Sigma-Aldrich Management Discusses Q1 2014 Results - Earnings Call Transcript

Sigma-Aldrich (NASDAQ:SIAL)

Q1 2014 Earnings Call

April 24, 2014 11:00 am ET

Executives

Quintin J. Lai - Vice President of Investor Relations

Rakesh Sachdev - Chief Executive Officer, President and Director

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

Analysts

Peter Lawson - Mizuho Securities USA Inc., Research Division

S. Brandon Couillard - Jefferies LLC, Research Division

Timothy C. Evans - Wells Fargo Securities, LLC, Research Division

Paul Richard Knight - Janney Montgomery Scott LLC, Research Division

Michael J. Sison - KeyBanc Capital Markets Inc., Research Division

Isaac Ro - Goldman Sachs Group Inc., Research Division

Tycho W. Peterson - JP Morgan Chase & Co, Research Division

Jonathan P. Groberg - Macquarie Research

Daniel L. Leonard - Leerink Swann LLC, Research Division

John Roberts - UBS Investment Bank, Research Division

Steve Willoughby - Cleveland Research Company

Derik De Bruin - BofA Merrill Lynch, Research Division

Jeffrey T. Elliott - Robert W. Baird & Co. Incorporated, Research Division

Dmitry Silversteyn - Longbow Research LLC

Operator

Good day, ladies and gentlemen, and welcome to the Sigma-Aldrich Corporation Q1 2014 Earnings Conference Call. [Operator Instructions] As a reminder, this conference call is being recorded.

I would now like to introduce your host for today's conference, Mr. Quintin Lai. Sir, you may begin.

Quintin J. Lai

Thank you, Crystal. Good morning. Thank you to everyone participating on this call and the webcast. Presenting for the company, we have Rakesh Sachdev, President and Chief Executive Officer; and Jan Bertsch, Executive Vice President and Chief Financial Officer.

Rakesh will start with the review of our first quarter 2014 performance and highlights. Jan will then provide a review of our financial performance. Following Jan's remarks, we'll open up the call for your questions and comments. We will be using a slide presentation as part of today's call. That presentation can be viewed on our Investor Relations website at www.sigmaaldrich.com.

Before beginning the review, I want to remind you that today's comments include forward-looking statements about future activities and our expectations for sales, earnings, cash flow 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 latest annual report on Form 10-K and quarterly report on Form 10-Q and in the cautionary statements included in today's earnings release and slide presentation. We have no plans to update these forward-looking statements after this call. Also in today's conference call, we are providing information on non-GAAP financial measures. Management uses these measures and its internal analysis of results and believes this information may be informative to investors as well. For a reconciliation of non-GAAP measures, please see today's earnings release in the Appendix in the slide presentation.

With that, I'll turn the call over to Rakesh.

Rakesh Sachdev

Thanks, Quintin, and greetings to all those who are listening in to the call this morning. I'm pleased to report that we achieved a new quarterly record for sales of $689 million with solid 3% organic sales growth coming from all business units and geographies.

We also expanded our adjusted operating income margin by 80 basis points from a year ago, which contributed to a record adjusted quarterly EPS of $1.06. We leveraged good top line growth with strong efficiency gains from our global supply chain initiatives, which in turn, drove EPS results above our March guidance of $1.03. We mentioned our focus on margin expansion at our March Analyst Day. And I'm pleased to see the progress we have made on this front. And we continued our strong performance and free cash flow generating $143 million in the first quarter or an increase of 11% from last year.

Since realigning the company, our customer focus strategy has been gaining momentum with our key customers. And this quarter, we were honored by 3 of our largest customers with their respective Supplier of the Year awards.

And now turning to business unit highlights for the quarter. As we had indicated at the Analyst Day, our organic sales growth in our Research business in the first quarter was impacted by several severe weather days in the U.S. We estimate that this reduced overall Research business unit sales by at least 1%, as many of our academic and pharma customers stayed at home during those days. Additionally, U.S. academic sales continued to be impacted by weak funding. While recent headlines talk about stronger NIH funding in 2014, we have yet to see any change in the spending environment. Researchers are currently spending much of their time writing grants. We think spending could modestly improve in the back half of the year once grants are issued and the labs get their funding and hire and train additional staff.

On a brighter note, our Research business unit saw solid growth in the EMEA region and very strong growth in Latin America in the quarter. The funding environment for academic research in Europe has stabilized, and our performance was particularly strong in Northern Europe. Longer term, as more academic labs shift resources to translational drug discovery projects, we are expanding our offerings in that exciting area. During the first quarter, we launched new workflow offerings in the area of target identification. In the second quarter, we'll be launching new gene editing workflow offerings, and we expect to offer further product line enhancements to address the evolving needs of our research customers. We also launched new green chemistry alternatives in the first quarter. The customer response has been very positive for our chemical technologies that enable more environmentally friendly reaction conditions. For example, we launched catalyst kits that permit reactions to be conducted in water-based systems without any organic solvents. For our Research business, the outlook for the rest of the year remains on track with our expectations.

Our applied business unit had another strong quarter with 7% organic sales growth. Both the Diagnostics & Testing and Industrial segments performed well. Our applied business unit now has a full year of operating results under its belt, and I'm pleased with the success this team has had, expanding its business with existing customers and by penetrating new accounts.

