Financial Review (continued)

Use of Non-GAAP Financial Measures

When discussing our financial performance, we at times will present certain non-GAAP (generally accepted accounting principles) 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 No. 1148) in Philadelphia, and analogous procedures have been implemented in the state courts of California, Pennsylvania, New Jersey and New York. Generally, these actions allege that medical personnel have suffered allergic reactions ranging from skin irritation to anaphylaxis as a result of exposure to medical gloves containing natural rubber latex. Since the inception of this litigation, 367 of these cases have been closed with no liability to BD (313 of which were closed with prejudice), and 28 cases have been settled for an aggregate de minimis amount. We are vigorously defending these remaining lawsuits.

     We, along with another manufacturer and several medical product distributors, are named as a defendant in four product liability lawsuits relating to healthcare workers who allegedly sustained accidental needlesticks, but have not become infected with any disease. Generally, the remaining actions allege that healthcare workers have sustained needlesticks using hollow-bore needle devices manufactured by BD and, as a result, require medical testing, counseling and/or treatment. Several actions additionally allege that the healthcare workers have sustained mental anguish. Plaintiffs seek money damages in all of these actions. We had previously been named as a defendant in seven similar suits relating to healthcare workers who allegedly sustained accidental needlesticks, each of which has either been dismissed with prejudice or voluntarily withdrawn. Regarding the four pending suits:

• In Ohio, Grant vs. Becton Dickinson et al. (Case No. 98CVB075616, Franklin County Court), which was filed on July 22, 1998, the Court of Appeals, by order dated June 3, 2003, reversed the trial court’s granting of class certification and remanded the case for a determination of whether the class can be redefined, or the action should be dismissed.
  
• In Illinois, McCaster vs. Becton Dickinson et al. (Case No. 98L09478, Cook County Circuit Court), which was filed on August 13, 1998, the court issued an order on November 22, 2002, denying plaintiff’s renewed motion for class certifi- cation. The plaintiff has voluntarily dismissed the action without prejudice and with leave to re-file within one year.
  
• In Oklahoma and South Carolina, cases have been filed on behalf of an unspecified number of healthcare workers seeking class action certification under the laws of these states, in state court in Oklahoma, under the caption Palmer vs. Becton Dickinson et al. (Case No. CJ-98-685, Sequoyah County District Court), filed on October 27, 1998, and in state court in South Carolina, under the caption Bales vs. Becton Dickinson et al. (Case No. 98-CP-40-4343, Richland County Court of Common Pleas), filed on November 25, 1998.
  

     We continue to oppose class action certification in these cases and will continue to vigorously defend these lawsuits, including pursuing all appropriate rights of appeal.

     BD has insurance policies in place, and believes that a substantial portion of potential liability, if any, in the latex and class action matters will be covered by insurance. In order to protect our rights to additional coverage, we filed an action for declaratory judgement under the caption Becton Dickinson and Company vs. Adriatic Insurance Company et al. (Docket No. MID-L-3649-99MT, Middlesex County Superior Court) in New Jersey state court. We have withdrawn this action, with the right to re-file, so that settlement discussions with the insurance companies may proceed. We have established reserves to cover reasonably anticipated legal defense costs in all product liability lawsuits, including the needlestick class action and latex matters. With regard to the latex matters, we recorded special charges in 2000 and 1998 of $20 million and $12 million, respectively. Based on a review of available information at that time, these charges were recorded to reflect the minimum amount within the then most probable range of current estimates of litigation defense costs. We do not anticipate incurring significant one-time charges, similar to 2000 and 1998, relating to the latex matters in future years.

     On November 6, 2003, a class action complaint was filed against BD in the Supreme Court of British Columbia under the caption Danielle Cardozo, by her litigation guardian Darlene Cardozo v. Becton, Dickinson and Company (Civil Action No. S83059) alleging personal injury to all persons in British Columbia that received test results generated by the BD ProbeTec ET instrument. Plaintiffs seek money damages in an as yet undisclosed amount. We are assessing this action, and intend to vigorously defend this matter.

     On January 17, 2003, Retractable Technologies, Inc. (“RTI” or “plaintiff”) filed a third amended complaint against BD, another manufacturer and two group purchasing organizations (“GPO’s”) under the caption Retractable Technologies, Inc. vs. Becton Dickinson and Company, et al. (Civil Action No. 501 CV 036, United States District Court, Eastern District of Texas). Plaintiff alleges that BD and other defendants conspired to exclude it from the market and to maintain BD’s market share by entering into long-term contracts in violation of state and Federal antitrust laws. Plaintiff also has asserted claims for business disparagement, common law conspiracy, and tortious interference with business relationships. Plaintiff seeks money damages in an as yet undisclosed amount. On October 6, 2003, BD filed a motion for summary judgment. Argument of that motion has been scheduled for December 11, 2003, and a trial date has been set for February 3, 2004. We continue to vigorously defend this matter.

