Bio-Rad Laboratories, Inc. (BIO) Q3 2012 Earnings Report, Transcript and Summary

Good day, ladies and gentlemen, and welcome to the Q3 2012 Bio-Rad Laboratories Earnings Conference Call. My name is Darcell, and I will be your operator for today. [Operator Instructions] I would now like to turn the conference over to your host for today, Mr. Ron Hutton. Please proceed.

Thank you, Darcell. Before we begin the call, I would like to caution everyone that we will be making forward-looking statements about management's goals, plans and expectations. Because our actual results may differ materially from these plans and expectations, 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. With that, I'd like to turn the call over to Christine Tsingos, Vice President and Chief Financial Officer.

Thanks, Ron. Good afternoon, everyone, and thank you for joining us. Today, we are pleased to report quarterly net sales of $498.7 million, a decrease of 3.5% on a reported basis versus same period last year sales of $516.5 million. However, on a currency-neutral basis, sales increased 3.6% compared to last year. This swing highlights the significant strengthening of the dollar and represents a negative currency impact of more than $36 million in sales. During the quarter, we experienced good currency-neutral growth in our diabetes monitoring, quality control and BioPlex 2200 product line, as well as many of our Life Science product lines, most notably process chromatography, imaging and food science products. Sales of our new QuantaLife digital PCR products more than doubled from the second quarter to $5.2 million. The overall quarterly growth was tempered by a continued decline in Europe and challenges in certain emerging markets, especially for the Life Science segment. Excluding currency and the addition of QuantaLife, organic sales growth for the quarter was 2.5%. The gross margin for the quarter was slightly lower than expected at 54.8% compared to 56.4% last quarter and 57.3% in the year-ago period. When compared to last year, the third quarter gross margin was negatively impacted by a $3.8 million noncash charge for a long-term environmental remediation program, as well as $2.2 million of amortization expense related to our acquisition of QuantaLife. Excluding the environmental remediation charge, consolidated gross margin for the quarter was 55.6%. And finally, the total noncash purchase accounting expense recorded in cost of goods sold related to prior acquisitions was $6.5 million for the quarter. SG&A expenses for the third quarter were $160.3 million or 32.1% of sales compared to $176.9 million and 34.2% of sales last year. The current quarter SG&A spend includes approximately $10 million of reduced expense due to currency translation. And similar to the second quarter, we also recorded $8.5 million of favorable impact due to the reduction in the valuation of the purchase consideration for QuantaLife. These positive items were partially offset by incremental costs associated with our ERP project. Also recorded in SG&A is $3 million for amortization of intangibles related to prior acquisition. Research and development expense in Q3 was 9.8% of sales or $49 million compared to $45.4 million last year. This increase is primarily related to the addition of QuantaLife, as well as our investment in new technology and platforms for the diagnostics market, including diabetes monitoring and blood typing. Going forward, we continue to expect R&D expense to be 9% to 10% of sales. Excluding the onetime benefit associated with the $8.5 million reduction in the QuantaLife purchase valuation and the $3.8 million environmental remediation reserve, the operating margin would have been approximately 11.9% for the third quarter and in line with our previously stated outlook of 11% to 12%. During the quarter, interest and other income was a net expense of $10.8 million. This compares to $18.1 million of net expense in the year-ago period and $7.3 million in the second quarter. The decrease in expense versus last year is primarily related to the sizable currency losses and hedging costs incurred during the year-ago period. The effective tax rate used for the third quarter was better than expected at 21% primarily due to discrete benefits during the quarter, including the release of reserves for the closing of certain statute of limitations and the reduction in the QuantaLife contingent consideration, which is not considered income for tax purposes. Excluding any future discrete items, we