In our Diagnostics & Testing segment, we saw strong growth from our analytical chemistry initiatives. And our standards and certified reference materials grew double digits. We continue to introduce new products, such as the recent launch of Cerilliant's new certified Snap-N-Spike solutions for corticosteroids. These products are used to calibrate and provide reference controls in hormone detection test for neonatal screening and pain management. And we, again, had strong sales of stable isotopes for use in our diagnostic test for stomach ulcers. This has caught the attention of other potential new customers, who are looking to use our stable isotopes for other types of cancer testing.

Our Industrial segment had mid-single digit growth in the quarter with contributions from all geographies. We continue to gain traction in providing critical raw materials to customers that value high quality and worldwide delivery. And recently, I had the chance to visit a multinational medical device maker, where we provide critical monomers for the production of a very important consumer product. And it was great to hear how our products are supporting their $1 billion product offering.

SAFC Commercial grew 3%, as expected. Unlike our Research business, SAFC Commercial business can be lumpy and may be affected by the timing of customers' purchases. In the first quarter, Life Science products growth was led by a strong sales of cell culture media. And we continue to focus on winning projects in the early development phase and support leading therapeutic drugs on the market with our biopharma offerings. Life Sciences Services had another strong quarter of growth led by biopharma services.

Our BioReliance business continues to perform well as we continue to grow our biological safety testing business. We are also seeing a resurgence of interest in gene therapy as a model for treating major catastrophic illnesses. The technologies and capabilities of BioReliance position us as the leader in the outsourced gene therapy market.

In Hitech, we continue to see strong interest in and growth of our semiconductor precursors. However, the sales of precursors to the LED industry declined, and we are becoming much more selective by focusing on those LED customers who value higher product quality and consistency. And we continue to be bullish long term on the commercial market. We are on track to open our Scotland dry powder media facility in the second half of this year and expect to have increased antibody drug conjugate production capabilities online in the U.S. by 2015.

At our Analyst Day in March, Dan Key, who heads up our global supply chain team, outlined the initiatives that we are working on to drive further efficiencies in our global supply chain network. We are beginning to see positive results from several of these initiatives, including in areas such as improved productivity and inventory management. Operational excellence is a journey. Sigma-Aldrich has a long history of continuous improvement, which has contributed towards gains in margins. We know we have more room for improvement, and we look forward to building on our global initiatives.

So before I hand it over to Jan, I want to close by saying that we had a solid first quarter, and we remain on track to hit our full year guidance. The organizational structure put in place at the beginning of 2013 is meeting our expectations. And I'm very pleased with the enthusiasm of our teams, who are working hard to meet their targets. Our customers look to us more than ever for innovative scientific content, as well as the product availability and convenience that we provide through our broad global channel. And we continue to invest both internally and externally in capabilities and services that will enable our customers to do great research, testing and commercial manufacturing.

So with that, I'll turn it over to Jan.

Jan A. Bertsch

Thank you, Rakesh. Sales in the first quarter of 2014 were $689 million, an increase of 2% from last year. On an organic basis, sales grew 3%. Adjusted operating income was $175 million, an increase of 5% from last year.

GAAP EPS for the quarter was $1.05. Adjusted EPS, excluding $1 million of restructuring costs primarily associated with the closure of an SAFC Commercial site was $1.06, an increase of 5% from last year. Foreign currency exchange rates lowered EPS compared to the prior year by $0.03. Excluding this impact, our operating income would have increased by 8%. Free cash flow was $143 million, an increase of 11% from last year. And during the quarter, we returned $112 million to our shareholders through share repurchases and dividends.

Research Organics sales growth was 1% in Q1. Without the R&D lab closures in the U.S. due to the severe weather, Research Organics sales growth would have been about 2%.

Looking at segment performance. Academic, government and hospital were flat. And pharma segment sales slightly declined in the quarter. We saw solid growth in our EMEA region. Funding for R&D has been stable, and we saw good growth in countries like the U.K. and Germany.

The U.S. was down because of weather. We were also impacted by a large pharma customer consolidating its R&D footprint. In APAC, sales growth in China continued to be strong, but again, was offset by weakness in India as temporary funding uncertainties continue to impact the country.

Dealer sales grew on the low single digits. We had a slow start to the year, especially in Russia and Africa. Overall, dealers' sales improved in March, and we expect to return to mid-single digit growth in Q2 and for the full year 2014.

For the first quarter of 2014, Applied organic sales growth was 7%. We saw Diagnostics & Testing sales grow high-single digits with growth in all geographies. And Industrial sales grew mid-single digits, also with contributions from all geographies.

In Q1, SAFC Commercial organic sales growth was 3%. Looking at segment performance, Life Science products grew in the low-single digits after 2 consecutive quarters of double-digit growth. We received a few large contract manufacturing orders in the fourth quarter of 2013 that otherwise would have been placed in Q1 2014. And as expected, we experienced lower growth in Q1. We expect this segment to return to mid-single digit growth in Q2 and to high-single digit growth in the second half of the year.

Life Science services sales grew in the double digits. This represents the third consecutive quarter of double-digit growth. As Rakesh mentioned, our BioReliance business continues to perform strongly. Hitech sales declined in the low-single digits. While we continue to have strong growth in the precursors for the semiconductor market, the pricing weakness in LED precursors continues to be a drag on results. In Q1, we announced our intention to be more selective in pursuing customers in certain Asian LED markets. As we turned down on profitable business, we expect Hitech sales to decline in the low-double digits for the remainder of the year. As a reminder, our sales to the LED segment represent less than 2% of total sales.

In Q1 2014, our gross margin was 50.9%. Excluding the impact from unfavorable changes in FX, our gross margin would have expanded by 60 basis points from Q1 2013.

