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Sigma-Aldrich Corp.(NASDAQ:SIAL)

Q4 2007 Earnings Call

February 13, 2008 11:00 am ET

Executives

Kirk Richter - Treasurer

Jai Nagarkatti - President and CEO

Mike Hogan - Chief Administrative Officer and CFO

Rich Keffer - VP, General Counsel

Analysts

Steven Nissan - Mindflow Capital

Jon Wood - Bank of America

Quintin Lai - Robert W. Baird

Derik De Bruin - UBS

Douglas Charlie - KeyBanc

John Roberts - Buckingham Research

Dan Leonard - First Analysis

Jonathan Kraft - Longbow Research

John Sullivan - Leerink Swann

Operator

Good morning. My name is Michael, and I'll be your conference operator today. At this time, I would like to welcome everyone to the Fourth Quarter Results Conference Call. All lines have been placed on mute to prevent any background noise. After the speaker's remarks, there will be a question-and-answer session. (Operator Instructions). Thank you.

I would now like to turn the call over to Mr. Kirk Richter, Treasurer. Sir you may begin.

Kirk Richter

Thank you, and let me also add my good mornings and welcome to the Sigma-Aldrich fourth quarter 2007 earnings conference call. With me today are Jai Nagarkatti, our CEO and President, and Mike Hogan, our Chief Administrative and Chief Financial Officer. Following my introductory comments, Jai will review a few highlights of our Q4 and full year 2007 results, but he will direct most of his comments to our expectations for 2008.

I’ll follow that with more detail on our fourth quarter performance, then Mike will provide additional comments on our sales and EPS guidance for 2008. Following these reports, we'll open up the call for your questions and comments

Before we begin these reviews, I do need to remind you that today's comments will include forward-looking statements about future activities and our expectations for sales, earnings and other possible future results. While we believe these expectations are based on reasonable assumptions, actual results may differ materially due to any number of factors including the risk factors listed in our annual report on Form 10K, for the year-ended December 31, 2007, and in the cautionary statement in yesterday's release.

We have no plans to update these forward-looking statements after this conference. Also, SEC regulations require us to provide information on any non-GAAP financial measures covered in today's conference. That information which consists of currency and acquisition adjusted sales growth, currency adjusted process improvement savings, and profit and EPS results on both a pro forma and reported basis is also contained in yesterday 's release which is posted on our website. 

Now, I will ask Jai to begin our review. Jai,

Jai Nagarkatti

Thank you Kirk, and good morning everyone. As I reflect back on the past year, I am reminded of the lyrics of the famous Frank Sinatra song and can say for Sigma-Aldrich when it comes to 2007, that it was a very good year. When we first spoke last year, I told you that we believed it was going to be yet another exciting and rewarding year for Sigma-Aldrich.

We entered 2007 optimistic about the opportunities in the Life Science and High Technology markets we serve, and committed to add one more year to the 32 previous years of consecutive growth in sales and earnings per share for our chemical businesses. And now that it's behind us, I am happy to be able to say that the year met and in some cases exceeded all our expectations.

During the year, we announced a few key changes in the management team that drives our business and then watched these changes provide clear benefits in 2007, with the promise for enhancing those benefits in 2008 and beyond, and we achieved some exciting milestones along the way.

I trust you've all seen the fourth quarter and full year 2007 results we released yesterday, that now represent 33 years of consecutive top and bottom line growth. That's certainly one of our milestones. Another is having exceeded $2 billion in sales for 2007, yet another is having done so while improving our margins, and delivering a 14.1% increase in diluted earnings per share for the full year.

Importantly, we closed the year strong with fourth quarter earnings per share of $0.64 producing an increase of almost 21% for the final quarter. And finally, despite recent general market softness that has dialed our and other stock prices back a bit, I haven't found anybody who was not pleased or even elated with the final milestone, our stock price increase.

Sigma-Aldrich's stock price increased more than 40% at year-end 2007 from the previous year's close, a clear indication to us that shareholders have confidence that we are doing the right things to grow our business. Other supporting achievements in 2007 related to our five key growth initiatives, with many successes in the individual programs that make up those initiatives. So by every measure, I think I can clearly say that 2007 was not only a very good year, but perhaps even an exceptional one.

I think that most of us when we have reached a new and significant milestone pause briefly to reflect on our past, before moving quickly to what the future may bring. From the somewhat humble beginnings of Sigma-Aldrich more than 50 years ago, our predecessors and those of us here today, have been able to contribute to the advancements of science by providing customers with the tools to improve research productivity and enable commercialization of the research to improve our collective quality of life around the globe.

We have done that with the broadest product offering in our market, adding literally thousands of new products along the way through our internal research and development, our wide knowledge in product sourcing and procurement, and through product licenses, technical collaborations, partnerships and acquisitions.

We have done that with service that is second to none, both in terms of getting high quality products to customers when and where they need them, and in providing them with ready access to the technical information they need to do their important work. In the process we have a built a loyal customer base that's key to our future growth. And by helping and being customer centric, we plan to continually innovate and improve in all that we do to keep our customer loyalties.

As I reflect back on 2007 accomplishments, I want to be sure to thank each and everyone of my 7900 colleagues around the world. It was their dedication and commitment that enabled us to ship 15,000 orders each business day, to add innovative products each year in and year out, to find ways to reduce cost that improved margins of paid for important new initiatives, and that provided all of the often otherwise thankless behind-the-scene support to effectively mange and grow our business.

In one way or another, each of them contributed to the drivers for the growth we achieved in 2007 and we will do so to deliver what's expected for 2008. Those drivers are the five key initiatives that we launched in 2006. They will continue to drive our growth this year. As part of our normal three year planning cycle, we plan to conduct another strategic review by mid-year 2008, but as in the past, we expect any changes from that review to be evolutionary rather than revolutionary. Any tweaks identified to improve on a strategy that is working will be rolled out in 2009.