anticipate a full year tax rate in the range of 27% to 29%. Net income for the third quarter was $42.4 million and diluted earnings per share were $1.48. The decrease versus last year is primarily related to the lower sales results. Excluding the onetime benefits associated with the QuantaLife purchase consideration adjustment and the soil remediation reserve, we estimate that diluted earnings per share for the quarter were approximately $1.27. And now for certain segment information. Life Science reported sales for the third quarter declined year-over-year to $167 million, a decrease of 2.6% on a reported basis. On a currency-neutral basis, sales rose 2.2% versus last year. This growth was primarily fueled by sales of our new Droplet Digital PCR System, as I mentioned earlier. Organic currency-neutral sales for Life Science declined 1%, reflecting the continued challenges in the European market and increased price competition. Despite these challenges, we believe that our market share remains strong. Segment profit for the Life Science group was negatively impacted by the lower sales, as well as the charge for the environmental remediation. And finally, reflective of our intention to increase presence in the cell biology market, during the quarter, we acquired an exciting, new benchtop cell sorting system from Propel Labs, which we plan to begin selling in early 2013. This new technology, combined with the continued momentum of the digital PCR products, as well as several other newly developed products, bode well for increased Life Science sales next year and beyond. Our Clinical Diagnostic group posted sales of $328.4 million, a decrease of 3.8% compared to last year. However, on a currency-neutral basis, diagnostics sales increased an impressive 4.5%. This strong currency-neutral growth was fueled by demand for our quality control, diabetes monitoring and microbiology products, as well as sizable placements of our BioPlex 2200 system. On a geographic view, diagnostic currency-neutral sales for the quarter increased in nearly every geography, most notably strong in Asia-Pacific, Japan and the emerging markets. The growth was tempered somewhat by the challenging economic environment in Europe, where sales declined versus last year. Despite the decrease in reported sales, Clinical Diagnostics segment profit for the quarter remained solid at $47 million. And now for a quick review of the balance sheet. As of September 30, total cash and short-term investments were $854 million. Cash from operations during the quarter was $71.3 million, an increase of $20 million versus last year. EBITDA remained strong at $97.4 million for the quarter and nearly $298 million year-to-date. Net capital expenditures for the quarter were $36.6 million. Our full year expectation for CapEx continues to be in the $130 million to $140 million range as we invest in our global ERP project. Depreciation and amortization for the quarter increased slightly to $32.1 million. Moving to our outlook for the remainder of the year, on our last call, we guided currency-neutral revenue growth to be at the low end of our 3.5% to 4.5% range. Given our year-to-date currency-neutral growth of about 2.7% and combined with the continued economic challenges, especially in the European region, we now believe the full year currency-neutral sales growth for 2012 will likely remain in that same 2.5% to 3% range we have experienced so far this year. As is typical with our historical pattern, the fourth quarter often reflects a sequentially lower gross margin as the product mix shifts towards a higher percentage of instrument sales, as well as a lower operating margin, reflecting higher SG&A expenses, which are typical of our year end. In addition, the inclusion of the new cell sorting products will negatively impact expenses by $3 million to $5 million a quarter until sales ramp up. But even with that in mind, we continue to believe that our operating results will be within our original guidance given at the beginning of the year, and that is for full year gross margins to be around 56% and operating margins to be between 11% and 12%. As we have mentioned before, the expected decline in operating profit from prior years is driven primarily by 2 key investments: the building of our digital PCR business and our global ERP project. As has been our practice in prior years, we will share our thinking and outlook for 2013 in February, during the fourth quarter earnings call. And now we are happy to take your questions.