Looking at performance over the past 4 quarters, we saw a pickup in gross margin in this quarter. We are encouraged with the leverage we're achieving in operational and sales efficiencies.

Adjusted operating income in the quarter was 25.4%, an 80 basis point improvement from the same period last year. In fact, our Q1 2014 operating margin would have been even higher, but unfavorable changes in FX rates caused the 70 basis points headwinds from last year. We are off to a good start towards our target of operating margin expansion of 50 basis points this year.

We are reaffirming our 2014 guidance. We expect full year organic sales growth to be in the low to mid-single digit range. We expect Research to grow in the low to mid-single digits. Applied was expected to grow in the mid-single digits, and SAFC Commercial is expected to grow in the mid-single digits.

Let me provide more color on the second half of the year. We expect better organic sales growth in Research in an improving academic funding environment. Applied growth in the second half should remain strong and similar to that of the first half. And for SAFC Commercial, Life Science product sales growth should accelerate from Q1 levels as the year progresses. However, as you recall, we had a very strong Q4 last year, which will result in very tough comps in the fourth quarter this year.

In addition, our strategy to be selective with Hitech customers will result in about $10 million of lower sales in the second half of the year. Overall, we expect organic sales growth in the second half of 2014 to be better than the first half. Our effective tax rate in 2014 is expected to be approximately 27%. Our full year adjusted EPS guidance remains unchanged and in the range of $4.30 to $4.40. And for the full year, we expect the operating cash flow to be in excess of $600 million and free cash flow in excess of $475 million.

So this concludes today's remarks. And operator, we're ready to take questions.

Question-and-Answer Session

Operator

[Operator Instructions] And our first question comes from Peter Lawson with Mizuho.

Peter Lawson - Mizuho Securities USA Inc., Research Division

Rakesh, the Diagnostic business is very nicely...

Rakesh Sachdev

Peter, can you speak up. I think...

Peter Lawson - Mizuho Securities USA Inc., Research Division

So that Diagnostic business is growing really nicely -- seems that standards and reference material. Just wondering if you could talk about utilization or any pricing pressure you may be seeing in that business?

Rakesh Sachdev

No, I think first of all, our Diagnostics & Testing business is made up of several things. Certified standards reference materials is one of them. We have a lot of analytic and chemistry products. We are now providing more kits for diagnostic manufacturers. In fact, the value that I think we are creating for a lot of the diagnostic companies is quite significant. And so far, we haven't seen any pricing issues in that business. And now, it looks very good from a pricing standpoint. It looks very good from a growth standpoint.

Peter Lawson - Mizuho Securities USA Inc., Research Division

And then the Service business, so that's 3 quarters of double-digit growth. Any additional color you can give around, which businesses are driving that, which geographies, which product classes?

Rakesh Sachdev

Yes, so Life Science Services -- as I said, I think our BioReliance, our safety testing business has been strong. Our viral manufacturing business, out of Carlsbad, California, which is also part of BioReliance, has been very strong. In fact, we are seeing a lot of strength there. I talked a little bit about gene therapy. There are a lot of companies that are heavily funded by our venture capital that have a great deal of interest. And I think we offer some very unique capabilities in the U.S. And it's unmatched by anybody else. And I think we are seeing -- we continue to see double-digit growth in that business.

Operator

And our next question comes from Brandon Couillard from Jefferies.

S. Brandon Couillard - Jefferies LLC, Research Division

Rakesh, are you able to quantify the savings directly gained from the supply chain efforts?

Rakesh Sachdev

I think we talked about a 50 basis point margin expansion. Some of that is obviously coming from supply chain. We're not calling out how much we got in Q1. I would say that the margin expansion, about half of it, you can assume, came from supply chain initiatives. I think we're just beginning to take hold in supply chain. There are several things that are happening there. So one is, Dan and his team are very focused on productivity and bought our manufacturing and distribution plants. And they have a plan that they're working now with their global teams. That's one area that is beginning to show some promise. The second area where I think we're beginning to see some benefit is our global freight. We've had regional freight teams in the different regions. After Dan came, we have globalized our freight span. I think there's some great analysis being done. So I think we are going to see some improvement there as we go forward. And then longer term, I think Dan and his team are quite focused on looking at the overall footprint within supply chain and how we're going to optimize that. And we'll talk more about that as we've got -- we firm up some of our plans. But overall, I think we see some good benefits both short term, but also we see that there are some long-term benefits that we'll call out once we've had some plans that we can share with you.

S. Brandon Couillard - Jefferies LLC, Research Division

And then Jan, the share repurchase activity is the most aggressive we've seen in a while. Would it be afoul to read into the activity as a reflection of a heightened sense of urgency to deploy the capital? And what should we be assuming for the share count outlook for the year?

Jan A. Bertsch

So I would not extrapolate what you saw in the first quarter necessarily. Our continued focus on capital deployment is organic and inorganic growth for the company. I think we had a very strong quarter again of free cash flow. And we elected to purchase incremental shares in the first quarter, but we continue to look at that on an ongoing basis.

Operator

And our next question comes from Timothy Evans from Wells Fargo Securities.

Timothy C. Evans - Wells Fargo Securities, LLC, Research Division

Is there any way to -- I know you called out 100 basis points from the weather. And I'm just curious, how do you ascertain that, that was in fact, weather-related rather than just a budget issue overall?