We have got a great business model, but we are always open to ways to improve it to enhance our performance, continue to take share in each of the markets we serve, and seek to deliver even better top and bottom line growth.

My comments on our 2007 accomplishments for each of the initiatives were included in yesterday’s release, so I won’t repeat any of that here. But I will share our expectations for 2008, that form the basis for delivering 7% organic sales growth and delivering earnings per share in the range of $2.52 and $2.62, a gain of about 7.7% to 12% over last year's $2.34.

Our customer-centric focus is delivered by our four business units, each serving the individual needs of its only distinct customer group. For Research Essentials and Research Specialties, we plan to build on the activities that enabled us to exceed our long-term growth goals for each of these units in 2007, believing that we can do that again in 2008.

Here it is continuing to be innovative with the products we offer, delivering those products cost effectively and supporting our customers’ needs for information and solution in a real time. We will continue the joint approach that worked so well for us in 2007, when we combined sales and marketing activities of the two units for many of our largest global customer accounts.

In Research Biotech, we will continue to add innovative new products, expand the technical information available to our customers, and make it easier for customers to search that data with new website tools like Mike will describe a little later.

The new management team for this unit is already showing promise, as evidenced by the increased growth of 6% achieved in the second half of the year that we promised at the time the new team assumed a new role in the middle of the year.

In SAFC, our focus is on capacity, both on adding it and on using it. We increase both capacity and asset utilization with new 24/7 schedules at several existing plants and announced a number of new capital additions to support this business in St. Louis in Madison, Wisconsin, with more to come as we look to expand our footprint in places like China, Ireland, Israel, South Korea and Switzerland. With new plants or plant expansions already planned and announced for each of these locations.

We continue to see tons of activity on our second key initiative that calls for exploiting accelerated growth opportunities in CAPLA Markets. With 20% of our global sales in these markets for 2007 and a goal of boosting that to 25% by 2010, we made several key decisions in 2007 that are expected to help us get there.

Gilles Cottier, our Research Essentials President will be spending more of his time on the potential in China and India. We have committed to a new plant in China that is expected to come online early in 2009. We also plan to continue improvements to local service and product availability in these markets, by intentionally building in local inventories and entering into new local sourcing arrangements. And we intend to do this last piece without building overall inventories as we find ways to reduce our inventory investments in other slower growth locations.

On initiative number three, effective use of e-Commerce. We reached our 2007 goal to have 40% of our research based sales come through this medium earlier than expected during the year. And significant enhancements made in 2007 should provide benefits in 2008 and for several years to come.

We installed a new IBM e-Commerce platform to ensure that our site remains both robust in content and timely in response. This new platform also enables us to more efficiently integrate with customer's procurement systems and it provides online chat capabilities for customer communications on technical issues and problem resolutions, often leading to a sale. I could go on and on here, but I think these examples give you a feel for what we are up to. We have built what we believe is the industry's best website; we have no plans to relinquish our leadership position; and we have set our goals for 2008 e-Commerce sales to a new high of 42% of total research sales.

Our initiative number four, process improvement, continues to help pay for the rest. We fully expect another $15 million in cost reductions in 2008. And above and beyond that $15 million, our new supply chain initiatives should begin to enhance margins modestly before year end 2008, improving on our earlier expectations for benefits commencing in 2009, with a full benefit of $35 million to $45 million in annual benefits in 2012, resulting in a 150 basis point pretax margin improvement buy that time.

Finally, new technologies continue to drive our acquisition and in-licensing activities. Our two acquisitions in 2007 enhanced capabilities in the high performance semiconductor market and in the development and manufacture of novel vaccines and gene therapies. With more at stake we have also stepped up our patent activity, having filed for 10 patents in the past year, and in 2007, we successfully in-licensed more than 45 other technologies from leading academic and scientific organizations around the world. We expect to continue this overall approach in 2008. Possibly stating the obvious I am sure many of you may want to know what impact if any the possible slow down in the U.S. economy might have on our 2008 expectations.

To date we have seen no significant change in the underlying growth in the market we served. And we don't really expect that to change much as we move through 2008. I will remind you that almost 64% of our 2007 sales came from customers outside the U.S. Several countries particularly in Europe and CAPLA enjoy good economic growth, and countries like China and India continue to display strong growth in excess of 30% in each of the last two years.

We are not dependent on just a few customers or products that could have a significant impact in an economic downturn. Rather, as we often shared with you, no single product or customer accounts for more than 2% of our sales. Even in the US in our sales to academic accounts we are better than overall government funding might suggests during the final three quarters of 2007, and should remain and maintain that phase at least early into 2008.

So I think I can safely say, the same thing about starting 2008, that I did about 2007 at this time last year. It should be another exciting and rewarding year for Sigma-Aldrich. I am confident that our current initiatives are on track and that they should enable us to meet our organic sales growth and earnings per share goals. And I'll look forward to updating you on our progress towards doing so each quarter.

Before turning it over to Kirk, I want to thank you for you ongoing interest in our company. Our company remains strong, our Life Science and High Technology and customer focus is clear. In times of economic uncertainty we are fortunate to have the legacy of broad and deep scientific knowledge and loyal customers, to be extremely diverse in the customer segments and markets we serve, to be overly dependent on no single customer or product, to be truly global with well over half of sales spread across 160 countries outside the United States, and to have the confidence that comes from having performed well, even in the tough times as recent as the last economic downturn in 2002.

As we have said on many occasions, while not recession immune, we believe we are definitely recession resistant. We have positioned for whatever rates large amount enough to have the financial strength and borrowing capacity to exploit opportunities, yet small enough to react quickly to changes in the underlying markets we serve.

