Sigma-Aldrich's Management Presents at Citi 2013 Global Healthcare Conference (Transcript)

Sigma-Aldrich Corporation (NASDAQ:SIAL)

Citi 2013 Global Healthcare Conference

February 25, 2013 9:35 am ET

Executives

Quintin J. Lai - Vice President of Investor Relations

Jan A. Bertsch - Chief Financial Officer, Executive Vice President and Treasurer

Analysts

Amit Bhalla - Citigroup Inc, Research Division

Amit Bhalla - Citigroup Inc, Research Division

I'm Amit Bhalla from Citigroup's Life Science Tools and Diagnostics Team and we're happy to have our next presenting company, Sigma-Aldrich, with us this morning. With us from the company are Jan Bertsch, Chief Financial Officer and Treasurer, to my right; and at the podium is Quintin Lai, Vice President of Investor Relations and Strategy. Quintin's going to take us through a couple of slides on Sigma-Aldrich to give us an overview, and then we'll go through Q&A. So Quintin?

Quintin J. Lai

Great. Thank you and good morning. On behalf of Sigma-Aldrich, we'd like to thank Citi and Amit for the invitation to be here today. Today, I will be making a presentation. The slide deck is available on our investor website at www.sigma-aldrich.com.

And here's just the cautionary statements. And I will refer you to our latest 10-K.

If you look at our company, our mission remains still very focused on enabling science to improve the quality of life. We have a very balanced, stable business model. We sell -- sales all around the world to very diverse end markets and we offer over 215,000 products, 50,000 of those that we self-manufacture, the rest of them we take and repackage under the Sigma-Aldrich label, and we do that and use our industry-leading channels both through e-commerce and direct sales and our dealer network to distribute that around the world. No 1 product is more than 1% of our sales, no 1 customer more than 2% of our sales

I'm going to skip over the fourth quarter highlights and just go to the -- look at the full year 2012 highlights. For sales, $2.6 billion of revenues, 5% year-over-year growth, 3% organic. Record year for sales, record year for operating income and net income. GAAP diluted EPS of $3.77 and excellent free cash flow of $453 million.

If you take a look at our segment sales in 2012, Research was, which used to be 70% of our overall sales, grew 2% organically in 2012. And SAFC, which contribute 30% of our overall sales, grew 5% for a total of 3% for the full year.

Looking at our sales performance through the quarters. What we saw was that we ended Q4 kind of a bit on the same tone as we ended -- what we saw from Q3. In Research, our Analytical business continued to have very strong performance. We had a little bit of a tough comp in Q4 year-over-year, which kept the stock from going completely green for the full year. Again, very strong performance, and then we expect a lot of that is going to help carrying over for the momentum we have in the Applied Markets.

On Biology and in Chemistry, we saw a little bit of a stabilization in the fourth quarter, especially as the impact from some of the big pharma consolidations that we saw in the first half of the year eased. And as we look on to 2013, we expect -- hopefully, that trend will continue, and we're expecting to see a little bit of performance as the comps get easier for the year. And then Lab Essentials was pretty steady.

In the Sigma-Aldrich Fine Chemicals business, our Hitech business had kind of an up-and-down performance in the year. Most of that was impacted by pricing on our Hitech metal precursor business that we do for the LED business. As we talked about all year long, we saw some big pricing declines after a big one up in 2011, as capacity started to come on in line 2012.

And then Bioscience business improved a little bit on Q4, as we had some timing issues of Q3 and Q4, we'd mentioned on the call. And so just in general, overall the end markets were relatively stable. And from a geographical basis, what we saw was flat[ph] performance in the U.S. Europe actually ended the quarter on a little better note. And then the Asia Pacific, Latin America region was our best performer for the full year.

So finally, looking at the 2012 highlights, record sales, profits and free cash flow for the company, we -- and despite having significant FX headwind and the slowdown that we saw in Pharma and just overall uncertainty on the U.S. academic front, we continue to make a lot of investments and actions to improve the growth profile of the company. We expanded our footprint in emerging markets, investments in manufacturing processes. We continue to invest in our leading e-commerce platform, now over 51% of Research sales, as well as doing acquisitions of BioReliance and Research Organics.