Rakesh Sachdev

Yes, because I think we -- the great pains in looking at which schools and which pharma customers were affected by weather because we can see a clear change. And we look at, we can look at orders on an hourly basis, even on a minute-by-minute basis. And so we know when we have inclement weather, what happens to a certain customer. So that was our best estimate. I think we did a fairly, I think, detailed analysis to understand it. And that's our best estimate.

Timothy C. Evans - Wells Fargo Securities, LLC, Research Division

And then just quickly, Jan, can you call out what the foreign exchange impact on revenue and EPS for the full year is expected to be?

Jan A. Bertsch

Okay, well first of all, in the first quarter, I had mentioned that it was $0.03 negative on the EPS front, and sales were basically negligible. But on a full year basis, we're looking at a slight tailwind, and I'm saying very slight. I mean it doesn't even round to near to 1% and maybe a slight negative on the EPS front. But again, very, very slight at this point, not a significant movement for full year.

Operator

And our next question comes from Paul Knight with Janney Montgomery.

Paul Richard Knight - Janney Montgomery Scott LLC, Research Division

You mentioned cell culture media driving the business. Is this something you saw really accelerating here in the last 6 months, 3 months obviously? Can you comment on that and the color around it? We all know, I guess, the pipeline's pretty strong with Biologics. Is that what you see happening, and can you give us some pacing, tempo, color on it?

Rakesh Sachdev

So I think this is not a recent phenomenon. I think we have been seeing a growth in cell culture media on the commercial side as pretty much maintain high-single digit growth across -- it goes beyond 1 year. And I think that's what we saw this quarter as well. We saw our media business was strong. I think what was weak this quarter was our contract manufacturing business, which was again, lumpy for weeks. We expect that to come back in the second quarter. But the media business has been incredibly consistent in growth. And I think a lot has to do with where we have our media with the biopharma companies. And so it's a good business, and we continue to invest in that. As you know, we are going to be opening up an expanded facility in Scotland in the second half of this year where we will be making dry powder media. And we will have redundancy on both continents, probably the only company that will have redundancy. We're on both liquid media as well as powder media. So we feel pretty good on the investments we are making and the outlook with our customers.

Paul Richard Knight - Janney Montgomery Scott LLC, Research Division

And has there been any disruptions in the market with the Gibco-iClone [ph] transactions.

Rakesh Sachdev

None that we have seen, so I mean I...

Paul Richard Knight - Janney Montgomery Scott LLC, Research Division

No market share opportunities?

Rakesh Sachdev

Well, I think our guys are always looking at opportunities, and they'll continue to look at opportunities. And hopefully, with the performance we're having, you'd like to think that there will be opportunities. So we will keep you posted.

Operator

And our next question comes from Mike Sison with KeyBanc.

Michael J. Sison - KeyBanc Capital Markets Inc., Research Division

Rakesh, I thought you said that productivity helped you sort of get that $0.03 extra in the first quarter. That's pretty impressive. Any reason why you didn't raise guidance? Is that sustainable going forward, or are you investing some of that maybe in terms of growth?

Rakesh Sachdev

So I think productivity did help us. It surprised us a little bit. I would say that wasn't the entire $0.03, but it was a part of it. The other thing is that we've been talking about -- some of the successes we're having on the customer end, clearly as we have reorganized the company, we have learned a lot in the last 12 months. We're getting closer to our customers. We've been investing more in customer-facing people. In fact, I think what we're going to do is probably even think about investing more in the balance of the year in some of our sales and marketing activities given that we had some -- a little bit of strength. So I think we'll plow some of that back in some of the investments that we make, which is why we are sort of holding on to our full year guidance even though we exceeded Q1. Because I think there's an opportunity for us to invest more and get the returns. Starting next year, these investments should start paying off in 2015 and beyond.

Jan A. Bertsch

Mike, you might actually want to think about our SG&A spending for the balance of the year being -- we were about $160 million in the first quarter, somewhere in the $160 million to maybe $163 million range per quarter, something like that.

Michael J. Sison - KeyBanc Capital Markets Inc., Research Division

And then Rakesh, when you think about SAFC and I mean I think if you strip out the Hitech business, it appears that overall, it could be growing more like double digits potentially. Is that the growth potential for the segment if you exclude sort of the issues that Hitech has over the next several years?

Rakesh Sachdev

I think probably the way to think about Hitech growth in the high-single digits is where we'll be comfortable. I mean we are probably going to have some quarters that might -- will be in the double digits, but I would say from a guidance standpoint, more in the high-single digits.

Operator

And our next question comes from Isaac Ro from Goldman Sachs.

Isaac Ro - Goldman Sachs Group Inc., Research Division

I just want to maybe ask Rakesh and Jan a question on M&A. You are, if we look across the equity markets, seeing a lot of companies getting rewarded in their stock prices for taking more sizable transactions on. So just given that fact and your capital position and where rates are right now, is it reasonable to say that you guys might be more flexible on some of your historical churn base metrics as you look at potential deal flow? Just trying to get a sense of your appetite for taking on larger deals.

Rakesh Sachdev

So I think we've been pretty consistent what we have said. I think when it comes to M&A, it's less about size, it's more about creating shareholder value and customer value. Really it's -- you know this, but the realities are that the candidates out there are mostly smaller bolt-ons. There are just only a handful of few companies that have set any significant size. For us, the 3 things that drive us all the time: one is the strategy, making sure that it fits with where we're trying to take the company; two, having the financial discipline is making sure that we're not going to overpay for a transaction and lose some of the value right on day one; and the third 1 is execution. We want to be sure that if we do acquire companies that we have the capability both at our end, plus who we are acquiring to be able to integrate the company then those 3 drive our thinking. At the end of the day, I would say and maybe Jan would also echo this, is that when it comes to the returns, when you put all this together, we are an ROIC-driven company. We want to make sure that at the end of the day, that as we acquire companies, that our returns get well in excess of our cost of capital. In a relatively short time, some transactions might take a little longer.

but typically, those are the things that we look at very, very closely and so does as our board.