With that commentary on the year to come, I will now ask Kirk to say a bit more about our fourth quarter results. Kirk?

Kirk Richter

Thanks Jai. As we reported in yesterday's release our sales in the fourth quarter set a record from two perspectives. Total sales of $532.1 million in Q4 reached to new quarterly high, beating the prior record achieved just two quarters ago by more than $24 million, and Q4 percentage growth of 14.6% was our best quarterly performance in 2007.

All four of our business units contributed to this growth in Q4 with Research Essentials largely matching its 2007 quarterly high in reported sales and Research Specialties, Research Biotech and SAFC each achieving a new individual high in reported quarterly sales. Our three research base units deliver just what we expected they would, and three of the four product areas within SAFC did that as well. Our sales of our Biosciences products reflected the always unpredictable and variable nature of quarterly sales of industrial cell culture products.

Overall, organic sales growth was 5.5% in the fourth quarter, about $7 million shy of the 7% organic growth we had hoped for when we talked to you one quarter ago. After achieving that 7% organic growth for the first nine months of 2007, our Q4 performance resulted in an overall organic growth rate of 6.5% for the full year because Q4 was our strongest sales quarter of the year and compared to a very tough comparable for sales performance in Q4, 2006. We retain our optimism about our ability to hit 7% organic growth in 2008. You'll hear more about this from Mike.

Currency benefits added 6.8 percentage points to Q4 growth, a little more than previously expected. And our February 2007 acquisition of Epichem contributed another 2.3 percentage points to our Q4 growth, with highest single digit growth in this business over pre-acquisition levels under Sigma-Aldrich ownership during 2007.

Details of the Q4 increase for each business unit were included in yesterday's release, so I'll refer you to that release for the organic, currency and acquisition components of growth and some of the reasons for that growth for each of them. But I do want to highlight just a few of the more encouraging items that give us optimism about our ability to achieve our 2008 sales growth expectations.

Our two core research businesses, Research Essentials and Research Specialties again performed at better than expected levels in Q4. This is the third successive quarter of above target performance for Research Essentials, and the sixth consecutive quarter of exceeding long-term growth goals for Research Specialties.

Our data indicates that there's been no major change in these two markets. The coordination of sales efforts for these units to deliver a total customer solution for [Lab basics] and the most commonly used analytical, organic chemical, and bio chemical reagents contributed to the above targeted growth for each unit. Demand from the major commercial sectors, pharmaceutical and biotech remained strong, consistent with our experience in the earlier quarters of the year. And sales to academic customers particularly in the US and Europe largely continued the improvement and experience in the second and third quarters of 2007.

We continue to see benefits from our efforts in capital markets where we've consciously increased our inventory to improve service and developed new third party supplier relationships to drive increased sales. In Research Biotech, organic growth for Q4 were 4.4% combined with the 7.2% organic growth for Q3, enabled us to achieve our earlier prediction for improved growth at the 6% level over the second half of 2007, far better than results achieved during the first half. But what may not be evident from what we reported is that Q4 was not only Research Biotech's best quarter in 2007 for reported dollar sales, but also it's best 2007 quarter in constant currency sales dollar as well.

Demand from the molecular biology and peptide products remained robust, helped at least impart by our increased sales efforts in the field, and through internet marketing tools like the Q2 addition of our "Your Favorite Gene" internet search tool that continue to draw over 6000 visits a month. In a more recent partnership with Ingenuity Inc., adds a new dimension to biological information searches with links to our enabling biotech research products.

It's worth repeating that SAFC had a new quarterly high in sales at $155.7 million. Strong demand for our custom pharmaceutical products continued, but was somewhat offset by lower unit prices and reduced demand for industrial cell culture products, as large cell culture orders were either deferred to later quarters or did not repeat. We remained encouraged by the strong level of SAFCs booked orders for future delivery. Still new record highs, giving us confidence about our opportunities in 2008.

Moving now to profits; we are obviously pleased that our new record of $0.64 diluted EPS for Q4 represented a quarterly increase of 20.8%, our strongest quarterly gain in 2007, and enabled us to deliver EPS at the high-end of our forecast range for the full year. Operating and pretax margins in Q4, 2007 were 22.2% and 21.3% of sales respectively, an improvement over the comparable margins in last year's fourth quarter of 21.4% and 20.1% respectively. The factors contributing to the improved margin in this year's Q4 over last year were mentioned in yesterday’s release, so I won’t repeat them today.

More importantly, our improved performance in the second half of 2007 enabled us to deliver improved operating and pretax margins for the full year 2007, giving us confidence about our ability to continue that improvement as we enter 2008. We had a number of favorable factors that contributed to our [last] quarterly effective tax rate in 2007 at 25.1% for Q4, which as we look at it was about $0.01 to $0.02 better than our earlier expectation. That said, it was hard to overcome the benefit realized in Q4, 2006, when the U.S. government had reinstated the R&D tax credit for 2006 in that year's final quarter, enabling us to record the full benefit in Q4, 2006.

Let me now ask Mike to comment on our 2008 sales growth and EPS expectation. Mike?

Mike Hogan

Thanks Kirk. As Jai indicated earlier, we fully expect to achieve our 7% organic sales growth goal for 2008. And he has already given our view that current economic forecast aren't expected to have a significant impact on our business. That said, quarterly results are likely to vary at that throughout the year. With Q1 having a small carryover benefits from the February 2007 Epichem acquisition, and all quarters potentially effected by the traditionally lumpy nature of our SAFC business.

[And we ask] that troublesome holiday timing issue between the first and second quarters will return in 2008, making determinations about performance in those early quarters somewhat subjective as we all wait to see what the smoothed out first half results will be. We expect an overall currency benefit of about 3% for all of 2008 if rates just stay at 12/31/07 level. But that too will vary by quarter.

