Scully Royalty Ltd. (SRL) Q2 2008 Earnings Report, Transcript and Summary

Welcome to the Millipore second quarter 2008 earnings call. All lines have been placed on mute to prevent any background noise. After the speakers’ remarks, there will be a question-and-answer session. [Operator Instructions] I would now like to turn the call over to Mr. Joshua Young. Please go ahead, sir.

Thank you very much, Stephanie. Good evening. I would like to welcome everyone to Millipore’s second quarter 2008 earnings conference call. My name is Joshua Young and I am the director of investor relations for Millipore. Joining me on today’s call are Martin Madaus, Chairman, President and CEO; and Charlie Wagner, Chief Financial Officer. In addition to the earnings release we issued earlier today, we will also be referencing a slide presentation as part of today’s call. This presentation can be viewed by clicking on the webcast link on the Millipore.com home page, or by accessing Millipore’s investor our website. A PD F copy of the slides will be posted to our website after the call. We’ll also be highlighting non-GAAP information. A reconciliation of our GAAP financial to our non-GAAP financial measures is included in our earnings release and posted on our website. Before we begin, I’ll make the usual Safe Harbor statement that during the course of this conference call we’ll forward-looking statements regarding future events or the financial performance of the company that involve risks and uncertainties. The company’s actual results may differ materially from the projections described in such statements. Factors that might cause such differences include but are not limited to those discussed in today’s earnings release and in our Form 10-K, as well as other subsequent SEC filing. Also note that the following information is related to current business conditions and our outlook as of today July 31, 2008. Consistent with our prior practice we do not intend to update our projections based on new information, future events or other reasons prior to the release of our third quarter, 2008 financial results. Now, I would like to turn the call over to Martin Madaus.

