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Executives

Joshua Young – Director, IR

Martin Madaus – Chairman, President and CEO

Charlie Wagner – Corporate VP and CFO

Analysts

Derik DeBruin – UBS

Tycho Peterson – JPMorgan

Isaac Ro – Leerink Swann

Marshall Urist – Morgan Stanley

Jon Groberg – Macquarie Capital

Dan Leonard – First Analysis

Eric [ph] – Thomas Weisel Partners

Millipore Corporation (MIL) Q3 2009 Earnings Call Transcript November 5, 2009 4:45 PM ET

Operator

Good afternoon. My name is Casey and I will your conference operator today. At this time, I would like to welcome everyone to the Millipore’s third quarter 2009 earnings conference call. All lines have been placed on mute to prevent any background noise. After the speakers’ remarks, there will be a question-and-answer session. (Operator instructions) Thank you. Mr. Young, you may begin your conference.

Joshua Young

Thank you very much, Casey. Good evening. I would like to welcome everyone to Millipore's third quarter 2009 earnings conference call. My name is Joshua Young and I am the Director of Investor Relations for Millipore. And joining me on today's call are Martin Madaus, Chairman, President and CEO; and Charlie Wagner, Chief Financial Officer.

In addition to the earnings release we issued earlier today, we will be referencing a slide presentation as part of today's call. This presentation can be viewed by clicking on the webcast link on the millipore.com homepage or by accessing Millipore's Investor Relations website. A PDF copy of the slides will be posted to our website after the call. We will also be highlighting non-GAAP information. A reconciliation of our GAAP financials to our non-GAAP financial measures is included in our earnings release and posted on our website.

Before we begin, I will make the usual Safe Harbor statement that during the course of this conference call, we will be making forward-looking statements regarding future events or the financial performance of the company that involve risks and uncertainties. The company's actual results may differ materially from the projections described in such statements. Factors that might cause such differences include but are not limited to those discussed in today's earnings release and in our Form 10-K, as well as other subsequent SEC filings.

Also note that the following information is related to current business conditions and our outlook as of today, November 5, 2009. Consistent with our prior practice, we do not intend to update our projections based on new information, future events or other reasons prior to the release of our fourth quarter financial results.

Now I would like to turn the call over to Martin Madaus.

Martin Madaus

Thanks, Joshua. Good evening, everybody. Thank you for joining us on the call today. Q3 was another very strong quarter of operational performance for Millipore. Many of the same trends that began early in the year continued in the third quarter. There are parts of our business that are performing extremely well, while there are few other areas that remained somewhat soft, but overall driving very strong growth in revenues and earnings and in cash flow.

The key contributors for this quarter’s great results are the following. First, our Bioprocess Division is sustaining its strong momentum and is generating very attractive growth. Just as we projected last year, the division’s performance has returned to tracking the strong fundamentals of the biotech industry and that we have seen also an additional benefit of an increase in vaccine productions.

Second, we saw an improvement in our Bioscience Division performance, but segment of the bioscience market remained soft. It’s right now a difficult environment to sell laboratory instrumentation and spending from large pharmaceutical customers remains weak. The good news is that we continue to grow faster than many of our peers, but the division is still well below the levels of growth we’ve seen over the past five years.

Third, we are capitalizing on the strength of our business to invest in our future growth. We continue to increase our R&D spending in the third quarter and we are improving our innovation capabilities throughout the company. Our higher growth and profitability gives us the opportunity now to invest while the general market is in a downturn. This investment will benefit our competitive position over time.

Finally, our cash flow performance continued to be outstanding. We generated approximately $112 million in free cash flow in the third quarter. And in the first nine months, we have generated $234 million of free cash flow already surpassing the cash flow that we generated all of last year. This exceptional performance is primarily the result of a substantial improvement in our working capital efficiency.

The programs we launched to improve our cash flow have been a resounding success, and we continued to use our cash to pay down our debt, which is increasing our flexibility to make strategic growth investments in the business.

So with that brief summary, let me move into some more specific comments about Q3. Third quarter revenue increased 4% to $412 million. If you exclude a 3% unfavorable effect from changes in foreign currency exchange rates, organic revenue growth in the quarter was 7%. From a divisional perspective, if you exclude the effects of changes in foreign exchange rates, the Bioprocess grew 8% organically while the Bioscience Division generated 4% organic growth.

On the bottom line, we reported $0.95 in non-GAAP earnings per share, which is about $0.02 higher than last year. We took advantage of the high levels of profitability we generated through the first six months of ’09 to make investments in our business during the second half of the year. This higher level of spending combined with a higher year-over-year tax rate lowered our earnings growth in Q3.

Year-to-date, our non-GAAP earnings per share growing at 13%, and we are in a position to generate attractive earnings growth for the full year. Finally, our free cash flow grew at a rapid rate of 74% compared to the third quarter of 2008.

So I’m quite pleased with all these results as we are on track to meet and exceed all of our financial targets in 2009 despite the general turmoil in the market and challenges. So let’s view now each of our two divisions in a bit more detail. I’ll start with the Bioprocess Division.

The Bioprocess Division started off being strong and its performance has remained strong throughout 2009. During Q3, we grew organically in all geographies and we saw strength across a number of different product lines. Bioprocess continues to benefit from the favorable trends we saw earlier this year. Our growth has still been driven by very good spending from our large biotech customers.

