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Sigma-Aldrich (NASDAQ:SIAL)

Q2 2012 Earnings Call

July 24, 2012 11:00 am ET

Executives

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

Quintin J. Lai - Associate Director of Research and Senior Research Analyst

Rakesh Sachdev - Chief Executive Officer, President and Director

Analysts

Jonathan P. Groberg - Macquarie Research

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

Peter Lawson - Mizuho Securities USA Inc., Research Division

S. Brandon Couillard - Jefferies & Company, Inc., Research Division

Daniel L. Leonard - Leerink Swann LLC, Research Division

Isaac Ro - Goldman Sachs Group Inc., Research Division

Tracy Marshbanks - First Analysis Securities Corporation, Research Division

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

Derik De Bruin - BofA Merrill Lynch, Research Division

Dmitry Silversteyn - Longbow Research LLC

John E. Roberts - The Buckingham Research Group Incorporated

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

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

Daniel Arias - UBS Investment Bank, Research Division

Operator

Good day, ladies and gentlemen, and welcome to the Sigma-Aldrich Corporation's Second Quarter 2012 Earnings Call. [Operator Instructions] As a reminder, this conference is being recorded. Now I'll turn the conference over to Jan Bertsch, Chief Financial Officer. Please begin.

Jan A. Bertsch

Good morning, and welcome to Sigma-Aldrich's Second Quarter 2012 Earnings Conference Call. With me today are Rakesh Sachdev, our President and CEO; Kirk Richter, our long-time Head of Investor Relations and Treasury; and Quintin Lai, our new Head of Investor Relations and Corporate Communications. Today is Kirk's last earnings call with us. Many of you in the financial community have worked with Kirk for as long as you have known the company. And I want to recognize him for his 34 years of dedicated service. I want to express my deep gratitude for his integral role in Sigma-Aldrich's success for over the past 3 decades and for his friendship. Kirk, we shall miss you and wish you and your family all the best. We also welcome Quintin. Many of you know Quintin from his 10 years on the cell side, and we are happy that he has joined us. Quintin?

Quintin J. Lai

Thank you, Jan. I would also like to add my congratulations and best wishes to Kirk. I'm excited to join Sigma-Aldrich, and I am looking forward to work with all of you on my new role. In today's call, Jan will lead off with a review of our second quarter and first half of 2012 performance. Rakesh will follow with -- that discussion with an update on the activities that contributed to our second quarter results and our updated 2012 outlook. After completing those reviews, 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 annual report on Form 10-K for the year ended December 31, 2011, and in the cautionary statement that is included in today's release and in our slides. 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. That information, which consists of currency and acquisition-adjusted sales growth, operating income and related margins, net income and EPS results on both an adjusted and reported basis and free cash flow reconciled to net cash provided by operating activities is also contained in today's earnings release, which is posted on our website and in the appendix to today's presentation that begins with Slide 13. With that, I'll ask Jan to start with a summary of our second quarter results. Jan?

Jan A. Bertsch

Thank you, Quintin. As reported in today's release, second quarter sales were $664 million, a reported increase of 4% over 2nd quarter 2011. Our organic sales growth, which excludes the impact of changes in foreign currency exchange rates and the benefit of our recent acquisitions was 3%. Our Research and SAFC businesses generated organic sales growth of 1% and 8%, respectively. Acquisitions, primarily BioReliance and Research Organics, added another 6% to overall growth while changes in FX rates reduced the otherwise reportable sales growth by 5%. Our second quarter operating income was $167 million. Net income was $115 million, and reported diluted EPS was $0.94. Our adjusted diluted EPS, which excludes $0.03 of restructuring costs related to some recent office closures was $0.97, a 4% increase from the same period last year. Year-over-year changes in FX caused a $0.04 EPS headwind and excluding this impact, adjusted EPS would have grown 9% to $1.01. Our effective tax rate for the quarter was 31% compared to 29% in the same period last year. The lower tax rate in the second quarter 2011 is primarily attributable to higher international tax benefits as compared to the second quarter of this year. The effective tax rate for 2012 is expected to be approximately 30% to 31% of pretax income and is unchanged from prior guidance. Our second quarter free cash flow was $56 million as compared to $77 million in the same period last year. The lower cash flow was due primarily to the timing of vendor payments. We don't expect this timing to have an impact on the full year. In the second quarter, we returned about $50 million to shareholders in the form of $25 million in dividends and $25 million in share repurchases. For the first 6 months of 2012, we generated an excess of $1.3 billion of sales. The first half overall organic growth rate was 3% and was consistent in both Q1 and Q2. Operating income in the first half was $339 million. Net income was $232 million. First half GAAP diluted EPS was $1.90, and adjusted diluted EPS was $1.96. For the first half of the year, we generated $168 million of free cash flow as compared to $210 million last year. As I mentioned earlier, this first half free cash flow is lower than last year's due primarily to the timing of vendor payments, as well as greater capital spending related to new facilities. For the full year, we expect to generate an excess of $400 million of free cash flow. Rakesh will provide more color when he discusses our second half and full year outlook.

