Sigma-Aldrich Corporation F3Q08 (Qtr End 09/30/08) Earnings Call Transcript

Sigma-Aldrich Corporation (SIAL)

Q3 2008 Earnings Call

October 23, 2008 11:00 am ET

Executives

Kirk Richter - Treasurer and Investor Relations

Jai Nagarkatti - Chief Executive Officer and President

Mike Hogan - Chief Administrative Officer and Chief Financial Officer

Analysts

Amy Zhang - Goldman Sachs

Quintin Lai - Robert W. Baird

Michael Sison - Keybanc

Isaac Ro - Leerink Swann

Dan - UBS

Dmitri Silversteyn - Longbow Research

Jon Wood - Banc of America Securities

Dan Leonard - First Analysis

Seth Teich - Apex Capital

Presentation

Operator

Good morning, my name is Dennis and I will be your conference operator today. At this time, I would like to welcome everyone to the Sigma-Aldrich Third Quarter 2008 Results Conference Call. [Operator Instructions].

I will now turn the call over to the treasurer Mr. Kirk Richter. Please go ahead, sir.

Kirk Richter – Treasurer and Investor Relations

Thanks Dennis and let me also say good morning to you and welcome you to third quarter earnings conference call. With me today are Jai Nagarkatti, our CEO and President and Mike Hogan, our Chief Administrative Officer and Chief Financial Officer.

After a few introductory comments, I will review the highlights of our third quarter performance. Mike will then comment on our full year 2008 expectations including observations on market trends and activities. Jai will follow that and review the new initiatives that we expect to drive growth in 2009 through 2011. And then, after completing those reviews we will open up the call for your questions and comments.

Before we begin these reviews, I do need to remind you that today’s comments will include forward-looking statements about future activities and our expectations for sales, earnings, and other possible future results.

While we believe these expectations are based on reasonable assumptions, actual results may differ materially, due to any number of factors, including the risk factors listed in our annual report on Form-10K for the year ended December 31, 2007 and in the cautionary statement in yesterday’s release. We have no plans to update these forward-looking statements after this conference.

Also, SEC regulations require us to provide information on any non-GAAP financial measures covered in today’s conference. That information, which consists of currency and acquisition adjusted sales growth, currency adjusted process improvement savings, and profit and EPS results on both the pro forma and reported basis is also contained in yesterday’s earnings release, which is posted on our website.

Now, let’s turn to our third quarter results. As we reported in yesterday’s release third quarter sales were 540.6 million an increase of 7.4%. Our total dollar sales for Q3 exclusive of currency impact reflect the traditional third quarter run rate reduction related to summer holidays and vacations that have been pretty consistent over the last several years. But, there are a few additional factors as well.

So, let me provide some insight on what we see behind the 7.4 percentage gain. Our three research base research-based units had a currency adjusted sales gain of exactly 7%, largely matching their first half performance. Sales performance for the supply solutions Biosciences and high tech areas in our SAFC business that provide more than 80% of this unit sales was pretty much in line with their first half growth on a currency adjusted basis. The sales from our SAFC Pharma business where we experienced a slowdown in growth in the second quarter of this year were impacted in the third quarter by economic conditions that deteriorated well beyond our earlier expectations.

I’ll have more comments on these business unit results shortly. The currency benefit that we enjoyed in the first six months of the year that had 7.5 percentage points to first half growth continued to provide benefits but at a reduced rate of just 3.1 percentage points in Q3 with the strengthening of the U.S. dollar during that quarter. Achievements on each of our four key sales enhancing initiatives were covered in detail in yesterday’s release. Overall, they’re delivering about what we expected, just as they’ve done since launching them at the beginning of 2006. The only exception to that was the impact that the Chinese government’s restrictions related to the recent Olympics had on local chemical shipments that impacted our Q3 sales in China, but we fully expect China to return to normal sales levels in Q4.

Details of the Q3 increases for each business unit were also included in yesterday’s release so I will refer you to that release for the organic currency and acquisition components of growth and the reasons for that growth by unit. I do want to highlight just a few of the contributing items to that growth.

Our two core research businesses, research essentials and research specialties again performed at better than expected levels just as they have throughout much of 2007 and in this year’s first half. In research biotech, our Q3 sales of cell signaling and molecular biology products largely matched their first half performance. And there has been no major change in synthetic DNA sales with a little extra boost from improved unit selling prices as product mix shifted to the higher value added modified oligose. But we did elect to sacrifice some of our sales base and growth by dropping some of our less profitable custom peptide and antiserum products from that unit’s offering during Q2 and the impact of that decision is reflected in our Q3 results. We’ll replace our efforts here with a focus adding new genomics, proteomics and antisera and kits and expanding our offering of custom peptide libraries, all of which we believe have greater potential.

Our fine chemicals business, SAFC is a slightly different story. As we’ve shared previously, this is our most economically sensitive business. I indicated earlier that three of our four focus areas in SAFC, supply solutions, biosciences and high tech that collectively provide more than 80% of that unit sales reported performance that was pretty much in line with our first half results. But our custom Pharma business continued to be affected by spending cutbacks in the pharmaceutical sector. We saw the beginning of that impact in Q2 with that situation further exacerbated in Q3 as customers have either deferred committed orders or not repeated the business we've enjoyed in the past. However, we remain optimistic about the long-term potential to this to this market and continue to actively promote our capabilities here.

That said, we have adjusted our expectations for the four year, not fully knowing what the implications of the current turmoil in the markets might bring for this business unit sales. Our best current estimate of our expectations for SAFC for 2008 is a reduction of 1 percentage 8 point from our earlier overall 2008 growth expectation to a new range of 4% to 5%. Our Q3 diluted EPS was 64 cents. This increase of 18.5% represents the largest the largest percentage gain in 2008 Our Q3 pretax margins for write-in line with second quarter levels reflecting the continued benefit from currency, lower interest rates, ongoing passes improvement activities, the benefit of lower interest costs due to reduced rates and a modest benefit from our from our supply chain initiative. Selling price increases announced on September the 1st provided a modest benefit in Q3 and are expected to offset higher input costs later in the year. Mike will comment on that shortly.