     We also are involved both as a plaintiff and a defendant in other legal proceedings and claims that arise in the ordinary course of business.

     We currently are engaged in discovery or are otherwise in the early stages with respect to certain of the litigation to which we are a party, and therefore, it is difficult to predict the outcome of such litigation. In addition, given the uncertain nature of litigation generally and of the current litigation environment, it is difficult to predict the outcome of any litigation regardless of its stage. A number of the cases pending against BD present complex factual and legal issues and are subject to a number of variables, including, but not limited to, the facts and circumstances of each particular case, the jurisdiction in which each suit is brought, and differences in applicable law. As a result, we are not able to estimate the amount or range of loss that could result from an unfavorable outcome of such matters. In accordance with generally accepted accounting principles, we establish reserves to the extent probable future losses are estimable. While we believe that the claims against BD are without merit and, upon resolution, should not have a material adverse effect on BD, in view of the uncertainties discussed above, we could incur charges in excess of currently established reserves and, to the extent available, excess liability insurance. Accordingly, in the opinion of management, any such future charges, individually or in the aggregate, could have a material adverse effect on BD’s consolidated results of operations and consolidated net cash flows in the period or periods in which they are recorded or paid. We continue to believe that we have a number of valid defenses to each of the suits pending against BD and are engaged in a vigorous defense of each of these matters.

Environmental Matters

We believe that our operations comply in all material respects with applicable laws and regulations. We are a party to a number of Federal proceedings in the United States brought under the Comprehensive Environment Response, Compensation and Liability Act, also known as “Superfund,” and similar state laws. For all sites, there are other potentially responsible parties that may be jointly or severally liable to pay all cleanup costs. We accrue costs for estimated environmental liabilities based upon our best estimate within the range of probable losses, without considering possible third-party recoveries. While we believe that, upon resolution, the environmental claims against BD should not have a material adverse effect on BD, we could incur charges in excess of presently established reserves and, to the extent available, excess liability insurance. Accordingly, in the opinion of management, any such future charges, individually or in the aggregate, could have a material adverse effect on BD’s consolidated results of operations and consolidated net cash flows in the period or periods in which they are recorded or paid.

2002 Compared With 2001

Worldwide revenues in 2002 were $4 billion, an increase of 8% over 2001 and resulted primarily from volume increases in all segments. Sales of safety-engineered devices grew 38% to $573 million.

     Medical revenues in 2002 of $2.2 billion increased 7% over 2001 or 8%, excluding the effect of unfavorable foreign currency translation of 1%. The primary growth drivers were the conversion to safety-engineered devices, which accounted for $353 million in revenues compared with $253 million in the prior year. Also contributing to the growth of this segment were sales of worldwide prefillable drug delivery devices, which grew $48 million or 17%. Medical revenue growth was partly offset by reduced sales of conventional devices in the United States due to the transition to safety-engineered devices and, to a lesser extent, by lower U.S. sales of Diabetes Care products, reflecting the unfavorable effects of redirecting promotional efforts toward branded insulin syringe sales at the retail level and revisions to sales and inventory estimates provided to us from distribution channel partners.

     Medical operating income was $470 million in 2002 compared with $447 million in 2001. Medical operating income in 2002 included $23 million of special charges, net of reversals, and $7 million of related manufacturing restructuring costs, as discussed above. Medical operating income in 2001 included $17 million of goodwill amortization recorded prior to the adoption of SFAS Nos. 141 and 142, as discussed below. Excluding these items in both years, the increase in Medical operating income reflects gross profit margin improvement resulting from continued conversion to safety-engineered devices from conventional products. Medical operating income was negatively impacted by economic conditions in Latin America and the impact of the above-mentioned factors affecting the Diabetes Care unit.

     Diagnostics revenues in 2002 of $1.2 billion rose 7% over 2001 or 8%, excluding the effect of unfavorable foreign currency translation of 1%. Major elements comprising this underlying revenue growth were the continued conversion to safety-engineered products in the Preanalytical Systems unit of the segment, which accounted for $220 million in revenues compared with $163 million in 2001. Diagnostics revenue growth was partly offset by reduced sales of conventional devices in the United States. Revenue growth was favorably impacted by incremental BD ProbeTec ET system sales of $19 million over 2001 in the Diagnostic Systems unit of the segment.

     Diagnostics operating income was $251 million in 2002 compared with $213 million in 2001. Excluding goodwill amortization of $6 million in 2001, the increase in Diagnostics operating income reflects gross profit margin improvement resulting from continued conversion to safety-engineered devices from conventional products and the improved profitability of the BD ProbeTec ET platform.