The biotech business is up in double digits in revenues, as many customers are increasing production to meet their solid underlying demand in the market. For this year, sales of our consumable products have more closely aligned with our customers manufacturing campaigns and what we experienced in 2008.

There are two other drivers of our biotech business worth noting. First, our vaccine business is up nicely on a year-over-year basis due to the increasing sales to manufacturers who ramp up production for the H1N1 flu virus. There are approximately 20 companies who worked to [ph] manufacture the vaccine worldwide. And many of these are our largest customers.

And as many of you know, our products are used widely through vaccine manufacturing process from separation to purifying the antigen, which is the key component of manufacturing that vaccine to quality control testing of the final vaccine before it is released into the market. So as a result, demand for sterile filtration, tangential flow filtration, disposable manufacturing and sterility testing have all seen a nice uptick in sales.

Many of these customers who are producing vaccine began to accelerate their production in July. So we saw the greater revenue impact in our vaccine business during Q3. And since many of these manufacturers are located in Europe, this has created the biggest positive benefit in Europe. We are not specifically breaking our revenues from a specific segment like vaccine production, but I can tell you that’s an important driver – it was an important driver in Q3 for our performance and will also be meaningful in Q4.

When you look forward, there is uncertainty about the future production levels of this specific vaccine for H1N1. So our best estimate at this time is that we would expect the H1N1 strain to be just included in the standard, seasonal flu vaccine in the future rather than having two separate vaccines that are manufactured this year. So, resulting from that is that it’s unlikely that we will have the same level of H1N1 vaccine production in 2010. There will be some.

Second important revenue trend, our biotech business comes from the strong growth we’ve seen in Singapore and China. We believe that much of the increased volume in the region is really incremental production to meet expanded market growth. Customers in these markets are expanding capacity and we are beginning to see some of the first plants come on line in the region. And in response to this expansion, we’ve also made a number of investments to support the rapid growth.

Our Bioprocess team just concluded a very successful tour of several countries, presenting best practice approach for biotech manufacturing, and there were standing-room-only crowds in each of the cities. I expect that Bioprocess growth in Singapore and in China, some other countries will continue to be very important part of our performance as we enter into 2010.

And interesting in multiple strength of the division was also what we called a classic pharma business, which is a little less than half the Bioprocess business. And while this business has been historically a little bit more sensitive and lower growing, it had shown great strength in the last quarter. And certain segments in that business, such as plasma market, are up 20%, which again contributes to our overall performance.

Now let’s talk about products for a little bit. Our downstream bioprocess business unit led the growth for the third quarter in a row. Here the products are chromatography, tangential flow filtration, clarification and biofiltration. All of these product lines, core product lines, performed very well. We also had very high growth of our disposable manufacturing product lines and we booked some new first orders for the revolutionary Mobius FlexReady systems.

We had also very good growth in disposable tubing and connector products, all performed well. And again, these products are in part also used by vaccine manufacturers to do final finish and fill. Process monitoring products are also very steady in the quarter, grew well, driven by onsite testing and disposable sampling that came from our NovAseptic acquisition. And this is in response to increased production levels.

So, to sum up the Q3 performance in Bioprocess Division, continued to deliver strong performance, is on track to have really an excellent year. With the first nine months of 2009, we’ve generated 9% organic revenue growth, which is exceptional performance in the current environment. And this performance just reinforces my view, and our business is less affected by downturns in the economic cycle.

If we look forward, we see the same trends as we have in Q3. Large biotech accounts increase the spending, higher levels of vaccine production and good continued growth in China, Singapore that should continue through the fourth quarter. I think I commented last year that I couldn’t wait for the day when I could once again say that the division is back on track, and now I can certainly say that they have come.

Now let’s turn to the Bioscience Division. We generated 4% organic revenue growth in the division during Q3 and have grown the business 3% organically through the first nine months of the year, which I will call solid growth in a challenging business environment. Our organic growth in Q3 is a nice increase from the flat performance we saw in Q2. So we are clearly seeing modest levels of improvement. As a result, I would characterize Bioscience business performance right now as stabilizing.

The market isn’t much better, but it’s also not worse. The trends and customer buying patterns are very comparable to what we saw when we last spoke in August. On the positive side, we are growing faster than the market and faster than many of our peers. We have a very good consumable product portfolio, and that continues to be resilient and is growing nicely, particularly in the academic accounts where we are seeing overall activity.

We also are seeing modestly better performance in Asia. So for example, the Bioscience business in Japan was seeing really steep declines early in the year and that has clearly stabilized, and also that’s an improvement trend. But overall, Bioscience business is still tracking well below its long-term growth rate for two main reasons. First, we continued to see weakness at larger pharma companies. Pharmaceutical customers are rationalizing network pipelines, recessing their research priorities, and they focus very much on integrating acquisitions.

Second, it’s a more difficult environment to sell lab instrumentation. We see a continuation of the trend we had in Q2. But even though these are some challenges, we still are able to grow (inaudible) based business. Geographically, Bioscience Division generated year-over-year organic growth in all geographies. Additionally, each geographic region reported high organic growth rates than what we experienced in Q2 2009.

Products, our life science business unit continued to be the best performer in the Bioscience portfolio. The market for life science research consumables remained steady. And as I mentioned earlier, our academic customers remain healthy and continue to drive very good levels of research activity. The life science business unit in Bioscience is really the primary beneficiary of the strength since it has really the most exposure to that market.