Finally, we did experience a significant change in currency rates during the third quarter. But the earnings contribution from currency in Q3 was down only slightly for what we realized in the first and second quarters, as there's still some benefit remaining in what's already in our inventory. That said, our diluted EPS for the third quarter would have been $0.03 higher had currency rates remained at June 32,000 levels. Mike will tell you what we expect in Q4. What we're really pleased about is our ability to take costs out to deliver strong margins in our $0.64 Q3 diluted EPS, which matched our performance in Q1 2008 but on roughly $29 million less in sales than we delivered in that first quarter. We expect to continue to be able to produce strong margins.

Finally, the higher level of share repurchases in Q2 provided a modest extra contribution to the third quarter earnings. The Q3 tax rate, while largely comparable to that rate in last year's third quarter, was higher than the rate in the first half of 2008 due to a higher provision for tax audit contingencies. But you'll hear more shortly about the advantage we do expect in Q4 from the recent extension of the R&D tax credit in the U.S. when Mike reviews our expectations our expectations. So, I'll ask Mike to comment on those [2000] expectations for sales growth, EPS and cash flow. Mike?

Mike Hogan - Chief Administrative Officer and Chief Financial Officer

Thanks, Kirk. As indicated in yesterday's release, we expect full year 2008 organic sales growth to match our year-to-date gain of 10%. How confident are we about that? Reasonably confident. Thankfully, our markets are far more stable and relatively more predictable than some others. As Kirk indicated, we're getting about what we thought we did from our recent selling price increases, with a further expectation that we'll realize about an extra 2% price contribution in Q4, largely or largely or completely offsetting the impact of input cost increases. Will that create upside potential for our sales growth expectations? It is possible.

But in today's economic environment, it is not likely customers' overall spending will increase to fully absorb higher prices, particularly for our nonprofit customers. Even our commercial accounts are trying to manage costs, just as we are, so we're not assuming a higher level of spending there either. So, we'll take our customary prudent approach, we'll expect and be ready exploit opportunities as they come to us, but we'll also plan for and be ready to handle more likely scenarios which is to not count on upsides in making such forecasts. We will be very happy to take them if and when they come. So, stay tuned. Our sales expectations for each of our business units were included in yesterday's release. So, I'll refer you to that for specifics. The sales programs that support those expectations haven't changed much over the last 90 days. But just as we did more we weathered a far more severe storm under far less robust market conditions back in 2002 and 2003 we have been adding to our sales force to retain customer loyalty and attention. Since the start of this year, 40 employees to our sales out puts, So what are the expectations for our business units? Our two core research unit’s research essentials and research specialties should continue to exceed our organic sales growth expectations for all of 2008 at 45% for essentials and 7 to 8% for specialty.

As we crude up play on many occasions, we believe we're recession resistant but not immune. And whether in good markets, okay markets put up the ones, our diversity by region and by customer type and sector is a strength, not a weakness. Researchers need the consumables we offer to be productive and we've not seen or sure about significant work force reductions anywhere that would cause us to believe that our overall expectations for the final quarter won't be met.

This applies to our biotech business as well. But we've lowered our growth expectations for research biotech by a percentage point to a forecast of 7% or more for 2008 to reflect our decision to drop certain less profitable peptide and antis era products from our offering and to transition to more promising opportunities in new genomics and proteomics products and kits.

This is immaterial, in tracking significant at the total of Sigma-Aldrich, but at the business unit level, it has affected and it will affect our sales growth numbers for the first full year following implementation. I'm happy to report that we've done this without any material financial impact. We were able to sell our remaining inventory in Q2 and Q3 and we redirected the plant capacity dedicated to those products to other productive uses. To expect to see the benefit from those activities more fully as we move ended into 2009.

For SAFC, we moderated our organic sales growth expectations for the full year to a new range of a 4 to 5% gain. That's a reduction of 1% from our forecast a quarter ago. But in both for a fourth quarter stronger than the one just delivered some were in a met single graduate rate final is all ready come into reasons for that in reviewing our Q3 results and I don't have any additional information to share here, but we look all be happy to respond to whatever questions you might have on this after Jai completes our prepared comments.

As I indicated earlier, we raised some of our selling prices to pass along the extra cost increases we've been seeing. We're certainly not alone here. Others space (inaudible) while we believe our recent price increases will cover current cost increases, we're also resolute about using whatever additional price increases or cost controls may be needed to continue to maintain our recently enhanced margins and to achieve and deliver the margin expansion we've targeted and promised from our supply chain initiative. We also expect our added price contribution to mitigate the impact of slowing pharmaceutical demand enabling us to deliver the 6% organic growth we achieved in the first nine months once again during the fourth head quarter With the strengthening of the U.S. dollar in Q3, The currency benefit it included in our sales forecast has been revised with an expectation that otherwise reportable growth in the fourth quarter may be as much as 3% lower, bringing the full year currency benefit to a range of just 3 to 4%. That assumes that FX rates remain at September 30, 2008 levels just as prior forecasts assumed that rates had stayed at June 30 levels. So, all. In our 2008 reported sales could increase in the 9 to 10% range, with additional upside potential from further efforts to acquire and companies or add new technologies through partnerships, licenses or other collaborative arrangements.

These sales growth expectations and an assumption that currency rates will remain at 9-30-08 levels coupled with a modest contribution from the supply chain initiative we launched. In mid 2007 and other margin improving activities to drive pretax profit gains at a faster pace than sales should enable us to post an improvement on the 21.5% pretax margin we achieved in 2007. And we'll continue to manage our costs for the goal of making sure they continue to remain at least in line with sales volume growth. That's part of our goodness.

Our other good news is that we now know we can reflect cumulative benefit from the retroactive reinstatement of U.S. R&D tax credit for all of 2008 into our Q4 results, as that benefit was included in the tax extenders legislation that passed early in October. This should add about $0.02 to our otherwise reportable EPS in Q4, partially offsetting a reduction in our expected currency benefit, which should produce an effective tax rate for 2008 that's more likely in the middle of our previously forecast range of 30 to 32 % 'with higher tax audit contingencies, a lower manufacturing deduction and higher state income taxes continuing to be the primary causes for the increase in the tax rate over2007 rate of 28.9%.