Now let's review our sales performance. First for Research. Quarter 2 organic sales growth was 1%. Organic sales growth for Research in the U.S. and Europe was flat and in Asia-Pacific, Latin America or the APLA region was in the mid-single digits. Acquisitions contributed 2% sales growth, which was more than offset by a 6% FX headwind. We are pleased to report that SAFC had its best quarter ever, with record quarterly sales of $223 million, up 22% from the same period last year. Organic sales growth was 8% and above our expectation of mid-single digit growth. Our recent acquisitions, primarily BioReliance and Research Organics, contributed 18% to sales growth, while changes in FX reduced sales by 4%. For the first 6 months of 2012, organic sales growth was 3% for the company: 2% in Research and 5% in SAFC. While we generated 3% organic sales growth in Q1 and 2, we can we can see that the components of growth were different in each quarter. This slide helps demonstrate Sigma-Aldrich's advantage in having a diverse product portfolio. Quarter-to-quarter, we typically see some initiatives outperforming and offsetting others that are growing less than expected. When looking at Research, we saw better growth in Q1 than Q2. As you look at the slide, most of our product initiatives had positive growth in Q2. In both quarters, analytical sales had strong sales growth led by analytical standards business, and we continue to be pleased with the results of Cerilliant and RTC, which again, outperformed our expectation. Biology grew in both quarters, but growth declined sequentially from Q1 to Q2. The same trend occurred in Chemistry where both quarters saw declines, but Q2 experienced a bigger decline. Both segments were impacted by continued softness in academic spending, but the bigger impact was a decline in Pharma demand. We saw an impact from lab facility closures and consolidations, as some of our Pharma customers are rationalizing their Research footprint. When looking at SAFC, Q2 sales were stronger across all segments than Q1. Hitech sales benefited from increasing sales from our new Taiwan facility, and we expect further acceleration in the back half of the year. Bioscience had a strong Q2 and also as you know, Bioscience had a tougher comp in Q1 due to pre-buying. Custom Pharma had excellent results in Q1 and Q2 and helped drive the outperformance this quarter. Rakesh will go into greater detail on these positive trends and our reaffirmed outlook for low double-digit SAFC organic sales growth in the second half of this year. Geographically, we saw similar growth trends from Q1 to Q2. Overall, North American sales grew in the low single-digits in the first half of the year and grew 3% in Q2, improving on our Q1 performance. Europe also grew low single-digits in the first half of the year and grew 2% in Q2, consistent with first quarter performance. APLA continues to be our leading growth area and grew 6% in Q2. In our focus markets of China, India and Brazil, combined second quarter organic sales growth was 16%, which was better than Q1. But in Japan, growth was more muted in the second quarter relative to the first quarter, but we were pleased with stronger growth with our top dealers as our Dealers as Partners program is showing signs or early traction. Our adjusted operating income margin in the second quarter 2012 was 25.8%, an increase of 40 basis points over the adjusted operating margin in Q2 2011. When we exclude the impact of year-over-year FX changes and the incremental amortization from recent acquisitions, our operating margin would have been 26.4%, an improvement of 100 basis points from last year. In the first half of the year, FX headwinds reduced adjusted EPS by $0.05, with $0.01 in Q1 and $0.04 in Q2. Historically, the way our inventory moves, this is about a 4- to 6-month lag in the full effect on FX and our bottom line. With the deterioration of FX in recent months, we expect to see a bigger impact in the second half, which will be about $0.20 of EPS headwind in the back half of the year. This is the primary reason we are trimming our adjusted EPS guidance for the year. Now I'll ask Rakesh to comment on some of the operating highlights in Q2, as well as our 2012 forecast. Rakesh?

Rakesh Sachdev

Thanks, Jan. Let me start by also thanking Kirk Richter for his 34 years of dedication at Sigma-Aldrich. I wish him all the very best in the years to come. And welcome, Quintin. Now, let's turn to business. Overall, we were pleased with our second quarter results. We generated 3% organic sales growth, same as in the first quarter, with stronger than expected SAFC growth. We generated $664 million in total sales, near our all-time record results achieved in the first quarter despite incremental FX headwinds. We estimate that since our last earnings call in April, changes in FX caused headwinds of $11 million in overall second quarter sales and $0.01 in adjusted EPS. If these rates would have been steady from our last earnings call, our results would have been $675 million in sales and an adjusted EPS of $0.98.

Looking at our business units, we were very pleased with the strong 8% organic sales growth generated by SAFC during the second quarter. All geographies and all segments contributed positively during the quarter. We had strong sales of custom-manufactured high-potency compounds to Pharma customers. As you know, we invested in capacity in this unique manufacturing capability in Wisconsin and are pleased to see the investments are being recognized by our customers, which has resulted in double-digit growth. We expect to continue to drive growth of high-potency compounds through enhanced customer intimacy and tailored solutions, specifically for our top customers.

SAFC Hitech benefited from capacity at our new Taiwan facility, where we are producing chemical precursors for the LED and semiconductor industry. As a reminder, last year, the LED market was capacity-constrained, causing prices to move substantially higher. As we and other manufacturers have brought on new capacity, as expected, prices have come down. However, we stand to benefit from the mix of higher volumes even at lower unit prices. We have good visibility into our order book and remain comfortable with our outlook of accelerated sales growth for Hitech in the second half of the year.

We continue to be on track with our integration of BioReliance. The teams are focused on providing superior customer service and increasing profitability. Sales growth for BioReliance has been flat year-to-date, largely due to timing of customer orders in the U.S. But as we mentioned on our last call, we expect to see higher sales in the back half of this year. BioReliance had its strongest month of the year in June, and we have good order visibility into higher sales in the second half. BioReliance is playing an important role as we continue to position our company to benefit from the ongoing growth of Biologics. And additionally, we are reaffirming our full year EPS accretion from recent acquisitions of $0.05 to $0.07.

While SAFC results were better-than-expected, organic sales growth in our Research business was 1% and at the low end of our previous guidance of low to mid-single digits. We saw slowdowns at some of our big Pharma accounts from site consolidations and facility rationalizations. While academic demand remains soft, we are seeing stable low single-digit organic sales growth. We continue to do well with our products sold into applied markets. We have been increasing our presence in the clinical, forensics and environmental testing markets, and this has resulted in Q2 double-digit organic sales growth in our analytical products used in these applied labs. In a relatively soft Research environment, we continue to believe that it is even more important than ever to innovate and provide leading edge products to our customers. We continue to expand our zinc finger franchise, with a gene editing suite targeted for this area. We have recently introduced more rat knockout models for immunology and inflammation studies in fields such as asthma, multiple sclerosis and rheumatoid arthritis, and our proteomics portfolio has surpassed the 60,000 mark for antibodies.