The business unit grew faster than the overall division, as consumable products in really hard research areas such as neuroscience, stem cell research, metabolic research continue to be strong. And this strength has helped particularly our multiplex immunoassay kits, which is still one of the fastest growing product lines in the Millipore portfolio.

Also, our most recent acquisition, our flow cytometry instrumentation and reagents continue to drive attractive growth and have a strong uptick by the academic accounts, and that in turn helps offset somewhat weaker sales of these products into pharmaceutical customers. We also have some success with our diagnostic test kits that detect a flu and that has also resulted in becoming a nice addition to our growth.

We have – many of you received questions about the impact of the US federal stimulus package on our business. So we speak to that. We have seen a lot of grant writing activity, particularly related to Guava flow cytometry instruments. But we have not seen a major impact, a major noticeable impact from the stimulus package.

We are a consumables driven company and we will not see the impact from additional spending until the grant money is actually released and researchers are actually in the labs conducting experiments. So we don’t expect this to happen until the second half of 2010, and the impact on our business will likely be modest since about 70% of the Bioscience Division revenues are generated outside of the US.

Moving on to lab water, our lab water business continued to grow in Q3, delivering similar performance to what we experienced in the last quarter. We generated solid sales growth in services and consumables, which was offset by flat performance in lab water instrumentation and accessories. We expect to generate low-single digit growth in lab water during 2009, and (inaudible) the business will ultimately benefit as we see a cover in capital spending and an improved environment for selling laboratory instrumentation.

In the meantime, with 60% of the business derived from consumer growth and services, we continue to grow the business performing better than most of our instrumentation-driven businesses – most other instrumentation-driven businesses.

Moving on drug discovery, our smallest business unit, this business and service business continues to be adversely affected by cancellation and delays of services, contracts that we have with large pharmaceutical customers. These contracts are mainly focused on small molecules of discovery services and almost all business is coming from the pharmaceutical industry.

And as I mentioned earlier, continued cutbacks by these customers, most pronounced and bright spot in drug discovery continues to be our rapid growth in the biopharmaceutical service business. So this is one marked difference as an increased number of biologics enter the pipeline. Companies are leveraging our immunoassay multiplex expertise to help them to develop drugs and bring them to market a little bit faster.

During the quarter, we completed the acquisition of BioAnaLab that’s a UK-based company that provides a broad range of services to assist companies with value-added advancing protein-based drugs. Strategically, this transaction will help us to expand our offering in Europe and to better serve our multinational customer base. To me, this bolt-on acquisition is a great example how we are executing our acquisition strategy and expanding to really rapidly growing markets and leverage our global brand presence.

So to sum up our Bioscience performance in Q3, the division is proving to be resilient and generating above market growth in a difficult market environment. Pharma spending remains sluggish and it’s difficult to sell out instrumentation right now. But the division’s performance improved modestly from the last quarter and is growing faster than most peers in 2009.

Before I turn it over to Charlie who will go through the financials in more detail, I want to leave you with some thoughts about 2009. 2009 will not only be a year of very attractive financial performance from Millipore, but it’s also a year marked by targeted investments that will help us to underpin the organic revenue growth in the future.

Clearly, one of the advantages of growing at a time when many of our competitors are seeing declining revenues is that we have greater flexibility to make investments to drive future growth. This higher level of investment is reflected in the growth of R&D spending this quarter, which was up 15% over last year. Innovation that at the heart of our company is critical to the long-term success of Millipore. Our customers are driven by innovation and so are we.

Our ability to anticipate customer needs and deliver high value differentiated product, the single most important factor in creating long-term value for customers and shareholders. We are investing in innovation, the combination of internal R&D, third-party collaborations and acquisitions. We are focusing on internal investments on programs that will expand our presence in very dynamic market segments such as disposable and manufacturing, rapid testing in real-time process monitoring, stem cell research, virus filtration and flow cytometry and many more in the future.

Our approach is to leverage both our own capabilities and technologies and capabilities provided by the partners, third-party companies to develop what we call differentiated solutions. Our pipeline of promising R&D projects is the strongest I’ve seen in my five years at Millipore. It has grown broader and more innovative every year.

We are leading in many fields, and because we have scientists and marketing experts that understand how customers work, we can apply this knowledge into products and services solutions like very few companies can. And that is the promise of the Millipore brand. That’s what we call advancing life science together with our customers.

So with that, I’ll turn it over to Charlie.

Charlie Wagner

Thanks, Martin. I’ll now provide some additional details on Q3 and year-to-date results and our full year 2009 outlook. I’ll begin with a discussion of our GAAP operating results in the third quarter. Total revenues increased 4% from last year’s third quarter. Excluding a 3% unfavorable impact from changes in foreign exchange rates, organic revenue growth was 7% in the quarter. Revenues from our BioAnaLab acquisition were not material in the quarter, and Guava-related revenues are now part of our organic growth since we had Guava-related revenues in Q3 of 2008.

Our gross profit margin increased 130 basis points on a year-over-year basis from an expense standpoint. SG&A costs increased 6% on a year-over-year basis, while our R&D spending was up 15%. Our GAAP operating margin increased slightly to 15.3% from 15.1% in Q3 2009, and earnings per share were $0.71 compared to $0.68 in Q3 2008.

From a geographic perspective and excluding the effects of foreign currency translation, our revenue growth was 6% in both the Americas and Europe while our business in Asia grew 10%. Both of our divisions saw improved performance in Europe during the quarter, with our Bioprocess Division benefiting from higher levels of vaccine production in the region. Our growth in Asia continues to be driven by China and Singapore.

