Bio-Rad Laboratories, Inc.

Ladies and gentlemen, thank you for standing by, and welcome to the Bio-Rad Laboratory's third quarter earnings call. At this time, all participant lines are in a listen-only mode. After the speaker's presentation, there will be a question-and-answer session. To ask a question during the session, you will need to press star, then 1 on your telephone. If you require any further assistance, please press star, then 0. I'd now like to hand the conference over to your speaker today, Mr. Ron Hutton, Vice President and Treasurer. Please go ahead.

Thank you, Liz. Good afternoon and thank you for joining us. Today we will review the third quarter financial results for 2019. With me on the call 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 Hrdia, President of the Clinical Diagnostics Group. Before we begin our review, I would like to caution everybody 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 reconciliation of these non-GAAP measures to the comparable GAAP results contained in our earnings release. I'd like to turn the call now over to Ilan Daskal. Ilan?

Thank you, Rohan. 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 third quarter of 2019 were $560.6 million, which is an increase of 2.8% on a reported basis versus $545.1 million in Q3 of 2018. On a currency-neutral basis, sales increased 4.5%. During the quarter, we experienced good demand across many of our key product areas and growth in all three regions. When comparing to the third quarter of last year, remember that Q3 of 2018 included about $6 million of sales that customers pulled into the second quarter of 2018, substantially all of it related to our diagnostics business. If we adjust the easy compare of the sales that customers pulled in last year from Q3 to Q2, we estimate that the year-over-year currency-neutral sales growth for Q3 of 2019 was about 3.4%. Sales of the life science group in the third quarter of 2019 were $215.7 million compared to $206.6 million in Q3 of 2018, which is an increase of 4.5% on a reported basis and 5.7% increase on a currency neutral basis. Much of the year-over-year growth in the third quarter was driven by a double-digit growth in droplet digital PCR and in food safety, as well as good demand within gene expression and Western bloating product lines. Process media, which can fluctuate on a quarterly basis, had a slight year-over-year growth. Excluding process media sales, the life science business grew about 5.8% year-over-year on a currency-neutral basis. On a geographic basis, LifeScience currency-neutral year-over-year sales grew across all three regions. Our Droplet digital PCR platform continues to have good momentum, and we are scheduled to introduce next month the QX1, which is a fully integrated system. This allows customers to fully automate the Droplet digital PCR workflow and increases the multiplexing capability. We have an initial backlog of orders for this new instrument, and we anticipate production and shipment ramp over the next 12 months. Sales of clinical diagnostics products in the third quarter were $341.8 million, compared to $334 million in Q3 of 2018, which is a 2.4% growth on a reported basis, and a 4.3% growth on a currency-neutral basis. When adjusting for the $6 million sales that customers pulled in last year from Q3 to Q2, the year-over-year currency-neutral sales growth was about 2.4%. During the quarter, we posted solid growth of blood typing, quality control, and immunology product lines. This growth was somewhat offset by year-over-year decline within diabetes as a result of price pressure in core markets. On a geographic basis, the diagnostics group posted nice growth in the Americas and in Asia, while the macroeconomic environment in Europe weighs on the growth rates in the region. The reported gross margin for the third quarter of 2019 was 54.8% on a get basis and compares to 52.6% in Q3 of 2018. The year-over-year margin increase is driven mainly by product mix and lower cost of inventory reserves. Amortization related to prior acquisitions recorded in cost of goods sold was $3.9 million compared to $4.7 million in Q3 of 2018. SG&A expenses for Q3 of 2019 were $201.6 million, or 36% of sales. The SG&A expenses in Q3 of 2018 were $201.2 million, or 36.9%, and including $4 million of contingent consideration benefits. Total amortization expense related to acquisitions recorded in SG&A for the quarter was $1.9 million versus $1.8 million in Q3 of 2018. Reducing the SG&A spend continues to remain a focus area to achieve our 2020 goals. Research and development expense in Q3 was $47.9 million or 8.6% of sales compared to $49.2 million, or 9%, in Q3 of 2018. All of this adds up to