So if you look at our company and the history, we've had 38 consecutive years of increasing EPS and annual dividend. And over that time period, we have been really, really successful with our product-led focus. And at the start of this year, what we talked about was moving our product-led focus more toward a customer-centric focus.

And let me explain a little bit what that means. So if you look at what we had at the start of last year, we had a Research business that was focused mainly on analytical, biological, chemistry and mature science projects. And that business and that strategy has just exploded the number of customer segments that we now serve. We serve over 100,000 different accounts, 1.4 million individual customers. We do that all around the world into a variety of customer classes -- and as listed here. And what we've done is we've turned the lens now to focusing our business to focus on the customer -- on specific and distinct customer classes. And so what you're seeing now is that we're taking Research as a standalone business, which will be focused primarily on company -- on researchers that are trying to push the edge of the envelope. This is our traditional core customer base.

We're increasing -- we're introducing a new business unit called the Applied Market; and then, finally, SAFC Commercial.

So I'll go quickly through those. If you take a look at the Research market, what we're focusing now on is on the academic and government customers, on research, on pharma and biotech customers, as well as our dealer network. And what does that mean for us? It means just continuing the same mission that Sigma-Aldrich has always been on, continuing to broaden our product portfolio, broadening and deepening our sales channels and e-commerce, direct sales and dealers and working closer with those customers, especially the larger ones, to offer solutions for packages and processes. This new business unit, if we look back and restated 2012 results, would've been about 53% of overall sales.

Looking at SAFC Commercial. This is comprised, some of the old SAFC business. Here we provide critical raw materials and APIs and services to customers that are doing large scale-up. And those customers would include people buying industrial cell culture media, that's in our Life Science products; high-potency APIs, which used to be part of our Custom Pharma business; as well as our Hitech business, which is the metal precursor businesses for the LED and semiconductor industry; as well as our Services business, which include BioReliance.

And the initiatives that we've got there continue to be the things that we've talked about all last year, helping our top 100 customers continue to drive solutions with our components, strengthening our leading position in cell culture media, leveraging the capacity and the growth potential in high-potency compounds, broadening the opportunities to apply our technology and the fact that we are one of the few suppliers of these organic metal precursors, metallic precursors, and then continue to integrating and growing the BioReliance business.

Then finally, the Applied business, which is our new business unit. There are 2 major sections for this unit, which is Diagnostics and Testing, as well as Industrial Applications. And here, what we're doing is that we are taking a business which represents right now 23% of 2012 overall sales. And if you look at it, we sell a variety of components today to clinical labs, environmental labs and industrial applications. And our focus primarily has been on components, selling antibodies and buffers and enzymes to these customers. What we are now moving toward is offering solutions and becoming more solutions-based. Because these customers, unlike our Research customers, are pushing the edge of the envelope. What they're doing is they're taking our tests, they're taking our standards, and they're applying it to more protocols, more routine testing. And for -- to the extent that we can help them with that process, I think that that's where our new infrastructure and our business unit focus will be going on a go-forward basis. We'll have plenty of time for the Q&A to talk about that.

So if you take a look at the organic sales growth on a what-if basis for last year, our Research business grew 1%. And again, was impacted by the big pharma consolidation and just U.S. academic-ish overhang. The Applied business grew 4% versus 6% in 2011. And our SAFC Commercial business grew 5% versus 11% last year. And most of that was on the Hitech pricing.

So finally, going to guidance, and then I'll turn it over to Amit and Jan for the Q&A. What we're looking at for the full year is that low-to-mid-single digit growth. In the first half of the year, we expect: Research to be in the low-single digits, and in the second half, to maintain the low-single digits; Applied to be mid-single digits in both quarters; and then SAFC, starting in the first half of the year in the low -- in the mid-single digits, with Q1 being a tougher comp due to the Hitech issues, so being lower than that, being better in the second quarter, and in the second half, going to mid-to-high single digits as both initiative as well as Hitech pricing should be better. And then all that will roll into an adjusted EPS for the full year of $4.10 to $4.20. And with that, Amit?