[Operator Instructions] Your first question comes from the line of Jon Wood with Jefferies. Jon Davis Wood - Jefferies & Company, Inc., Research Division: Hey, so either Christine or Norman, we would love to hear just -- if you look at the new guidance down, let's call it, 50 bps to 100 bps. Is it possible to kind of parse out geographically what's changed there? Is it a little bit of everything, or are there specific regions that are -- continue to be slower than you forecast?

I think primarily Europe. I think that's the region that we've talked about the most. And I think a little bit on the Life Science side in the third quarter, again, having to do with the anticipation of potentially -cuts in the fourth quarter or cuts next year and with sequestration, if that happens. So I think that's primarily where it comes from. Jon Davis Wood - Jefferies & Company, Inc., Research Division: Understood. And if Brad's there, I would love any detail you guys are willing to talk about on the cell sorting system in terms of revenue contribution over the next 12 months or so as you get that ramped up. I would love to hear an update there.

So, Jon, as far as the revenue contribution, we're going through our budgeting process right now, and we'll have a little more clarity on that when we talk about our 2013 outlook on the February call. Brad can certainly speak to why it's a compelling offering, but I don't think we're ready to talk numbers yet. Jon Davis Wood - Jefferies & Company, Inc., Research Division: Okay. But just on the cost side is $3.5 million to $4 million, and that's not -- is that kind of net of revenue, Christine, or...

No, that was more to imply the fourth quarter, right, and -- where there are no sales because we don't plan to start selling it until the beginning of next year. And that $3 million, $4 million includes about $800,000, $900,000 a quarter for amortization.

Your next question comes from the line of Jeffrey Matthews with RAM Partners.

I'm going to ask all my questions in a bunch because we just got power back on about an hour ago. I don't trust the cellphone connection, so here goes. Number one, what is the statute of limitations issue that Christine mentioned in terms of some goodwill item? Number two, what's the nature of the price competition that you highlighted in Life Sciences? Number three, I could have sworn I heard you mention an emerging market movements maybe in Life Sciences. I wonder if -- Norman didn’t mention emerging markets and about the sales outlook. And then fourth, for Norman, you seem to have added more product lines in the last 24 months, a pretty good clip, more than I recall to prior. And I just wondered if there's a true acquisition. And I just wonder if there's a theme to them, how they've come about, why you've been able to get them. And I know you're very price-sensitive, so why you’ve been able to really ramp up in the last, say, 24 months?

Okay. So I'll start with your first question, Jeff, and we really didn't talk anything about goodwill. When we were talking about the tax rate and why it was lower than expected this quarter, there's 2 primary drivers. One is the reduction in the contingent consideration for QuantaLife of $8.5 million, which is not considered income for tax purposes, so that brought the rate down. And the other is just the normal expiration of the statute of limitations that has to do with audit years. And under the accounting rules, under FIN 48, you take certain reserves as the years remain open. And then as they close, then the reserves are released. And so it seems like every year at this time, in this quarter, there's some amount of reserves that we end up releasing. The next question was about price competition in Life Science.

Yes, and I don't know, Brad, do you want to take that?

Sure. I think there's 2 issues with price competition. Certainly, with the market slowing in the U.S., a lot of competitors are looking at the attachment rate of reagents and are willing to sort of forgo or drastically reduce their price in order to get the sale with the sort of ongoing revenue coming from reagents. We've seen a lot more of that. Certainly, the budgets have been tight in U.S. And as Norman mentioned, even the threat of sequestration, while it's not even scheduled to happen until next year, it's a cause of level of people being conservative. There's another factor which is impacting margins in the case of base thermal cyclers, which is a considerably big product line for us. We've shifted from some higher-priced models to some lower-priced models. So overall, we're seeing an increase in our unit volume and our market share through selling lower-priced models. So those are probably the 2 things that were most in play there.

Okay. Can I just follow up, Brad, on that? Is the -- the guys deciding they can get reagents at a better price in this environment that it makes more sense to cut prices on the equipment, is this a short-term effort to drive sales and profits by public companies? Or is this some kind of change in strategic direction in the business?

Well, that's a good question. I wish I can know exactly that. I think really, it's a short-term view. I think that in the end, right now, the markets are slow enough. Most of our competitors, most people look at the market at sort of a mid to low single digits. And when you're at that level, people are fighting for every sale and placements. People have instrument manufacturing facilities to run, and so they're willing to accept lower gross margins on the front end of the sale with the prospect of getting the reagent attachment. Now as you know, most of these platforms are open, so there's nothing that you could certainly guarantee, like in a diagnostics sales. But it remains to be seen how that ultimately plays out. But for right now, it's kind of our new reality.

I think your third question had to do something with emerging markets, and why I didn't call that out is something special in terms of the...

I thought it had been mentioned in the script in terms of weakness.

Yes.

For Life Science, that's true.

But relative to our kind of our original thoughts and relative to our original plans for the year, I think the emerging markets are kind of more on plan than the European market.

Got it. And along those lines, Norm, could you talk about China? There's a lot of dust in the air over there in terms of whether the slowdown is some kind of systemic issue or more of a short-term issue.