Thanks, Joshua. Welcome everyone. I’ll begin my providing some high level commentary on our performance and the current market trend. The key drivers of our second quarter performance were similar to those we reported if Q1. Our Bioprocess Division reported a year-over-year revenue decline, which was in decline with our expectations. The division continues to be adversely affected by the same handful of large U.S. biotech customers that began reducing their spending last year. This performance stood in contrast to our Bioscience Division, which provided exceptional growth in the second quarter. Excluding changes in foreign currency, Millipore’s total revenue was flat in Q2, a modest improvement from the 1% decline we saw in the first quarter due to sequentially stronger performance from our Bioscience Division. During Q2, we continued with our efforts to manage expenses and drive efficiency improvements throughout the entire organization, and much like in Q1, our efforts enabled us to drive solid earnings and cash flow growth Our non-GAAP earnings per share grew 13% and our free cash flow increased year-over-year by %36 million, totaling $45 million in the quarter. Even with controls and discretionary spending and some targeted reduction, we are still making investment that will drive future revenue growth. We are committed to increasing our long term possibility and cash profile of the company even during periods of lower revenue growth. For the past three calendar years, we have significantly improved profitability of our business, increasing our non-GAAP operating margin 350 basis points. As we look ahead, we are now evaluating programs that I will be incremental to our effort of controlling discretionary spending, and Charlie will talk about these activities later in the call. So the key highlight in this quarter was the performance of our Bioscience division, which posted as I said outstanding results. The underlying bioscience market is strong. We’re benefiting from successful new product launches, and from sales and marketing initiatives that we have implemented in the past few quarters. I’m really pleased with the progress we’ve made in the division, and I expect that our Bioscience business will continue to deliver strong performance over the rest of 2008. As expected and as previously discussed, our Bioprocess business continues to be adversely affected by year-over-year declines at some our largest customers. We’ve seen this negative trend in our business since the third quarter of 2007. And I spoke last quarter about expectations for an improvement in the division’s results during the second half of 2008. Now, while we still expect Bioprocess to resume modest topline growth over the next six months, the division’s revenues will be slightly lower than we previously planned due to weaker demand from a large U.S. biotech account. We previously anticipated these large accounts to stabilize or stop declining on a year-over-year basis, beginning in the third quarter. We now expect revenues from these accounts will continue to decline through the remainder of 2008. Although the magnitude of these declines in these accounts will be significantly smaller than what was experienced in the past two quarters, they will still result in lower revenue growth than we previously forecast. Outside of these large accounts, we continue to generate positive growth from our other biotech customers, and we expect these dynamics to continue through the end of this year. So to summarize the key takeaways of the second quarter: We faced a significant revenue decline in our largest business, Bioprocess, which is only partially offset by outstanding growth in our Bioscience division. The Bioscience division continues to perform well. All of it’s business units contributing to our growth in the quarter, and this performance, combined with control of spending brought solid earnings and cash flow growth. Going forward, evaluating programs that will drive additional profitability improvement in 2009 and beyond. So next, I’d like to move into some of more of the details of the second quarter. You can see on the slides we reported total revenue in the quarter of approximately $414 million U.S. dollars, excluding changes in foreign currency exchange rates, the Bioscience division generated 9% organic revenue growth in Q2. As we’ve seen over several quarters, we generated strong growth in both, in our Lab Water and also in our Drug Discovery business units. We also noted very good improvements in our Life Science Business unit this quarter. The success of out Lab Water business has come from our ability to expand our presence with existing customers by offering new products and services. And Lab Water is once again off to a great start in 2008. Driven by the launch of our new Milli-Q Integral, which will be an important product upgrade for many customers. I spoke last quarter abut how Milli-Q Integral is the most significant new launch that lab water has had over the last three years, and it’s significant performance advantages allow us to command a very good price in the market. The success of Integral has helped to drive the very strong Lab Water performance in North America. We are in the process of launching Integral in the Asian market in Q3. So we expect it to continue drive growth in the remainder of the year. In addition to growing our growing presence amongst the existing customers, we also are reaching new lab water customers, our entry into clinical diagnostic markets through our partnership with Siemens. Now to our drug discovery unit which is split equally between products and services. That unit continues to be the fastest grows piece of the Bioscience product portfolio. We are seeing robust growth in several of our products and service offering, particularly our portfolio of assets that are used under Luminex multiplex platform. We have one of the industries broadest portfolios of multiplex assays and we are seeing demand for these high value kits continue to grow each quarter. And on the Biopharm services side of the business, we have seen a five-fold increase in the number of customers in biomarker assays that we are developing for biopharmaceutical customers. This is a really good service based business that is growing significantly due to an increasing number of protein based therapeutics that are entering into the clinical development pipeline. And as you know, when we come to market, this will help the Bioprocess business too. Now let’s move on to the Life Science business unit, the performance of our Life Science business unit continues to improve and it contributed meaningfully to the growth we delivered in the quarter. Over the past few quarters, I have been speaking a bout the efforts to advance the performance of this business unit and these efforts are starting to pay off. We are seeing much better performance. Sales and marketing programs we have run have been successful. Our sales force’s effectiveness has improved. We are winning new business versus competitors in large accounts, and we are seeing significant demand for our new products. For example, our SNAP i.d. product we launched at the beginning of the year. This little instrument has been very well searched by our customers. SNAP i.d. is used by protein researchers to conduct protein blotting, innovative and makes faster, so the researchers can be more productive. Its shows that the value…it shows the value of our Serological’s acquisition, because it combines, on the one hand traditional Millipore products, reagents and antibodies that we gained from the acquisition. We also are driving strong performance of affidavit our Life Science product internationally, plus we are seeing rapid growth from our products ordered over the internet. All of these factors combined, are contributing to our growth. And additionally, beginning of July, we sold our first product from our partnership with Guava targeting the market the flow cytometry market, which also we expect will help our Life Science business to grow during the remainder of the year, and thereafter. So overall Bioscience market is in good shape, healthy spending environment is good, and we expect the division to have a strong year. We’re encouraged by the progress we have made in our Life Science business unit, very excited about the early results, the potential impact from our new product introduction. Let’s move on to the Bioprocess division. Excluding changes in foreign currency, the division’s revenues declined 7% in Q2, about the same amount we had declined in previous quarter, and while we were obviously disappointed with our Bioprocess revenue performance, it was pretty much what we expected. We continue to experience lower sales as a result of reduced spending by a handle of large U.S. biotech customers, and we believe our Bioprocess performance has bottomed out now in Q2, and we will not experience a significant year-over-year decline in the back half of 2008 that we have experienced in the past two quarters. As a result, we expect the Bioprocess division will return to modest growth in Q3 and Q4, but that improvement will not be enough to offset the declines we’ve seen in the past two quarters. Now our Bioprocess is a long-term business as you all know, and our long-term outlook for Bioprocess has not changed. And the expectations that the division’s performance will return more to normal levels in ‘09 remain the same, and they are positive. We are convinced that the biotech market is fundamentally healthy, and that we’ll return to attractive growth in 2009. When you just look at the level of investment going into the biotech industry, it’s very substantial. And last year alone, pharma companies spent $94 billion on acquiring biotech companies in U.S. and Europe to bolster their drug pipeline. Companies are very actively investing in Asia, and we expect significant new volumes of biopharmaceutical drugs to come on-line live in production in Asia over the next few years. More and more Research and Development dollars are invested by drug companies are going into protein-based therapeutics. We see that in our research business versus chemically based drugs, which is increasing the number of protein-based drugs entering the clinical pipeline. So over time, this will and should increase the number of biologic drugs in the market, and in turn require demand for our products in Bioprocess. So, in short, biotech remains one of the more attractive segments of the overall healthcare industry and despite the near term challenges, we feel very confident in our ability to benefit from this market in the future. Our revenue growth challenges are temporary, and completely related to slower growing end markets, not related to competitive issues. Our market leadership position remains strong, and many customers continue even during this downturn, they continue to expand the adoption of our products. Our success rate of competing for manufacturing steps on drugs in the chemical pipeline remains fundamentally strong. We expect to gain additional revenues, once these new therapies are approved. We are also seeing much faster customer acceptance of our new products than we have experienced historically. I believe this is a reflection of the value and high performance benefits that these new products provide. And particularly our virus filtration product, our chromatography media for augment cellular or disposable manufacturing products have performed very well since their launch. Recently, we completed a very promising biotech drug and we were awarded 11 of the 13 process that were up for grabs. This is, for me, a telling example of Millipore’s strength and further evidence that our strategy of providing complete solutions to customers is working as customers are looking for suppliers with more integrated overall product. Another key area within Bioprocess that continues to perform well has been our products used in vaccine manufacturing. There are a handful of key subculture based vaccines on the market today, and they are driving this growth, and more importantly, there’s a strong level of investment going on that continues to go into sub based…subculture based vaccine production that could expand our vaccine business even further in the future. So before turning it over to Charlie, I want to reiterate the key message you should take away from this Q2 call. First, growing our Bioprocess business remains challenging and will continue to be difficult until the end of 2008. But we feel confident about the strength of this market and our competitive position, and we believe we will return to attractive top-line growth in 2009. Second, our Bioscience business is performing very well, and we are reaping the benefits from investments we have made in that business over the past years. We feel very good about the foundation we have built in Bioscience. We expect the division to have a strong 2008. And third, we are driving significant expansion of our cash flow, and we’re using this cash to pay down our debt, our cash flow performance. Its benefiting from the more profitable business portfolio we have built over the past three years. And finally, we are not standing still during a challenging year. We are taking the steps to ensure we are in a strong position to continue to expand our profitability in the future, and this will involve further streamlining our operation to make us leaner and more efficient for the future. And with that, I’ll turn it over to Charlie.

