Bio-Rad Laboratories, Inc.

Good day, ladies and gentlemen, and welcome to Bio-Rad Laboratory's second quarter 2019 earnings conference call. At this time, all participants are in a listen-only mode. Later, we will conduct a question-and-answer session, and instructions will be given at that time. If anyone should require assistance during the conference, please press star then zero on your touchtone telephone. As a reminder, this conference is being recorded. I would now like to turn the conference over to Ron Hutton, Treasurer, and Vice President. You may begin.

Thank you, Tiffany. Good afternoon and thank you all for joining us today. Today we will review the second quarter financial results for 2019. With me today are Norman Schwartz, our CEO, Ilan Daskal, Executive Vice President and Chief Financial Officer, Andy Last, Executive Vice President and Chief Operating Officer, Annette Tumalo, President of the Life Science Group, and John Herdia, President of the Clinical Diagnostics Group. Before we begin our review, I would like to caution everyone that we will be making forward-looking statements about management's goals, plans, and expectations, our future financial performance, and other matters. Because our actual results may differ materially from these plans and expectations, you should not place undue reliance on these forward-looking statements and I encourage you to review our filings with the SEC where we discuss in detail the risk factors in our business. The company does not intend to update any forward-looking statements made during the call today. Our remarks today will also include references to non-GAAP net income and non-GAAP diluted income per share, which are financial measures that are not defined under generally accepted accounting principles. Investors should review the reconciliations of these non-GAAP measures to the comparable GAAP results contained in our earning release. I'd now like to turn the call over to Ilan.

