as well as the impact of the above-mentioned factors affecting the Diabetes Care unit. Partially offsetting the growth in Medical operating income was higher incremental spending for the launch of the blood glucose monitoring product line.

     Diagnostics revenues in 2003 of $1.4 billion rose 11% over 2002, or 7% excluding the estimated impact of favorable foreign currency translation of 4%. Revenues in the Preanalytical Systems unit and the Diagnostic Systems unit each contributed about one-half of the underlying revenue growth. Revenues in the Preanalytical Systems unit included U.S. safety-engineered device sales of $272 million compared with $220 million in the prior year. This growth was partly offset by reduced sales of conventional devices in the United States. Revenues in the Diagnostics Systems unit reflected strong worldwide sales of its molecular diagnostic platform, BD ProbeTec ET, which reported incremental sales of $29 million over 2002, and good worldwide performance in the more traditional infectious disease categories.

     Diagnostics operating income was $302 million in 2003 compared with $251 million in 2002. This increase reflected gross profit margin improvement resulting from increased sales of products that have higher overall gross profit margins, including safety-engineered products and the BD ProbeTec ET platform.

     Biosciences revenues in 2003 of $697 million increased 8% over 2002, or 3% excluding the estimated impact of favorable foreign currency translation of 5%. The primary growth driver was Immunocytometry Systems unit revenues, which included sales of the BD FACSAria cell sorter, which replaced the BD FACSVantage cell sorter upon launch in March 2003. Clontech revenues declined due to continued weakness in demand for certain reagent products and the shift of research spending away from gene identification programs to gene function and other related studies.

     Biosciences operating income was $89 million in 2003 compared with $117 million in 2002. Excluding the $27 million of impairment charges, as discussed below, operating income was slightly below the prior year. Higher gross profit margins from strong sales of flow cytometry reagents and instruments, compared to the prior year, was offset by inventory writedowns, as discussed below.

     On a geographic basis, revenues outside the United States in 2003 increased 17% to $2.2 billion. Excluding the estimated impact of favorable foreign currency translation of 9%, underlying revenue growth outside the United States was 8%. Revenues in Europe accounted for approximately 4 points of the underlying revenue growth, led by strong sales of prefillable syringes, BD Bifurcated Needles and hypodermic products. Revenues in Japan contributed approximately 2 points of the underlying revenue growth, led by strong sales growth of prefill-able syringes. Revenue growth was adversely impacted by unfavorable economic conditions in Latin America.

     Revenues in the United States in 2003 of $2.3 billion increased 8%, primarily from strong sales of safety-engineered devices. This growth was partly upset by reduced sales of conventional devices. Revenue growth in the Diabetes Care unit included sales of $13 million related to the launch of blood glucose monitoring meters, test strips, and related disposables, and benefited from a favorable comparison with the prior year, which reflected the impact of the above-mentioned factors affecting the Diabetes Care unit. U.S. revenue growth was partially offset by lower sales of Clontech reagent revenues, as discussed above.

     We recorded non-cash charges of $34 million in the third quarter of 2003 in cost of products sold. The majority of these charges resulted from the decision to discontinue the development of certain products and product applications associated with the BD IMAGN instrument platform in the Biosciences segment. As a result, we recorded an impairment charge of $27 million for the related intangible assets and inventory. In addition, as the result of a review of under-performing portions of its Clontech product line, the Biosciences segment also wrote down the value of related inventory and intellectual property by $7 million. See Note 2 of the Notes to Consolidated Financial Statements for further discussion of the write-down of the intangible assets.

     Gross profit margin was 48.4% in 2003 compared with 48.3% in 2002. Excluding the aforementioned impairment charges of $27 million in 2003, the increase in gross profit margin primarily reflected increased sales of safety-engineered products, which have higher overall gross profit margins, compared to the prior year. Such increase was unfavorably impacted by increased costs associated with our blood glucose monitoring products.

     Selling and administrative expense of $1.2 billion in 2003 was 26.7% of revenues, compared to $1 billion in 2002, or 25.6% of revenues. This increase was primarily the result of incremental spending on key initiatives, including our enterprise-wide program to upgrade our business information systems and processes, and the launch of our blood glucose monitoring products.

     Investment in research and development in 2003 was $235 million, or 5.2% of revenues, compared with $220 million, or 5.5% of revenues, in 2002. Incremental spending was concentrated primarily in key initiatives, including blood glucose monitoring, ophthalmic systems and advanced drug delivery systems.

     We recorded special charges of $22 million in 2002. Included in these charges were $26 million of charges related to a manufacturing restructuring program in the Medical segment, as more fully described in Note 5 of the Notes to Consolidated Financial Statements. Special charges were net of the reversal of $4 million of fiscal 2000 special charges, primarily due to lower than anticipated employee severance and lease cancellation costs. Fiscal 2002 results also reflect $7 million of other manufacturing costs, primarily accelerated depreciation related to the restructuring program that are included in cost of products sold. Beginning in 2004, we expect to achieve annual savings of approximately $15 million related to this restructuring program.

     Operating margin in 2003 was 16.5% of revenues, compared with 16.8% in 2002. Operating income in 2003 of $749 million included $34 million of non-cash charges, as discussed earlier. Operating income in 2002 of $676 million included $22 million of special charges, as discussed earlier. Excluding these charges, operating margin was about the same in both years.