a reported Q3 operating income of $57.5 million, or 10.2% of sales, compared to $36.3 million, or 6.7% in Q3 of 2018. Looking below the operating line, The change in fair market value of the equity securities holdings reduced the reported income by $390.6 million 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 $2.1 million compared to $4.2 million last year. The year-over-year improvement primarily reflect higher investment income. The effective tax rate in Q3 of 2019 was 22.8% and compares to 23.1% in Q3 of 2018. Reported net loss for the third quarter was $258.8 million and diluted loss per share for the quarter was $8.68. The decrease in net income and earnings per share versus last year is substantially related to the valuation of the Sartorius holdings. 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 the 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 third quarter, in cost of goods sold, we have excluded $3.9 million of amortization of purchased intangibles and $3.2 million of restructuring expenses. These exclusions move the gross margin for the third quarter of 2019 to a non-GAAP gross margin of 56%, versus 53.5% in Q3 of 2018. The non-GAAP SG&A in the third quarter of 2019 was 35.5% versus 36.3% in Q3 of 2018. In SG&A, on a non-GAAP basis, we have excluded amortization of purchased intangibles of $1.9 million, a restructuring cost of $2.7 million, and $1.9 million adjustment to legal reserves. In R&D, we have excluded a small amount of restructuring benefit. The non-GAAP R&D expense in Q3 was 8.5%, which is in line with our expectation. The cumulative sum of these non-GAAP adjustments results in moving the quarterly operating margin from 10.2% on a GAAP basis to 12% on a non-GAAP basis. This non-GAAP operating margin compares to a non-GAAP operating margin in Q3 of 2018 of 8.2%. We have also excluded certain items below the operating line, which are the decrease in value of the Sartorius equity holdings of $390.6 million, as well as a small loss associated with venture investments. The non-GAAP effective tax rate for the quarter was 25.5%, and we estimate the full-year tax rate on a non-GAAP basis to be approximately 27%, which is primarily driven by the geographic mix of earnings. And finally, non-GAAP net income and diluted earnings per share for the third quarter of 2019 were $48.6 million and $1.61 per share, compared to $27.6 million.91 per share in Q3 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 third quarter was $217.5 million, and associated liabilities are included in the 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. Total cash and short-term investments at the end of Q3 were $985 million, compared to $850 million at the end of 2018. During the quarter, we completed an acquisition of a small manufacturer in the diagnostics group that will expand our capabilities within our quality control products. Also during the third quarter, we purchased 14,745 shares of our stock for $5 million at an average share price of $339.05. For the third quarter of 2019, net cash generated from operations was about $100 million, which compares to about $62 million in Q3 of 2018. This improvement mainly reflects the higher operating profits and improved working capital. The adjusted EBITDA for the third quarter of 2019 was $95.1 million, or 17% of sales. The adjusted EBITDA in the first nine months of 2019 was $288.5 million, or about 17.1%, compared to $253.1 million, or 15.1% in the first nine months of 2018. Net capital expenditures for the third quarter of 2019 were $31.1 million. We project that the full-year capex spend will likely be at the low end of the forecasted range of $110 to $120 million. Depreciation and amortization for the Amortization for the third quarter was $33.6 million. Moving on to the guidance. The overall performance in the first nine months of the year. We continue to see strong momentum for the fourth quarter. However, we remain cautious of the macroeconomic softness environment in Europe, as well as geopolitical and global trade tension in other parts of the globe. With that in mind, we are maintaining our full-year guidance range. We estimate a full year-over-year currency-neutral revenue growth between 4% and 4.5%. Full-year non-GAAP gross margin is projected between 55.5% and 56%. And full-year non-GAAP operating margin between 12.5% and 13%. And with that, we will open the line to take your questions. Operator?

As a reminder, to ask a question, you will need to press star, then 1 on your telephone. To withdraw your question, press the pound key. Please wait while we compile the Q&A roster. Our first question comes from the line of Brandon Collard with Jefferies. Your line is now open.