Now let's turn to our outlook for the second half of the year. We know the industry faces macroeconomic headwinds, but we see several positive growth trends for Sigma-Aldrich and we expect to post higher organic sales growth in the second half of the year than in the first half. We expect macroeconomic pressures will continue to create uncertainties for our customers. Most likely, the question surrounding U.S. academic funding won't get more visibility until after the November elections. Organic sales growth to academic customers in the first half of the year was in the low single-digits, and we think it is prudent to assume similar growth rates for the back half of this year. We also expect Pharma demand in Research to remain soft in the second half of the year due to the issues we just discussed. Based on current rates, we expect FX to reduce full year sales by 4% and negatively impact our EPS by $0.25. This EPS headwind is higher than our prior guidance of $0.10. Despite these headwinds, we remain optimistic that some of our initiatives will drive higher organic sales growth in the back half of this year.

SAFC had a strong second quarter, and we reaffirmed low double-digit growth in the second half of this year with contributions from Bioscience and Hitech expected to lead the way. Our backlog remains robust and grew double digits from June 30, 2011. Emerging markets in Asia Pacific and Latin America are again expected to lead growth for us. China and India grew double digits for us in the second quarter. We have seen a slight softening of Research sales in China but continue to see strong growth in our SAFC Supply Solutions business aimed at applied markets and chemical industrial segments in that country. Supply Solutions makes up about 30% of our China business.

And finally, our cash flow and solid financial position enables us to consider a variety of capital deployment strategies, including acquisitions and share repurchases. Our business development teams continue to identify and evaluate such opportunities.

Now let me wrap up with a review of our expectations for the year. We are revising our full year 2012 guidance for organic sales growth and adjusted EPS. For sales, we now expect full year organic sales growth to be low- to mid-single digits versus our prior guidance of mid-single digits. Based on our second quarter performance, we think we have been prudent in guiding Research sales to grow organically in the low-single digits for the second half, similar to what we experienced in the first half. We are reaffirming our expectations for SAFC to grow organically in the low double-digits in the second half. We are revising our prior full year adjusted EPS guidance of $3.90 to $4.05 by $0.10 to $0.15 to a new range of $3.80 to $3.90. We estimate that incremental FX headwinds, since our last call, are likely to lower EPS by about an additional $0.15 for the full year. We also expect lower Research sales to impact our bottom line by about $0.08. But we have implemented cost control programs that should more than offset the EPS impact from the lower expected Research sales. We estimate these cost savings should provide a positive $0.08 to $0.13 impact in the back half of this year.

We are being very thoughtful on how we manage our cost and headcount during these times. Part of these cost savings are from consolidations of offices and facilities and consolidations of positions that will not affect our initiatives to drive future growth. For 2012, we expect to generate an excess of $400 million in free cash flow as compared to our prior guidance of $425 million. Our revised outlook includes the cost of restructuring. We reaffirm our guidance of $125 million in CapEx to support our long-term initiatives. We continue to frequently monitor market conditions and if we see additional changes we have additional levers to use as offsets, and our management team remains prepared to take further actions if necessary. Our entire Sigma-Aldrich team is committed to achieving these results, and I look forward to updating you on our progress in the next conference call. Again, I want to thank you for your support and ongoing interest in our company. And on behalf of the worldwide Sigma-Aldrich organization, I thank you for joining us today. And now, let's open up the call for your comments and questions.

Question-and-Answer Session

Operator

[Operator Instructions] First question is from Jon Groberg of Macquarie Capital.

Jonathan P. Groberg - Macquarie Research

I'll offer my congratulations to Kirk and also welcome Quentin. So if we can -- I mean, obviously, can you maybe just start off, Rakesh, on the outlook again a little bit because it sounds like, you can correct me if I'm wrong, I know there's a lot of different ways to slice the business but it sounds like Research, you now expect low-single, no real change to SAFC from what you were forecasting before and it sounds like most of that delta from first half to second half is driven by the Hitech business, that Taiwan plant coming online, so can you maybe help...

Rakesh Sachdev

You mean in SAFC?

Jonathan P. Groberg - Macquarie Research

In SAFC, yes. So can you maybe just help us understand, given your comments around China and just given the uncertainty, I guess, on the macro and the pricing dynamics you mentioned there. Just help us get comfort around that Hitech business really being able to drive that growth in the second half.

Rakesh Sachdev

Sure. So first of all, yes, again, the only change that we have made on our guidance is we are expecting Research to be a little softer than what we said a quarter ago, and so we're saying we probably expect Research to perform similarly as we did in the first half. Now on SAFC, really the strength is coming not just from Hitech, the strength is also coming from Bioscience. Bioscience did not grow in Q1. It grew slightly in Q2 but it has, I think, tremendous tailwind in Q3 and Q4. So we are going to see a very strong growth in our Bioscience business in the second half of this year. We're also going to see a very strong growth in Hitech, and we are pretty comfortable. We started the shipments from our Taiwan facility in the second quarter. We have decent visibility in the growth. As I said, pricing has come down. We expected pricing to come down as the capacity was put in place, that was in our plans. But so far, everything that we see, Bioscience and Hitech will be strong growth drivers of our SAFC business in the second half. In our Pharma business, the contract Pharma business, had just a terrific quarter in Q2. This is where we are doing our high-potency compounds for our customers. That business grew almost 40% in Q2 after growing double digits in [indiscernible]. So we are seeing strong growth. I expect the Pharma business to also post very strong growth in Q3. So across the board, it's the type of businesses we are in, frankly, that is causing SAFC to grow so strongly. Also our Supply Solutions business, which is part of SAFC, grew stronger in Q2 than Q1, and we expect that growth to be even stronger in the second half. So overall, we're pretty encouraged about what's happening in SAFC.