Finally, we expect a modest contribution to EPS from our recent and ongoing share repurchase activity. As announced yesterday, our director just approved the addition of another $10 million shares to our repurchase authorization. No one here has changed philosophies. As in the past, we'll be prudent in our buy back program. But I don't think we'll shock anyone by saying that we'll look at our share price when our trading window opens later this week and act accordingly to take long-term advantage of any continuing and we think unwarranted share price weakness. Considering all of these factors, we're retaining our diluted EPS guidance for 2008 in the range of $262 0to $272 per share. This result in a diluted EPS gain for 20089 of 12 to 16% over the $234 reported for 2007 While there are a number of factors that could influence where we land in that range, we're likely to deliver results in the middle of the range if, and I'll repeat the if, results come in exactly as I've described them.

Our 8000 employees are optimistic about their ability to continue to take market share in the final quarter of 2008 and they remain fully committed to delivering these results. Since credit market conditions seem to be on others' minds these days, I'll close my mentioning that our cash flows remain extraordinarily strong, that our cash on hand at September 30^th didn't change much from June 30^th after considering FX rate changes, and that unlike some others, we've not encountered any significant change in our ability to place short-term debt in U.S. or international markets. And we believe we have sufficient cash and borrowing capacity for both operations and acquisitions for the remainder of 2008. I'll now ask Jai to complete our review with comments on the new growth initiatives included in yesterday's release. Jai?

Jai Nagarkatti - Chief Executive Officer and President

Thank you, Mike. Good morning, everyone. The third quarter was an active one for Sigma Aldrich and that has certainly not changed over the last few weeks. You've already heard from Kirk and Mike about our third quarter performance and expectations for 2008. Let me just add how pleased I am that the Sigma Aldrich team has been able to respond in such a timely way to less than robust market conditions to deliver upon market sales growth and to actually improve margins. I'm confident about our ability to finish 2008 strong and that deliver increased diluted earnings per share in the range of $2.62 to $2.72. That's an increase over 2007 of between 12 and 16% for all of 2008. Our challenge is to keep all of that going in 2009 and beyond.

With that in mind, we launched another strategic review of our markets and activities earlier this year to reassess existing initiatives and identify new ones that can enable us to continue to exceed market growth and enhance margins. As you have seen from watching this over the years, we watch our markets continually and tweak what we're doing to address changes and take advantage of opportunities as they arise. But as has been our practice since 1999, we also conduct critical strategic reviews on a three-year cycle to enable us to maintain momentum. We use our own best and brightest led by one of the most senior members of our executive team and in our most recent exercise, we dedicated 13 people full time for several months with added contributions from dozens of others across the business. As in past reviews, this one was fact-based and externally focused, with some of our best ideas coming from listening carefully to our customers through more than 100 interviews and over 1000 surveys.

The end result of that review is that our fundamental financial goals remain the same, to build shareholder value by delivering currency adjusted sales growth of 10% per year over the long term and return on equity of at least 20%. In looking at our existing infrastructure, we feel we are designed to grow sales at above market rates. Initiatives already in place from our last review are expected to deliver organic growth rate around 7%. Our new initiatives are expected to improve internal growth, supplemented with contributions from technology acquisitions and new opportunities added from our innovation efforts to drive overall currency adjusted growth to 10%.

We have been successful in adding new technologies with the addition of six businesses, seven significant partnerships and well over 100 license agreements over the last three years. We seek to build stronger, more formal capabilities, expecting to continue to identify and acquire similar new investments that can deliver the desired profitable growth each year. As I indicated in yesterday release, our new activities will build on many of our current activities. So, our focus on customer’s centricity to business units, extending ecommerce capability, expanding in faster growing geographic markets and margin enhancement to the supply chain activities will all continue. We'll supplement that with a new ventures group focused on identifying new business opportunities derived from our unrivaled scientific knowledge and global logistic capability. We're not ready to share full details about our initiatives today. But we already have teams hard at work on first steps to implement several of them and I'm happy to share them with you at a very high level. They fall into three broad categories, encompassed by the terms accelerate, elevate and innovate. Initiatives in the accelerate category include fully delivering on our supply chain project over the next four years.

To achieve the 150 basis point margin improvement already established but not yet fully reflected in our results by year 2010. This is the single largest process change project in our history. And the team driving it continues to learn to adapt and to grow as they drive eight interconnected activities centered on procurement, inventory management and distribution logistics. Other activities within accelerate relate to achieving our goal of 10% top line growth in research biotech to greater focus in targeted growth areas and to take advantage of opportunities to sell larger quantities of our prepackaged research products to our SAFC supply solutions business and to continue our effort to drive sales in capital markets towards our existing goal of 25% of total sales sigma out of sales by 2010. Our next broad category of activity is elevate.

One of our focus activities here will be on even further refinements in our pricing strategies. As you might imagine, with 130,000 products, well over 400,00 stock keeping units and 80,000 customer accounts, setting prices against different competitors sets in each of more than 150 countries is not an easy task. Is our pricing optimal? Likely not. We believe there's opportunity for improvement here. Another opportunity to elevate comes in our web strategies. We have invested significantly to build and operate industry leading web and electronic ordering tools. But we believe we're far from the end. Of using these to accelerate growth. Ecommerce, the catalog and marketplace of the future, has fully arrived. And it is moving faster and providing new opportunities for sales every day. Our global presence provides even more elevate opportunities.

Several of these will require new talent and we continue to expand our team to include it. Our final category is innovation. This has been a hallmark of Sigma-Aldrich for our entire history. And it will be a differentiating factor of increasing importance in our markets. We have been a leading partner with researchers for more than 50 years and have tighter and established better relationships with development and manufacturing groups in life science and high technology since rebranding our fine chemicals business as SAFC just a few years ago. Here, we plan to capitalize on our broad knowledge of product sourcing, offering differentiation in our markets with customer directed configurations that include. Custom packet sizes, mixtures and solutions. We also seek to take advantage of our unrivaled scientific knowledge providing support for breakthrough technologies in the life science and high tech arena and facilitating both general and highly specific scientific collaboration, because our teams are hard at work on.

Early phases of several of these new initiatives, we expect to hit the ground running on January 1st next year. We are not ready to provide specific contribution expectations from these new initiatives or overall financial guidance for 2009 today, but we plan to do so when we release our fourth quarter earnings in February. Consistent with our past experience, such new initiatives bring new focus and energy to our company. We expect nothing less this time around. So whether external markets are tough or on the rebound, we are looking forward to 2009 with optimism. As we finish our detailed work on these new activities, it is likely we'll be making some changes in our organizational design and in our people assignments, both to exploit new opportunities and to continue to develop, broaden and deepen the bench strength of our management team. So, stay tuned for some future announcements. Those future announcements will soon include the naming of a new Chief Financial Officer.