Yes. Obviously, it's hard to say. They've been on a -- quite a roll, and obviously, they've got quite a big export market. And so it makes sense that when the rest of the world slows down a little bit, they might slow down as well. But I guess I'd continue to think that this is going to be a good, strong market. They are investing very heavily both in Life Science and certainly in establishing a healthcare system. And so we continue to look for a lot of good growth to come out of there. And I guess the other question you had was something about the theme of acquisition.

Right. It just seems like you're coming up with these new press releases more frequently, right? Well, I don't know if that's just my imagination or not.

Yes. I don't know. It I think it may be a little bit of luck of the draw. We've been a little more successful recently in some of these. I mean, it's the same theme for us. It's trying to expand on our base and acquire things that are complementary. These are obviously typically base hits, and that seems to work well for us.

Your next question comes from the line of James Shurtleff with ICM.

Mine relates to the Premier agreement. To what extent does that agreement for blood reagents open up the market? And then secondarily, are the legacy DiaMed products a part of that?

This is John Goetz. I'll take that. Yes, that agreement is -- that we announced is largely around our immunohematology product line that we offer here in the United States. So that just mainly is our Biotest acquisition product line. And at the moment, our DiaMed product line is not offered in the U.S.

Do you have any timeframe on when that should be available? I recall years back, it was a few years, but it wasn't real firm.

Yes. We're still continuing to forge ahead with our Biotest product line. We are preparing ourselves for products to be introduced in the United States, but I don't have a timeline I can give you.

Your next question comes from the line of Jon Wood with Jefferies. Jon Davis Wood - Jefferies & Company, Inc., Research Division: Okay, so I'm looking for John. I mean, I understand overall Norman's comments on Europe. But if I look at the diagnostics markets in Europe, I would love to hear from John if we've seen sort of a flattening out there, is it still getting worse. And just give us a kind of a state of the union in terms of what's different from the second quarter.

Well, I would say from a diagnostic point of view, the emerging markets are a good, bright spot for us. We’ve recognized some pretty decent growth and kind of how we define that region. We have products across our product line going in there and being placed. So at least I think I would say that's probably one of the things that balances out our company. We do have opportunities in diagnostics that we're taking well advantage out there. Jon Davis Wood - Jefferies & Company, Inc., Research Division: Okay, in Europe, John?

Yes. On the European side, it's slow for us. We continue to slug it out with increasing competition and price pressure there. It's a tough market. Jon Davis Wood - Jefferies & Company, Inc., Research Division: Would you say it's still deteriorating from a volume and price perspective? Or I mean have you seen things flatten out, at least? And I think you guys started talking about Europe and diagnostics probably the second half of last year. So I'm just trying to get a sense of do you feel like you’ve found the bottom there, or is it still very uncertain?

Yes. Well, I'd say it's uncertain, but I certainly don't see a precipitous cliff here. We see the same competitors. We see the same pricing questions. It's just highly competitive. That's what it is.

And I think we expect that to continue in the fourth quarter.

Oh, yes.

And that's kind of why we landed on this, what's our growth rate year-to-date, and I'm not sure it'd be much different.

Yes. If you're looking for a turnaround question, no, I think we kind of see this continuing for the near-term anyway. Jon Davis Wood - Jefferies & Company, Inc., Research Division: Understood. So Christine, can you give us just where the ERP expenses kind of shook out for the quarter? And I think the last time we spoke, you were expecting kind of a $28 million expense for the year. Is that still a good number?

Yes. So for the quarter, incrementally, the expense is probably up $2-plus million, $2 million to $3 million versus just last year and even up sequentially. In terms of full year, total OpEx spend on this is in that $25 million-ish range. Jon Davis Wood - Jefferies & Company, Inc., Research Division: Okay, and that's that not incremental, right? That's...

No, the incremental is somewhere between $10 and $15 million. Jon Davis Wood - Jefferies & Company, Inc., Research Division: Okay, great. And then QuantaLife actually did quite a bit better in the third quarter. So Brad, would you expect kind of that upward trajectory to continue in the fourth? And Christine, I'd love to get an update from you on the kind of operating burn there for the quarter and year.