At year end rates the currency benefit will decline sequentially across the quarter, with Q4 expected to have very little benefit. Summing this all up, we expect overall recorded sales for us for 2008 to be approximately 10%, with upside potential dependant on the success of our efforts to make additional strategic acquisition and to add new technology through partnerships, licenses and other collaborative arrangements.

Let me now turn to our forecast of business unit results to support that 7% organic growth goal. Our two core research businesses, Research Essential and Research Specialties, they collectively provided 56% of last year's sales, are again expected to take market share with organic growth of 4%-5% for Essentials, which would meet if not beat its 4% long term growth goal, and Specialties seeking to build on its quarterly string of above target growth, with an increase in the 7% to 8% range for all of this current year.

Research Biotech is expected to improve on its 2007 performance, and to achieve 7% to 8% organic growth this year, continuing its momentum towards reaching its long-term organic growth goal of 10%. After achieving 6% organic growth over the second half of 2007, we're comfortable that this 7% to 8% gain is a reasonable expectation.

A carry over benefit from increased sales efforts launched in 2007 should make a contribution. And we've continued to add new and innovative products with recent addition such as the new microRNA Isolation kits to expand our MISSION RNAi portfolio, our new siRNA Transfection System, and a new line of Proteomics Standards over just the last few months.

In addition to new products we've added new catalogue and web search capabilities, seeking to build on this success of search tools like your favorite gene, Antibody Explorer and PathFinder. New information sources included in antibodies catalogue and Ion Channel Solutions brochure and Ion Channel website, and we plan even more for 2008.

SAFC is expected to have another strong year in 2008, with organic growth in the 8% to 9% range. Having just posted its strongest quarter ever with record sales of almost a $156 million, we are optimistic about our ability to hit this growth target in 2008. Our booked orders for future delivery at 12/31/07 remains relatively unchanged from the record level at the end of Q3. And the expanded capacity added later in 2007 by increasing production to a 24x7 schedule will be complimented by additional capacity for solid-state research services that will come online in the first quarter of 2008. With even more capacity scheduled to be available in 2009. We've also expanded our flavors and fragrances offering with Halal-certified food-grade flavor.

So, we are optimistic about our ability to improve on 2007's growth and to set even more new records for SAFC sales in 2008. These sales growth expectations and an assumption that currency rates will remains at 12/31/07 level, coupled with a modest contribution from the supply chain initiative we launched in mid 2007, and other margin improvement activity to try pretax profit gains at a faster pace in sales should all enable us to post a small improvement on the 21.5% pretax margin we have achieved in 2007. That's the good news. But on the flip side our effective tax rate is likely to rise from 2007, 28.9% to a range of 30% to 32% for 2008, with higher international factors and the absence of the U.S. R&D tax credit in 2008, the primary reasons for the increase at the high end of that range.

We've had lower statutory tax rate in Germany, in the UK, and in the Italy. But that won't be sufficient to offset the larger 2007 benefit received from changes in our international organization. And while there is some indication that the U.S. government will extend the R&D tax credit for 2008, that hasn't occurred to date and thus can't be and hasn't been reflected in our earnings guidance at this time.

Finally, we expect a modest contribution to EPS from our share repurchase activity. For 2008, it's likely we will at least match the 4 million shares we bought in 2007. At current prices it may well be such an attractive buy that we'll consider taking advantage of that, and we have the cash and the borrowing capacity to do just that. We expect 2008 will improve on the $419 million in cash provided by operations last year, so stay tuned.

Considering all of these factors, our diluted EPS guidance for 2008 ranges from $2.52 to $2.62, representing a 7.7% to 12% increase over the $2.34 reported for 2007. We are optimistic about our opportunities in 2008, and we are committed to delivering these results.

On behalf of Jai, Kirk and all of our 79,000 colleagues around the world, I want to thank you for joining us today and for your continued interest in our company. These are exciting times in Life Science and High Technology at Sigma-Aldrich, two billion strong and getting stronger.

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

Question-and-Answer Session

Operator

(Operator Instructions). Your first question comes from Steven Nissan with Mindflow Capital.

Steven Nissan - Mindflow Capital

Yeah, thank you very much, Jai and Mike, and everyone on the call thanks for always being so [optimistic] that obviously you guys are riding in for the job. Couple of things, can you give us some more color on your bringing in Six Sigma initiatives revolving around your operational excellence programs and how you expect to see better output into your plants?

Jai Nagarkatti

I think -- this is Jai. In Sigma-Aldrich we have always prided ourselves in doing continues improvement in everything that we do. And history has shown that we have taken costs out of various aspects of our business. Last year when we found especially in our plants that our lead times were getting longer, we decided that we needed to expand our 24/7 operation. And then as we do that leveraging our capabilities and sourcing and technical expertise, even looking at processes and the capabilities that we have a different locations, we leverage that to continually improve our operations, reduce cost, so that it can flow to the bottom line.

Steven Nissan - Mindflow Capital

What metrics are you guys using in your manufacturing process to measure this against your peers? Are you at [Rhona], [OE] what is important to you guys to make sure that you stay number one in the industry.

Mike Hogan

So the answer is we look at lots of different measures whether they are return on net assets as you suggest or return on capital. Much of the work that Jai is talking about is simply keeping up with customer demand. A lot of the process improvement activities last year in SAFC were aimed not so much at cost take-out, as they were at just being able to put more through the existing assets which of course is very helpful to things like [Rhona].

And my memory is that there were between 15 and 20 separate initiatives that were aimed at de-bottlenecking certain parts of processes which limited our ability to put product out on the street. As Jai mentioned, we went to 24/7 shift at some places where we've been 24/5 or even 16/5. And so that activity continues through this year. The good news in that is demand is strong enough that we're required to go to extreme measure to meet it.