Thanks for the afternoon. Maybe for Elan, you know, I generally think about BIRAD as being the least macro-sensitive business in my coverage universe. You sort of elaborate on what parts of the diagnostics business that you perceive as being a little more macro-sensitive, perhaps in some instrumentation placements. And then on diabetes pricing that you mentioned in the script, is that a competitive dynamic? And, you know, what regions is it mostly concentrated in, if one or two? Thanks.

John Hardy I'll take that. I'd say that the overall macro diagnostics market in Europe is pretty soft. It's not just a function of our product line but it's just in general if you look at many of the market reports out there and that's certainly reflected. We did see some growth in EMEA in the quarter. We're mindful about the fact that this was an easy to compare to last year. We do look to continue a modest growth trend from EMEA but As Elan mentioned, we're watchful of the geopolitical instability and how that might impact our business in the Middle East. With respect to diabetes, we have been continuing to see price pressure over the quarters. That certainly affected our business, and I'd say across most regions, but I'd also say that some of the decline this year was related to timing, which sometimes happens with shipments in our diabetes business.

Thanks. And one for Annette. On the QX1 launch, could you help us just sort of understand the mix of the current backlog between upgrades and new users? Do you expect that system to sort of open up accounts who would adopt it, sort of given the workflow and the plexing advantages? And can you sort of speak to sort of the traction of this system in the clinical markets right now? Thanks.

Sure. This system was really designed primarily for biopharma customers, and we know that we have current biopharma customers who are interested in adopting the new system as well, but there are customers who have been waiting for this system because of the workflow and the multiplexing capability. I'm not sure if that answered all of your questions, Brandon.

I think so. Okay, and then maybe, I'm not sure if Andy's here, but Elon, you can speak to, now that you've sort of been in the business for about six months, where do you see some of the best opportunities for cost outs and any specific actions you expect to take over the next 12 months would be helpful.

All right, all right. I can certainly add. I mean, SG&A, I think Ilan called it out in the script. This is Andy, I'm sorry. SG&A continues to be a focus area for us and we'll continue to work to reduce that as a percent of sales. Operating efficiencies broadly, again, we're not working to release 2020 guidance yet or any expectations around that, but And SG&A is the primary focus for us.

All righty. I'll hop back into the queue. Thanks.

Thank you.

As a reminder, ladies and gentlemen, that is star then one if you'd like to ask a question. Our next question comes from the line of Jack Meehan with Barclays. Your line is now open.

Thanks. Good afternoon. I wanted to continue on with the QX1 launch and just get a sense for the initial game plan. Is there a menu that you're looking to launch that with? What are some of the key assays that you're planning to roll out over the next year or two?

That's a great question. So we made sure that this platform was 100% compatible with our current platform and assays. So we have thousands of RUO assays that are available for people to buy today, and they can buy them tomorrow for the QX1. In addition, we'll be rolling out four-color versions of those assays so they can increase their multiplexing in one well. with validated assays. Over time, we will likely move this platform into the IBD market, and that's when we'll have regulated menu develop.

Got it. Is there any color you can give on the economics of the platform, and is there, and also maybe just the size of the current installed base, and how many of those you expect to move on to the new system?

Well, I can say that we have spoken with quite a few current customers who intend to continue to use their old platform and add this platform into their workflow. And we have also spoken to quite a few new customers as well who don't have our platform yet. You know, this is a higher-end platform than the QX200. So, you know... You get a lot more flexibility and ease of use and workflow flexibility, and you'll have to pay a little bit more for the platform.

Great. Keep it going, Annette. Maybe are there any updates you can provide in terms of some of the new product development in single cell using the Droplet technology?

What I can tell you is we have several active programs. We just launched a new product for epigenomics in single cell. It's our attack seek product that is generating a lot of interest with our customers and our collaborators are generating a lot of really great data using that kit. and we're working on next-generation systems for single-cell RNA-seq as well.

Great. And then one final one, and I'll hop back in the queue. The results are about as in line with my numbers as you can get on the revenue line, so I have to follow up on Brandon's question related to diabetes. That was really the only delta I see. You know, John, you mentioned some There could have been some timing related to that. Is it possible to quantify how much might have moved into the fourth quarter?

Not really.

Okay. I'll hop back in the queue. Thanks.