Question-and-Answer Session

Amit Bhalla - Citigroup Inc, Research Division

Thanks a lot, Quintin. Before we jump in to some of the specifics of the business, you want to stick to the conference theme of value in health care. And as the health care system continues to wrestle with lowering costs while increasing quality of care, Sigma's primarily a reagent consumable supplier. So I wanted you to kind of put the trends in the market into perspective, in the context of the end markets we serve and how that value theme of health care impacts your strategic decision making.

Jan A. Bertsch

Okay. And as you duly noted, we are a leading supplier of reagents and consumables in the Life Science and the High Technology segment. And many of our customers are -- we have many customers all over the map, including pharma and biotech, that are involved in developing therapeutics and vaccines, diagnostic companies, academic researchers, industrial and chemical companies. And so we believe that -- and our strategy is that the pursuit of R&D innovation and growth in the long-term is really needed in the market today. It's needed to develop better diagnostics, to develop better drug and to be able to address critical diseases like cancers and neurological disorders, just to name a couple. So our company is a premier provider of products and services, reagents and consumables that really -- to enable science, to improve the quality of life for the people. So just doing more tests and providing more drugs only really enhances some of the issues that we're seeing in the market today. It enhances the issues of funding, of reimbursements, of rising costs and things like that. So I think what we believe the system really needs and what our strategy is, is that to provide more effective and help enable our customers to design more effective tests, to define more effective therapies and diagnostic types of tests so that in the end, the consumer, the patient, is the one that -- benefits by having a more thorough experience. And that may mean less tests, but it may mean more effective type of tests. And I think part of the reason why we decided to break apart the Applied Markets within our own organization, as Quintin explained a couple of minutes ago, was really so that we could position ourselves, I think, to play a more integral part within the R&D arms of all of our customers to be able to provide them more opportunities to effectively design and develop some of these solutions with them.

Amit Bhalla - Citigroup Inc, Research Division

Great, well, that's very helpful. And expanding on this new strategy and organization for the business, talk to us a little bit about how much of an internal cultural shift had to take place. Because my sense is that this was happening internally a little more than external change. But walk us through that piece.

Jan A. Bertsch

Well, you know, in the last few years, we've been trying become more and more customer-centric. And what we were finding was we had 2 business units in our organization. And one was Research and it housed much of the supplied markets area, but it was 2/3 of our business, so 70% of our business. And it probably wasn't getting the personalized attention that it needed. And as we look back, we see that this is the part of our business that is growing at a more rapid pace than the more mature market within Research. So we elected to, in the new organization, pull that Applied Market out so that we could just provide it more attention that it needed. So I think it is -- from an internal perspective, we're doing a little bit of reorganizing, we're placing more focus on certain growth markets that maybe we hadn't been this focused on previously. And from an external perspective, we're really placing a lot more emphasis on working soon upfront as we can with our customers, placing more emphasis on trying to become part of the design of their solutions early on. So that's where we see the growth opportunities for us.

Amit Bhalla - Citigroup Inc, Research Division

So as you get more involved in the R&D organizations of your customers, are you finding that it's much tougher to compete for those limited dollars within the organization, the customer organizations? Are you fighting with other suppliers? How are you wrestling with that issue?

Jan A. Bertsch

Well, I mean, I think that there's always competition out there, so in general, competition's a pretty good thing. But because of our focus and because of our long-standing reputation with many of these customers that we have, we're certainly getting a seat at the table. And it's giving us the opportunity to get involved in some things that we had never done before. And we've got lots of examples on some things that we've recently been involved in, like we're providing sample prep for Vitamin D testing now. That is kind of new for us. We're providing an isotope-based pyruvic acid for the detection of prostate cancer now. So we're working with some customer on that initiative as well. And we've got many more that are now coming to the forefront and that we're just starting to work on to be able to get more involved in the R&D upfront.

Amit Bhalla - Citigroup Inc, Research Division

Got it. Now the important discussion around the -- around sequestration, we heard in our opening keynote, Peter Orszag discussed his view that he believed sequestration will take place at least -- and hold through the end of the month. How do you factor that into your planning for the year and how do you think customers are going to react?