Jonathan P. Groberg - Macquarie Research

That's helpful If I could just one more, on the restructuring and the Research, can you maybe just give a little bit more detail about what you're doing there to restructure?

Rakesh Sachdev

Yes. So on the restructuring, we have announced certain closures of some sales offices in Europe. We are actually consolidating into a few of the larger countries. We have consolidated certain positions that's allowing us to reduce our headcount over the course of this year and that's, I would say, probably half of the cost reductions are through headcount reductions and office closures. The other half is probably some of the spending that, especially around consulting and other stuff, that we will take down through the balance of this year. In terms of what we can expect, what will be recurring as we go forward, clearly, we would see at least half of that to stay with us recurring as we go out into the future years.

Operator

Your next question is from Tycho Peterson of JPMorgan.

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

My congrats to Kirk as well. Maybe just to start off with one for Jan, I'm just wondering if you could talk a little bit about your priorities as CFO and if you see any changes maybe to things like the hedging strategy. I know the company's also talked about getting the tax rate down about 200 basis points. So can you talk about some of your initiatives?

Jan A. Bertsch

Sure. I think, Peter, clearly one of our strongest initiatives for the finance group as total is really supporting the business and our strategy as we go forward and profitably grow the company. I think on the FX side, I had mentioned previously, when I came into the company that one of my focuses would be on working here to try to make sure that we put an appropriate hedging strategy in place where we can try to mitigate some of the risk associated with profitability and we're moving down that path, I think, in a very solid direction. We've really began focusing on some of the key currencies for the company, which clearly with the euro, the yen, the pound, et cetera, and we are just about to put our pilot program in place here. One of the key items, really, was getting our arms around all the cross-currency implications for the company because it's a pretty complicated structure, and we've spent a lot of time doing that. I think we're on target, and we plan to become more active in that and launch our plan later this year. And then...

Unknown Executive

Tax.

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

Yes. The tax rate.

Jan A. Bertsch

The other side, on the tax side, we had indicated previously that we expected about a 200 basis point improvement in our tax rate beginning in 2013, and we are very much on target to achieve that as well. So we'll see the tax rate coming down a little bit in the second half of this year and then starting next year, continue on that trend. And we should be achieving that 200 basis points throughout the year, next year and going forward, of course.

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

And then just my last one, maybe back to Rakesh on M&A. Can you talk a little bit about your thought process here? You've obviously been talking a little bit more about doing deals more broadly. How should we think about size? Should we expect other deals like BioReliance, or will it be smaller tuck-ins? And any commentary you can make on kind of the maximum leverage ratio and any targets or hurdles that you would look at in terms of ROI that you could communicate?

Rakesh Sachdev

I think for the most part, the acquisitions that we continue to look at are bolt-on acquisitions. Really, I think most of the ones that we are looking at are smaller than the BioReliance acquisitions. But that's just the nature of the industry. Would we consider something bigger? It would have to make strategic sense, as I said. But I would say, a lot of the work that we are doing are smaller tuck-ins, and we continue to look at those. We have a lot -- ample room in terms of when we look at those sized acquisitions, to be able to do that really without addressing -- affecting our debt to cap. And one of the things that we do look at is, in all these acquisitions, is what is the return on invested capital that we are likely to get when we make these acquisitions, and how quickly can we get the ROIC accretive. And that has been a significant focus of this company. As you know, our ROIC is fairly impressive and as we look at these acquisitions, even though the multiples that we have to pay are pretty high and might cause some early dilution of our ROIC, we are very, very focused, making sure that we do not lose sight of that long-term.

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

And how much of your cash is offshore right now?

Rakesh Sachdev

I would say most of it is offshore today.

Jan A. Bertsch

Yes, that's correct.

Operator

Our next question is from Peter Lawson of Mizuho Securities.

Peter Lawson - Mizuho Securities USA Inc., Research Division

Just firstly, congrats to Quintin and Kirk. And then just on the up-margin expansion, just wondered how low organic growth can go and you could still get operating margin expansion.

Rakesh Sachdev

Well, our margin expansion has come largely because of organic growth, that's correct, because we get the leverage. But I think also, partly because we have been taking cost out through our supply chain efforts. So it's a combination of organic growth and it's a combination of the efficiencies that we are getting as we are driving continuous improvement throughout all our operations in the company. I don't know if I can specifically answer how low can we go and still get the expansion, but our margins have expanded very nicely. I think Jan talked about our margins having expanded 100 basis points from a year ago if you exclude the impact of FX and if you exclude the impact of the incremental amortization cost. Actually, if you took out the impact of acquisitions completely, not just the incremental amortization, our margins would have expanded close to 200 basis points from a year ago. So if you just look at our base business and what we have done in the base business, excluding acquisitions and excluding FX, if you ran through the math, our margin expansion has been very, very significant from a year ago.

Peter Lawson - Mizuho Securities USA Inc., Research Division

And then just on the geographical outlook for the second half, which countries or areas worry you the most?

Rakesh Sachdev

Well, it's -- Europe remains somewhat of a concern to us, just listening to what's happening in Southern Europe. Now what I would say is if you look at Spain and Italy, Spain and Italy make up about 5% of our total sales in the company, just so you know. And what's interesting in the first half of this year, we have been reasonably strong in Italy and we haven't declined in Spain. So we have been holding our own. Now, we have to wait and watch and see what's happening in Spain. We have early indications that second half of this year in Spain is going to be tougher. But again, Spain itself is probably a couple of percent of our total sales, and so it's notably muted. So we do worry a little bit about Southern Europe. And I guess, we worry a little bit about just making sure we have visibility on Research business in China because the Research business has softened a little bit in China in the latter part of Q2 than what we saw. But then, we have offsets in China. We have several other businesses that actually picked up a lot of steam. In fact, our growth in China in Q2 was substantially higher than Q1 in total of the company.

