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Operating margins rise and SG&A spending increases.

When sales growth lags, companies look to increase profits and drive earnings through cost cutting and increased productivity. Over the last two years, companies have benefited from these activities with record profit growth and higher operating margins. Instrument companies have been no different. The economic downturn earlier in the decade, compounded by a slowdown in spending by pharmaceutical companies, shifted many companies' emphasis from sales growth to increased profitability.

As a result, many established instrument companies are participating in the record profit growth posted by US companies over the last two years. Business Week's Corporate Scoreboard, which tracks corporate results for 900 US companies, reported that GAAP profits grew 76% in 2003, the fastest in the Scoreboard's 30-year history. Thomson First Call, using a different calculation method excluding unusual items, reported a 17% increase in corporate profits for the year. Profit margins for the Scoreboard companies were 6.7% in 2003 versus 1.8% in 2002.

IBO's Laboratory Instrument Index, which tracks sales and operating profits for 31 instrument companies worldwide, reported a 21.5% increase in operating profits in 2003 and an 180-basis-point increase in adjusted operating margins to 14.4% (see IBO 8/15/04). As does Thomson First Call, the Index records adjusted annual operating profits, which exclude unusual items, including amortization and restructuring charges. Although sales in 2003 grew 6.5%, companies kept stockholders happy with higher earnings per share.

In this article, IBO examines the adjusted operating profit margin for five major instrument companies. These companies were selected due to their size and their concentration on high-end analytical instrumentation, although two of the companies (Applied Biosystems, Waters) have sizeable consumables businesses. The figures presented are not intended to suggest a comparison between the companies as each operates different businesses with distinct product offerings and business models. Rather, the figures are presented to show trends in instrument company profitability. Although the figures are only presented for five companies, these five companies can be considered representative of broader trends as together they account for more than $3.3 billion in sales, or approximately 13% of the global analytical and life science instrument market (see IBO 7/31/04).

The average adjusted operating profit margin for the five companies--Applied Biosystems, Bruker BioSciences, Dionex, Molecular Devices and Waters--increased to 6.8% in 2003 from 6.2% in 2002. The 2003 figure also topped 2001's 6.5% operating margin. The year-over-year gains for 2003 came from a decrease of 100 basis points in the costs of goods sold (COGS) and a drop of 60 basis points in R&D expenses as a percentage of sales. It appears that the decrease in COGS was due to improved productivity driven by operational efficiencies and sourcing savings. IBO surmises that declines in R&D spending were due to the integration of R&D operations, greater use of partnerships and reprioritizing of R&D portfolios. In addition, some new technologies were obtained through acquisitions rather than developed in-house.

However, the average SG&A as a percentage of sales for these five companies rose by 120 basis points from 2002-03. The increase in SG&A appears to have been driven by a greater number of product introductions, increased competition and the growing complexity and sophistication of high-end instrumentation, for which specialist sales personnel are needed.

In 2003, Waters's operating profit margin was 24.7%, considerably higher than the other companies surveyed. However, Waters's gross margin was not the highest, indicating that its cost saving came from controlling operational expenses. Waters had the lowest R&D percentage as a percentage of sales from 2001-03, and it has the second-lowest SG&A costs as a percentage of sales among the companies examined. According to IBO's analysis, Waters's focused product line in each of its three businesses (HPLC, MS, thermal analysis), its strong competitive position in each business and its large aftermarket business for HPLC are key factors in its profitability. Product focus and competitive position allow for more specialized R&D spending and sales efforts.

The company with the highest gross margin over the last three fiscal years is Dionex. In 2003, the company's gross margin was 65.6%. However, its SG&A spending as a percentage of sales was above 30%. Dionex gains operating leverage through very focused product lines (IC, HPLC and ASE). The company is curently spending a relatively higher percentage of sales on SG&A as part of its its effort to grow its HPLC business, according to IBO's analysis.

Also recording SG&A costs above 30% of sales over the last three years is Molecular Devices. Molecular Devices spends the highest percentage on R&D among the five companies examined. IBO attributes the relatively high percentage to Molecular Devices' launch of its ion channel testing platform, a new product area for the company, and, as the company stated in its annual report, "increased spending related to sales and service worldwide."

Not surprisingly, considering its product lines of expensive, sophisticated analytical instrumentation, Bruker BioSciences' COGS is above 50% of sales. The company's product lines overwhelmingly consist of sophisticated, expensive instrument systems that require specialized components, skilled labor and take longer to manufacture. In addition, the diversity of the company's product lines creates lower manufacturing volume.
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Publication:Instrument Business Outlook
Geographic Code:1USA
Date:Sep 30, 2004
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