Thanks, Martin. I’ll now provide some additional details on Q2, 2008 financial performance, beginning with a discussion of our GAAP performance in the quarter. Revenues grew 8% over last year, with all of that growth coming from changes in foreign exchange rates. Our AAP operating margin increased to 16.8%, up from 13.4% in Q2 2007, and our earnings per share were $0.72, a $0.20 per share or 40% increase over Q2 2007. The increase in GAAP operating margins and EPS reflects improvements in gross margins, control over discretionary spending and a $7 million reduction in one-time costs. On the next slide, we show our Q2, 2008 non-GAAP operating results. I would encourage you to review the non-GAAP reconciliation table in the press release for the detail of out adjustments. Martin already provided a divisional view of our revenue dynamics, so I’ll add some color from a geographic perspective. Excluding the effects of foreign currency translation, revenues in the Americas declined 11% in the second quarter, due to the softness in U.S. biotech accounts. Europe increased 11%, and Asia Pacific revenues grew 2% in Q2, 2008; with Asia Pacific being affected by weaker performance in Japan and India. I would note, however, that the softer Q2 performance in these two countries is driven primarily by the timing of orders and year-over-year comparability and not by significant changes in the business. On a six-month basis, excluding changes in foreign currency, we reported an 11% decline in the Americas, 7% growth in Europe, and 7% growth in Asia Pacific. Our Q2 2008 non-GAAP gross margin of 56.6% increased 190 basis points on a year-year basis, due primarily to a more profitable product mix. This positive mix effect was especially evident in the Bioprocess division, where we benefited from the lower level of sales of several lower margin products. We also benefited from the strong performance from our X-Cite [ph] product line, which is one of our more profitable products in our portfolio, and from Bioscience, representing a higher percentage of total company revenues in the quarter. Bioscience products typically carry high gross margins than Bioprocess products. We searched a significant number of inquiries during the quarter about how higher raw material and energy costs are affecting our business due to the increase in the cost petroleum based products and oil. Purchased raw materials and finished goods represent about 40% of our cost of goods sold and all thought we are seeing higher cost for some material, the impact has been modest because of our long-term contracts and the efforts of our global procurement organization, which has been able to drive cost savings that have outpaced the increases in certain raw material costs. We’ll continue to analyze and manage the impact of commodity price increases in future quarters. Non-GAAP SG&A expenses represented 29.2% of sales, compared to 28.2% in Q2 2007, an increase of 100 basis points, primarily due to higher FAS-123R cost and some employee separation costs in the quarter. Non-GAAP R&D spending represented approximately 6.3% of sales, a decrease of approximately 50 basis points over Q2 2007. The year-over-year decrease is primarily attributable to the level and timing of R&D project spending. In 2007, we had a significant amount of spending related to major product launches, such as Milli-Q Integral and SNAP i.d. that did not repeat in this quarter in 2008. Our R&D headcount related expenses continue to grow on a year-over-year basis. Our non-GAAP operating margin of 21% increased 120 basis points over last year’s second quarter due primarily to the higher gross margins. Our non-GAAP tax rate in Q2 was just under 28%, which was higher than the prior year, due to the geographic mix of profits, and we expect that our full year non-GAAP tax rate will be approximately 27%. Our non-GAAP EPS was $0.92, an increase of 13% over Q2 2007. On the next slight slide I show our GAAP results for the first sixth months of the year. We’ve grown total revenues by 7%, including an 8% positive benefit from currency translation and our improved GAAP profitability was driven by higher gross margins, spending control, and the lower one-time expenses I mentioned earlier. On the next slide, I show our sixth-month non-GAAP results. Non-GAAP operating margins increased 50 basis points due to slightly higher gross margins and controlled operational margin. This operating margin improvement led to the bottom line earnings per share growth of 10%. Cash flow from operations during the second quarter was approximately 62 million, which represented an increase of approximately $23 million over the second quarter of last year. This increase was driven by a higher level of profitability in the business. Depreciation and amortization in the quarter was approximately $33 million. Factoring in CapEx spending of $17 million during the second quarter, we generated approximately $45 million of free cash flow, an increase of $36 million from Q2 2007. We paid down approximately $19 million of debt this quarter, bringing total debt reduction to approximately $59 million in the first half of the year. On this next slide, I compare our free cash flow over the past four quarters to our comparable performance in the prior year. And you can see that we’ve been driving very significant year-over-year increases in our free cash flow since the third quarter of last year. The primary drivers of this increase in cash flow have been the higher level of profitability we’ve built into the business over the past three years, combined with a lower rate of capital spending. Over the past 12 months, we generated close to $200 million of free cash flow, an increase of almost $140 million over the comparable period. As we look ahead, we see additional opportunities to drive improvements in our profitability and working capital. These improvements combined with the Bioprocess recovery should put us in a very strong position to continue to further expand our free cash flow in the future. At the end of the second quarter, net accounts receivable were approximately $326 million, representing 72 days sales outstanding, up from 67 days at the end of 2007, and flat with last year’s second quarter. Inventory at the end of the second quarter was approximately $297 million, representing 147 days supply, which was up nine days from 138 days at the end of 2007 and up 16 days from last year’s second quarter. So to summarize, the second quarter of 2008 pretty much came in as expected. Lower Bioprocess organic revenue growth, offset by outstanding performance in Bioscience, and despite the lower revenue growth we generated meaningful earnings growth and increased our free cash flow by approximately $36 million. Before turning over to updating our guidance, I want to spend a few minutes providing some additional detail regarding other factors that impact our financial results. One key trend we continued to see in the business is the substantial impact the changes in foreign currency are having on our reported results. The Euro, Yen, and other currencies remain quite strong against the Dollar. Changes in foreign currency added 8 percentage points of growth to our top line revenues in Q2, the same amount of percentage growth we saw from currency translation in Q1. The impact of currency changes on our bottom line is much less significant. However, as currency changes also drove a significant increase in our reported costs. Because we have significant manufacturing operations in Ireland and France, the stronger Euro translates into higher reported manufacturing costs. And although the stronger Euro hurts our reported gross margin percentage, as I mentioned earlier, it does have a positive impact on reported revenue growth, and a smaller positive impact on our bottom line overall. The net result of changes in foreign exchange rates, were a positive impact to our earnings per share in Q2, which was about $0.03 above the assumptions embedded in our recent guidance. In addition to the currency changes, higher costs receipted to FAS-123R continue to be reflected in our financial results for second quarter. FAS-123 expenses were $0.08 per share compared to $0.05 per share in Q2, 2007, which is very much in line with the increase we shared with you on our last call. Earlier in the call, Martin mentioned that we’re evaluating programs to drive incremental improvement in profitability and cash flow. With the downturn in one of our businesses we believe it’s a good time to focus on programs that will improve our efficiency to ensure that we emerge from this slowdown as a stronger more competitive organization. Accordingly, we have begun to evaluate new supply chain initiatives and other programs that will help us further expand our profitability in 2009 and beyond. The analysis of these programs is still happening, as we speak. So I’m not yet in a position to share too many specifics with you. But what I can tell you is that we currently estimate that these programs, depending on the scope of implementation, could result in charges that will range between 15 and 25 million over the next two years. These charges would be incremental to the approximately 10 million of costs we expect to incur in 2008 for our ongoing manufacturing consolidation strategy. And if enacted, these new programs could also generate an incremental 7 million to 12 million of annual savings, though only a very small amount of that could be realized in 2008. I want to stress that these are very preliminary numbers, which could change in the coming weeks, but we want to provide you visibility into the potential impact of programs we’re currently evaluating, and will provide additional details about these programs on or before our next earnings call. Now turning to 2008 guidance. Due to the slowdown in biotech key account spending lasting longer than we originally anticipated, we now expect total revenue growth of approximately 6 to 7% in 2008, with approximately 5 to 6 percentage points of that growth coming from changes in foreign currency, which translates to full year organic revenue growth of 1 to 2%. We’re lowering our non-GAAP earnings guidance for the year to reflect the impact of our lower revenue growth outlook. We’re now projecting non-GAAP EPS of $3.50 to $3.58 per share. At the high end of this range, however, we would still be within the original EPS guidance we provided at the beginning of the year. The down ward adjustment in revenue and earnings is primarily related to our outlook for a weaker fourth quarter than originally expected. Reflected in our non-GAAP results, we continue to project that our FAS 123 expense will grow from 16 million or $0.20 of EPS in 2007 to 23 to 24 million or $0.28 to $0.29 cents of EPS in 2008. Moving to our cash flow forecast, we’re maintaining our free cash flow guidance of 150 million, with free cash flow defined as cash flow from operations less capital expenditures. With that let me turn the call back over to Joshua to begin the Q&A.