Peter Lawson - Mizuho Securities USA Inc., Research Division

And that weakness in China on the Research side of things, what was driving that? Competition or...

Rakesh Sachdev

It's mostly academia. Actually, if you look at what's driving weakness in research, overall, I would say there are 2 factors globally. One is of course, academia. And in fact, in Europe, the biggest concern would be is if the funding for academia continues to go down, so that's one. And I would say the second one is the large Pharma companies who have been changing their footprint who still continue to sort of announce sort of these shut downs. I think that the large Pharma consolidation, that will even out here shortly. I think as we go into 2013, it will probably be less of a headwind because they would have stabilized. The real unknown is going to be what's going to be happening in academia. But again, that's all baked into our outlook and other than that, I think we still see a lot of pockets of strength in our business as I just outlined in the call.

Operator

Your next question is from Jon Wood of Jefferies.

S. Brandon Couillard - Jefferies & Company, Inc., Research Division

This is Brandon Couillard in for John. Jan or Kirk, the revised operating cash flow outlook, does that imply some improvements on the working capital front, relative to the first half experience and particularly, where you expect to see that benefit?

Jan A. Bertsch

Yes. The revised operating cash flow really reflects a couple things. One is the lower earnings in the second half on the Research side. The second is the cost of the restructuring, which we have now embedded into that forecast. So when we say greater than $400 million in free cash flow, that includes the cost of restructuring. We took a little in the first half and we'll take some more in the second half. It also includes, and this is -- a very important piece of this is you could see our free cash flow was a little shy of last year's for the second quarter, and that was just some timing due to some vendor payments. So we'll see those coming back in the second half, and that won't have an impact on the full year. But on the working capital front, our inventories were up a little bit in the second quarter and we are putting, I would say, a big internal review here of our working capital components, including payables and receivables and inventory. And that's a focus that we'll be continuing to put here with the company and try to make improvements as we go forward.

S. Brandon Couillard - Jefferies & Company, Inc., Research Division

And then it looks like SG&A stepped down about $9 million sequentially, pretty big move relative to what we've seen in the business historically. Was there something discrete in that line item that drove the benefit in the second quarter? And then, where do you think or where should we anticipate the cost savings actions manifest in the P&L in the back half?

Jan A. Bertsch

Right. Well, the reduction in the SG&A cost in the second quarter was really across many lines. So I would say really, an appropriate number to look for in the second half, instead of the $160 million in the first quarter, the $151 million in the second quarter, it's probably more around a $156 million kind of level, maybe somewhere in the middle there. $156 million, $157 million would be an appropriate number.

S. Brandon Couillard - Jefferies & Company, Inc., Research Division

And then lastly, could you quantify the impact of FX on the gross margin in the quarter?

Rakesh Sachdev

You had that in the slide, right?

Jan A. Bertsch

Yes, just give me a second.

Rakesh Sachdev

While Jan is looking at that, I think we had a slide that showed the impact of FX on operating margin, which I believe was either 20 or 30 basis points. My guess is that the gross margin impact was...

Jan A. Bertsch

Yes, the gross margin impact was about $12 million for the quarter versus a year ago.

Operator

Your next question is from Dan Leonard of Leerink Swann.

Daniel L. Leonard - Leerink Swann LLC, Research Division

I was just hoping to get more color on what's going on in the Pharma market. At least, it's my understanding, some of the facility consolidations have been pretty well telegraphed. So I'm curious where the downside surprise came from in that business and also, what inning you believe we're in on that activity.

Rakesh Sachdev

Yes. So you're right, it's been telegraphed. I don't think that in itself was a downside surprise. I think there was maybe a little bit more softness there than what we thought. And I think also, just the academic softness that we saw, we didn't see a pickup in academic spending. So it was really a combination of those 2. We came in at 1%, we were expecting to be a little higher, maybe 2%, 2.5%, so that's the difference. I would say the Pharma companies are still announcing. So if you look at what's been announced here in the last several weeks, there have been some further announcements about some shutdowns, more so in Europe. And so, we know we're going to see some of that for the back of this year, which is why, I think, we have been conservative in what we came out and said what to expect for Research.

Operator

Our next question is from Isaac Ro of Goldman Sachs.

Isaac Ro - Goldman Sachs Group Inc., Research Division

Rakesh, I was hoping you could comment a little bit more in China. Specifically, could you maybe characterize what you're seeing there in terms of academic budget holdbacks? Is it a function of timing, or are you actually seeing budgets getting cut?

Rakesh Sachdev

If anything, China has been a little choppy. I would say that as we entered into Q2, China showed some softness. But I got to tell you, in May and June, again, we saw some very considerable strength in the Research business. A few months, Isaac, doesn't make a trend. But I would say overall, if I look at -- I don't have the exact numbers, but I think China Research business grew slightly less for the quarter in Q2. I think we were probably 10%, 11% versus 13%. Overall, I think China grew, I think, for us, close to about 18% for the quarter, which was substantially above Q1. But if I look beyond the numbers, if I talk to the folks, our folks in China, clearly they are seeing that there is softness in the Research business. It's hard to quantify. It's not dramatic right now, but it's one that I think they're going to watch and see what happens in the second half.

Isaac Ro - Goldman Sachs Group Inc., Research Division

Fair enough. Just a follow-up there on the SAFC side of the business. For the back half of the year, can you maybe quantify how much contribution you expect for the acceleration in the second half of the year from the new facility for the LED products? How important is that?