Thank you, Ron. Good afternoon, and thank you all for joining us. We will review the results on a GAAP basis as well as commentary on a non-GAAP basis. Net sales for the second quarter of 2019 were $572.6 million, which is a 0.6% decline on a reported basis versus $575.9 million in Q2 of 2018. On a currency-neutral basis, sales increased 2.7%. During the quarter, we experienced good demand across many of our key product areas, and growth in all three regions. When comparing to the second quarter of last year, remember that Q2 of 2018 included about $6 million of sales that customers pulled in from Q3. Q2 of 2018 also included about $4 million higher sales associated with the discontinued Raindance Marriott account, and we expect it to be immaterial as of Q3. If we exclude the myriad reduction of sales and the sales that customers pulled in last year from Q3 to Q2, we estimate that the year-over-year currency-neutral sales growth for Q2 of 2019 was about 4.6%. Sales of the life science group in the second quarter of 2019 were $212.4 million compared to $217.8 million in Q2 of 2018, which is a decline of 2.5% on a reported basis and about flat on a currency-neutral basis. Process media, which can fluctuate on a quarterly basis, was slow in the second quarter after a very strong sales in Q1 of 2019. All other product areas within life science had a solid year-over-year growth and of note, a double-digit growth in droplet digital PCR, antibody business, and in food safety. Our droplet digital PCR growth continues to have good momentum due to its high sensitivity, precision, and thousands of optimized assays. To date, it is cited in several thousand of peer-reviewed publications. Excluding process media sales, the life science business, grew about 7.5% year-over-year on a currency-neutral basis, driven by continued biopharma demand. On a geographic basis, life science currency-neutral sales, excluding process media, were strong across all three regions, and most notably in the Americas. Sales of clinical diagnostics products in the quarter were $357.1 million compared to $354 million in Q2 of 2018, which is a 0.9% growth on a reported basis and a 4.8% growth on a currency-neutral basis. During the second quarter, we posted solid growth of diabetes and quality control products. Immunology also hit strong quarter, which has driven by sorry, which was driven by a reagent pull-through, a very high one. We also received this quarter an FDA approval for a bioplex Lyme disease panel, which has been much anticipated by our customers. On a geographic basis, the diagnostics group posted a year-over-year currency-neutral sales growth across all three regions. The reported gross margin for the second quarter of 2019 was was 53.7% on a gap basis and compares to 52.4% in Q2 of 2018. If you recall, in Q2 of 2018, we experienced product mix headwind and atypical inventory-related expenses. Much of the year-over-year margin increase is driven by improvements in these two areas. Amortization related to prior acquisitions recorded in cost of goods sold was $3.8 million compared to $4.7 million in Q2 of 2018. SG&A expenses for Q2 of 2019 were $201.3 million or 35.1% of sales compared to 36.5% in Q2 of 2018. Total amortization related to acquisitions recorded in SG&A for the quarter was $1.6 million versus $2.1 million in Q2 of 2018. Reducing the SG&A spend remains a focus area to achieve our 2020 goals. Research and development expense in Q2 was $50.1 million, or 8.8% of sales, compared to $47.5 million or 8.2% in Q2 of 2018. Looking below the operating line, the change in fair market value of the equity securities holdings added $716.4 million of income to the reported results and is substantially related to the holdings of the shares of Sartorius AG. Also during the quarter, interest and other income resulted in net other expense of $3.2 million compared to $9.9 million income last year. The year-over-year decrease primarily reflects the Sartorius dividend that was declared this year in Q1 versus Q2 last year. The effective tax rate used in Q2 of 2019 was 22.2%, and compares to 21.2% in Q2 of 2018. These rates are primarily driven by the sizable gain related to our sartorius investment, and in Q2 of 2019 also included tax reform related benefits. Reported net income for the second quarter was $598.8 million, and diluted earnings per share for the quarter were $19.86. The increase in net income and earnings per share versus last year is substantially related to the valuation of the Sartorius holding. Moving on to the non-GAAP results. Looking at our results on a non-GAAP basis, we have excluded certain atypical and unique items that impacted both the gross and operating margins as well as other incomes. These items are detailed in the reconciliation table in the press release. Looking at the non-GAAP results for the second quarter, in cost of goods sold, we have excluded $3.8 million of amortizations of purchased intangibles and small restructuring adjustments. The exclusions move the gross margin for the second quarter of 2019 to a non-GAAP gross margin of 54.4%, versus 53.4% in Q2 of 2018. If you recall, Q2 of 2018 included a headwind from product mix and at-typical inventory-related expenses, and again, much of the year-over-year margin increase is driven by improvements in these two areas. The non-GET SG&A in the second quarter of 2019 was 33.9%, an improvement of more than a point versus the 35.1% in Q2 of 2018. In SG&A, on a non-GAAP basis, we have excluded amortization of purchase intangibles of $1.6 million, legal-related expenses of $5.4 million, and small amounts for restructuring costs and acquisition-related benefits. In R&D, we have excluded a small amount of restructuring benefits The non-GAAP R&D in Q2 was 8.8%, which is in line with our expectations. The cumulative sum of these non-GAAP adjustments results in moving the quarterly operating margin from 9.8% on a GAAP basis to 11.7% on a non-GAAP basis. This non-GAAP operating margin compares to a non-GAAP operating margin in Q2 of 2018 of 10%. We have also excluded certain items below the operating line, which are the increase in value of the Sartorius equity holding of $716.4 million, as well as a small loss associated with venture investments. The non-GAAP effective tax rate for the quarter was 26.4%, which was primarily driven by the geographic mix in the second quarter earnings. We continue to estimate the annual tax rate on a non-GAAP basis to be in the 27 to 28% range. And finally, non-GAAP net income and diluted earnings per share for the second quarter of 2019 were $47.4 million and $1.57 per share, compared to $49.5 million and $1.64 per share in Q2 of 2018. Moving on to the balance sheet. In the first quarter of 2019, we adopted a new accounting standard related to leases, which requires us to recognize most leases as assets and liabilities on the balance sheet. The right of use assets balance in the second quarter was $215.5 million, and the associated liabilities included in other current liabilities and in other long-term liabilities. These balances primarily represent our operating lease obligations for facilities and auto leases. The adoption of this standard has a minimal effect on the income statement. The total cash and short-term investments at the end of Q2 were $987 million, compared to $850 million at the end of 2018. and $865 million at the end of the first quarter. During the second quarter, we purchased 51,398 shares of our stock for $15 million at an average share price of $291.85. For the second quarter of 2019, net cash generated from operations was about $155 million which compares to about $78 million in Q2 of 2018. This improvement mainly reflects the higher operating profits, improved working capital, the payment of the Sartorius dividend that was declared in Q1, as well as a tax refund. The adjusted EBITDA for the second quarter of 2019 was $95.1 million, or 16.6% of sales. The adjusted EBITDA in the first six months of 2019 was $196.7 million, or about 17.5%, compared to $180.3 million, or 16% in the first six months of 2018. Net capital expenditures for the second quarter of 2019 were $22.2 million, or 3.9% of sales. The full year expectation for CapEx spend is at the low end of the forecasted range of $110 to $120 million. Depreciation and amortization for the second quarter was $33 million. And lastly, I'd like to mention that we are pleased with the federal court's recent ruling upholding the decision against 10X Genomics and the $23.9 million award and injunction related to our Droplet Digital PCR intellectual property. Moving on to the guidance. We are pleased with the overall performance in the first half of the year, and we continue to maintain the annual guidance range. We expect a full year-over-year currency-neutral sales growth of 4% to 4.5%. We continue to target a non-GAAP gross margin in the 55.5% to 56% range for the year, and non-GAAP operating margin range of 12.5% to 13%. And with that, we will open the line to take your questions. Tiffany?