Stephanie, place assemble the Q&A roster. Question and Answer

[Operator Instructions] Your first question comes from the line of Joshua Groberg with Merrill Lynch.

Hi. Thanks for taking my call.

Hello?

Can you hear me okay?

Yeah, we’ve got you.

Okay, right. So can you, maybe just first of all starting off on gross margins and very strong gross margins in the quarter, Charlie. Can you calk about, I noticed some of your inventories are elevated, and I am assuming some of that has to do with as you continue to manufacture for the Bioprocess out of the business and you’re not selling as much, and how...I’m assuming there’s maybe a little less utilization. So how, maybe, do we think about gross margins over the next six to 12 months for the business?

Sure. I’m sure you recall Q1 our gross margins were on the low side, and Q2. I would tell you that they’re on the high side. Some of that, of course, is mix, which we talked about in the call. Some of it is also just a function of cost accounting, and as we saw, the downturn in volumes in our Bioprocess plants in the fourth quarter, some of that doesn’t actually hit the P&L until 2008. So, what I would say for gross margins is that, that kind of in between our Q1 margins and our Q2 margins is where you should be thinking for the year.

But there’s also mix improvement. We clearly have deemphasized lower profitability product lines such as hardware and Bioprocess and we have actively emphasized other product lines. So there is also the mix effect from having a higher percentage of bioprocess products in ‘08. So all of these factors combined contribute to the picture.