We have a follow-up question from the line of Brandon Killard with Jeffries. Your line is now open.

All right. Thanks. Maybe one for you, John. One of the other diagnostics players in the space alluded to some material change in the macro environment in China specifically for diagnostics. Just curious if you've seen any changes in the landscape there.

Well, from a diagnostics perspective, we continue to see significant growth in Asia, but I guess I'd turn it over to Andy to talk about maybe China in general for the company, and then if you have any follow-up questions.

So with respect to China more specifically, We've been encouraged by our year-to-date performance. We remain optimistic for Q4. I think like everybody else, we'd also put out the caveat that we're closely watching the geopolitical situation and impact of tariffs, which have been so far modest in our exposure. We keep an eye on that for the long term and any changes. So we're cautiously optimistic as we look forward in China.

Okay, and then maybe one follow-up for Annette. We'd love to get an update on the cell analysis portfolio and specifically any interest you're seeing in the ZE5 cell imager. Thanks.

Well, you know, I think we're seeing good demand in our flow analysis products. And with respect to the DE5, we see a lot of traction in pharma and biopharma due to the particular feature set and value proposition it offers those customers.

All righty. Maybe one for Norman just to round out here. You know, cash continues to build pretty substantially on the balance sheet. The buyback is relatively immaterial in the third quarter. Just, you know, give us a sense of, you know, perhaps why the buyback doesn't seem to be a higher priority and kind of your current view on the M&A pipeline and whether or not you might be any closer to finding something attractive out there.

Thanks. So, Brendan, I'm going to just go to Norman.

Go ahead, Norman. Yeah, I've got that answer. I think that it's always a balance. You've got opportunities that you're looking at. We try to keep the cash for those, but nevertheless, we did get in the market and did buy back some shares during the quarter. Again, it's a balance between saving it for the right acquisition and the buyback. So we're trying to manage it the best we can.

All righty. Thank you. Thank you.

We have a follow-up question from the line of Jack Meehan with Barclays. Your line is now open.

Thanks. Maybe just to start on the process risen business. So I know that was up modestly year over year. I think previously you were assuming some modest levels of growth back half over back half. Is that still the implied assumption for the fourth quarter?

So, Jack, thanks for the question. The short answer is yes. I mean, we still project the incremental growth to be this year. So obviously most of the growth we projected in Q4.

Okay. And then the gross margin of 56% was, you know, really strong 250 bits year over year. Was there anything to call out in terms of some of the efficiency initiatives or mix of consumable versus instrument, which might have helped that progression in the quarter?

Yeah, great question. Thanks, Jack. You know, The reason, obviously, the mix with more consumables in this quarter relative to Q3 of 2018, that was definitely one major component there. And two other items that I would highlight would be the lower inventory reserves and the lower logistics costs. These are two items that, you know, we called out last year at the same time. And these are definitely, you know, items that – areas that – we improved, you know, and that contributed to the incremental gross margin this quarter.

Great. And maybe, you know, Andy, I know you mentioned you weren't giving 2020 guidance at this point, but, you know, at the last analyst day in November of 2017, you had the 20% target. You know, just given the progression you've had the last few years and the trajectory year to date, I mean, does that still feel pretty doable?

Yeah, I think we're optimistic about exiting 2020 with our stated targets in hand. Nothing at this point to say we can't achieve that.

Great. And maybe just a final one on the income statement. The tax rate came in a little bit below my forecast, but it still feels like there's a lot of opportunity to keep pushing that down over time. You know, Alon, is there a number you have in mind? You know, like, is this a good 25.5% number to use on a go-forward basis?

So, Jack, thank you. You know, for this year, we project a 27% rate. Overall, you know, it depends on the geographic mix. That's a That's one main item that does impact the overall non-GAAP rate. And, you know, long-term, you know, we may get to the mid-20s, but I'm not ready right now to kind of forecast the 2020. And I'll provide an update on the next poll, but for this year, it's still at the 27 level.

Sounds good. Thanks.

And I'm showing no further questions in queue at this time, so that will conclude today's question and answer session. Ladies and gentlemen, this concludes today's conference call. Thank you for participating. You may now disconnect.