Rakesh Sachdev

Yes. I think -- let me see if I have that data here, but I would say that the Hitech business we're probably at, I think -- our forecasts show Hitech to be about maybe $15 million -- $10 million to $15 million more in the second half than the first half, somewhere around that. But I think that's probably a right range.

Isaac Ro - Goldman Sachs Group Inc., Research Division

Okay. But if I put it in context, it sounds like that's sort of only part of the story here. You are expecting your acceleration from other sources.

Rakesh Sachdev

Well, absolutely. Yes.

Operator

Your next question is from Tracy Marshbanks of First Analysis.

Tracy Marshbanks - First Analysis Securities Corporation, Research Division

Congratulations, both Kirk and Quintin. Appreciate everything you've done over the years, Kirk. A couple of quick questions on housekeeping, really. What type of price increases were you seeing in Research, and I guess that maybe implies you had a slight volume decline in Research?

Rakesh Sachdev

Yes. So the price increase for the full year, I think, we will expect, for the company, about 1% to 1.5%. And I would say that some of that, we might even get towards -- in the second half of the year too. So I mean, if we could -- if we say that we got a 1% growth in Research and we had somewhere around that in pricing, it was fairly flat. You're right, it was fairly flat in volumes in the U.S. and Europe. But definitely, we had volume growth in Asia-Pacific and Latin America.

Tracy Marshbanks - First Analysis Securities Corporation, Research Division

Okay. A question one of your customer bases just to see if you're able to assess any trends. As far as CROs globally and in particular countries, do you have any insight on the spending trends there?

Rakesh Sachdev

Yes. So I would say that CROs generally have been weaker, especially in Asia. So when we look at a country like India where we have -- I think I had mentioned that in Q1, we had very good growth in India. In fact, in Q2 also, we had very impressive growth. We grew over 15% in India in the second quarter as well. But it did not come at the backs of growth at CROs, which historically would be obscene. It's coming from different segments and frankly, coming because we have improved our delivery performance in India and we began to take some share away too. But I would say the CROs have generally been weak in Asia.

Tracy Marshbanks - First Analysis Securities Corporation, Research Division

Last question. Just a little insight on your Pharma business, particularly the GMP side of that. Is the growth there, sort of the number of projects -- and you're obviously in a great area with some unique capabilities or do you have some -- is it really not new projects but projects progressing or even going to commercial phase? How does that sort of break out as far as you see the growth?

Rakesh Sachdev

Yes. So again, we have -- again, the facilities that we have put in place, 2 facilities now we have in Wisconsin that have very unique capabilities of manufacturing these very hard to manufacture, high-potency compounds. Yes, we've been working with a lot of our Pharma and Biopharma customers over the last couple of years and doing validation, and we are finally beginning to get into a number of programs. And there are still a lot more programs that we are working on that brings a lot of promise for us to continue to grow sales in this business.

Tracy Marshbanks - First Analysis Securities Corporation, Research Division

So it's really the maturing of the pipeline of projects that's sort of -- that's driving it and giving you visibility?

Rakesh Sachdev

Yes, you could say that.

Operator

Our next question is from Mike Sison of KeyBanc.

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

Kirk, it was great working with you over the years and I wish you well. Welcome aboard, Quintin. In terms of the Research business, in 2Q when you think about the 3 old bucket essentials, specialties and Biotech, did they all grow a little bit in the quarter? And do you expect all of them to contribute some growth in the second half of the year?

Rakesh Sachdev

We don't break it that way, Mike, but I would say that clearly -- I think we all grew about the same. There is not -- I would say the Chemistry business, as Jan outlined, is where we saw some decline. And that was largely because of Large Pharma, frankly. But other than that, even our Lab Essentials business, if that was your question, our Lab Essentials business grew about 1% in the quarter. So it's not that we have more growth or less growth in between those segments. I don't have the breakout since we don't look at that anymore in those 3 buckets. But we can certainly try and get you an idea later on.

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

Got it. And then in terms of SAFC, the growth in the second half, pretty impressive. Does that have a pretty good tail as you head into 2013?

Rakesh Sachdev

We haven't given guidance on 2013 but I would say that as long as the growth trends in biological drugs continue and I think with what we've been doing in our Contract Pharma business, I would think that we should have a pretty good next few years. At the Analyst Day, we said that we put plans in SAFC and we've thought through this, that we should be able to continue to grow this business in the high single-digits and I don't expect that as we said today, that to be different in 2013 or any other year in the coming next few years.

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

Okay. And then finally, the Hitech has been a great addition for you guys over the last couple years. Are there any opportunities sort of in that realm for acquisitions? And when you take a look at the outlook for the second half that you noted, is that -- how quickly can that expansion be sort of taken care of and then you might need to add some more capacity over time?

Rakesh Sachdev

I think for now, we have added enough capacity, and the way we constructed our plant in Taiwan is that we could add further capacity at that same site. So we had that in mind when we put that facility. So we will decide depending on how we are ramping up, when should we kick in the next phase which will, of course, be a lot less expensive than the initial phase of construction on the facility. What was the other question?

Quintin J. Lai

That's it. You're good.

Operator

Our next question is from Derik De Bruin of Bank of America.

Derik De Bruin - BofA Merrill Lynch, Research Division

I'll add my dittos to the comments to Kirk and Quintin. So when you look at the -- you're talking about double-digit backlog growth. Can you talk about conversion to backlog? I mean, are you seeing any lengthening of the time there as things really change with the market? And I guess, how do we think about double-digit backlog growth? And how do we think about how quickly that will turn over and turn into revenue?