Steven Nissan - Mindflow Capital

What constraints are you guys still seeing in your plants still and obviously your demand is outstanding. How are you guys synchronizing orders, on (inaudible) capacity to make sure your constraints remind you to provide your customers with the right product, at right time, at the right place.

Jai Nagarkatti

I think basically again it's the combination of utilizing your plant, making sure that your suppliers provide products to your qualified suppliers and your own raw material inventories. So you can balance all three against the commitments that we have made with the customers. Especially the fact that we are geographically, fairly well spread out, that presents worldwide to kind of move products and the capabilities at different plants.

Steven Nissan - Mindflow Capital

Are there certain plants in different parts of the world, that you have concern with, like in the Asia Pac region or what do you say in certain parts of the world that your biggest concerns are?

Jai Nagarkatti

Right now I think our plants in Asia, really we haven’t -- beside the laboratory facility in Bangalore, most of our facilities are in the US or in Europe. Having said that, we have a plan to expand manufacturing in China that will come on-stream in next couple of years.

Steven Nissan - Mindflow Capital

And final question going forward, I really like (inaudible) as we go into 2008 you guys obviously are having a ball. What other systems and solutions do you plan on putting in place to accelerate these great continuous improvement initiatives? You have to make sure a year from now, if you're looking to come back to us and say, we had great results again. Are we continuing on our momentum?

Mike Hogan

So we believe history is probably the best guide of how we are likely to do in the coming year. We've got a record over the last seven years of exceeding $15 million in process improvement savings from literally hundreds of projects put in place by every manager at Sigma-Aldrich around the world. And our expectation is we will do that again, through what we consider to be low hanging fruit or small systems changes.

On top of that, as we announced last year, we've got a four to five year project which has some fairly fundamental changes in the way we manage our supply chain. That team is in place, people are working on the systems and process changes required to deliver the kinds of savings that we talked about last year and that Jai alluded to this morning in his comments, which is to get 150 basis point improvement in pretax margin by 2012 not a small change in that their relative profitability of the company.

Those efforts are on track and in fact as you heard Kirk say we expect to see some modest benefits from that in late 2008 slightly ahead of the schedule we announced last year.

Steven Nissan - Mindflow Capital

Okay. Thank you very much. Continue success for remainder of '08.

Mike Hogan

Thank you.

Operator

Your next question comes from Jon Wood with Banc of America.

Jon Wood - Bank of America

Okay. Thanks. Kirk or Mike could you give us a sense of the local currency sales growth of the cell culture business in 2007?

Kirk Richter

I think what we are seeing on the research side is a nominal increase in that business where we are seeing a big difference, and is more a pricing factor on the industrial side as the prices comes down pretty significantly from a volume standpoint. In industrially we had our best quarter in the fourth quarter of 2007. So, that gives us some of our optimism about 2008.

Jon Wood - Bank of America

So, is the pricing you talked about is that the cell business or I mean it seems as if the media side of things is pretty robust from a pricing stand point.

Mike Hogan

Media is doing very well, it just continues to be that FBS cell culture business that we are referring to. And as Kirk mentioned demand continues to be strong the pricing is a best (inaudible).

Jon Wood - Bank of America

Okay. Do you expect the rate of the industrial cell culture business to accelerate or decelerate in 2008? I mean what have you built into your plans for SAFC in ’08?

Jai Nagarkatti

This is Jai. I think as you very well know in the industrial cell culture business there are two parts. There are the large orders, where we sit down with our customers and talk and understand and estimate their demands. And then, we also have what I call the development projects and the intermediate and smaller scale media projects. Both of these had to be looked differently and we have built a modest, a very modest increase in the overall media portion of the cell culture business. But we are fairly optimistic about growing the large, the many development projects that we have in the pipeline in 2008.

Jon Wood - Bank of America

Okay. Is that business still about third of the SAFC?

Kirk Richter

Yeah, it's in the low to mid 20s, yeah.

Jon Wood - Bank of America

Low to mid-20s, okay. You disclosed 33%, I think in your last Investor Day, is that just acquisitions coming in that skews it?

Kirk Richter

There's been tremendous growth in parts of SAFC that are not in pharma, other than this business in High Tech, which included an acquisition of a fairly sizable company. In our supply solutions business which was 40% of the total last year, that's the same quantities or larger quantities of same stuff we sell in our Research business largely.

We've had really good success in others parts of the business. So those ratios are changing, and when we hold our shareholder day this year, we will go into that in a bit more detail.

Jon Wood - Bank of America

Okay. And then one more, how big is the current sales force in the Biotech division, do you have any plans to add additional bodies in ’08? Thank you.

Mike Hogan

Yeah, we added a few and I think there will be small incremental adds. We probably overall in our sales force added something in the 20 to 25 range during 2007, and I would say those were certainly Biotech got more than their fair share of that as we continue to push the product line because, as you know Jon there is much more consultation that goes on with the Biotech piece so remindful of that as we add more sales folks.

Jon Wood - Bank of America

Any update on the size of the Biotech sales force at this point?

Mike Hogan

It's running at about in the 70s.

Jon Wood - Bank of America

Okay. Thanks a lot.

Operator

Your next question comes from Quintin Lai with Robert W. Baird.

Quintin Lai - Robert W. Baird

Hi, good morning.

Kirk Richter

Good morning Quintin.

Quintin Lai - Robert W. Baird

Thanks for giving all that information and outlook for 2008. As we look at the fourth quarter, gross margins were a little lighter than what we were expecting despite having lots of FX. Is that an impact of mix in SAFC or could you give a little bit color of that and kind of expectations in '08?