All right, Jon, this is Brad. Yes, we certainly do see a ramp-up of this product line. And quite candidly, it took a little bit longer than we originally thought. Certainly, the budget restrictions made it a little bit harder for people to get a discretionary sort of $80,000, $90,000. We see a real strong take-up in the U.S. market, and our projections are that's going to continue. What's very exciting about this product is we're now seeing a lot of publications come out, and as we expected, our customers are doing great things with this instrument, so it's even greater than we appreciate it. So we're quite happy about it.

So regarding the financial impact, Jon, I think at the beginning of the year, we talked about QuantaLife would have a negative impact on the operating line of about $25 million, and we estimated that maybe $10 million of that is amortization, $15 million is operating. And obviously, as we move through the year and the sales start to grow, that the loss is more heavily weighted the first half of the year than the second of the year. But we're obviously still upside down. And again, moving into next year, when we finish our budgeting process, hopefully, that will show that QuantaLife becomes operating-neutral and then starts to really move forward. And obviously, this conversation excludes the onetime noncash bring-back of the purchase consideration, which could go the other way next year. But in terms of impact to the 2012 outlook, that $25 million seems to be pretty much in line, excluding the onetime reversal, with what we're going to achieve, what we're going to experience here in 2012.

[Operator Instructions] Your next question comes from the line of Justin Bowers [ph] with Leerink Swann.

Just kind of piggybacking on the prior question, did you -- I mean, do you expect to see kind of similar momentum in terms of revenue growth for the PCR system?

With the PCR system.

The digital?

Yes.

You mean the new sales order?

Yes. I'm sorry, maybe the question is how did that progress versus your expectations.

Say that again.

So how did that progress versus your expectations?

Yes. That's a good question. So when we laid out our guidance at the beginning of the year, a full percentage point of the growth was related to the QuantaLife products. And I think we talked about it being $20 million was our estimate. And we may be in that ballpark, perhaps just shy. We'll see how Q4 unfolds. So it could be just shy of that for the full year, but we'll see. But the fact of the matter is that the pipeline is very strong, and we remain so encouraged by the prospects for this product. It's just the sales cycle is a little longer than we originally anticipated when we laid out our plans and our guidance. So even -- '12 could come slightly shy of the original $20 million, but the momentum is pretty strong.

Got it. And then you may have addressed this earlier, but how are you guys thinking about sequestration and maybe managing the business any differently if an amendment isn't made? And then if Congress steps in and does make a change there, what impact do you think that will have kind of on spending at a more macro level?

Well, okay. So the first question is whether you really think it's going to happen. I guess I have a hard time believing it's really going to happen. But if it does and you think about the percent of our sales that come from NIH relative to our total business, it's a relatively small percentage. So what do we have to do to adjust? We might have to make some minor course corrections and have a little bit different focus in terms of what we do. But I don't think it will be major.

Got you. And then just -- I may have missed this, too, but what was the organic growth rates for the segments, for Life and Clinical?

So organic growth, currency-neutral growth for Life Science was 2.2%, but much of that was driven by QuantaLife. So if you strip out currency and you strip out QuantaLife, Life Science declined 1% for the quarter. And then Diagnostics, organic currency-neutral growth was 4.5%.

And your next question comes from the line of Jeffrey Matthews with RAM Partners.

I just want to follow up on the acquisition question. I'm wondering if it's harder to be a smaller company these days, both from a regulatory perspective and then in terms of options of going public. Is it easier for smaller businesses to look for a home with someone like you? Is that anything out there that may be helping you?

So I've got one anecdote for you, and this is someone here in the Bay Area, who's been a longtime venture capitalist. And talking with her recently, she said that it's impossible to get funding for, in her case, it's medical device companies, and she pointed out that it's both Sarbanes-Oxley and the regulatory environment that cause investors to be very -- to not want to put their money in these kinds of investments. So that's just one anecdote that says that yes, it's harder for a small company these days to get, first of all, funding to get started and then, of course, to finance them out. So I guess you could infer from that, that maybe there would be some more opportunities for us. As you can see, recently, we've picked up a couple of things that have been what I call earlier stage. So it's potentially an opportunity.

And there are no further questions at this time.

Okay, great. Well, thank you, everyone, for taking the time to join us today, and we look forward to seeing you soon. Bye-bye.

Ladies and gentlemen, that concludes today's conference. Thank you for your participation. You may now disconnect. Have a great day.