Rakesh Sachdev

Well, when we look at backlog for SAFC, like for instance, in Hitech and even in Bioscience, we have several months of good visibility. But the backlog has been staying pretty strong in the double-digits. Actually, it translates to double-digit growth in sales. The question is around timing and I would say that at least, the visibility of over 2 quarters is pretty darn good. And so, I would say our visibility for the balance of this year is pretty good in SAFC and as we go another quarter, we'll have decent visibility for Q1 of 2013.

Derik De Bruin - BofA Merrill Lynch, Research Division

Great. The Industrial Cell Culture business and BioProcess business there, I mean, could you talk about how that grew during the quarter? And I just -- is that -- how much acceleration you're kind of building in for that into the next couple of quarters?

Rakesh Sachdev

Yes. So the Bioscience business, I said we saw Q1 was hampered because of the comp from Q1 of last year so we didn't see any growth. Q2, we saw growth. Q3 and Q4, we are expecting again in low double-digits growth in our Industrial Bioscience business.

Derik De Bruin - BofA Merrill Lynch, Research Division

And I guess is that new product coming online existing -- expansion of existing conditions?

Rakesh Sachdev

It's both. It's both.

Derik De Bruin - BofA Merrill Lynch, Research Division

Both?

Rakesh Sachdev

It's both.

Derik De Bruin - BofA Merrill Lynch, Research Division

And I guess in terms of just like overall volume of proteins that are being manufactured and stuff there I guess, could you give us just some clarity or some color in terms of how much is being produced today versus how much you think your customers are producing a year ago? Just to get some idea what the volume trends are.

Rakesh Sachdev

Yes. So I couldn't give you an aggregate number for the total production of biological drugs this year versus last year but we think, based on what we are doing that, that's going to be close to double-digits.

Operator

Our next question is from Dmitry Silversteyn of Longbow Research.

Dmitry Silversteyn - Longbow Research LLC

A lot of my questions have been answered, but I do want to follow up on a couple of things. Number one, with your comment about margin expansion if you ignore the foreign exchange headwind, historically, this company has not been known to have much of an operating margin leverage and the margin expansion that we did see was probably, over the last couple of years, was driven at least in part by foreign exchange rates. So can you talk about what's changed over the last couple of years that there is some margin leverage to volumes now? Is it just this SAFC business becoming bigger and it's a real manufacturing business, or did you find a way to leverage top line in the Research business as well?

Rakesh Sachdev

So I think, Dmitry, it's a little bit of everything you said. So when you look -- when you think about our SAFC business, as the SAFC business expands, even though the overall margin of SAFC is lower than our Research business, it's a fairly fixed overhead business. So as we add more sales into our Hitech plants or Custom Pharma plants, we really get a benefit. So just think of our Pharma business that grew over 40% in the quarter. It's a business that the variable margins are very, very good. And so we are beginning to see that expansion coming that way. But also, we see expansion from Research so especially where we have volume growth. I would say that pricing has been fairly -- pricing has given us some margin expansion but for the most part, I would say in the last year, our pricing has also gone towards some inflationary increases and cost of just running the business. But we have began to benefit from SAFC growth. We continue to benefit, frankly, also from growth in the emerging markets. I think I mentioned this in several calls. Margins in the emerging markets are at least as high, if not higher, than the margins we make in the U.S. and Europe. And as we are growing that business, it's also helping our margin expansion.

Dmitry Silversteyn - Longbow Research LLC

That's very helpful. And then just a follow-up, volumes have been challenged over the last couple of years, let's say, low single-digits last year. It looks like your organic growth is probably going to be flattish this year outside of SAFC. Sort of, what do we need to see changing in the environment beyond the sort of incremental Pharma being done with their restructuring and rationalization of researchers, something like that, is there something that needs to change in the industry as you see it for you to sort of be able to get to the, let's say, let's call it mid-single digit growth in the Research side of the business?

Rakesh Sachdev

Yes. So I think -- let's just break this down. SAFC, as I said, I think we feel fairly optimistic that even though it's 1/3 of our business, that we should be able to grow that in the high single-digits. That gets us about, on its own, about 3% growth for the total company. And then if you look at the Research business, we know right now we have some tough comps on the Pharma side as they continue to right size their research labs. I think that's going to wind down here. But the 2 areas of growth that we are driving quite aggressively, one is emerging market growth. We continue to see, at least, for the next few years, given our position in these markets, we will drive Research growth in the emerging markets. I think the second thing, if you caught that on when I made my comments was, we are becoming more aggressive in applied markets, and the applied markets are going to go give us some good growth. We have lots of products that are very relevant for applied markets and we have not made a huge portion in the last several years, but we are going to be making a bigger portion. We are already seeing a lot of success with what we've achieved in the last couple of quarters. So I think a combination of pushing the emerging markets, pushing applied markets, that clearly, growing our innovative products and even though they are a smaller piece today in the U.S. and Europe and if you kick in all that, I think we will be where we wanted to be and what we said in our analyst call earlier this year.

Dmitry Silversteyn - Longbow Research LLC

So if you look at sort of flat Research market this year, for you to get to kind of a mid-single digit growth that you need to with SAFC, to get to your goals, would you say it's about half-and-half between end markets improving and what you guys are doing internally as far as new products, the applied Chemistry in the emerging markets, or would you say you need more help from the macro environment because you're already doing as well as you can do internally?

Rakesh Sachdev

Yes, listen, in the near term, I would say, in the near term, the end markets improving would obviously have a greater assistance on our growth. But I would say medium and long-term, with the things that we're trying to drive and the initiatives, we could still grow in end markets that may not experience such growth. So I would say near term, you're right. Near term, I think end markets would have to improve for us to show higher growth in Research. But medium and long term with I think, the initiative we're doing, we will drive higher growth.

Operator

Our next question is from John Roberts of Buckingham Research.