Jan A. Bertsch

We saw pretty low single-digit growth in our Research market last year, and we planned this year, assuming that we would have a similar type of year. We did that because we didn't know the results, like no one else did. But we just wanted to be prudent in our planning. I think that from our perspective, the NIH funding, regardless of if you look at it from last year or this year, it basically impacts about 5% of our overall company business. A larger percent in the United States, obviously, but 5% of our overall company business. So -- which is about 10% of the new Research organization today. Research is about half of our business. So it is something that's very critical for us, but because of the nature of -- our diverse nature of our products, of our customers and of our geographic footprint around the world, I think, that it's one aspect of things that we worry about every day. It doesn't encompass us, it's not everything that we do. So we'd like to see some resolution, I think, so that people aren't speculating what will happen. And we'll work our hardest to offset that -- the impact on the company. I think we've been pretty successful on doing that in the past. And last year, when we found that we had a lot of pressure on the organization because of the economy and the environment and the uncertainty revolving around this issue, we elected to take some short-term actions and some smaller long-term actions to adjust it and still keep us in our guidance. And well, I think, we'll continue to focus on it that way.

Amit Bhalla - Citigroup Inc, Research Division

Got it. From a geographic perspective, take us through what underlies the low to mid-single digit growth that you're forecasting for revenue for 2013.

Jan A. Bertsch

Okay. So for 2013, and you can see it up here on the slide Quintin just took you through, but from just in total again, Research, we think, low single-digit growth. And that will impact probably the United States the most. In Europe, this year, we've actually -- last year in 2012, we actually I'll say enjoyed some reasonable growth throughout the year. We saw low single-digit growth first, second, third and fourth quarter. But fourth quarter actually has the strongest growth for us of the entire year, in the fourth quarter of 2012 in Europe versus any other quarter. So I think that's a function of the products that we're selling, a function of the fact that maybe the European government still wanted to retain a lot of the academic innovations that they were going after. And so as a consumable-type company, we were able to keep that low single-digit growth going very steady throughout the year in Europe. In Asia Pacific, that is clearly -- Asia Pacific and Latin America are highest growth regions and are expected to be so in the near future. Each country differs a little bit. In Japan, we saw much of our products, most of our products through the dealer system and we've been working very closely with the dealer body and trying to enhance the coverage of products, the scope and the breadth of products that we have, that we sell in Japan. In China, we ended up, the year in a very strong note, in the fourth quarter, albeit, we had a little bit slower growth in the midpart of the year. So it started out strong, a little bit slower and then ended up in a very strong note. In India, we had strong growth all year long. But in the fourth quarter, on the academic side, it was more constrained. So we see different markets reacting different ways. But in general, it's our highest growth market and we have continued to invest in those markets and continue to expect to grow nicely in those markets in 2013.

Amit Bhalla - Citigroup Inc, Research Division

So generally, you're taking -- are you taking the performance in fourth quarter and carrying it forward or it's more of a full year performance from '12 carried to '13?

Jan A. Bertsch

Well, I think it varies. I mean, it's hard to say, like, for example, with India, the fourth quarter stress that they had, will that continue in the first and second and third quarter? I mean, I'm just in general saying that Asia Pacific, Latin America piece of our market's about 1/3 of our markets. And Japan is 1/3 of that 1/3. So Japan's about maybe 7% roughly of our total market. And then China, India and Brazil constitutes about another 7% of our total company sales, and then everything else in the Asia Pacific is the balance. So we see good things in Brazil, we see good things in China and India, but any quarter, there can be a fluctuation, so.

Amit Bhalla - Citigroup Inc, Research Division

The European performance in the fourth quarter also caught our attention. What was really underlying that? Was that end of the year flush of any budgets or what do you see in Europe that can carry forward?

Jan A. Bertsch

Yes, well, like I said, it's been actually a very stable market for us in all of 2012. And I think part of that is because selling primarily consumables into the market when budgets are put under pressure, many times, as long as there's still a scientist doing their research, they still require our product. So we have a tendency to get less -- probably have less immediate downside on that. Alternatively, we'll probably have less immediate upside when budgets are infused with incremental capital because of the nature of the business that we're in. So we just saw solid stable kind of growth in Europe when many of our competitors were saying that they felt more and more pressure, we were feeling very stable results. And so I think in the fourth quarter, it was just more of the same.