If we move beyond...I’m looking at your inventory days, I guess...but if we kind of…if we think of it as a slowdown lasts throughout the year, and maybe your continuing to manufacture but not as much, I think a lot of people are going to start looking at 2009. So I am just wondering, would you expect the slowdown in Bioprocess today to have a negative impact as to those units come out of inventory and you begin to sell them in 2009?

Not necessarily, no. We are...we’re looking at resetting the expected production volumes in our plants this year, and there are some actions we can take to offset the lower volume. So I wouldn’t necessarily draw that conclusion. We’re not in a position today to give guidance on 2009, but I don’t think you should necessarily draw that conclusion. We’re clearly working very hard to reset the factories at this point, based on this outlook.

Okay. And then maybe, just tying one follow-up here, again on the bioprocess. Obviously congratulations on Bioscience, which is performing very well. But on bioprocess, can you just, maybe, describe a little bit more in detail of what you had? And you probably feel like you’ve done this a lot, but what you have been expecting and kind of what…what’s different, and then can you tie that into guidance because you actually had a stronger second quarter in terms of non-GAAP earnings per share than probably than obviously the street was expecting, and yet you’re lowering the guidance for the year, even though you are ahead of where the street was.

I’ll start on it, and then you can chime in, Charlie. So first of all, we had sized the downturn between four quarter’s duration and fifth quarters. So what we’re seeing is it’s going to take a little longer, that means six quarters. It started in Q3 of 2004 and we simply look at the purchasing trends and the expected forecasts from these customers, and sometimes we get very updated forecasts, and based on that, based on these few large accounts, we are adjusting it downward. Previously, before we saw this forecast, we were expecting a modest increase from these accounts. That is not the case, and so we are adjusting it downward. Nothing else has changed with these customers. They simply have still the process of working down their finished drug inventory, so running fewer production runs, and that has impact on us. In fact, when you look at the molecules that are impacted, there’s no change whatsoever in the end market. And you’ll see that these major molecules have come back to normal growth. Its just a matter of working it down.

Right. And then I guess what I would add, as far as the quaterization goes, we don’t give quarterly guidance, and I know folks do their best to build quarterly models. We had guided at the beginning of the year that the second half would be more back-end loaded both for revenue and earnings. Still pretty much the case, but obviously with a… you know, we started out the year from a spending standpoint cautiously, and that has resulted in some reasonable earnings growth in the first half, and so I think that’s why you see some of the outperformance there. In terms of the downward revision, it’s primarily concentrated in the fourth quarter, a little bit in the third quarter, but it’s more… less revenue in the fourth quarter than we expected.

Your next question comes from the line of Tycho Peterson with .JPMorgan.

Hi, this is sitting San Chi [ph] sitting in for Tycho. Thank you for taking the questions. The first question is, could you provide more, I guess, color on kind of the Milli-Q Intgral, as well as the SNAP i.d. in terms of what the market may be for those products.

The Milli-Q Integral is one of the Lab Water filtration desktop units. And I would not... I can give you ranges. It’s in the tens of millions of dollars, but I couldn’t give you an exact number, because there are many other follow-on products. There’s hardware. There’s service, and there are consumables that go into it. But we mention it because it’s one of our larger product launches. We have tens of thousands of products, so this is a very significant one, and similar to the SNAP i.d., we mentioned it because it’s a combination product of acquired products and classic Millipore products, and it’s unique in its market, and it has exceeded our expectations. So again several millions of dollars, so it’s significant to mention, but we don’t know what the potential could be. We’ve sold thousands already.

And then also could you comment on kind of the outlook for MilliPROBE, can you define in terms of development, highlights for additional assays there?

I really don’t have an update on that. The key here is to get a combination of assays out in the market and right now I don’t have the most recent timeline, but it’s sometime in ‘09.

Your next question comes from the line of Derik De Bruin with UBS

Hello?

Hello.

Hi. There you are. I guess, when you kind of look out and you just kind of look at the bio manufacturing pipeline, and I guess could you… I know you won’t give us on color about drugs that you’re… specific details about the drugs that you’re most excited about, but could you tell us if you’re expecting to see ramps in existing drugs, or we’re talking more about new products that you see as being the real drivers that are out there?

It’s both, clearly. When you look at the break down of the, let’s say, five years out, growth profile of biopharmaceutical, the existing drugs will continue to grow, and they will contribute at least half of the market growth. The new products, if they hit, they will give you the other part of the growth profile and then for us specifically, we would add revenue from new products that we add or process steps that we gain. So I would say roughly active 50/50, but the existing products are still very key, and, as you know, there are a number of products that are growing very well today, very large products.

Right. You mentioned that you’ve recently run a series of contract where you’re doing 11 of the 13 process steps. Just basically what I want to know about some of the other manufacturing processes that are out there, that’s an unusually large number of steps for you to be in control of. Could you talk about, what is going into getting this? Is it more disposables that are coming in? I guess what’s getting you to this higher level?

I would say first we have done two things over the last three years. We have upgraded our entire, what we call down stream filtration line-up. So with that goes clarification, virus filtration, chromatography media, sterile filtration. So these new products, they’re starting to get specs [ph] in now. I would maybe highlight the virus filtration product, which has gotten very good customer reviews, clearly better than anything out there in the market. So we are getting faster adoption for that reason, because it solves a major concern around problems around filtration requirements. So that’s one. So its basically strengthening the core. Number two is the acquired businesses are doing particularly, the business we acquired in ‘05 NovAseptic doing well. So that’s additional volume, and then the disposable business, which we bought in… about two and a half years ago, is also contributing to the growth. So it’s really adoption of new products, and then additional revenue from acquired businesses.