Isaac Ro - Goldman Sachs Group Inc., Research Division

And then just a follow-up on the pricing environment. Maybe if you could comment on what you've realized year-to-date on the pricing front, how that compares year-on-year? And then to the extent we can kind of talk about the forward, be curious about your views on the commodities environment. Is there anything there we should keep in mind as it relates to pricing and margins for the balance of 2014?

Rakesh Sachdev

Yes, so on the pricing front, we typically start off slow in the year. We, I think, had a few pricing actions. In some of the regions, we don't do it uniformly. I would say that in Research for the full year, we would expect about a 1%, maybe a slightly north of 1% just in the Research business. If you have a negative pricing trend in the SAFC business because of Hitech, so it takes off some of that pricing. And some of the pricing is to pay for the inflation. Most of the inflation for us, really is not in the raw materials, it's mostly around people. We typically give merit increases to our people 1st of April, so that's the other thing that's going to happen in the last 3 quarters of this year is we're going to have some inflation as it relates to salaries and -- but some of the pricing that we get more than offsets that. But overall for the year, I think we see a year that's going to be fairly similar to last year in terms of the overall pricing for the company.

Operator

And our next question comes from Tycho Peterson from JPMorgan.

Tycho W. Peterson - JP Morgan Chase & Co, Research Division

Actually want to go back to the original question you had on the Diagnostic business, which has been putting up great numbers. Rakesh, utilization trends haven't been great, and we've seen some of the diagnostic companies put up pretty mixed results. So can you maybe just talk to your comfort and the sustainability of the trends? And is your growth here really just a function of adding a lot of new products and building up portfolios, so therefore, you might not be as exposed to some of the utilization trends in the market?

Rakesh Sachdev

So I think first of all, I'd make a couple of comments, Tycho. We are working off a smaller base. So the Diagnostic business is smaller than our Research business today. Where we are really growing nicely is also outside the U.S. If I look at what we achieved in both Europe, as well as in Asia, it was staggering in the Diagnostics & Testing business. And we continue to see opportunities there. Now we are certainly, are growing nicely in the U.S. But when I look at what we're getting in Asia Pacific, as well as -- and it's across-the-board whether it's China, India, all those places. India was weak for us in Research. In fact, India was incredibly weak in the academic markets in the first quarter. But when I look at -- overall, India, for us, grew 10% even though we had a very weak Research business. And a lot of that had to do with what we were able to achieve in the diagnostics space.

Tycho W. Peterson - JP Morgan Chase & Co, Research Division

And then as a follow-up, on pharma, you were very clear at the Analyst Day about some of the perceived headwinds there, and consolidation's obviously been a theme for a while. But now that you have some proposed deals on the tape, can you talk a little bit how you're thinking about the pharma trajectory for the rest of the year? Are you able to kind of go and engage some of these parties proactively in the midst of this and then try to kind of carve out some additional business? And then you did call out one large pharma customer in the U.S., which impacted the quarter, so I'm just wondering if you could provide any more color on that?

Rakesh Sachdev

So I'm assuming you're talking about pharma business in Research because the Pharma business in SAFC is growing very nicely.

Tycho W. Peterson - JP Morgan Chase & Co, Research Division

Correct.

Rakesh Sachdev

So the pharma business in Research was very flat this quarter for us. We do expect to pick up in the subsequent quarters. We would expect that to be in the low to mid-single digits for the balance of the year in pharma and research. We had a couple of events, I would say, this quarter. We had one of our customers who had to shut down a facility because of a fire. I think -- and that was temporary. We're going to see that come back in Q2. We also had one of -- the large pharma company that did a layoff last year that's still -- we still have -- saw a lingering impact of that in Q1. That will also get flushed out later this year. But I would say overall, we've been fairly pleased the last 2 or 3 quarters in pharma and what we have been doing. This quarter was a little less growth, again, mostly in the U.S. I think our pharma business in Europe grew nicely. And so I think we should be able to achieve low to mid-single digit growth for the balance of the year in research pharma.

Operator

And our next question comes from Jon Groberg from Macquarie.

Jonathan P. Groberg - Macquarie Research

So Rakesh, I guess, can you maybe just talk a little bit about your business, since your business review? So you mentioned you get hourly, daily updates on orders. I'm just curious in a sense since the review, maybe just what March looked like relative to February and January and whether you feel more comfortable about the, kind of the run rate in March given some of the weather and other issues that you have on this.

Rakesh Sachdev

Well, listen, we don't review our results on an hourly basis, just so you know. But we have that information that people are running their respective businesses are on top of that. But I think we've got a pretty rigorous process of reviewing our businesses both in terms of what they're achieving on a quarterly basis, but also reviewing long-term plans. And I think most good companies who have that kind of governance do that well. And I think we are in the same bucket. Your other question was about January, February. So I think I mentioned at the Analyst Day that we had a slow start in January and February was slow, too, but March was strong. So clearly, March, we saw some of the business coming back. I think the weather issues were less in March. But even despite the weather issues, we clearly saw March as a stronger month than both January and February.