Amit Bhalla - Citigroup Inc, Research Division

Okay. If there's any questions in the audience, make sure you raise your arm, or raise your hands and we can make sure we get a mic to you. Talking more about end market trends, the pharma industry, there's been a lot of discussion about R&D budget rationalization. It's not something that's new, it's been happening for a few years, but how is that impacting how -- your long-term outlook for that end market?

Jan A. Bertsch

We saw -- in the pharma, especially the large pharma, we saw continued kind of pressure throughout last year mainly due to site consolidations that had really begun in the end of 2011 and then continued in the first and second quarter of 2012. So in the latter part of 2012, I think we started seeing the impact of that slightly subsiding. I hope that's the beginning of a new trend. But one quarter is hard to really to know. But I think that when these site consolidations occur, obviously there's an immediate impact. And then sometimes after that, the scientists, the researchers, they end up in another venue somewhere. Small biotech's opening up, work being outsourced to CROs and them cropping up in emerging markets and then we see some of that business coming back. So we haven't seen so much activity on the site consolidation side recently, so I think that's more favorable news for us.

Amit Bhalla - Citigroup Inc, Research Division

Now I just want to take a step back and ask you about your view of the company now that you've been in the seat for about a year or so. Your background has been outside of health care, in the automotive industry. Now that you've been at the company for a year or so that you've been there, what do you see as some of the biggest unlocked opportunities at Sigma?

Jan A. Bertsch

It's been, first of all, a great, great year. I mean, I've had a really enjoyable time learning a new business and getting my frequent lessons all the time to supplement my background, which is not highly in the scientific area. It's been a great year. And I'm happy to say that when I came to Sigma-Aldrich in '12 last year, that working with the team, we were able to identify some further opportunities for the company. Because I think it would be pretty sad if you could never identify an opportunity. So I'm glad we really have found some opportunities to work on. First of all, I'll say this, there's always the cost kind of opportunities. And I think we're relatively lean organization, but we are also a growing organization. And when the organization grows, and especially it grows in various geographic regions, things change. And so, where we may not have had as big an opportunity to look at something a few years ago, some things are availing themselves now. And I think one of those are in the whole rationalization of the supply chain, being able to rationalize further how we move product. We sell a lot of product from our manufacturing locations around the world to other distribution centers, and then to the ultimate customer from there. And so as we're growing our footprint in Asia, for example, we're starting to rethink the way that we house products and where we house them and for how long and what methods of transportation we use to get them to various locations. Because what's very important to us as a company is providing product to our customers immediately as they need them, right off the shelf. And so that's been something that's been a very -- a nice strength of the company and we want to retain that. But at the same time, we want to be able to rationalize our costs. So we're looking at how do we retain that, and at the same time, move product in a more efficient manner. So those are some of the cost things. But I think on the -- a way to really continue to enhance the business is through profitable top line growth. And for that reason -- that was one of the reasons that we restructured ourselves into a new organization so we can have more specific focus on certain parts of the business. Because when we can enhance our top line growth organically, a lot of that can fall through to the bottom line as very profitable growth in our margin. So we're very, very focused on that, and then also inorganically growing our business. And Sigma-Aldrich, we're very disciplined approach in a way that we approach looking at inorganic growth. But at the same time, we have a very, very strong balance sheet. I think we're well poised for growth. The key is that we find opportunities that really fit with us. And they have to fit our strategy of the company, certainly have to be a reasonable cost proposition so that we can retain a solid return on capital for our shareholders. And it needs to provide long-term growth opportunities, profitable growth opportunities for Sigma-Aldrich

Amit Bhalla - Citigroup Inc, Research Division

What's lacking in the portfolio, generally? I mean, you have a very broad product portfolio. You serve broad geographic regions. Are you talking about broadening distribution capabilities? Is it new legs to the overall business that you need to add? Like how do you think about what's lacking at the organization from there?

Jan A. Bertsch

Well, really we look at opportunities in all the segments of our business. The Research business is a far more mature business. To the extent that we grow our sales in that area, and we already have a well-defined infrastructure in the company, that's always helpful. But the Applied Market is where the real, I think, a very strong focus is going to be this year. Because these are areas that have a tendency to be higher growth opportunities for the company. That's one of the reasons we pulled them out. They're growing at a faster pace than the more mature Research market. And it's involved in businesses that we may not have been so involved in, like some of the examples that I've provided to you, like some of the industrial examples of food and water, air quality, safety, things like that, that we have capabilities to do more of. So we want to be able to grow the customer base that we work with and where we grow that business.