     Biosciences revenues in 2002 of $645 million increased 9% over 2001 or 10%, excluding the effect of unfavorable foreign currency translation of 1%. This growth was led by sales of Immunocytometry Systems products, particularly BD FACS flow cytometry systems, which contributed approximately 5 points of the underlying revenue growth. In addition, sales in the Discovery Labware and Pharmingen units each contributed about 3 points of the underlying revenue growth. Clontech unit revenues decreased about $6 million from 2001 due to continued weakness in some portions of the molecular biology market, largely due to a softness in pharmaceutical/biotech research and development spending, and a shift in pharmaceutical focus from early stage drug target identification to later stage drug development.

     Biosciences operating income in 2002 was $117 million compared with $97 million in 2001. Excluding goodwill amortization of $13 million in 2001, the increase in Biosciences operating income reflects improved gross profit margins on Pharmingen reagents and Discovery Labware products due to lower manufacturing costs and shifts to sales of products with higher gross profit margins than the mix of products sold in 2001. Biosciences operating income was negatively impacted primarily by lower margins on Clontech reagents due to the market weakness described above and to a lesser extent by lower margins on flow cytometry products due to competitive pricing pressures and higher manufacturing costs.

     On a geographic basis, revenues outside the United States in 2002 increased 7% to $ 1.9 billion. Excluding the estimated impact of unfavorable foreign currency translation of 2%, underlying revenue growth outside the United States was 9%. Revenues in Europe accounted for approximately 5 points of the underlying revenue growth and were led by strong sales of pre-fillable syringes, BD FACS flow cytometry systems and hypodermic products. Revenues in the Asia Pacific region contributed about 2 points of the underlying revenue growth and were led by strong sales growth of Immunocytometry Systems products and I.V. catheters. As indicated earlier, revenues were adversely impacted by economic conditions in Latin America.

     Revenues in the United States in 2002 of $2.2 billion increased 8%, primarily from strong sales of safety-engineered devices. This growth was partly offset by reduced sales of conventional devices. Revenue growth was offset by lower sales of Diabetes Care products and Clontech reagent revenues, as discussed above.

     Gross profit margin was 48.3% in 2002, compared with 48.9% in 2001. Higher gross margins from sales of our safety-engineered products were more than offset by lower sales of products with overall higher gross profit margins, including insulin syringes and products in the Biosciences segment, as discussed earlier.

     Selling and administrative expense of $1 billion in 2002 was 25.6% of revenues, compared to $983 million in 2001, or 26.2% of revenues. Selling and administrative expense in 2001 included $32 million of goodwill amortization.

     Investment in research and development in 2002 was $220 million, or 5.5% of revenues, compared with $212 million, or 5.7% of revenues in 2001. Incremental spending was concentrated primarily in the Biosciences segment and in key initiatives, including blood glucose monitoring.

     Operating margin in 2002 was 16.8% of revenues, compared with 17% in 2001. Operating income in 2002 of $676 million included $22 million of special charges and $7 million of other manufacturing restructuring charges. Operating income in 2001 of $638 million included $36 million of goodwill amortization. Excluding these items, the decline in operating margin reflected the decrease in gross profit margin.

     Net interest expense of $33 million in 2002 was $22 million lower than in 2001, primarily due to lower interest rates.

     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. Other expense, net in 2001 of $6 million, included write-downs of equity investments to fair value of $6 million.

     The effective tax rate in 2002 was 23.6% compared to 24.0% in 2001.

     Net income and diluted earnings per share in 2002 were $480 million, or $1.79, respectively, compared with $438 million, or $1.63 in 2001, before the cumulative effect of accounting change, as described below. Special charges in 2002 reduced net income and diluted earnings per share, before the cumulative effect of accounting change by $17 million and 6 cents, respectively. In 2001, goodwill amortization reduced net income and diluted earnings per share, before the cumulative effect of accounting change by $28 million and 10 cents, respectively.

     We adopted the provisions of Staff Accounting Bulletin No. 101, “Revenue Recognition in Financial Statements,” (“SAB 101”) in the fourth quarter of 2001 and, as a result, recorded the following accounting changes, described below, effective October 1, 2000. We changed our method of accounting for revenue related to branded insulin syringe products that were sold under incentive programs to distributors in the U.S. consumer trade channel. We concluded that the preferable method is to defer revenue recognition until such product is sold by the distributor to the end customer using inventories reported by such distributors. We also changed our accounting method for certain Biosciences instruments to defer revenue from these products until completion of installation at the customer’s site. As a result of these accounting changes, we recorded a total cumulative effect of change in accounting principle of $37 million, net of tax in 2001. See Note 2 of the Notes to Consolidated Financial Statements for additional discussion of the accounting change. Net income and diluted earnings per share in 2001 were $402 million, or $1.49 per share, after reflecting the after-tax cumulative effect of accounting change of $.14 per share.