Thank you. Ladies and gentlemen, at this time, if you have a question, please press the star followed by the number one key on your touchtone telephone. If your question has been answered or you wish to remove yourself from the queue, please press the pound key. And our first question comes from Patrick Donnelly with Goldman Sachs. Please proceed.

Great. Thanks, guys. Maybe one for you, Elon. You know, margins came in ahead of our expectations again this quarter, you know, clearly gaining some momentum with the internal initiatives there. Can you just give us an update on what you've seen to date? You know, obviously you've been in the seat for a little while now. And then expectations there going forward, as we think ahead even to the 2020 target, what are the key levers or initiatives you have yet to kind of capitalize on that help you get towards that target?

Yeah, sure. Thank you, Patrick. Good question. So, you know, being here for a few months, obviously, you know, not only myself, but also Andy, we looked at the initiatives that are ongoing to achieve the 2020 target model. And we are also looking at additional initiatives in order to achieve the 2020 margin. For the most part, we are focused on the SG&A related items. And to a lesser extent, but also an incremental expansion of the gross margin. But again, the main focus is on the SG&A line.

Okay. And then maybe just on the growth side, you know, flat organic and life science was actually pretty encouraging given the comp there. Can you just talk through, you know, what specific areas you're seeing strength? And then maybe specifically on DDPCR, you know, that seems to be continuing to gain momentum there. Can you just help frame that opportunity for us? What type of sales are you seeing to date, if you're willing to break that out? Just trying to get a better handle on how significant of a growth driver that can be for you guys going forward.

Hi, this is Annette. Yeah, well, we're seeing good growth across all of our core product lines, and that's really encouraging to us. But in particular, our genomics lines and digital PCR is really leading the way there. We are getting really good traction in the biopharma segment, for sure. And we're moving, you know, we have a lot of our customers adapting and validating our platform for lab-developed tests. So we're moving into the clinic along with some of our cleared products. And we're just starting. So we really see... Good traction in those segments, and we are very optimistic moving forward.

Okay, maybe just one last one. Elon, I know you briefly touched on the litigation side. Can you just maybe parse out a little bit on the update? You know, we saw last week, obviously, they're talking about a 15% royalty, some sort of injunction. Maybe just give us your thoughts on what you expect to kind of be finalized on that front, maybe timing once we'll have kind of, again, a conclusive, definitive outcome there.

This is Annette again. I'll take that. We generally don't like to talk a lot about ongoing matters in litigation, but there have been some public announcements there. The Delaware court recently confirmed the jury verdict that the 10X products infringed the patents that we asserted and awarded us damages, and the judge followed that and with a ruling issuing an injunction. The way it works, though, is the court has to finalize that order, and that's what's happening now, and we imagine in the next days to weeks we'll get the final issuance from the court on what exactly the details of that injunction are.

All right, that's very helpful, and I appreciate it. Thank you.

And our next question comes from Mitch Peterson with Barclays. Your line is open.

Hey, thanks. Maybe first off, just on Droplet Digital, I was hoping you could update us on the timing of the new products that you're developing there.

Sure. We are launching our next generation integrated system with four colors probably in the fourth quarter of 2019.

Got it. That's helpful. Maybe similarly, just on that business, within Droplet Digital, could you comment on how big your business is in single-cell today? And then relatedly, just on, I think you called out double-digit growth for Droplet Digital as a whole. Just as a clarification, does that include the headwind from Raindance in the quarter?

Yeah, definitely. It does include the headwind from RainDance. And, you know, usually what we disclose is kind of the double-digit growth that we mentioned.

Got it. And then lastly for me, I noticed that you didn't call out blood typing in the script. Could you just comment on how that business trended in the quarter? Thank you.

Hey, this is John Herdia. I'll take that. Our blood typing business did grow year over year. It just wasn't that highlight level, but we continue to see strong placements of both the IH1000 and the IH500 around the world and strong reagent pull-through.

Great. Helpful. Thank you.

Thank you.

And our next question comes from Dan Leonard with Deutsche Bank. Please proceed.

Thank you. Can you please elaborate on market conditions in China across both your businesses? That seems to be a point where we've seen softness from a number of peers in the quarter.

This is Andy. I'll take that, and others can certainly add. Generally, we've been pleased with our China performance. We're not experiencing any material impact the way that some others may have reported. And subject to any major geopolitical shifts that may occur, we continue to see China as a positive for us across the portfolio.