As most of you are aware, Mike Hogan indicated his desire earlier this year to retire to recap the benefits of his years of labor and to devote more of his energies to civic and charitable causes. So, this will likely be the last time you'll hear from him in a quarterly conference call, unless, of course, as a stockholder, he decides to join those of you in asking questions on future calls. We expect to name his successor shortly. Mike has assured me he will provide whatever transition assistance is and charitable causes. So, this will likely be the last time you'll hear from him in a quarterly conference call, unless, of course, as a stockholder, he decides to join those of you in asking questions on future calls. We expect to name his successor shortly. Mike has assured me he will provide whatever transition assistance is needed to make sure the hand off is seamless. And those of you that know Mike know that that means it will be as seamless as seamless can be.

Over almost the past ten years, Mike and his team have improved the financial discipline of our company, installing systems, controls and processes that will last for a long time. He has been a key contributor to our executive management team, a trusted adviser, a colleague and even a friend. I thank him for his service and I wish him well in his retirement and I know we will name a great person to build further on what Mike and his team have constructed. I want to thank you for your ongoing interest in our company. It remains financially strong, with products, scientific knowledge and services that are second to none and over 8,000 talented and dedicated employees who can make it all possible. We remain confident that by providing exceptional service to our customers, we will enhance our chances to deliver superior returns for employees, ourselves and our investors. On behalf of Kirk, Mike, and all of our colleagues around the world, I want to thank you for joining us today.

Now, let’s open up the call for your comments and questions.

Question-and-Answer Session

Operator

[Operator Instructions]. Your first question will come from the line of Bob Trout with Goldman Sachs.

Amy Zhang

Hello. This is Amy Zhang, sitting in for Bob. I have several questions. The first one, can you give us an update on the trend in Europe which accounts for more than 40% of the total sales. And also given the current challenging economic environment in our region, what type of growth rate shall we expect from Europe going forward?

Jai Nagarkatti

Amy, this is Jai. To give you a very, comment at a high level, the trend in Europe, we are seeing very promising developments there and growth, with the exception of the pharma sector. The customers in all other segments which account for roughly 65% of our business, even in Europe, continue to be very strong. I use the word very strong. And we expect that to continue in the fourth quarter.

Amy Zhang

Okay. And then so going to ‘09, shall we expect some slowdown in our region, pretty meaningful slowdown in our region, given probably we’ll head to a recessional environment.

Mike Hogan

Again, as we’ve seen a lot of times, we tend to be a bit recession resistant, particularly since 70% plus of our business is in the research field. While we’re not ready to give 2009 guidance, we don’t see any indications in the market that would question our ability to remain recession resistant.

Amy Zhang

Okay. Got you. My second question is associated with the guidance for the fine chemical business. Essentially, the first nine month organic growth for that segment is about 3.6%. And then you give the guidance of 4 to 5% for the full year. This adjusts, the mid single digit growth for the fourth quarter. I understand you have some nice initiatives out there. But given even darker economic and outlook and going forward and why you’re still comfortable with this, the mid single digit growth and fourth quarter, actually up from 9% in third quarter.

Jai Nagarkatti

Amy, this is Jai. You recall that in the SAFC, which roughly accounts for 40% of our business, there are four distinct sub groups within SAFC and Pharma happens to be one which is the weaker part right now. The other three, the high tech, supply solutions and to an extent SAFC biosciences, they’re all seeing growth at different levels. Some time back, we made a conscious decision to expand and diversify our fine chemical capabilities beyond the life science and biotech area into high tech. And we’ve seen very promising growth there and supply solutions which accounts for roughly 40% of the SAFC solution is still very robust and very similar to our research business. So, that gives us the confidence that SAFC business will continue to, these segments will continue to contribute to our growth in the fourth quarter.

Amy Zhang

For fourth quarter, should we expect further erosion in the pharma business in the SAFC? Or -- would just assume the trend probably stay at the current level?

Mike Hogan

Amy, this is Mike. Without giving specific sub segment guidance, we’re very comfortable with telling you we had a mid single digit expectation for SAFC currency adjusted growth in Q4. All four sub segments combined.

Amy Zhang

Okay. Then last question, you probably mentioned in the prepared remark. I probably missed that. Assuming the currency stays at the current level, what would be the headwind for ’09?

Mike Hogan

It is hard to say for ‘09 but I think it would be slightly negative to possibly flat.

Amy Zhang

Okay. Thank you.

Operator

Your next question will come from the line of Quintin Lai with Robert W. Baird.

Quintin Lai

Hi good morning

Mike Hogan

Good morning

Quintin Lai

Hey, Mike. All of us here would like to wish you all of the best as you move on to your next assignment there.

Mike Hogan

That being relaxing a lot more and enjoying giving back to charitable and civic causes and remaining a shareholder and rooting from the sidelines. So thank you Quintin.

Quintin Lai

It has been a pleasure working with you.

Mike Hogan

Thank you.

Quintin Lai

Diving a little bit closer into the pharma side on SAFC, is that related to the API synthesis business for you? And to make it clear, not the bio-production or biologic production.

Jai P. Nagarkatti

That’s absolutely correct. This is the custom organic, mostly the custom pharma business which we keep separate from the bioscience.

Quintin Lai

And so, you talk about delays or do you think that some of it may have shifted to competitors or what gives you that confidence, I guess, delays I mean. Are they saying that maybe deliveries for Q4 or Q1?

Mike Hogan

This is Mike. So, we do not believe it shifted to competitors. We do believe it is a slowdown in ordering expectations. And we know what we’re told. But we ship to customers when they need it from us. We’ve been told that these are delays. I think we’re waiting to see, just as we are, what their needs will be based on outward demand, external demand. We were very heartened this morning to see a tremendously positive release by one of our customers in the pharma segment.

Quintin Lai

And, then with respect to high tech, which you did expand some of your capacity late last year and early this year, some of that goes into areas like the semiconductor side. How economic sensitive do you think your customers are with respect to that order?

Jai P. Nagarkatti

Quintin, I think the products that we are supplying to our customers through the high tech division are still in the fairly experimental stage and not really in the manufacturing yet, which means the price sensitivity of these materials is not the same as those that go into commercial application. So, I think that area will be just fine.