Jonathan P. Groberg - Macquarie Research

That was my question is if you kind of felt a little bit -- have you felt like the trends in March were more emblematic of kind of what the rest of the year was likely to entail, or if there was -- given some of the issues in the earlier part of the year or if you're expecting...

Rakesh Sachdev

Yes, it's hard to say by just looking at March because some of the March trends could have been just some of the pent-up stuff that didn't happen in January and February. So I think that we have to be careful not to extrapolate March and say that the rest of the year is just going to be incredibly strong. So we want to see a couple of months before we say that something has changed.

Jonathan P. Groberg - Macquarie Research

And then SAFC, I'm just curious, how are you -- given your experience in the LED in the precursor market where you build out capacity, others build-out capacity and then you saw the prices plummet, which some of us wondered if that may occur and I think you're building out a new facility. Just generally speaking, how are you thinking about capital allocation in SAFC in terms of building new facilities and building capacity and when you'll do that? Are you changing any of the ways that you're your negotiating with customers. I'm just kind of curious how the experience is impacting the SAFC business.

Rakesh Sachdev

So really, we continue to invest in SAFC, especially in the areas of, as we have said, in the media business because that's a business that has legs for growth. We are investing in some of the contract manufacturing business, particularly around antibody conjugates. There's been a, there's a lot of interest on the part of customers to using our capability. So I think what I would say is in SAFC, we are trying to base our investments, so we're not trying to put everything all at once. We did that even in the Hitech business when we put the investment in Taiwan. We had planned on a Phase I and a Phase II, and that was a good move. Because given kind of what's happening in the LED side, we are probably going to have to rethink about a Phase II, but at least we didn't invest the whole thing at once. But no, I think our thinking around capital investments continues to be invest in areas where there is high growth and where the margins are good. And I think the customers -- especially in the SAFC business, this business is sticky. Once you are, you have created a partnership with a customer, whether it's on media or even on some of the contract manufacturing business, that business stays for quite some time. So we feel pretty good that we can recover or get a return on these investments.

Operator

Our next question comes from Dan Leonard with Leerink.

Daniel L. Leonard - Leerink Swann LLC, Research Division

Rakesh, I was hoping, perhaps, you could elaborate on what visibility you have on the return to growth or acceleration of growth in the U.S. academic market in the back half of the year. It sounds like you have some field checks with folks doing grants, but if you could elaborate it to some degree and then also the magnitude of the inflection you're expecting.

Rakesh Sachdev

Yes so, if I look at the what, at least, we have heard from NIH and where this is going. There's a good chance that some of that money is going to flow into real research work as opposed to just going into payroll and construction of facilities. So I think we are expecting that the second half will see stronger growth in terms of monies going into academic in the U.S. Just the dimension, this is for you. 15% of our Research business is U.S. academic. And that 15% of our total Research business, which is tied to U.S. academic, had a slight decline in Q1. In the second half, we fully expect that, that 15% will return to a growth. And if that happens in what we are thinking, that's probably going to add about 1% of the total company's growth in the second half versus the first half. Now, we'll wait and see how this plays out, but I thought I'd just give you a little bit of dimensioning of how this could impact us.

Daniel L. Leonard - Leerink Swann LLC, Research Division

And then for my follow-up, Jan, can you give us an update on your efforts to drive down the tax rate over time?

Jan A. Bertsch

Sure. Well, you've probably noticed that, first of all, our tax rate is going up year-over-year, and that's a result of a couple of things. Primarily, we had a onetime U.K. tax rate change last year that was favorable to us. And the other thing, of course, was that we had a 2-year impact on R&D tax credit. And so far this year in our 27% guidance for the full year tax rate, there is no R&D tax credit assumed in that number. So if that occurs, you'll see our 27% for the year drop maybe about 0.5 point. But our team continues to focus on and look for ways to improve our tax rate. And most of this, of course, revolves around the fact -- revolves around our manufacturing footprint for the company. And as we continue to grow our sales faster outside the U.S. than inside the U.S., that has a positive impact on that tax rate. So we'll continue to look for opportunities. They've been very successful in the last year or 2, and we'll continue on that front.

Operator

Our next question comes from John Robert with UBS.

John Roberts - UBS Investment Bank, Research Division

I think this morning, 3M actually said they're expecting -- they have the R&D tax credit in their planning and expect that to happen. So if it does happen, in the fourth quarter, you would have -- it's 0.5% for the full year, but it might be 4x that for the fourth quarter when you would do a catch-up?

Jan A. Bertsch

Yes, I'm not sure it would be exactly 4x, but we would have 0.5 point full year impact, so it would be higher in the fourth quarter, of course.

John Roberts - UBS Investment Bank, Research Division

And what's the basis of you not including -- I mean so they're using their auditors or accounts, I guess, to give them a recommendation of that and yours just disagree?

Jan A. Bertsch

Well, John, I check on this on a regular basis and we don't have any confirmation that it will be extended. So that's why we haven't included it, but we have been very forthright in saying that it has not been in our guidance. So as soon as we believe that it will be, we'll put it in there for sure.

John Roberts - UBS Investment Bank, Research Division

And then just lastly, on that Hitech LED business, how do we think about the segmentation of that marketplace to where you want to play and where you don't want to play? Is there a specific, either price point or volume cutoff of the customer? How do we think about what you call the high end versus the low end?