Okay. When you look at the Bioscience growth in the quarter, 9% organic, that’s certainly trending above where it has. Is it fair to say that probably a point or so of that is contributions from left over from the Easter holiday? And I guess what’s your… I mean, do you think you can sustain the high single-digit type of organic growth in the Bioscience business? Yes, that’s definitely what we’re aiming at with Bioscience business.

That’s what exactly what we are aiming at with Bioscience. I think if we continue to target the markets right and we get new products out, I think that’s doable.

And have you heard any feedback from the field about, given that one of your competitors is going to be in the middle of a rather big acquisition, have you heard any chatter, or have you seen any increase in resumes, heard anything of potential disruption to the customers there?

Well, I don’t deal with that directly, so it’s hard for me to comment on it, but I would say that it’s a bold move. I think it’s definitely something everyone pays attention to and tries to figure out what it means for them.

Your next question comes from the line of Ross Muken with Deutsche Bank Securities.

Hi, good afternoon.

Good afternoon, Ross.

So I just want to get a better sense for the moving parts in terms of the lower bioprocess guidance. If you had to break it up amongst the big players in terms of inventory reductions, slower script sale, lack of new products, lack of contribution from smaller accounts, what have you, whatever was the key underlying drivers. How would you assign percentages to that in terms of what really, in terms of the Delta, has changed, understanding, clearly, last quarter you didn’t have the visibility to this that you do now?

It’s a continuation of what we said before. It’s the handful of large U.S. biotech accounts, lack of continued demand, and, again, given that we have the highest market share in biotech overall, and particularly in these accounts, you can see it very much concentrated on those accounts. And you can see it also in the North American numbers. Nothing else has changed. That’s why I said that the trends from Q1, they basically have continued in Q2, and they’ll continue in Q3 and Q4. Fairly isolated, and you can see it mainly it impacts, mainly the big volume products which are for us in down stream processing.

Yeah, I was just looking to get…I mean I understand in terms of similar trends, but I don’t think we’ve ever actually understood...because the thing that I look at is you listen to the biotech calls of all the big players,, and they talk about continuing efforts to take down inventory in-house, and I’m just trying to understand that versus what we see in terms of your numbers.

Yeah.

Because it seems like they are focused on that is heightened today versus, say, six months ago.

Yeah, that is true, but, over time, we’ve never had a situation like this where a handful of customers that were very large were driving down inventories so hard, so I think the level of inventory varies greatly by customer.

Okay. And in terms of the supply chain initiative, is that more of a sort of restructuring based on these new lowered expectations? Is this something you were driving to six months ago, and now you’re finally starting to show some leg on it? Help me understand how that fits into the whole spectrum in terms of what you’re doing from a cost perspective.

Yeah, Ross, I think you should think of it more as a continuation. Our current manufacturing consolidation strategy and the other supply chain initiatives alongside of it, we started a couple of years back. We’ve made great progress with that, and though aspects of that original initiative are winding down. So I think I probably even mentioned on the last call that we had started to think about ways to...ways to go further. I think with the down turn in Bioprocess and lower volumes in parts of the business, really just taking the opportunity to accelerate some of that thinking and see if there’s anything else that we can do. So I would think of it mostly as a continuation or extension of similar programs that we’ve done in the past.

And lastly, in terms of uses of cash, obviously the cash flow has ticked up nicely here. You’ve talked a little bit more about maybe utilizing it for some M&A, maybe small M&A. Is that playing a bigger piece in your external efforts, or is the number one goal still currently to pay down debt?

The number one goal is still to pay down debt, but we are working, also, actively at smaller acquisitions. So it has to...both has to fit, so for this year, certainly, number one is cash flow generation and paying down debt.

Okay. Great. Thank you.

Your next question comes from the line of Dan Leonard with First Analysis.

Good afternoon.

Hi, Dan.

Hi there, Charlie, a question for you. The raw material headwind obviously didn’t show up in the quarter due to your purchasing initiatives, your long term contracts and the fact you report on FIFO. But could you help me better understand what impact higher raw material costs can have on your medium term margin picture?

I can’t, because I can’t tell you ultimately where raw material prices are going to end up, but what I can tell you is that our procurement organization has been very successful at achieving cost reductions in a significant amount to offset what we’ve seen so far. And you can expect that that will continue. I would also say some of the savings that we’re seeing is tied to our sustainability initiative, as well. The company has been very, very focused over the last year on finding ways to be more efficient, use less energy, and Martin probably has some of the statistics at his finger tips, but we have really reduced our energy consumption in some areas in a very meaningful way. And so while the unit costs of fuel and energy might be up, our overall consumption in some areas is down, and we think we are effectively managing the impact of those price changes.

Would it be safe to conclude that at current...I mean without asking you to forecast raw material cost, the costs you see at their current levels, all of your initiatives would be enough to offset that additional burden down the line?

Yeah, it’s...it’s a bit of a leap to say, because we cannot predict, really, how commodity prices go up, but from the current trends, we’re pretty confident that we have offset everything, maybe more than offset. So we’ll continue...I think there is a lot of opportunity to drive efficiencies, reduce energy consumption. So, yeah, unless something crazy happens with the oil price, which is always possible, I think we are in pretty good shape.