Quintin Lai

Okay. And then from our back of the envelope calculation, it looks like based on current FX rates that you could be look at maybe 4% or so, FX revenue headwind next year. If that’s the case, do you budget that or do you try to put that into your factoring of how you’re going to run expenses and maybe accelerate initiatives for 2009 for operating margins or do you just say that’s FX, it is a math issue and it will be what it is?

Mike Hogan

So, the answer to your question is all of the above except the last. We do not assume it is just a math issue. One thing I do need to correct. So, FX as we report it consists of two things. Straight currency to currency comparisons at a quarter’s end and also the time difference which Kirk alluded to in his comments between when we have made something and when and where -- and where we’ve made it and when and where we sell it. And since we’re FIFO, first in, first out, and many of our products sit on shelves for years, some what you see in currency will continue to flow through as a benefit regardless of what happens with head to head currency rates. So, I’m not sure a 4% headwind is an accurate portrayal of our expectation for next year when you include the inventory timing benefit of sale.

Quintin Lai

Okay. I guess just some top line.

Mike Hogan

It does affect top line. Now, we have a demonstrative record of controlling costs. In fact, we’ve just shown the ability to increase margins sufficiently in a quarter where sales were $29 million lower than first quarter and have the same kinds of results for profits. We will, if we believe currency is going to be less beneficial, take actions that help us to increase earnings at a rate that’s faster than organic sales.

Quintin Lai

Absolutely. Okay thank you very much.

Mike Hogan

You bet.

Operator

Your next question will come from the line of Michael Sison with Keybanc.

Michael Sison

Thanks, guys. Good luck as well, Mike. It was a pleasure working with you.

Mike Hogan

Thank you, Michael.

Michael Sison

Jai, in terms of the research chemicals market, you’ve talked about that general market growing 2 to 3% roughly, probably over the last couple of years. And clearly, where it’s essential, you’ve done a great job of outgrowing that market. I mean I think it is fairly certain or at least the pundits are saying that we’re going into some level of economic recession, Europe and the U.S. How does that tend to affect that market and the customers and just sort of generally, what typically happens to your customers when the economic environment slows?

Jai Nagarkatti

Okay, couple things Mike In an economic slowdown, our research customers generally continue to do the research because their projects are more long term oriented.

Michael Sison

Okay.

Jai Nagarkatti

So, the spending on research continues. All of the just like everybody else, they probably manage their costs a little bit carefully, which means that their spending on disposables would be tightly controlled, they'll probably buy material that they need and when they need it, but nonetheless, they'll still continue to buy. what puts us in an advantageous situation is our broad diversification in terms of the radius areas and pools that we provide. Even in the current environment, when we look at our product mix, we see continued robust, in fact, surprisingly strong growth in certain areas like analytical, chemistry, cell culture I think. So that gives the confidence that why we may not be completely recession proof, we will be recession resistant.

Michael Sison

Okay. Then I think that's a fair statement. But on companies like emerging pharma, emerging biotech, these are companies that tend to need to go get funding every nine to 94 months, do you see any effect there or any slowing there that could occur because of the slowing economic environment?

Mike Hogan

This is Mike. The other piece of this pattern is that when times get tougher, the first things that get slowed down are facility expansion or purchasing major equipment. And that the last thing to be affected is throughput. In some ways, research is no different than your business or other businesses in this sense. I mean up to staff reduction of about 10%. the 90% who were left just do 100% of the previous work. That's no different in research than it is anywhere else. It really depends on how severe the cutbacks are and again, the people seem to be like the third thing that goes and the throughput materials are fourth and last. And as we saw the last time we had a downturn, we lagged going in and it was not nearly as severe as it had been for others.

Michael Sison

And then in fine chemicals, it would seem that maybe is it possible during a slowdown that cost customers maybe think to outsource more and that's actually better for your business as they may struggle a little bit as maybe their customers' patients use more generic drugs, so on and so forth?

Mike Hogan

That's possible. That's why we'll focus our efforts on trying to go and seek these kind of customers, who are more aggressively looking at outsourcing maybe in this geography or outside, Mike. You're right.

Michael Sison

Okay. Then, just a quick one on the foreign currency issue. Clearly, dollar continues to strengthen here, even further relative to what you said. But at some point, it is going to be a negative hit to your earnings, assuming that levels stay at these levels.

Jai Nagarkatti

At some point, if our efforts to construct facilities and purchase companies in other countries to get our flexibility for where we produce what doesn't pay off, at some point, it could do that. We, as you will notice from things we've bought and things we've built over the last five years, have been building a natural hedge. Much more flexibility in producing things nearer where our customers are and, in fact, if currency turns. Sufficiently, we could actually reverse the flow and take advantage of strong dollar versus foreign currencies for some parts of our product line to offset that impact.

Michael Sison

Okay. Than last question for 9 I know you're not giving specific guidance but is there any type what would you need to see from the economic environment or the research markets for you not to be able to growth in terms of organic sales growth? You'll have pricing in the bag and so you really just have to worry about some volume here. Is there any sort of scenario? Do customers have to go out of business? Is there sort of a dire case scenario that. Would cause your volume growth to sort of be flat to down

Jai Nagarkatti

Okay, Mike. This is the Jai. History is our best guide in this type of situation You know that in the most severe market, in 2002 and 2003, SAFC markets were actually down 5%. We were down much lower. We were down only a percent or so. In the research market, when the market was flat, we were up by a percent. So, I don't see that we will have any significant impact because research spending will continue and the dire situation that you mentioned, where we can expect things to be negative is just about every pharma company every economic lab throughout the world stops doing research and you and I know that it is not going to happen, Mike.

Michael Sison

Great. Thank you.

Operator

Our next question will come from the line of Isaac Ro with Leerink Swann.

Isaac Ro

Hi, guys, thanks for taking the question

Jai Nagarkatti

Good morning

Isaac Ro

Morning could you talk a little bit about the price increases you took in the beginning of September? How broad based were they? And secondly, just given your expectations for continued margin expansion going forward, it doesn't sound like pricing will be part of that equation, given that the price increases you already took, I think you mentioned, were meant to be part of offsetting cost increases.

Jai Nagarkatti

If we look at the price increases, I think what we said our intent was to just offset our cost increases and I think we're achieving that at this point, so we're happy with that. I think if we got too greedy there, our customers would push back a little bit more. But I think they understand what is certainly going on in the broader markets. In terms of margin expansion, our key activities, the supply chain activity, we're absolutely committed to delivering that extra up to $0.25 by 2012 with some ratable part of that starting in 2009.