We are seeing good growth from both divisions in China, while our growth in Singapore is more specific to our Bioprocess Division and expanded biotech manufacturing in the region. Asia also benefited from better performance in Japan, particularly in our Bioscience business where we had seen double-digit declines earlier in the year.

On the next slide, we show our Q3 2009 non-GAAP operating results. And as always, I encourage you to review the non-GAAP reconciliation table in the press release for the detail of our adjustments. Last quarter I talked about how we expected to leverage our strong first half profitability to invest in our business during the second half of the year. Our Q3 non-GAAP performance reflects higher levels of spending than our original plan for the year, particularly in R&D.

Our Q3 2009 non-GAAP gross margin of 55.3% was an increase of 30 basis points on a year-over-year comparison due to a positive impact from changes in foreign currency and higher pricing. These benefits were somewhat offset by a negative product mix and higher incentive compensation costs. And despite higher sales volumes, manufacturing levels were roughly the same as last year, as we decreased inventory during the period.

From a mix perspective, the negative product mix was primarily related to our Bioprocess Division, as the higher percentage of our downstream processing revenues came from lower margin products such as chromatography, media and systems hardware. We also saw lower year-over-year revenues from some of our high margin upstream bioprocessing products.

Non-GAAP SG&A expenses represented 28.8% of sales compared to 28.6% in Q3 2008, an increase of 20 basis points. Increases in incentive compensation costs were offset by the favorable effects of foreign currency translation. R&D spending as a percent of revenue increased 70 basis points from the third quarter of last year, representing 7.1% of sales.

Last quarter I told you that our R&D spending would be up by at least $8 million in the second half of 2009 compared to the second half of 2008. We are on pace to meet that level of investment with non-GAAP R&D costs up approximately $4 million or 16% on a year-over-year basis.

We made a number of investments to advance our innovation strategy in both divisions. The increase reflects higher headcount, incentive compensation, project related spending, and payments to third-party technology partners. Non-GAAP operating margin in Q3 was 19.5%, a decrease of 60 basis points from the previous year, reflecting the higher level of investment in the business.

Our non-GAAP tax rate in Q3 was 22.8%, a 330 basis point increase from the previous year due to a higher proportion pretax income coming from higher tax jurisdictions. On a sequential basis, our Q3 tax rate was lower due primarily to the reversal of tax reserves when the statute of limitations expired during the quarter.

Our net interest expense was $11 million, approximately $3 million lower than last year, due primarily to lower debt balances. And we’ve kept our promise to substantially reduce our debt balances over the last several years. At the end of Q3, we have effectively paid off our primary revolving credit facility and we had $776 million of net debt.

We reported $0.95 in non-GAAP EPS, which was $0.02 higher than Q3 2008. Changes in foreign exchange rate added approximately $0.08 in EPS compared to the third quarter of 2008.

Moving on to the GAAP results for the first nine months of the year, total revenues increased 2% compared to the first nine months of 2008. Excluding a 6% unfavorable impact from changes in foreign exchange rates and a 1% contribution from the Guava acquisition, revenues grew 7% organically through the first nine months of the year.

Our GAAP operating margin increased to 16.6% from 15.5%, and our earnings per share in the first nine months of 2009 were $2.38 compared to $1.91 in the first nine months of 2008, growth of 24%. Our GAAP pretax income in the first nine months of 2009 benefited from a $9 million gain on our acquisition of Guava Technologies and a $10 million year-over-year decrease in net interest expense due to lower debt balances and slightly improved interest rates.

On the next slide, I show our performance by geography for the first nine months of the year. Excluding changes in foreign exchange rates, we have grown revenues in the Americas by 10% due to the strong performance of our Bioprocess Division. In Europe, we have grown the business 5% and it’s well balanced between the two divisions. And finally, revenues in Asia have grown by 6%, which is a bit lower than we would like in the region, but it reflects the weak performance of Japan in the first part of this year.

On the next slide, we show our nine-month non-GAAP operating results. Again I’d encourage you review the non-GAAP reconciliation table in the press release for the detail of the adjustments. Through the first nine months of the year, we are generating attractive margin expansion. This expansion came from some of the operational improvements and the positive impact of changes in foreign exchange rates, which were offset by higher levels of investment in the business.

Our non-GAAP gross margin of the first nine months of 2009 of 56.5% was an increase of 140 basis points due to a positive foreign currency rate impact, pricing increases and operational improvements. These effects were offset by a negative product mix, higher incentive compensation costs, and lower manufacturing volumes and inventory write-downs that were partially the result of our working capital initiatives.

SG&A expenses represented 28.5% of sales compared to 28.7% in the first nine months of 2008, a decrease of 20 basis points. The effect of higher incentive compensation expenses was offset by the favorable effects of foreign currency translation. R&D spending increased 50 basis points to 6.8% of sales from the first nine months of 2008.

Non-GAAP operating margin of 21.2% for the first nine months of 2009 was 110 basis point improvement from the previous year. We are on track to have a very strong year of margin expansion and we are showing strong leverage in the business. Our non-GAAP tax rate for the first nine months was approximately 25%. Our non-GAAP net interest expense was $32 million, which is approximately $11 million lower than last year due to lower debt balances and improved rates.