Okay. And Martin, my second question is for you. How does the proposed M&A activity in the biotech space impact your medium term outlook for the company, more specifically for the Bioprocess process business, if at all?

It’s...we have seen acquisitions over last years. We have seen be MedImmune being bought by AstraZeneca, we’ve seen consolidation. I think this will continue as large pharma, which are…today our customers, obviously, buy biotech companies. So what you’ll see is you see more globalized purchasing which we already have today. So you’re dealing with global purchasing functions in some of these companies. They will try to look at overall contracting. They will look at reducing the number of suppliers, which we, being a strategic supplier, should be good, and they will try to put some pressure on price. But none of this is new. They will probably maybe do it a little bit more consistently. I hope we get better visibility on inventory, as they implement really worldwide ERP systems. And so we’ll be always a partner with these companies. So I think that the impact will be modest, and in some areas we might see a little bit more price pressure. In other areas, we get more long-term contracts. So I don’t think it’s a big deal.

Okay. Thank you.

[Operator Instructions]. Your next question comes from the line of Isaac Ro with Leerink Swann.

Hello?

Can you hear me?

Yeah.

Yeah.

Okay. Sorry about that, just another big picture question regarding, the broader marketplace for biotech. There’s been a lot of volatility in the last few weeks regarding some late stage, monoclonals or ones that were potential blockbusters either for the better or for the worse. And I am wondering, how do you guys handicap your forecast when you look aft the Bioprocess process business for those large potential blockbusters, and how has that process changed versus maybe three years a go.

I guess given the experience of the last few quarters, we will take a little more cautious approach as far as new molecules go, because the adoption and the timing of it is uncertain, and we’ve seen years, where we have positive surprises, and recently we have seen more negative surprises. So I think our forecasting will be based much more on the base proved volume of biotech drugs, and our new product revenue. Because these things we can control better. And then we handicap the timing of new product launches and the probability. Therefore on the other hand, there were some good news in this quarter on a number of large biotech drugs. So if that moves forward and materializes, then I think once they are launched, we put them into our forecast.

Would you care to comment on what you sort of think you’re… if you total up sort of the various steps of each monoclonal drug process, filtering process, if you total up the total opportunity, what do you think your share is of new drugs to that are coming out to market in late stage, and maybe has that increased or stayed the same in the last couple of years?

It’s hard to say. There’s no good market data, but probably half of them, maybe 40 to 50%, and it’s about the same.

And then just lastly, as you look at sort of the smaller and mid-capsized biotechs that you work with, do you find that your Bioprocess business has been improved there given that you have another couple of point with the old deal through logic of that acquisition, have you found that your share in those smaller accounts has improved?

It is improving. We see more business there, although it’s small volume, but we have made an effort to actually target these smaller accounts more. So we see some small numbers still, but we see more activity. The way we measure it, we measure it in the number of trials we’re getting in these accounts, and the number of adoption of our products. Not material yet, but there’s a whole market that is potentially very promising.

Your next question comes from the line of Eric Fitzgerald [ph] with Thomas Weisel

Hi, good afternoon. Filling in for Peter Lawson today. Just on the drug discovery business, I was wondering if you could comment where you are seeing the strongest strength? Is it in the early stage work, or is it mainly in the preclinical trial setting, maybe if you could just provide a little color on that?

Its actually in both. It depends a little bit on the target drug target class, but it’s in both areas. The service business is more in the preclinical area, and all the way up to the clinical work. So it’s basically an assay that we would develop, then, once it’s developed and moves into clinical, we follow the development of the drug with all assays. And then in the earlier stage, you have basically product lines that we launched recently, such as GPCR, so our kinase business GPCR, and the Ion Channel business, and that is going also pretty well. I would say that the most important aspect of the drug discovery business today is these multiplexing assays that we sell.

Okay. Great. And I guess similarly, in the Lifescience business, any particular or specific areas of strength? Is it… whether it be, cytology, or Photocytometry [ph], anything in particular that’s really driving that growth?

I called out the overall… in the life science business unit. No, it’s good… again, good success in the area of what we call protein research, with our western blotting devices and sample prep, and improving performance also with our antibody business, and then I think it’s more across the board, and, again, it’s is a combination of a few new products that really make a difference, and then really better marketing sales and Internet execution.

And just one, lastly, on your tax rate. The Q2 tax rate, is that something we can expect going forward, or is it going to be slightly lower in the second half of the year?

The full year rate we expect to be around 27%.

Okay. Great. Thank you very much.

Yes.

Your next question comes from the line of John Groberg with Merrill Lynch.

Hi, thanks for taking the follow-up. Just three fairly quick ones. Again, on the Bioprocessing, I think Martin a lot of people are trying to get comforted as to what may or may not happen with that business. And can you… one of the things people hear a lot about is some of these large western biotechs that you’ve talked about discussing how they’ve increased their yield by 50%. And so could you maybe discuss how that impacts your business with them?

Yeah. That has some impact, and it’s mixed. It has, in some areas, and I discussed it with many times with many of you. So it has, for example, depending on where you are in the process, it has an impact on the media filtration step, for example. So if you have higher yields and a more concentrated production process, you need less media, so that media filtration volume go’s down. On the other hand, you need more high capacity filtration devices, so you need more sophisticated filters, because the requirements have changed, and that’s why our new products are being adopted. So, yes, higher efficiency, higher yields will overall, I’d say for all suppliers, reduce slightly the demand, but it will increase the demand for new devices. So I think…

I know you talked about the more specifics tests, I guess just on a net basis, does it hurt you, or is it neutral to someone like you, depending on, the wins that you to get, I guess, but overall is it a positive?