Rakesh Sachdev

So that's exactly right. When you look at the segmentation of customers -- and you have those customers, I would say, who are very quality conscious, who are willing to paying the price for quality products. But then you have some customers, who have chosen to go on a different path. And as I said, we have decided that we don't want to play the low quality, low-cost game. I think the investments we have made allow us to produce very high quality product. And there are absolutely going to be customers for that. I think our margins remain pretty good for those customers. But we have had to make a decision because we can't play a game of low priced, low quality as well as a game of high quality, higher price. And that's what we have decided.

Operator

And your next question comes from Steve Willoughby from Cleveland Research.

Steve Willoughby - Cleveland Research Company

For Jan, Jan, I want to follow up on the comment you made regarding SG&A. You expect it to be kind of in the $160 million to $163 million range for the rest of the year. If I look back, that equates to a pretty good year-over-year growth in SG&A for the remaining quarters of the year. While here in the first quarter, your SG&A actually declined by $1 million year-over-year. So I was just wondering, I understand some of the increased investments you might be making, but if you can maybe just talk a little bit more about what's driving the SG&A up so much on a year-over-year basis?

Jan A. Bertsch

Right. Well, there's a couple of things. First of all, last year as you might recall, we did have some onetime gains that we called out that were in our SG&A numbers, so those aren't repetitive. But it really goes back to what Rakesh had mentioned earlier about reinvesting some of our earnings into more resources in particularly, the sales and marketing areas of the company. And considering that, we also -- our merits kicking in the second quarter. I think it's prudent to take that first quarter and raise it by somewhere between $1 million and $3 million a quarter roughly.

Steve Willoughby - Cleveland Research Company

And then just a follow-up question related to gross margin. If my model's correct, it looks like this quarter was about the 8th quarter in a row of year-over-year declines in gross margin. So I was just wondering, what is -- I was kind of surprised by that given the mix this quarter as the Applied business was stronger than I had expected. So I was just wondering how you're thinking about gross margin going forward.

Jan A. Bertsch

Well, the first thing is our gross margin actually grew year-over-year if you account for the fact that we had a negative foreign exchange impact. And that foreign exchange impact was about 70 basis points. So margin actually grew about 60 basis points on a year-over-year basis. And those were for all the reasons that we talked about just a few minutes ago with Rakesh.

Operator

And our next question comes from Derik De Bruin with Bank of America Merrill Lynch.

Derik De Bruin - BofA Merrill Lynch, Research Division

So I want to go back to something that -- it was a question that Tycho asked and talking about some of the lumpiness in those pharma -- in your pharma end markets. I'm just curious what you factored in for those markets this year, just given the fact that in the last few weeks, we've seen a lot of potential deal activity in the pharma space, both on the large-cap pharma and the biotechs and the spec pharma side. I'm just wondering what you're sort of anticipating in terms of potential headwinds, if any, into your guidance for some of these recent actions? Or have you seen anything, any changes so far?

Rakesh Sachdev

Not really. Again, if you look at our Research pharma business, especially with the large pharma companies where there is a lot of activity going on as you point out. I mentioned this, 5% of our business. That's it, just 5% of our business is Research pharma business with large pharma company. So what are we assuming for this 5% of the business? Like I said, we're assuming that we will grow in the low to mid-single digits. I think we have done that consistently over the last several quarters. This quarter, I think we know why we had a slight softness. And that's what we're assuming for the balance of the year.

Derik De Bruin - BofA Merrill Lynch, Research Division

Great, and you've diversified the business by adding BioReliance. You've done a number of deals in contract manufacturing, the pharma services. I'm just wondering how big a chunk of the overall business is that today? I -- what are some of the other opportunities in the other vertical markets you go into? I mean it seems like that's a place where there's still a number of small private companies. There's a lot of opportunities in the Services area. I'm just wondering if you see anything that can sort of -- or if you could talk through some of your strategies and see where you could fit in to do better with your customers, to serve your customers better in that market.

Rakesh Sachdev

So just to give you an idea, the Life Science Services business is about, I think, about 20% to 25% of SAFC. So it's an important piece of business within that. The biggest piece, as you know, our Life Science products. And the SAFC business, that's made up of media and contract manufacturing. And so Life Science product is about 60%, 65% really. The Services business, as I know that when we first bought BioReliance, there were a lot of questions about whether we'll be able to grow that business and that the preceding owners had a tough time. And I maintain that we bought this because this gave us the ability to have much more strategic discussions with our customers. And that's beginning to play out. We are having conversations with the large bio pharma companies where we are able to talk about products and services. And frankly, it's beginning to help us. And the fact that for the last 2 or 3 quarters, we've been growing double digits is a testament to what our people, who are working with these companies, are able to produce. And I can't say that every quarter we'll grow at that rate, but we're encouraged with what we have seen over the last 6, 9 months.

Operator

And our next question comes from Jeff Elliott with Robert W. Baird.

Jeffrey T. Elliott - Robert W. Baird & Co. Incorporated, Research Division

Rakesh, could you talk about the industrial end market? What you're seeing there as far as end market growth? And specifically, what's driving your growth rates, and what are you seeing in emerging markets?

Rakesh Sachdev

The industrial businesses are reasonably strong for us. We grew about 5% mid-single digits in Q1, and we have growth in the Industrial segment across the globe. It was strong in Europe, it was strong as well in Asia Pacific. I think again, this is a result of the organization that we put together. I think, as I mentioned, till a year ago, we weren't even calling on a lot of these Industrial accounts. It was a business that was pretty much on autopilot. And we looked at industrial customers coming to us to buying our products. We have begun a lot of great discussions with a lot of these industrial companies, who are also discovering the kinds of products that we can provide to helping them out. So we are still in our early phase with Industrial companies. Industrial businesses do tend to be lumpy, but I would say that we've had a decent start. And we are looking forward to growing again. I'd like to say, we can grow this mid-single digits this year. I think that we are thinking it will be low to mid single, because this is a segment again that our people are beginning to really work on a more active basis.