For the first nine months of 2009, we reported $3 in non-GAAP EPS, an increase of 13% over the first nine months of 2008. Changes in foreign exchange rates had no impact on our earnings per share on a year-to-date basis.

Now turning to our balance sheet, we reduced net working capital by over $50 million in the third quarter and improved all three drivers of our cash conversion cycle. Compared with last year’s third quarter, we achieved a five-day improvement in days sales outstanding to 66 days and 8-day improvement in inventory days to 130, and a 3-day improvement in days payable outstanding to 41 days. Our improvement in DSO was the result of process improvements and customer collections and better enforcement of customer payment terms.

Turning to inventory, we improved the way we manage our inventory by executing programs to reduce our lead-times and cycle times and shrink our manufacturing lot sizes and safety stock. Importantly, we’ve done this while improving our on-time customer shipment rate at the same time. We are also rationalizing select products as part of our efforts to improve our product life cycle management.

Finally, our cash flow benefited from negotiating better terms with our suppliers and from the timing of certain payments. Overall, the net result of these improvements is that we have improved our cash conversion cycle by 16 days compared to the third quarter of 2008 and by 10 days compared to the second quarter of 2009.

Continuing down the cash flow statement. Cash flow from operations during Q3 was $130 million. Factoring in CapEx spending of $18 million, we generated $112 million of free cash flow in the quarter. Our cash flow performance reflected a significant contribution from working capital reductions, primarily as a result of implementing our working capital program.

Through the first nine months of 2009, cash flow from operations totaled $287 million. We’ve incurred $53 million in CapEx, resulting in $234 million of free cash flow for the first nine months of the year. The key drivers of the year-to-date cash flow performance are strong profitability and the working capital improvements I mentioned earlier.

When I began my tenure as CFO in August 2007, I shared with you that improving our cash flow performance was one of my highest priorities. And I’m pleased to report that the initiatives we’ve put in place are driving tremendous value and results for the company. We are on pace to generate record level of free cash flow for the company in 2009. In addition to substantial improvement in our balance sheet metrics, we have also significantly lowered the company’s CapEx spending as a percentage of our sales.

I show on this slide how substantially our free cash flow generation has improved as a result of the program from our working capital initiative. We have used most of this cash flow to pay down our primary revolving credit facility, which now has only $14 million balance as of the end of the quarter. While we have improved tremendously, we still have more room to improve in the future, especially as we target reducing our inventory days of supply to below 120 days.

Now let me turn to our guidance for the remainder of the year. We are reiterating our revenue and earnings guidance for 2009. We expect that we will report full year 2009 revenue growth between 2% and 3%, excluding a 3% unfavorable impact from changes in foreign currency, we expect to generate between 5% and 6% revenue growth, which includes one percentage point of growth from acquisitions.

We expect to generate non-GAAP earnings per share of approximately $3.85 to $3.95 per share. This EPS estimate is based on a projected non-GAAP tax rate for the full year of 25% to 26%. We expect that our fourth quarter tax rate will be as much as 10 percentage points higher than the fourth quarter of 2008, as several discrete items that affected Q4 2008 will not repeat this year.

This earnings guidance also assumes the changes in foreign exchange rates, will add about $0.07 to earnings per share for the full year. I mentioned on previous calls that the anomaly of our fiscal calendar will impact the comparability of our financial results during some of the quarters of 2009. During Q1, we benefited from having ForEx for selling days. In the fourth quarter, we will have five fewer selling days, resulting in one last selling day for the full year. I mention this to you again since you need to take these dynamics into account when making year-over-year or sequential comparisons of the company’s performance.

Now turning to cash flow guidance, we are increasing our guidance for free cash flow in 2009 and expect free cash flow to total approximately $265 million. As a reminder, we define free cash flow as cash flow from operations less capital expenditures.

So to summarize, the key takeaways from the third quarter we delivered another strong quarter of financial results, we are making important investments for future growth, and we are generating record levels of free cash flow.

With that, let me turn it over to Joshua.

Joshua Young

Thank you. Casey, if you could please assemble the Q&A roster.

Question-and-Answer Session

Operator

Yes, sir. (Operator instructions) And our first question will come from Derik DeBruin.

Derik DeBruin – UBS

Hi, good afternoon.

Martin Madaus

Good afternoon.

Charlie Wagner

Hi, Derik.

Derik DeBruin – UBS

Hi. So, just looking at the – Charlie, looking at the gross margin for the quarter, I mean, you cited a bunch of reasons why it was down. I guess how do we look at the gross margin number for the fourth quarter, same type of mix issues (inaudible) impacting there? And I guess what do you see when you look to next year just given all the current fluctuations and just do you still expect to see gross margin expansion in 2010?

Charlie Wagner

So Derik, you’re focused on sequential Q2 versus Q3?

Derik DeBruin – UBS

Actually sequential Q3 and just kind of what you think about in Q4 if you’re going to expect to see the same type of mix issues in Q4.

Charlie Wagner

Yes. Gross margin, obviously, it’s the mosaic of driver. So, you really have to focus on the few things to understand what happened there. Certainly mix had an impact in the quarter. And also as I mentioned, we took inventory levels down and also had some inventory write-offs associated with product rationalization. So those are some of the dynamics of the current quarter. Some of that does continue into the fourth quarter as well. I think the best way to think about it is that I’ve said I think a few times it’s very hard to look at gross margin in an individual quarter and draw too many conclusions because of the way the cost flow through the P&L – So if you at the year-to-date, the improvement of $140 basis points, good chuck of that is from currency, some of it is from operating improvements, and we would look at our ability to improve margins on a constant currency basis. That should continue into 2010 as well.