     Net interest expense was $37 million in 2003, compared with $33 million in 2002. This increase was primarily due to higher long-term debt levels and a reduction in capitalized interest, partially offset by lower short-term interest rates.

     Other expense, net of $3 million in 2003 consisted primarily of write-downs of investments and intangible assets of $5 million, which were partially offset by foreign exchange gains of $2 million. Other expense, net of $14 million in 2002 included net losses on investments of $19 million, which reflect declines in fair values that were deemed other than temporary. Also included in other expense, net in 2002 were foreign exchange gains of $16 million that were substantially offset by write-downs of assets held for sale and asset abandonments of $14 million.

     The effective tax rate in 2003 was 22.9%, which includes the impact from the 2003 non-cash charges, compared to 23.6% in 2002, which includes the impact from the 2002 special charges.

     Net income and diluted earnings per share in 2003 were $547 million and $2.07 respectively. Non-cash charges in 2003, as discussed earlier, reduced net income by $20 million and diluted earnings per share by 8 cents. Net income and diluted earnings per share in 2002 were $480 million and $1.79, respectively. Special charges reduced net income by $17 million and diluted earnings per share by 6 cents in 2002.

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.

     Our foreign currency exposure is concentrated in 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 one-time 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, 2003, a 10% appreciation of the U.S. dollar over a one-year period would increase pre-tax earnings by $73 million, while a 10% depreciation of the U.S. dollar would decrease pre-tax earnings by $37 million. Comparatively, considering our derivative instruments outstanding at September 30, 2002, a 10% appreciation of the U.S. dollar over a one-year period would have increased pre-tax earnings by $27 million, while a 10% depreciation of the U.S. dollar would have decreased pre-tax earnings by $15 million. These calculations do not reflect the impact of exchange gains or losses on the underlying positions that would partially 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 portfolio at September 30, 2003, is primarily U.S. dollar-denominated, with less than 2% being foreign denominated. Therefore, transaction and translation exposure relating to our debt portfolio is minimal. In an effort to manage interest rate exposures, we strive to achieve an acceptable balance between fixed and floating rate debt and may enter into interest rate swaps to help maintain that balance. For interest rate derivative instruments, market risk is determined by calculating the impact to fair value of an assumed one-time change in interest rates across all maturities. Fair values were estimated based on dealer quotes. A change in interest rates on short-term debt 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 rates are 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, 2003 and 2002, 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, 2003 and 2002 by approximately $35 million and $27 million, respectively. A 10% decrease in interest rates would increase the fair value of our long-term debt and interest rate swaps at both September 30, 2003 and 2002 by approximately $39 million and $30 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, 2003.

Liquidity and Capital Resources

Cash provided by operations, which continues to be our primary source of funds to finance operating needs and capital expenditures, was $906 million in 2003 compared to $836 million in 2002. Cash provided by operations was reduced by $100 million in both 2003 and 2002, reflecting the impact of cash contributions to the U.S. pension plan. Inventories increased by $109 million during 2003 to $795 million, due primarily to foreign currency translation adjustments and inventory of blood glucose monitoring products in anticipation of future sales.

     Capital expenditures were $261 million in 2003, compared to $260 million in the prior year. Medical and Diagnostics capital spending, which totaled $167 million and $62 million, respectively in 2003, included spending for various capacity expansions as well as safety-engineered devices. Biosciences capital spending, which totaled $22 million in 2003, included spending on new products and manufacturing capacity expansions.

     Net cash used for financing activities was $292 million in 2003 as compared to $314 million during 2002. At September 30, 2003, 3.6 million common shares remained under a January 2003 Board of Directors’ resolution that authorized the repurchase of up to 10 million common shares. Total debt at September 30, 2003, was $1.3 billion compared with $1.2 billion at September 30, 2002. Short-term debt declined to 9% of total debt at year-end, from 35% at the end of 2002. This change was attributable to the issuance to the public in April 2003 of $200 million of 10-year 4.55% Notes and $200 million of 15-year 4.9% Notes, the net proceeds from which were used to repay commercial paper. Floating rate debt was 55% of total debt at the end of 2003 and 59% of total debt at the end of 2002. Our weighted average cost of total debt at the end of 2003 was 3.8%, down slightly from 4% at the end of last year due to lower short-term interest rates. Debt-to-capitalization at year-end improved to 30.4% from 32.6% last year. Cash and equivalents were $520 million and $243 million at September 30, 2003 and 2002, respectively.

     We use commercial paper to meet our short-term financing needs, including working capital requirements. We have available a $900 million syndicated credit facility, consisting of a $450 million five-year line of credit maturing in August 2006 and a $450 million 364-day line of credit maturing in August 2004. The facility contains a single financial covenant relating to our interest coverage ratio. It can be used to support our commercial paper program, under which there was $100 million outstanding at September 30, 2003, or for other general corporate purposes. There were no borrowings outstanding under the facility at September 30, 2003. In addition, we have informal lines of credit outside the United States. At September 30, 2003, 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 these 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.

     Return on equity was 20.3% in 2003 compared with 20.0% in 2002.

Other Matters

We believe that the non-discretionary nature of our core products, our international diversification, and our ability to meet the needs of the worldwide healthcare industry with cost-effective and innovative products will continue to cushion the long-term impact on BD of potential economic and political dislocations in the countries in which we do business, including the effects of possible healthcare system reforms. In 2003, inflation did not have a material impact on our overall operations.