Kirk Richter

Sure, I think as we alluded to in the release some of that is the Epichem business certainly some of that is SAFC. The other thing you have to remember about FX is that doesn't all come through necessarily in the current quarter, because between international and domestic we've got anywhere between 3 to 4 up to our average of seven months of inventory. So a lot of that FX effect doesn't necessarily come in the current quarter. So --

Mike Hogan

And with regard to 2008 expectations as Quint you know us pretty well we have including in SAFC we've got at least 15 projects I am aware of to work on margin improvement through process improvement. And as we mentioned in cost improvement in general much of which goes on at that level in our income statement at the manufacturer and distribution level.

We literally got hundreds of small assets underway all around the world. The supply chain changes which will take a bit longer that should also have a pretty good impact there as well.

Quintin Lai - Robert W. Baird

And then just follow-up on that, the SAFC [sub sold], does the – may be a little bit lower gross margin for some of that business been net out to better operating margin because you don't need as much G&A or sales and marketing with those large orders.

Mike Hogan

We manage the whole income statement, and yes the fundamentals in the SAFC business had a higher costs or cost to goods sold, because they were sold in larger quantities to much larger customers, and they have a lower SG&A component than our research business does and at the end of the day those two kind of offset.

Quintin Lai - Robert W. Baird

Thanks. And then Jai with respect to the capital markets you kind of mentioned talking about increased stocking. How do you manage that with respect to growth and opportunities to take market share? Is that something that you have to build ahead of anticipated demand or do you tend to be lagging the demand?

Jai Nagarkatti

I think again it all starts with consultation with the customer, because if you look at what's happening in our capital markets, especially let's take China and India for example. Most of the work that is being done there is CROs who are doing the work for the various large and small pharma companies. So what happens there is, they are focused more on our ability to get products to them very, very quickly.

In fact when I go and talk to these guys, they are not as concerned about stocking the their site or from Germany or they want product fast. In fact they want product just like we supply products in the U.S. and in Europe to our customers. So, they are willing to share with us the demand, sometimes even the information on the projects that they are working on. So if there is a lot of trust issue here where large pharma, their contract organization, and Sigma-Aldrich in advance know the material that is needed and that helps us in the planning and stocking of the product that we keep there.

Quintin Lai - Robert W. Baird

And follow-up and I will go back in the queue. Because of that ability to see some of that demand flow from the CROs, is it possible to make a stab at, is it just general funding moving from pharma to CROs and is it kind of a net-net big pharma doesn’t spend as much and CROs do it. How do you kind of look at that as you then roll it all up to the overall end market demand?

Mike Hogan

Yeah, when it comes to the product that we supply Quintin we don't see that. Now the labor saving cost may be in these other countries in terms of efforts thrown at using our stuff but we are not seeing pressure on our pricing for material provided. One of the fundamental strength of Sigma-Aldrich is that over 60% of our sales are outside the United States. And in some of these countries where people are now moving as if they just discovered them, we have literally been doing business for decades. And so we had infrastructure in place to support movement of work for our largest pharma customers from Europe and the United States into India and into China. And the good news is we got great relationship with these large customers, so they are now more open to sharing with us their plans for the future and it gives us the ability to stock in anticipation of those much more accurately. You can see that in the fact that we are consciously building in those countries and we had our months on hand came down from 7.6 to 7.4 months.

Quintin Lai - Robert W. Baird

Great. Thank you.

Operator

Your next question comes from Derik De Bruin with UBS.

Derik De Bruin - UBS

Hi. Most of my questions has been answered. So just couple of housekeeping. What are you planning to do with the dividend, are you going to keep it as or whether you are planning to increase it?

Mike Hogan

Yeah. We announced the dividend increase in the $0.13 a share from $0.11 a share. That is roughly a 20% in net payout rate or roughly a 1% yield. That’s from all of the work that we've done on the advise that we had from outside third parties, that's an appropriate level of dividend in today’s tax and competitive environment.

Of course the dividend is going to depend on whether there other opportunities are to do what with cash, and our borrowing capabilities and all of that. But, I have to try, I think it's our Board, met yesterday, they were actually just reflecting back that they don't know many companies that can make the claim that we have made, that this is our 32nd consecutive dividend increase. 33 years of growth in earnings but our 32nd consecutive year of dividend increase and it's our intent to kind of stay at these levels.

Derik De Bruin – UBS

Great. Where should we go next?. And when you look at your R&D, it hovering around 3% of sales. Is that an appropriate level for the company?

Jai Nagarkatti

This is Jai. I think we have historically spent between that level 2.8% to 3% and I think we intend to keep it that way.

Derik De Bruin – UBS

Okay. I guess could you – you're very, very involved in certainly in Asia and it looks to me like there is an enormous life sciences market that's building there, I guess. Could you talk look at the potential for the Asian market between China for life science's research, I guess the equivalents of potentially building in Chinese and NIH for example, I guess, could you give us a feel for just in the magnitude what you see is the potential in China?

Jai Nagarkatti

I think, what would tell you is the magnitude or the potential, I think that is such a growing market, that estimates if you listen to people they would say that looking forward to 10 to 15 years it should be very comparable to some of the top countries, which involve and engage in research. Today even though the growth we see there is very large over 30%, relative to let say the top five countries where we do business, it is still fairly small.

Kirk Richter

To just draw your attention one other thing when we think of Asia, we think it of it for life science but we also think of it for high technology and there is tremendous growth in these countries we just mentioned but also places like Korea and Singapore for material science and other things, which you see more reflecting in our SAFC business particularly in things like our Epichem business. And so we see those markets has tremendous opportunities for years to come.

Derik De Bruin - UBS

Great, and just one final question I guess the stock option expense level still around $0.02 per share.

Mike Hogan

They are inching up.

Derik De Bruin - UBS

Okay. Great, thank you.

Mike Hogan

You bet.