Okay, and a couple of product-specific questions in diagnostics for John. John, can you update us on the autoimmune diagnostic testing environment in the U.S., specifically the competitive environment, and then secondly, Can you help us frame how you're thinking about this Lyme test opportunity? It seems like there's more in the news about that lately. Thank you.

Okay. Well, let's take autoimmune first. It's kind of a fragmented market. We have the only fully automated integrated multiplex system for autoimmune testing. We're seeing an evolution of manual IFA slide testing to automated systems and And that's the heart of our BioPlex business, which is doing quite well year over year.

And then on Lyme?

So Lyme, we just introduced, we just got FDA approval for the Lyme test. It's a large and growing market. There's a lot of dissatisfaction in Lyme right now. There's multiple court cases going around the world because of the lack of sensitivity and specificity in the market. It's a hard market. disease to diagnose, and it takes a long time. We have a very novel assay design that gives us better sensitivity and better specificity than anything else on the market, and it's a fully automated solution. Great.

Thank you.

Thank you.

And once again, ladies and gentlemen, as a reminder, if you do have a question, please press star then 1. Our next question comes from Brandon Couillard with Jefferies. Please proceed.

Hey, thanks. Good afternoon. Annette, maybe starting with you, can you just give us an update on where you stand with your cell analysis portfolio? Going back a year or two, you kind of cobbled together imaging, a cell sorter, and a flow cytometer. Just update us on where uptake is with that platform, and then would you still expect process media to be a headwind to life sciences in the back half as well?

Okay, thanks Brandon. So we are seeing really strong uptake in the biopharma segment of our cell biology products, in particular our ZE5 flow cytometer, flow analyzer. So we continue to invest. We think it is a perfect time to develop new tools for our customers in this era of cell biology. So we're optimistic about the future of the products we have, and we're looking to expand our market share in that area. With regard to process chromatography, you know, we think the second half of the year we're going to see incremental year-over-year growth, and we think that we'll end the year with growth over 2018. We said this before, quarter to quarter, it can be a little bit lumpy, so it's hard to, you know, compare quarter over quarter results sometimes.

And, Brendan, I'll add to that, you know, for Process Chrome, I mean, in the first half, it was about flat relative to last year, and we do anticipate most of the incremental revenue to come in in the second half, as Annette mentioned.

Super. And then one more on Droplet Digital. Annette, there's some newer entrants in the digital PCR space coming with a couple of new platforms. Can you sort of speak to the advantages and disadvantages of your droplet system versus other digital platforms?

Well, you know, I can say that our platform and our optimized assays, which we have thousands of, have already enabled a lot of breakthrough research. and give in clinicians new options in liquid biopsy and precision medicine. And we've got thousands, as Ilan mentioned, of peer-reviewed publications that support the scientific utility of the droplet system and clinical utility of the droplet platform that we developed. So I think that our focus moving forward is to make sure that we're developing new platforms in that area that will both expand the applications and the relevance to new market segments for digital PCR and build on the already compelling value proposition that we have. Droplets are a really good test tube for this assay, and they are very, very scalable. And given our success in this market that we created, it doesn't surprise us that people want to join in with us, but we think that we're in a position to just continue to build on the really strong lead that we have.

Thanks, and then maybe one for you, Alon. Cash continues to build on the balance sheet. I appreciate that you did $15 million of buybacks. in the second quarter, but that's a tiny fraction, really, of what you generated just in the second quarter in terms of cash flow. Just curious, like, why that's not a bigger priority for you, you know, given the operating cash flow improvement and where the underlying valuation of the stock is here when you strip out the sartorius valuation. Just curious, you know, what you're thinking there.

Yeah, great question. Thanks, Brandon. You know, generally, we continue to be opportunistic in terms of the buyback. The board authorized us A $250 million plan. We did about 65 so far. And we plan to continue to be opportunistic. And the way we think about it is, you know, how do we kind of bundle it as part of the overall capital allocation model? And specifically with various inorganic kind of opportunities that we keep looking into.

Thanks. The last one for Norman, just an update from your end in terms of how the M&A pipeline is shaping up right now. You know, again, balance sheets most overcapitalized it's been in quite some time. Are you any closer today to perhaps finding a bolt-on deal or not?

Yeah. Yeah. I think we, I think, you know, we've certainly got some possibilities out there and, and are encouraged by, by what we're seeing and, and yeah, and the progress we're making on a couple of fronts. So hopefully we can put more of that capital to use in the near term.

Very good. Thank you.

Thank you.

And I am currently showing no questions in queue. This concludes our Q&A session. I'd like to turn the call back over to Ilan Duskal for further remarks.

Thank you, everyone, for joining us today, and we'll connect again in the next quarter's call.

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