It is very really hard to say, because I think it’s neutral to slightly negative.

And then just to clarify what you were discussing before, around some of the new drugs, that there’s been some good news, and so without saying that you necessarily are in a drug like BMAb, whether there’s some good news coming out of that. If you were, just as a hypothetic, would it be fair to say, because they have to be approved, that is not in your forecast for Bioprocess?

Definitely not

…for ‘08?

No, we’re not counting on any new drugs this year. Anything that gets approved this year and we would potentially see any additional orders that’s not in our forecast. It takes… usually takes longer to get drugs approved in our experience, so we’re not betting on regulatory agencies here to meet the timeline. If it happens, great. If we get the order, and it’s material, we’ll talk about it, but as you can imagine, I’m a bit more cautious, I’m only counting on what we can see and what we have, and we’ve seen going up and down, and I’ll be glad to have this conference call when it goes up again, because that will be very fun.

Your next question comes from the line of Chris Arndt with Select Equity Group.

Hi, Martin. I wanted to just clarify something you said earlier on the Bioprocess side, which was, I think you mentioned for the second half of the year, you expected still year-over-year declines in Bioprocess, but a much smaller decline. Was that right, or were you talking about just the U.S. business, specifically, not the overall?

I was just talking about these few key accounts. Overall, you will see that Bioprocess as we predicted today will have bottomed out in Q2. So overall we actually see a slight recovery in Q3 and Q4. But not enough to really offset the decline we saw in Q1 and Q2, so net-net will be more or less flat.

Okay. And then it sounded like you have greater conviction that in 2009 the Bioprocess division will resume growth. Is that right? And aside from the easier compares, is there anything else that supports that logic, or that claim?

Yes, that’s a very good question, and I’ll tell you that’s the key question, and... but when you follow these large accounts, which we’ve known since their existence, since they produced commercial drugs, and you look at the changes they made, and you look at their demand forecast, and you plot it out, you will see that at one point, their inventories will be so low that they will need to resume production to a level. So that’s why we say even in ‘09, if these large accounts are not doing much and just going sideways, and we see the growth from the other accounts, we will absolutely be in growth territory.

Okay. So you feel like that’s relative to six months or nine months ago, you actually have a better handle on that analysis, where they are, and where the end markets are going, and that it will need to resume in ‘09?

Yes, I would say yes.

Okay. And lastly…

Your next question comes from the line of Tycho Peterson.

He got cut off.

Hey, guys, my question has actually been answered. Thank you.

Your next question comes from the line of Paul Lee [ph] with Brown Advisory.

Hello. Paul, you there?

Sorry. I was mute. Anyway, I have a question regarding the SG&A line. In Q2, there’s a bump up of SG&A, and can you tell me what’s behind that, and for the rest of the year, what should we model for that line of expense?

The bump up you refer to is relative to what, the first quarter?

Relative to the revenue growth, relative to first quarter year-over-year growth. First quarter SG&A grew like 5% year-over-year. This quarter is 12.2% year-over-year, and I’m just wondering what is behind the growth? And also, you look at margin, 29.2 versus 28.3 percentage of revenue.

Right, yeah. If...what I would say is if you...we talked about the fact that FAS-123 would step up this year. Let me step back. If you look…if you think about Q1 to Q2 sequentially, part of the impact is that for all of our employees in Q2 we have the full impact of salary increases that doesn’t show up in the first quarter. So there’s always a sequential step-up in Q2.

Okay.

But I would year-over-year…and that doesn’t explain the year-over-year. But I would say year-over-year, the two biggest drivers are, there is an increase in FAS-123 in 2008 over 2007. We talked about that, and most of that is in SG&A and there were also some employee separation costs that we talked about in Q2 of this year. So if you were to...if you were to take those out, in fact the SG&A percent of sales would be at or slightly below last year’s percentage.

Okay. Regarding the tax rate, 27% guidance for 2007, does that take into account the potential renewal of R&D tax credit?

It does not count on that at this point.

Okay. And the guidance for 2008, now the total revenue is 6 to 7 versus earlier 8 to 9, because in the first half, I think you achieved about 7%, so...so should we look for a deceleration in the second half? Is that...are you...are we looking at a deceleration in both units, or just the Bioprocess?

The outlook…the lower outlook is exclusively related to Bioprocess. The other thing to consider is that the impact from currency, year-over-year, is less than the second half than it is in the first half.

Okay. All right. Thank you very much.

Okay.

Your next question comes from the line of Derik De Bruin with UBS.

Hi. Actually my question was answered. Thank you.

At this time, we have reached the allotted time for questions. I would now like to turn the call over to Martin Madaus for closing remarks.

Good. Thank you for joining us this evening. I hope you were able to take away from tonight’s call that we are effectively managing the downturn of our Bioprocess business by putting ourselves in a position to improve our profitability and cash flow. We believe that our Bioscience business will continue to perform very well, and that our Bioprocess will start to generate solid growth in 2009. So we hope to see many of you at several investor events in the third quarter, including the UBS Bus Tour, Thomas Weisel Conference and the UBS Life Science Conference. Thank you, and good night.

This concludes today’s conference call. You may now disconnect.