Derik DeBruin – UBS

Okay. I guess let’s say, just looking at the historicals, I mean, typically Q4 tends to be sequentially down from Q3. And I just was wondering if that’s the same trend that’s going to repeat this year? That’s where I was going to go with that.

Charlie Wagner

Got it.

Derik DeBruin – UBS

Okay. And I guess how – what are you expecting for the top line impact on FX in Q4, and what are your first takes on looking at 2010 for the FX impact?

Charlie Wagner

No point of view on 2010 yet, Derik. And Q4, I don’t have that handy. We can do that offline.

Derik DeBruin – UBS

No problem. And I guess, Martin, you noted some expansion in Asia in the Bioprocess business. I guess what products are they making?

Martin Madaus

Well, it’s across the board. Our core filtration products will be required more because it’s not only the expansion of volume, it’s also the increase and quality requirements that is happening, particularly in China and then we have a very strong growth in our monoclonal production in Singapore with the large multinational organization. And our investment is around adding – technical people can support customer and we’re opening another lab in Singapore. It’s a very strong trend and it will continue. So it’s a good fundamental trend.

Derik DeBruin – UBS

Great. And then just one final question, Charlie you said you had $155 million in debt in the quarter?

Charlie Wagner

That’s right.

Derik DeBruin – UBS

Okay. And what’s the interest rate on that?

Charlie Wagner

It’s all fixed rates. It’s in the neighborhood of five basically.

Derik DeBruin – UBS

Great. That’s what I thought. Thank you very much.

Operator

Our next question will come from Tycho Peterson with JPMorgan.

Tycho Peterson – JPMorgan

Hey, good afternoon.

Martin Madaus

Good afternoon.

Tycho Peterson – JPMorgan

Maybe just going off Derik’s question earlier about Asia, can you talk a little bit about from an infrastructure perspective how you feel? And you talked a lot about stepping up R&D investments. Can you talk a little bit about sales and where you may need to add and how we should think about that trending?

Martin Madaus

We have – the countries in Asia that are most relevant to our business are Singapore right now and China and Japan basically because our largest Asian business recovering. But in terms of investments, we are adding sales and technical people, particularly in China. We’ve done that in Singapore during the end of last year and early this year. And infrastructure are – mainly investments into more laboratory capabilities that help customers to do certain validation procedures and scale-up capabilities. So it’s a mixture of training people, adding new technical people and transferring some of our knowledge down there.

Tycho Peterson – JPMorgan

Okay. That’s helpful. And in terms of some of the product launches, you talked I think in your comments about Mobius Flex, can you talk a little bit about the early demand and maybe give us some sense as to how large do you think that opportunity might be? I guess you will have five modules out by early next year?

Charlie Wagner

We have four out to date, and the launch is good so far. The selling cycle in biotech is long gone, but it’s a first generation of products that will be followed up by many other versions. Our vision is to basically simplify the entire downstream production process. And this is the first series of a number of products. The feedback is very good. We see it in a number of trials that we see with these products. And as I said, we have received a number of orders already. And so we have booked some sales, which is pretty good after a few months in this industry. So that’s a key product. I should also say that our more classical products, very strong, particularly when you talk about the virus filtration products, is contributing a lot to our new product growth, our clarification products. And we have seen also some new wins in chromatography, which we have worked on for long time. So we are also getting some additional customers in chromatography.

Tycho Peterson – JPMorgan

Okay. And then just one last one on drug discovery, you talked about some of the challenges with the pharma M&A. Is your sense that that is better next year or how disruptive do you think –?

Charlie Wagner

Well, I sure hope it is better next year. Pharma companies are in the business of discovering drugs, and they will come back at one point. What’s difficult to call is when this will happen. So at this point, we have experienced a lot of cancellations this year. But at the same time, we are also seeing a lot of interests. So there is a lot of quoting going on, a lot of potential contracts, but that business is not yet in. So I think it’s going to be better next year, but I cannot tell when.

Tycho Peterson – JPMorgan

Okay. Thank you very much.

Operator

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

Isaac Ro – Leerink Swann

Hi, good afternoon. Thank you for taking the questions.

Martin Madaus

Sure.

Charlie Wagner

Hi, Isaac.

Isaac Ro – Leerink Swann

Hey, how are you? First item would be on just sort of thinking about some of the new manufacturing facilities that we’ve seen in biotech in the last few weeks and months, both the monoclonals and vaccines. I’m wondering if – when these types of events happen, if there are any sort of meaningful startup costs or initial stocking events for your types of products that benefit your business? And if so, does that create maybe a tough comp in 2010 and the back half or the middle part of the year?

Martin Madaus

This is a good question, and we are watching stocking levels like hawks based on our experience with that. We don’t see any increase in inventories at the major customers. I think that would lead us to believe this is significant and could be a challenge next year. I mentioned earlier that just the volume of vaccine production is much higher than usual, so some of that will not repeat. But at the same time, we have some template wins and we have some new molecules that are being produced. So I think overall, our mix of businesses between monoclonals, classic pharma, vaccine and plasma is very healthy. So we don’t think it would be a challenge next year.