Isaac Ro

Okay. And then just regarding SAFC, you guys lowered the outlook for the full year last quarter and you saw further weakness this quarter Could you give us maybe a little bit more insight into why you think you have sufficient or improved visibility on the demand outlook, just given how much uncertainty there is in the overall economy?

Mike Hogan

That’s it this is Mike. I think as Jai shared, one of the nice things about that business is like the rest of our business, we're well diverse, we're 65% of the business is not heavily reliant on pharma. And I would just remind you that even though the backlog as we noted had gone down slightly during the last quarter, we, in fact, know what it looks like for the next 90 days. So, we know what sector that’s coming from. And we're I'll said again, confident of a mid single digit growth in SAFC currency adjusted for the fourth quarter.

Isaac Ro

Okay. And then, in terms of your goal of maybe getting a little bit more incremental market share going forward, what do you see the biggest opportunities to gain share in terms of product areas and then maybe on a geographic basis?

Jai Nagarkatti

First of all, let's take the geographic basis. One of our initiatives is to have 25% of our revenues come from our capital region. We're well underway toward achieving that. And geographically, we see a lot more growth coming from markets in Asia Pacific, Latin America and China and India. Then in terms of products, what we're also seeing is notwithstanding the life science applications and the pharma, we are seeing, as I mentioned earlier, very robust growth in some of the other areas, like the focus in the research biotech area with molecular biology growing almost at high double digits. Things like the effort that we're putting in cell signaling, (inaudible) analytical initiatives with research specialties. So, there are a number of subgroups within the research area where we're seeing and continue to see opportunities.

Isaac Ro

Okay. And then last question on China, I think you mentioned in the press release a slight slowdown, plus the Olympics. Was that a surprise for you guys and in what products did you see the slowdown and has the spending resumed there since the quarter ended?

Mike Hogan

Part of the reason for our comment was when we ship multiple shipments, small bottles which are mostly used in research at this point in China. And during the Olympics, just that two-month period, because of the constraints that were put by the government not to move products within China, there was a lot of backlog that was a lot of developing within the country. We were shipping products, which were sitting there on the dock to be cleared by the Chinese authorities. So, we are now seeing that they have put some effort to clear that and the volume of incoming new orders have gone back to the pre Olympic times. So, that gives us the confidence that this was a temporary situation. The nature of the organic molecules that we send, small number of different hazard classes, so the government was being a little cautious.

Isaac Ro

Got you. Okay. Thanks very much.

Operator

Your next question will come from the line of [Derek DeBerlin] with UBS.

Dan

Hi, this is Dan in for Derek. Mike, you had mentioned that as far as an FX benefit or detriment, you had both direct head-to-head currency translation and sales timing it fair to look at that in terms of 1/3 FX head to head and then another 2/3 coming from the timing of the sales?

Mike Hogan

Unfortunately, Derek, it varies all over the place and it has a lot to do with where made and where sold and distance of time between the two. That ratio over the years, that ratio has run about ¼ currency, 2/3 timing to 1/3 currency, 2/3 timing on average. But it has been as widely divergent in some years where currency has bounced all over the place to actually being negative from currency and positive from the other and vice versa. So, a good rule of thumb, maybe 30/70. But that's over several year period and it could be widely divergent from that on any given year

Dan

Okay, thanks. And then what are the currency assumptions behind the EPS benefits that you guys are looking at in 2009 from the supply chain initiatives, given that they were put forth several quarters ago, which was obviously a different FX environment.

Mike Hogan

Yeah we reiterated our general guidance to you even at 9/30 rates so they hold at 9/30 rate levels. Obviously, they will swing with currency changes. They will swing.

Dan

Okay. Fair enough. Just looking at the use of cash, I know you guys aren't looking too much into 2009 in terms of guidance, but do you see a dividend increase that is in line with previous years, given what may need to be an accelerated share buyback in order to maybe offset some FX?

Mike Hogan

I think what our practice has been is to keep our dividend roughly at about 20% of our net and I don't see any plans to change that today.

Dan

Okay. Thank you.

Operator

Your next question will come from the line of Dmitri Silversteyn with Longbow Research.

Dmitri Silversteyn

Good morning, gentlemen. And Mike, let me wish let me add my good wishes to your departure and sorry to see you go and it was a pleasure working with you. Couple of questions that I still have. Can you give us you've talked about the slowdown in the order patterns in European pharmaceutical customers. I'm just trying to understand where that's stemming from in the sense that I think the part of your business that's impacted with them is the clinical trial quantity or the small quantity production of active ingredients if I understood what you said correctly. Are the European pharmaceutical companies going through some cutback in R&D or are they redistributing their R&D dollars differently and going more for discovery and less for development? Can you give us an idea of why the slowdown occurred all of a sudden, given that typically this is not an economically sensitive market plus sector?

Jai Nagarkatti

Dmitri, in the pharma industry, what happens is the type of work that we do ranges the gamut right from small scale custom synthesis first for even studies up to a number of projects which are in various stages of clinical trials, one, two, and three. So, as the pharma European pharma companies are reassessing their portfolio, we are seeing less of the larger phase one, phase two type orders that we expected to repeat which brings in the bulk of the revenue on the products that we make. Having said that, we do get inquiries, it is not like it has stopped completely, on the front end, the smaller one, which means there is a different dynamic that could be taking place in the European pharma companies where they focusing there effort on pushing the very late stage pharma company a products out of their pipeline, where we don't have much in that particular space

Dmitri Silversteyn

Okay. So if I understand you correctly, it's the phase three and phase four are doing well and pre-clinical that are doing well. But phase one and phase two, which for you is a large chunk of your business

Jai Nagarkatti

Because we buy we are relatively new entrants in this business.

Dmitri Silversteyn

I understand. Is there a possibility that this behavior or this strategy will spread to U.S. companies or to Asian companies as they are focusing on getting late stage products out the door and discovery in early stage products?

Jai Nagarkatti

This is a trend that we're seeing across the board. Because as we all know and read, most of the blockbuster drugs of the pharma companies are going to come off of patent in the next five years. So the greater amount of effort is being put to push the products in the late stage clinical trials to create replacement for those that have went off of patent, which means that we benefit on the very front end, which are new projects that are going to CROs overseas.