Operator

Your next question comes from [Douglas Charlie] with KeyBanc.

Douglas Charlie - KeyBanc

Good morning.

Mike Hogan

Hi Doug.

Douglas Charlie - KeyBanc

First question, just more of a general to get some comments. Can you comment on any trends you have been seeing in outsourcing by pharmaceutical companies, do you expect this to provide a tailwind in 2008 for the SAFC business?

Jai Nagarkatti

I think what we are seeing in thus far, both for the large end intermediate pharma companies is definitely outsourcing is exactly what we predicted, upfront was for discovery, to greater extent outsourcing going to CROs in the far east, CAPLA countries.

And projects, in terms of Phase I, Phase II taking them through that coming to more reputed, reliable people who can deliver and that's where SAFC has been the beneficiary.

I think that trend is going to continue as more and pharma companies want to not to only utilize their capacity but also want to accelerate, getting their products to their pipeline faster.

Douglas Charlie - KeyBanc

Okay, thank you. A second question. SAFC organic growth came in a little bit later in the fourth quarter and kind of relative to what you have been seeing in these last couple of quarters. And you did comment that booked orders remained at a near record levels. Is there any way to quantify may be, some of the impact that timing of orders being pushed back in the Q1 math and on your organic growth rate.

Jai Nagarkatti

No, I think the first, as Mike must have mentioned earlier, I think even though the growth rate in the fourth quarter for SAFC that was not as robust. They are going against a very high strong fourth quarter of 2006. Having said that it was still I reckon in terms of the sales that we achieved in the fourth quarter.

The booked order backlog continues to be at the all time record levels that we have seen in the past. And now that we have not pushed any of the orders into first quarter this year.

Douglas Charlie - KeyBanc

Okay, thank you. That answers all my questions.

Operator

Your next question comes from John Roberts with Buckingham Research.

John Roberts - Buckingham Research

Good morning, guys.

Mike Hogan

Good morning John.

John Roberts - Buckingham Research

Web based orders as a percent sales looks like it's peaking near 40%. I think it's been slowly drifting up 1% every quarter or two. And even though the drop another 1% I think its first time in recent memory that its dropped at all. Is that affected by the regional mix as you grow the emerging markets or do you think there is some structural limitation here on how it can go because of the demographics of the customer market?

Kirk Richter

Yes. So, we can give because we think it's been 40 consistently. We hit 40 earlier in the year and pretty much stayed steady at 40. As Jai shared we believe it will be 42% in 2008. And so we continue to think it will creep up somewhat more slowly. When we began this way back in 1998 or 1999 we positioned it by saying that, kind of the wild eyed optimist thought that at some point 50% of our sales will comes through this medium. And at [Bloomberg] the customers thought it would be 25% and we thought that truth was someplace in the middle. We continue to think 50%, 60% of our sales will come through this method.

There are lots of built in initial things that keep it from going up to a level higher than that. Control system within purchasing organization, the fact that some of our orders come to us electronically but not through the internet through linkages with some of our larger customers. The lack of computers in some our markets that we were in, more people are ordering. And so we believe this is the catalogue of the future.

If we are going to make sure we maintain the best website of our industry and to the extent that they adopt faster than we think will be prepared for them, we spent fair amounts of money last year with IBM making sure that we have the architecture and the structure for our site that allows us to have just tons of data and useful design to have and also can handle amazing amount of volumes

And then as we share in the some of the exciting stuff that we are doing on the web, things like your favorite jean wear, people won't have to come in looking for a product, they’ll come in looking for a research area, and they can find whatever they would like to discuss, any kind of connection to that all, the response to that has been very strong and so, who knows that may help us to inch it up of faster than we think, John.

John Roberts -Buckingham Research

Follow-up, this is early days, kind of trend nowadays, personal genetics companies, the 23andMe and the deCODEme, as they move towards full sequencing of a person genetics in this kind of retail model if you will, for knowing your genome, will they become material consumers of reagent chemicals and so forth in their processes?

Jai Nagarkatti

I think that anybody who is involved in any of these type of work they would have absolutely need of those tools and with the broadest selection tools that we offer and the products that we continue to add 2000 too 3000 new ones, certainly is an opportunity for us to service that growing market as well. The answer to your question is yes.

John Roberts -Buckingham Research

Thank you.

Operator

Your next question comes from Dan Leonard with First Analysis.

Dan Leonard - First Analysis

Good morning.

Mike Hogan

Good morning Dan

Kirk Richter

Good morning Dan.

Dan Leonard - First Analysis

Mike, what's your capital budget for 2008?

Mike Hogan

Capital spending?

Dan Leonard - First Analysis

Yeah.

Mike Hogan

It's just over $100 million. This last year, we have probably did spend $80 million to $100 million last year, we had an appetite to spend more than we actually did. There is a limit to how much of this we can do and do well at the same time and so that $105 million includes a few carryover items on some of these very large projects we've announced like the China plant, like the Israel fermentation, expansions in Ireland, and the like. So, the numbers in the budget the $105 million. So $100 million to $110 million, more or less. Certainly well within our ability to fund it and have it turn out to be a good decision.

Dan Leonard - First Analysis

Okay, and I was a bit surprises by your comment that the cash flow from operations in 2008 would exceed the 2007 level just given that the 2007 level was as strong it was. Can you give me any additional detail around on some of the drivers behind that?

Mike Hogan

We've got a couple of things, first of all certainly we expect net income to go out, we are going to continue to chip away if you will, if you will at receivables and inventory. So we'll get a little bit of help from that Receivables was largely flat but we think we might be able to get maybe another day out of that. Continue to make small progress on our inventory MOH. So I think we expect some out that, which will inch it up a bit.

Dan Leonard - First Analysis

Okay. And then finally what EPS impact would reinstatement of the R&D tax credit have?