Amit Bhalla - Citigroup Inc, Research Division

So from a M&A criteria perspective, what are the key hurdles that deals need to meet for your M&A strategy?

Jan A. Bertsch

Well, I think there's several. The first one is the M&A opportunity has to meet our strategy, it has to be part of our strategy. It has to enhance our strategy. So that's the first kind of filter. If it doesn't make it through there, then it doesn't go any further. And then the next one is we really have to be able to construct a price for the business that allows us sufficient enough synergies, cost synergies and has to meet our return criteria. Today, we have a return on capital of 20%. There's not a lot of companies out there, big or small, that meets that criteria. So I mean, it's logical to think that most acquisitions that we do. And BioReliance was a good example last year where it had an impact on our return on capital. Although in the long-term, we believe that it will enhance our position, and clearly, the deal was greater than our hurdle rate. So it's very important for us that we provide positive shareholder value and that means that we have a return on capital that is -- has the capability of being above our cost of capital certainly within the near-term. And then, finally, and very, very importantly, is the long-term top line growth of the company. And some deals -- like we'll never do a deal just for cost synergies. It has to have a solid top line revenue synergies for the company and growth opportunities.

Amit Bhalla - Citigroup Inc, Research Division

How about size? How does that play into all these criteria?

Jan A. Bertsch

We never really talk about size at the beginning. I mean, if it meets all those criteria, I think we would look at it. What's important for us is meeting those criteria. Now saying that there's a lot more opportunities clearly in the more bolt-on kind of acquisition because there's a lot more of them available. So when we look at our pipeline, the mostly sold was bolt-on kinds of acquisition opportunities.

Amit Bhalla - Citigroup Inc, Research Division

So I know that in the past, the 6% to 7% organic growth rate number has been thrown out as the target. What needs to change in the landscape of -- the macro landscape to hit that? And what needs to change internally to get to that 6% to 7%?

Jan A. Bertsch

Yes, so -- if you look at the components of our business and you look at Research being half of our business and Research growing at low-single digits. It will be nicer if that would grow at low- to mid-single digits. So we -- that had a growth of 3%, 4%. That really helped towards that 6%, 7%. But the Applied Markets, we're seeing mid-single-digit growth this year. And really, I think, we have the capability to grow that business more than mid-single-digit growth. And in SAFC Commercial, albeit we are anticipating a lower growth in the first quarter and in the first half than the second half, think the mid-to-high single digit growth in the long term is where that is. So when you combine all those things together, that gets us to our 6% to 7%. Now it's been hard in the last year with all the pressure on the Research side. So we're hoping for better things there, but I still think that's within our range.

Amit Bhalla - Citigroup Inc, Research Division

Okay. Any last questions?

Unknown Analyst

Jan, specifically about the Research business. What are initiatives that you guys are taking to get to that low-to-mid-single digits rather than the low-single digits that you're currently experiencing?

Jan A. Bertsch

Yes, well one of the things that we're doing is working very much with our dealer body. We have found that our dealer -- the sales that go through our dealer body, and this is like in Japan, but it's also in other parts of the world, we use dealer selectively throughout various countries, depending on their reach versus our reach. And we're working very hard with them now to expand the product breadth that we're -- that we're providing to them, and also working with them on growing their presence in other regions of the world. So the dealers are about -- well that's about 1/4 of the business of Research, so it's a pretty big business, and we'd like to grow that further. That's one thing we're doing. We're also working very closely with our top accounts. I mean, it sounds maybe kind of silly. We always work with all of our accounts, but we're finding ways to work with them in a more meaningful and deeper way, working with them closer upfront in their R&D process and trying to bring them more solutions like some of them that I mentioned. And so those are some of the things that, I think -- we're trying to do to really to enhance the growth opportunities in that more mature market.

Amit Bhalla - Citigroup Inc, Research Division

Great. Well, with that, we're out of time. So I wanted to say thanks again to Jan and Quintin, and we look forward to talking again in the future.

Jan A. Bertsch

Thanks. Thank you, everyone.

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