Dmitri Silversteyn

Okay, I understand. Thanks Jai for that clarification. That helps. Secondly, you talked about the kind of the currency expectations for the fourth quarter and somewhat indirectly or directionally you talked about what you expect for 2009 on the top line. I was little bit surprised that with lower FX benefit, you were still able to expand your margins. The big fear out there, I guess, is that with FX adding in the neighborhood of $ 10.00 with extra levels or is to earnings, that as it turns neutral and then negative, you are going to see significant earnings headwind, but it looks like your margins are still expanding in this environment which to me would be somewhat counterintuitive. Can you go through some of the drivers, why your margin stability is (inaudible) continue to expect margins to expand?

Kirk Richter

I think as Mike said earlier, there is an effect coming through the timing of inventory. So, we've got pretty good visibility on the fourth quarter there. Obviously as you move forward, with about seven months roughly of inventory, by the inventory, by the way which we're happy to have seen go down a little bit, we can see certainly the next quarter and into the following quarter. So, we got some early visibility on 2009 after that, it is kind of subject to where the rates are at the end of the year. And that's why we're a bit hesitant to absolutely say where currency is going to be into 2009. But we certainly have good visibility on our fourth quarter.

Dmitri Silversteyn

I am sorry, go ahead.

Mike Hogan

Dmitri, this is Mike and so on the second piece of your question regarding margins, I just remind you, you noticed for a long time, we do $15to $20 million of process improvement savings a year, time in and time out. We have been working on the supply chain, which we've talked about ratably adding a certain amount each year starting next year. Well, we've started early, and we're starting to see some benefits from that. Over the first eight months of the year, we had supply input increases going on that we didn't have price increases to cover. And in September, we put in a price increase which has pretty much eliminated the negative by impact of those increases in our underlying costs at least for the month of September, and we suspect that will continue. So, there are you know lots of things. Again, you visited our corporate headquarters. And you know when it's time to hunker down, when you think margins or markets to the less robust, we have a very small management team. It acts quickly and, in fact, we're not spending money on things that aren't needed right now.

Dmitri Silversteyn

Okay. I understand. Thank you, Mike. And that leads into my next question on the share repurchases. I was glad to see that your board has approved an extra $1 million share authorization. Can you give us an idea of what your total authorization is currently and given where the level of stock is today and given your past history of being pretty aggressive with share repurchases when warranted, can we make the usual or the implied extrapolation of your action for the balance of the year?

Mike Hogan

It was a $10 million authorization just to make sure we (multiple speakers) and in total we have $11million share outstanding under authorization that we have not purchased. I think we'll let our history speak for itself. Less than a few weeks ago, the stock was trading at $60 or $63 a share. Yesterday, it was in the low $40s. This morning it opened lower than that. I said in my own comments, we believe that the price is unwarrantedly low, so you can draw your own conclusion.

Dmitri Silversteyn

Okay then last question on acquisitions. You talked about a natural hedge that you're developing by growing faster in international regions and trying to align your costs and your revenue stream, where foreign exchange may have an impact on translation level but shouldn't have much of an impact on the operating profit level. Given the fact that you are in a very strong position, balance sheet-wise in terms of bank commitments and debt level, and maybe better heeled than some of your competitors, let's say in the acquisition market, are you seeing or are you preparing to see a significant change in the acquisition environment and perhaps go after some larger businesses that -- where the multiples have come down to the point where they're attractive now?

Jai Nagarkatti

Let me comment that I think acquisitions will be continuing to be part of our growth strategy. But like we did in the past, we'll be judiciously looking at acquiring companies that, A, we can assimilate within our organization. And two, which help us create differentiation and are available at reasonable price and have some unique technology. So, I think as we have often mentioned, whenever there is an opportunity, we are always looking. The phone always rings at Sigma-Aldrich and stay tuned.

Dmitri Silversteyn

Okay. You haven't seen any changes in people's behavior yet.

Jai Nagarkatti

No, we have not.

Dmitri Silversteyn

Okay. All right, Jai. Thank you. Thank you, gentlemen.

Mike Hogan

Thanks.

Operator

Your next question will come from the line of Jon Wood with Banc of America Securities.

Jon Wood

Hey, thanks. Sorry in advance to dig into this again. But Mike, if I understand the comments about the consistent growth in SAFC's other businesses in the third quarter, it would seem to imply that SAFC pharma was down upwards of 30% in the third quarter. I mean first of all, is that estimate offend you? Is that way off?

Mike Hogan

So, it was not down 30% but it was certainly not up.

Jon Wood

Okay.

Mike Hogan

And we talked a little bit about the backlog being down. We really don't want to get in subsegment reporting, but I would say that the direction of your comment is not out of line.

Jon Wood

I just want to understand. Is there a customer concentration issue there just by nature of the business or -- I'm trying to understand how quickly you can redeploy the capacity to other customers or other projects. How does the pipeline flow in that business?

Jai Nagarkatti

Jon, remember that many our plants are shared between the various business units. So, the luxury that we had is when we have capacity, we can use that capacity to make products for our research. Now, having said that, I also said that the supply solutions which is a significant piece of our SAFC business unit is still growing robust and we make a lot of the products ourselves.

Jon Wood

Okay. So, it is not particular lines that take an inordinate amount of time to bring on or take off.

Mike Hogan

No. Our business, even in most of SAFC, our business resembles a large commercial bakery. Think of it as very large pots and pans, batch order processing, there are very few part of our asset base that are kind of what people think of as traditional chemical plants, a lot of piping and tubing that's continuous or that's dedicated to only one use. So, this stuff can get looped around and used broadly with very, very few exceptions. Like our cytotoxic equipment has to work on cytotoxic stuff. So, if there isn't demand in that space, fortunately, there is, but if there weren't, that would a bit of a risk to our sales. But most of this stuff, you literally can move a lot of the things that we use. You can put them on rollers and move them around. So, it is not -- that is not the issue for us.

Jon Wood

Okay. And then just to be clear, the weakness is in the development stage. It is not currently marketed therapeutics.

Mike Hogan

Yeah, that’s correct.

Jon Wood

Okay. All right. Then Mike, I know you've done your best to reinvest the currency windfall here over the past year or so. Can you categorize the main areas or -- where that windfall has been deployed or allocated? Is it sales reps? Is it direct mailings? Technology? I mean can you kind of break out where you've deployed the currency windfall over the past seven quarters or so?