Mike Hogan

Its worth about a third of the range, so we said 30-32% the R&D tax credit is worth in that a [third to half] and other things that could go good or bad or worst with third to half of the range. So $0.03 to $0.05.

Dan Leonard - First Analysis

But in your forecast you assumed that the R&D tax credit would not be renewed?

Mike Hogan

The high end of the forecast assumes that we get some benefits from it. The low end of the forecast assumes we get nothing from it.

Kirk Richter

We remember 2006 all to well, when it didn’t get past until the fourth quarter so…

Dan Leonard - First Analysis

Okay. Thanks for the clarification.

Kirk Richter

You bet.

Operator

Your next question comes from Dmitry Silversteyn with Longbow Research.

Jonathan Kraft - Longbow Research

Hello this is Jonathan Kraft for Dmitry.

Mike Hogan

Yeah, hi Jon.

Jonathan Kraft - Longbow Research

Just a question regarding the on your Biotech side, you reiterated your long term 10% organic growth and you discussed some means for your 78% growth in 2008, I guess we find that you have some difficulty reaching this 78% growth in 2008. Do you see yourself revisiting that long-term goal and if not what do you see drivers is -- looking down the road, what do you see the drivers being for the 10% organic growth, given that you are going to be going against more difficult comps?

Mike Hogan

Yes, so the answer to the question is, no. We would not have lowered expectations for the long-term growth prospects in that business. All the growth which have been – a business where the pricing has been coming down and volumes have at least been flat, it's sometimes up, sometimes down, is fortunately becoming a smaller and smaller percent of that businesses portfolio and so it's kind of relatively lackluster performances having less and less impact on the total.

Our molecular biology and a number of the newer things that we talked about today and [SH RNA] are all growing nicely, some in the high teens or better and that's where the future lies in that business. It's not going to be in oligos. And so as those things continue to grow at double-digit rate and oligos in terms of small and small part of the total we are comfortable with these growth rates for the total is going to come up.

And there is lots and lots of new developments in that business and we do have number of small technology bit and [majority] interest and our recent venture with [Sangmode] and some small acquisitions we made over the years. We think we are very well positioned to take advantage of those trends.

Jonathan Kraft - Longbow Research

Okay thank you.

Mike Hogan

You bet.

Jonathan Kraft - Longbow Research

And I guess we heard a few of your competitors saying that they are expecting the biotech market to be a bit weaker in the first half of 2008. Are you viewing the same thing?

Mike Hogan

No we are neither hearing nor -- we are listening to our own experience, the daily run rates that, that is true.

Jonathan Kraft - Longbow Research

Okay. And do you expect that you are going to be able to continue getting price increases in your Research Specialties and Essentials?

Mike Hogan

The phrase I think is Pick your self up or get slaughtered. We have intentionally for many years had a practice of not getting greedy on price. We get about 1.5% to 2%, 2.5% on a realized price increases. We believe we have a fair contract in place with our customers, where we passed along essentially cost of living increases, and that could be our intent. We demonstrated the ability to do that for decades and we don't see that changing.

Jonathan Kraft - Longbow Research

Okay. Thank you.

Operator

Your next question comes from John Sullivan with Leerink Swann.

John Sullivan - Leerink Swann

Hey guys. Good morning.

Rick Keffer

Good morning John.

John Sullivan - Leerink Swann

Just a quick follow-up. Mike you said that you expect at least 4 million shares of buyback in 2008, and that's in the outlook. And in 2007 you would buyback around 4 million shares, your net share count looks like it came down a couple of million shares as the remainder just restricted stocks and option and the like?

Mike Hogan

Yes. We are essentially buying back enough to cover exercise options and have a very modest impact. Over the last four or five years there have been quarters when we talked about share buyback ns having had EPS impact. I believe in the fourth quarter it didn’t even come to a penny. I mean it weren’t even remotely close to a penny. So, we are talking about very modest share buyback at the 4 million level. The other comments from today was just, we have continued confidence in the prospectus for the company, and depending on price to market conditions, we might consider either more or less purchase of stock. So, stay tuned.

John Sullivan - Leerink Swann

Thanks very much.

Operator

Your next question comes from Jon Wood with Banc of America.

Jon Wood - Banc of America

Hey thanks. Jai is the M&A pipeline more exciting to you now than it was six months ago?

Jai Nagarkatti

Jon, we are always looking at opportunities. There are certain criteria that we have, that we need have either from technology or get us expanding our footprint in areas where we like to. So, I think it's no different, I mean there is still lots of opportunities, and it is up to identifying and making sure that we get a good deal and meet our criteria.

Jon Wood - Banc of America

Okay. And would you or the Board be adverse to a large transaction something over, let's call 300 million, 400 million in size?

Jai Nagarkatti

I think we'll look at all opportunities.

Jon Wood - Banc of America

Okay, thanks a lot.

Operator

There are no further questions at this time. Gentlemen are there any closing remarks?

Mike Hogan

Yes, there are. So we certainly want to thank everybody for your participation today. Looking into 2008, now we do expect to release results for that first quarter on April 22, and our next conference call is scheduled for April 23, again at 10 o'clock central time. However, before reporting these results and we talked about it earlier, we will be holding a business review at our Life Science and High Tech Center here in St. Louis on March 19. We'd certainly like to invite all of you to join us for that event. If you are unable to join us in person, you can consider doing it over our live webcast. You can check our website for details on joining us either way or is always if it's easier for you, let me give you a phone number which is 314-286-8015 that you can contact us about that event. This concludes today's conference.

Operator

Ladies and gentlemen, thank you very much for dialing in for today conference call. You may now disconnect.

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Source: Sigma-Aldrich Corp. Q4 2007 Earnings Call Transcript
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