John E. Roberts - The Buckingham Research Group Incorporated

The e-Commerce side of the Research business was up 5% and the total was only up 1%, so the implication is that non e-Commerce declined, say, about 3%. And I just -- I don't know if it's a coincidence, but Analytical was strong and Chemistry was weak. So is Analytical largely e-Commerce and Chemistry not largely e-Commerce? Is that a stretch to draw the -- connect the dots here between the range of performance across your portfolio?

Rakesh Sachdev

First of all, I won't try and correlate the 5% to the 1% because I think there is still more people shifting from faxes and phones to e-Commerce. So I think part of this is just a shift that's taking place. And also, because -- and the shift is taking place because we are getting more entrenched with e-Commerce in markets outside the U.S. and Europe. I would say the other thing is there are a lot of B2B business that we conduct through e-Commerce as well and when Pharma goes down a little bit as we saw, the business that they conduct, a B2B through our Internet engine is also reduced, so that also has an impact.

John E. Roberts - The Buckingham Research Group Incorporated

Okay. So it's not e-Commerce versus fax, phone. It's not as correlated across the product areas, but it is correlated across the customer mix?

Rakesh Sachdev

It is. It could be. Yes.

Operator

Our next question is from Tim Evans of Wells Fargo.

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

A quick question on how you feel about the competitive position of your APLA business relative to, at this point, kind of the ability to service the global clients in the way that they've become accustomed in the U.S. business.

Rakesh Sachdev

Yes. So as you know, at least on the Research side, we've had -- I can probably say that we've had a first mover advantage in Asia-Pacific and Latin America compared to many of our peers. And that's clearly holding us in good stead with our customers because I think our global customers recognize the strength that Sigma-Aldrich has in Asia-Pacific and Latin America. And frankly, even the local customers who are not global customers recognize the strength that we bring in the local market. So that's held us in that stead, and I think we will continue to capitalize on that moving forward.

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

Great. And did you comment on the growth in the Chromatography business? If not, I'd be interested to hear how that business has been growing.

Rakesh Sachdev

We didn't call that out, so I don't have that number. I'm sorry; I don't have that in front of me.

Operator

Our next question is from Paul Knight of CLSA.

Unknown Analyst

This is Brian Kip [ph] on behalf of Paul Knight. A quick question for you all. What do you guys see as your key product in your biotech portfolio for the upcoming year? Is it currently in your catalog? And can you quantify that impact?

Rakesh Sachdev

So again, our biology portfolio is made up of all the way from traditional biology products, BioBasics, enzymes, so on, all the way to highly differentiated products such as zinc finger platforms. We are doing today, animal models. We are also into proteomics and antibodies. I would say that clearly, if you look at our emerging biotechnology products, which probably make up, I would say, about 1/3 of our biology portfolio, that's likely to continue to grow fairly impressive levels because again, it's products that clearly have a demand. I would say the other BioBasics products have been growing very much like most of our regular Reagent portfolio in the low to mid-single digits.

Operator

Our next question is from Jeff Elliott of Robert W. Baird.

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

Just on the LED business, you talked about pricing coming down as a percent of volumes. As volumes ramp and capacity comes on, what inning do you think we're in with respect to the uptick in that business?

Rakesh Sachdev

Sorry, can you repeat the question?

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

Yes, just in the LED business...

Rakesh Sachdev

Oh what inning? Okay.

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

Yes.

Rakesh Sachdev

Well, as we look at LEDs, the expansion of LEDs is coming from both general lighting, which has been -- which will really play out, I would say, after a year or 2 and the other one is applications in electronics such as TVs. And I would say over the next, at least, 3 to 4 years, we're going to see a very strong growth in LED's uptake. So I would say, we are probably in the third inning or so of LEDs. As far as pricing, pricing has come down, but what I didn't say is that pricing of a raw material has also come down quite significantly. So for instance, one of the precursors we make is trimethylgallium and the pricing has come down but if you look at pricing of gallium, it's come down also very sharply. So they're getting some benefits on the cost side. So I should have mentioned that, but I just think that's important for you to note.

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

Okay. And just a quick housekeeping question on shipping days. Is there anything special to model for Q3 or Q4 perhaps with the Olympics coming up?

Rakesh Sachdev

I don't know. I think -- I don't know if there's a difference between shipping days in Q3 and Q4. Jan, do you?

Jan A. Bertsch

I think it's very minor. I think there might be 1 shipping day difference. And regarding the Olympics, we think that really, London is about the only place that may get impacted and so in general, I think that not much to talk about on that front.

Operator

Our final question is from Dan Arias of UBS.

Daniel Arias - UBS Investment Bank, Research Division

Rakesh or Jan, should we look for any changes in inventory dynamics with the new sites in India and China and Taiwan coming online? And I guess, as you move into the second half, could that change the way that currencies move through the P&L at all or is that really not a factor?

Jan A. Bertsch

Well, in general, the way inventory moves through our P&L, we would expect to see that for the balance of the year, which is very lagged between 4 to 6 months or so. But I wouldn't expect to see a big change this year. I mean, the focus on trying to rationalize our inventory and reduce our inventory is always there. So I'd like to think we'll see it coming down a little bit. But substantially through the balance of the year, I don't think so.

Daniel Arias - UBS Investment Bank, Research Division

Okay. And I guess just lastly, any impact you're seeing on raw materials from the cost?

Rakesh Sachdev

Not really. Nothing has -- we don't expect the raw material environment to be different in the second half than the first half.

Quintin J. Lai

All right, I think that concludes it for today. Thank you, again, for your participation. We expect to release results for the third quarter of 2012 before the market opens on October 23, 2012, and we'll follow that with a conference call that same day at 10:00 am Central Time. This concludes today's conference.

Operator

Thank you. Ladies and gentlemen, thank you for your participation in today's conference. This concludes the program. You may now disconnect. Have a wonderful day.

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