Jeffrey T. Elliott - Robert W. Baird & Co. Incorporated, Research Division

Jan, could you please clarify, I guess, what drove the upside in the first quarter? I guess you mentioned the supply chain initiative, but what was the rest of the $0.03?

Jan A. Bertsch

On the -- are you saying the $0.03 relative to our discussion at the Analyst Day?

Jeffrey T. Elliott - Robert W. Baird & Co. Incorporated, Research Division

Yes.

Jan A. Bertsch

I would think it's really in several different areas. I think one was a little bit better volume and mix in the month of March than what we had anticipated. The second one, I think, is the supply chain initiative, kicked in nicely. And as Rakesh mentioned, it's really a journey as we go throughout the year because some of those initiatives are ones that will kick in, in the short term. And some will kick in, in the longer term. And I think the other one was probably SG&A. It was a little bit better than anticipated. So in my mind, that's where the $0.03 came from.

Operator

Our next question comes from Dmitry Silversteyn from Longbow Research.

Dmitry Silversteyn - Longbow Research LLC

A couple of questions, if I may. First of all, you mentioned in the Hitech portion of the business, citing the LED issues, you've also talked about good growth in the semiconductor side of the business. Was that specific to Sigma-Aldrich products or customers or platforms that you're on? Or was this sort of a general -- driven by the recovery in the industry?

Rakesh Sachdev

So we are working with semiconductor companies on the next generation of semiconductor chips. And so we are working on what's called, advanced nodes of wafers. And the precursor that we are providing to the semiconductor companies is really to help them reduce the size of these chips. And so this is a growth platform for most semiconductor companies, not to be confused with the old traditional wafers. So for us, this is a growth business. We are seeing very good growth in the semiconductor business. It started off being a pretty small business. And I can tell you it's only a matter of time before this business takes -- goes higher than our LED business at the rate in which we are growing this business.

Dmitry Silversteyn - Longbow Research LLC

So this really is your exposure to the leading edge of the semiconductor industry, where there's always sort of growth no matter what...

Rakesh Sachdev

Exactly. And we have a pipeline that's well established now for the next 5 years.

Dmitry Silversteyn - Longbow Research LLC

That's helpful, Rakesh. Secondly, you sort of addressed that in another response to an earlier question about your success with growing BioReliance. The previous owner was a company -- also strategic buyer, also a company with good exposure to the biotech industry and sort of the knowledge of the customers and vice versa. So what is it that you're doing that's moving it away from kind of eat-what-you-kill type of a business model to more sustainable contract repeatable revenue type of a business model? Is this just a natural evolution of the business and you're just giving it the right time? Or is it something that you're doing internally that's driving that?

Rakesh Sachdev

Well, I just don't want to comment on what happened before. I think all I can say is that we had a strategy of putting the service business alongside with our product offerings to create a compelling story for our customers. And I would say that our guys and gals are doing a great job of execution. We have got some great teams of people. And we are offering the customers that creates value for them, that's all I would say. I don't think it's just because the market has changed. Sure, biological products are becoming more important, and we knew that when we bought BioReliance. But I think it's a combination of our ability to work with customers and our ability to execute.

Dmitry Silversteyn - Longbow Research LLC

And then final question, again maybe going back to the question that was asked earlier about pharmaceutical M&A, all through sort of the large and the medium-sized deals to the space. You mentioned that it's only 5%, I think, of Sigma-Aldrich revenues overall. But historically, or at least, going back to the last time there was a wave of M&A, it seemed to have impacted the company significantly. It seemed to have held down the growth rate, at least, according to the then management team for several years after the sort of the M&A peak. So I'm just wondering, is it just -- again, is your reliance on pharmaceutical customers waned in that last 5 years, let's say since the last wave? Or why are you not as concerned as I thought you would be given all the announcements and the major deals in that space?

Rakesh Sachdev

Yes, so first of all, I would say that a lot of the M&A isn't really affecting a lot of the R&D. Now let me just say this. Even though 5% of our business with the large pharma companies on the research side, we do a lot of business with these same pharma companies on the commercial side. So when you look at the strength we have with these same companies, when you put our SAFC Commercial business alongside with our Research business, we become a fairly important partner to these same companies. I was just responding to kind of the whole Research business again -- are we going to be able to grow that? How fast are we going to grow that? We know that research spending has been tightly monitored by pharma companies, but we have been successful. And this is one of the things we are doing is continuing to offer innovative products, scientific content, and now, are working around -- along workflows both for the pharma customers, as well as for the academic customers where we are offering a whole complement of solution of products related to workflows, which is also going to fuel some growth for us going forward.

Operator

And I'm showing no further questions at this time. I would now like to turn the call back over to management for any further remarks.

Quintin J. Lai

Thank you, Crystal. Thanks again for everyone for their participation on today's conference call. We expect to release results for the second quarter of 2014 before the market opens on Thursday, July 24. And we'll follow that with a conference call the same day at 10:00 a.m. Central Time. And that concludes today's call.

Operator

Ladies and gentlemen, thank you for participating in today's conference. This does conclude the program. You may all disconnect. Everyone, have a wonderful day.

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