Mike Hogan

Not just currency windfall but also our process improvement savings which historically, other than our work on the supply chain, had been reinvested. We, between Jai and I, had mentioned both of those areas without quantifying it. I said 40 sales reps. That's $4 million a year before you throw on support costs without blinking. We have invested heavily over the last two years in totally reconfiguring our web from an architecture standpoint to essentially make it a tower of windows in which you can plug in all sorts of new capabilities, whether that's direct consumer to company contribution -- or conversation chat rooms, outbound emarketing campaigns and the like. Significant investments in web technology. We continue to add R&D capabilities. And so -- and on and on. It is the same general stuff that we have talked about. We have spent a few bucks on acquisitions, although not in the recent quarters, but over the last three or four years. It is not an insubstantial amount of money that we've put into new technology or into ventures like the broad institutes venture with the RNAI consortium in the proteomics and genomics. So, lots of areas, virtually all of which are closer to the customer, more actively engaged with the customer or very heavily engaged in scientific development and R&D.

Jon Wood

Okay, thanks. And then on the changes in the biotech portfolio, were those changes made in response to just product life cycles changes or competitive landscape changes?

Mike Hogan

To be real candid, we went through and we just looked at where are we getting our revenues and what are they costing us to do? And this is -- we're talking about something that's several million dollars a year in annual revenues, 2 to 3 million. So, in Sigma-Aldrich in total, it’s irrelevant. But in the biotech segment, 2 or 3 million in short order shows up in percentage. The end of next year, people will only remember we got out of that except to enjoy the better margins in biotech as a result of exiting its less profitable part.

Jon Wood

Understood. Thanks Mike.

Mike Hogan

Thank you.

Operator

Your next question will come from the line of Dan Leonard with First Analysis.

Dan Leonard

Hi, good morning.

Mike Hogan

Good morning.

Jai Nagarkatti

Good morning, Dan.

Jai Nagarkatti

I did hop on the call late, so if my questions are redundant, I won't be offended if you refer me to the webcast. Jai, I want to understand what appears to be a bit of a disconnect between your commentary around the SAFC pharma shortfall in the press release and then what I hear in some of the Q&A. You answered Dmitri's question, that it's phase one, phase two orders in Europe. To me, that sounds very customer and product specific as opposed to the industry and economic conditions cited in the P.R. Am I missing something?

Jai Nagarkatti

No, you are correct. In terms of industry, remember we have the same – a handful of customers who give us those projects. I think when those projects get delayed or bumped up, it impacts us. Those customers happen to be in the pharma industry in Europe.

Dan Leonard

Okay. And then also in your outlook, why are anticipating higher input costs?

Mike Hogan

It’s not just – this is Mike. It’s not just we are anticipating, we have been experiencing them over the first eight months of the year. It just is what it is. For a while there, it was fuel. And that will be interesting to watch because we've seen price per barrel of oil come down substantially. Be interesting to see how that all plays out. But it has been energy. It has been supplies. Go look at underlying markets. I think steel is some of our containers for steel drum have gone up 30, 35%.

Dan Leonard

Yeah, I mean I have looked at the underlying markets and the materials I look at have come down in the past month pretty substantially which I guess is why I ask the question.

Mike Hogan

And it’s true that means our price increase will do even more for us than we thought it would.

Dan Leonard

Okay. So you are not getting pressure from your customers to give some of that back?

Mike Hogan

No.

Dan Leonard

Okay. And then my final question on M&A. Jai, we have heard from a couple of your competitors that they are actually seeing more opportunities in this environment, add some technology oriented companies are having difficulties securing funding. But it didn’t sound like you echo those sentiments. Is that correct?

Jai Nagarkatti

I think -- again, perhaps our criteria may be a little bit different than theirs. We're looking for a certain critical size, not too small, not too large in certain areas so I can't comment on what they are seeing.

Dan Leonard

Okay. Thank you very much.

Operator

[Operator Instructions]. Your next question will come from the line of Seth Teich with Apex Capital.

Seth Teich

Hi. I was curious to know if you could comment as to if -- what the impact of foreign exchange is on your Q4 revenue if currencies were to stay at current levels.

Kirk Richter

Yeah, I think we gave that guidance and say it would be off in the 3 to 4% range if it stayed at 9/30 levels, but still slightly positive to EPS.

Seth Teich

At 9/30. I am saying today rates have changed substantially from that, what the impact is today?

Kirk Richter

Probably wouldn't change the EPS contribution significantly if it wasn't -- if it stayed where it is today, but obviously probably put at the higher end of the revenue guidance.

Seth Teich

Okay, great. And then I have maybe a different way of approaching the foreign exchange from a business model perspective. If I look at your earnings and I think Jon Wood touched on this, your organic revenue growth has been approximately 6 to 7% for the last nine months and then going back to '07, but yet your currency adjusted earnings have been roughly flat over that time period. What in that equation is going to change going forward to help you grow your earnings when the foreign exchange impact, once you burn through your inventory at whatever point next year, if it is Q2 or Q1?

Kirk Richter

I think there are a couple of things going on, Seth. In addition to FX, I think we talked about our tax rate being higher. So, if you look at the true operating margins, we have seen some lift, even over and above the currency contribution. Where tax rates go on a long-range basis, given what's going on in the world of politics these days, is probably as hard to predict as where currency rates are going. So, but as we said earlier, we think tax rates for this year will be in the middle of our prior guidance. We are certainly happy to see that the R&D credit is not only for the fourth quarter this year but for all of next year, but I think taxes will be somewhat volatile as well. I think the other thing we are doing is the supply chain initiative that talked about earlier together with some of the initiatives and again we are not ready to give guidance on, but some of the new sales related initiatives that Jai talked about earlier that will give more clarity on when we release our fourth quarter.

Seth Teich

Okay, great. Thanks.

Operator

And at this time, there are no further questions.

Kirk Richter

We would like to thank everybody for their participation today. Again, looking forward to our fourth quarter, we do expect to release those results on February, the 10^th of next year and that will be followed by our conference call on February, 11^th, again at 10 o’clock Central Time. This concludes today’s conference.

Operator

Ladies and gentlemen, thank you for joining the Sigma-Aldrich’s third quarter 2008 results conference call. You may now disconnect.

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