Isaac Ro – Leerink Swann

Great. And then just secondly, maybe a slightly different way to ask a similar question. You guys are obviously doing a good job controlling your working capital items. And I’m wondering – can you speak to the type of changes that you see either systemically or at least temporarily with both biotech and pharma customers on their own working capital items and to the extent that that might impact your own visibility?

Martin Madaus

There is more openness with large companies to collaborate as a strategic supplier. So, sharing information on demand. That is definitely better, and it’s happening – starting to happen on a global basis. As you know, we are a strategic supplier to all these customers, but we haven’t seen any different behavior right now. The only major shift, I would say, in the pharmaceutical and biotech industry is that the formally classical pharma companies are all basically investing through acquisitions or through R&D – their own R&D into biotech, which is a good thing. So whether it’s Eli Lilly or Merck or Pfizer, everyone is looking at biotech. And we see that in the drug pipeline and drug discovery, and that’s one reason why our drug discovery business that does exclusively biotech is growing very well. So there is a shift going on right now into biotech, which is very good for us.

Isaac Ro – Leerink Swann

Great. And then last question would be just sort of putting the vaccine item that you mentioned aside for a minute and looking at the totality of the late state pipeline for biotech, how would you say you feel about – we see some good data out of various drugs of importance in recent months. Would you say that you are probably more comfortable with the total pipeline now than you were maybe six months ago?

Martin Madaus

Yes. I think there is a marked improvement. We track, as you know, all the molecules, and that’s why we are fairly comfortable and confident about the next wave of molecules, and our contribution and resulting growth from that.

Isaac Ro – Leerink Swann

Great. Thank you very much.

Operator

(Operator instructions) And our next question will come from Marshall Urist with Morgan Stanley.

Marshall Urist – Morgan Stanley

Hey, guys, good evening.

Martin Madaus

Good evening.

Marshall Urist – Morgan Stanley

One question on SG&A levels. Obviously your business seems like going one that would have a pretty good amount of SG&A leverage year-on-year. So I’m wondering if you could just give us a sense of where the infrastructure is and how you see that playing out over the next few years. And can we look (inaudible) that piece of the income statement? Thanks.

Martin Madaus

We will – we see modest leverage from SG&A, nothing major. But we see continued modest leverage from SG&A like we’ve seen in the past. And as we alluded to earlier, we will take some of that and invest into R&D at a little bit faster rate than SG&A.

Joshua Young

Marshall, I want to have to ask you to mute your phone after this next question if you have any other remaining questions. Okay. Operator, if you could go to the next question in the queue?

Operator

Our next question will come from Jon Groberg with Macquarie Capital.

Jon Groberg – Macquarie Capital

Hi, good evening. Thanks for taking the call.

Martin Madaus

Good evening.

Jon Groberg – Macquarie Capital

Martin, first from a couple of – maybe just kind of along the lines what you are saying in Asia, but I’ve heard from some players out there that some people are looking at being able to manufacture vaccines and biologics is almost a matter of national defense. And so you’re going to see some of these countries like – particularly the big ones, if you think about the BRICK countries, but a lot of other countries actually, build out so they have the capabilities. Is that something you are seeing at all or hearing?

Martin Madaus

Yes, that’s correct. In fact, when you look at a very large country like China, their population versus their vaccine manufacturing capability is way, way undersized. And as we see more – more focus now in these countries and also more money going into health care, developing vaccines is always a matter of public health and a priority. So I would very much expect as the technology becomes more available and skills are being built that these countries will absolutely invest into vaccines. I don’t think they want to buy them from Western companies all the time.

Jon Groberg – Macquarie Capital

Would you have any – is this something you think as imminent? Is this five years out or –?

Martin Madaus

That – it takes a few years to build vaccine capabilities. That’s for sure. And it will be helped also by multinationals who are making investments at the same time. But I think it’s vaccine, but it’s also I think for us, in one-year term, is the pharma. The injectable pharmaceuticals are very strong in China. So from a business standpoint, that’s what we are focusing on near-term and then it will be followed by probably vaccine.

Jon Groberg – Macquarie Capital

Okay. And then just another kind of broader question on Bioprocess. If you look at kind of the first nine months and you kind of average over 2008 and 2009, we obviously went through some of the inventory issues in 2008, but it’s about 2% growth. It goes back a little bit to the inventory question. But would you expect as you move out into 2010, ’11, to be able to continue at this 9% growth or do you think that this becomes more kind of maybe a mid-single digit growth business, as you look at the next year trends?

Martin Madaus

That’s a good question. And of course, I would hate to have it in 2008, because we see it more as a – a very low – I mean, definitely below average year. And there were some special items going on there. 9% is probably too high, but I think you’re right about the mid-single digit is on a business of about $900 million would be a very good rate for us.

Jon Groberg – Macquarie Capital

Okay. And then last question, Charlie, can you just describe – I know on the Guava, because you were selling in the second half of last year, you now are including in your organic growth. But how is it accounted for in 2008? Did you account the whole sale, just the distributor margin, or can you maybe just describe how that works and just so we can understand kind of a year-over-year basis?

Charlie Wagner

Sure, yes. We started selling it in Q3 of 2008, although I think there were almost no revenues in Q3. They were very modest. So it really only affected Q4. And it was the full revenue on the system sale from what we had in the partnership at that point, which was the ability to sell into academic accounts. When we completed the acquisition, we gained obviously the ability to sell into all accounts. And so the way we looked at it this year was rather than trying to track the revenue, go back to the customer level and segment out which came from academic and which came from pharma and other accounts to do the organic/inorganic calculation that way. We just simply took all the first half revenue this year and excluded it from the organic growth rate, and we will take all the second half revenue this year and include it in the organic revenue growth rate. It’s really unique to this transaction. We wouldn’t normally do that, but it’s because of the partnership set up from last year.

Operator

Our next question will come from Dan Leonard with First Analysis.

Dan Leonard – First Analysis

Thank you. You mentioned that you are making a lot of investments in the back half of the year. I’m curious in your investments in the Bioscience business, are you investing more in products that would be used in an academic environment as opposed to pharma? Or is there no discernible customer mix?

Martin Madaus

The investments are in both divisions, I would say. And in the Bioscience Division, say, you’re correct. It’s a higher investment of products going into products that will be used predominantly by researchers in academic settings. It could also be used in pharma, but we have a big focus on that. I think we are also investing into our lab water new product offering, which go into a variety of settings, including research but not exclusively. It goes very broad. And then on the Bioprocess side, all the products that we’re developing, I mean, predominantly go into biopharmaceutical right now. And that’s also a major push.

Dan Leonard – First Analysis

Okay. I guess what I was trying to get at is your investment to bioscience. Is there any – maybe more of a preference to be in academic and in pharma, or is that just what you see, maybe the biggest opportunity for your skill set?

Martin Madaus

For more the latter, more the biggest opportunity and skill set. But we have invested into drug discovery for biotech this quarter by making this bolt-on acquisition. So we do believe that pharma will come back and will be a good market over time.

Dan Leonard – First Analysis

Okay. And then a question for Charlie on the working capital. Charlie, the improvement in the quarter really seems to be – the biggest driver seems to be coming from the large increase in accruals. Is that something I should assume reverses in the next question?

Charlie Wagner

Yes, that’s definitely a part of the story. Q3 was very strong overall driven by profits and improvements and receivables and inventory. But there were also some timing differences, things like pension payments and tax payments and so on that were very positive in the third quarter. They reversed in the fourth quarter, absolutely.

Dan Leonard – First Analysis

Yes. And then finally for BioAnaLab, should we expect meaningful sales from that going forward or now?

Charlie Wagner

Yes, absolutely. I mean, we didn’t have it for much of the quarter, and we are going through the integration process right now. It will be meaningful in 2010.

Dan Leonard – First Analysis

What’s the annual run rate?

Charlie Wagner

We’re not breaking that out right now.

Dan Leonard – First Analysis

Okay. Thank you.

Operator

(Operator instructions) And our next question will come from Peter Lawson with Thomas Weisel Partners.

Eric – Thomas Weisel Partners

It’s actually Eric [ph] filling in for Peter. I was wondering if you could maybe talk about that R&D, increasing investments and how you see it going forward. Is it still ramping up or is it hitting a steady growth rate or a plateau level?

Martin Madaus

It depends a bit on the projects that we need to fund. So we can – as I mentioned, we can increase R&D expenditures because we have the capability today financially. I would say, more importantly, we have really great projects that we would call breakthrough innovation projects that we can invest into. And I will always try to find a way to fund these projects if at all possible because I really believe that drives our business. So I don’t want to say that R&D will grow at 15%. That’s obviously a very high rate. It’s 9% year-to-date. But we have – let’s say, when you benchmark us against other companies, we have still some room to grow our R&D versus sales ratio. So it’s more driven by the opportunities we see than just a strict financial ratio. Having said that, it’s all within the means of what we will deliver in terms of earnings growth and cash flow.

Eric – Thomas Weisel Partners

Okay. And then on your diagnostics business, can you maybe talk a little bit about the strategy you have for that overall? I mean, is that something that you want to expand as you go or is it just something that’s a nice business to have and you’re kind of happy with where it is?

Martin Madaus

Yes, it’s more the latter. It’s a nice business we have. We have good success with that product line, but it’s not part of our overall strategic thrust at this time.

Eric – Thomas Weisel Partners

Okay. And then just lastly, regarding the Asian build-out that you are kind of involved with, is that helping lab water in any way? I know you said that the instrumentation for lab water is kind of down in, say, the US and Europe maybe. But, is the Asian build-out kind of helping that growth out a little?

Martin Madaus

Yes, it does. It has always been a very strong part of the lab water business. Today it’s already – Asia is (inaudible) much bigger than for the other business. And it’s just a much better market growth and that growth is driven by lab expansions that are happening in those countries and we benefit from that. So we remain very important for lab water, and we are very active in that market. So particularly, China is a very big market for our lab water business.

Eric – Thomas Weisel Partners

Great, thanks.

Operator

Ladies and gentlemen, that’s all the time we have allotted for today’s call. I will now turn the call back over to Mr. Martin Madaus for closing remarks.

Martin Madaus

So, thank you for joining us this evening. I’m pleased that once again we are able to report very positive news to our investors. We will be attending two investor conferences during the fourth quarter. Hope that you will have a chance to interact with many of us at those venues. We are presenting at the CSFB Healthcare Conference in Phoenix, Arizona, that is on November 11th, and at the Deutsche Conference in Boston on December 10th. If you’re interested in meeting with us, please contact Joshua Young. Thank you. Good night. Thank you for your attention. Have a good evening.

Operator

Ladies and gentlemen, this does conclude today’s conference call. Thank you for your participation. You may now disconnect.

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