Ron Hutton - VP, Treasurer Christine Tsingos - Executive Vice President and Chief Financial Officer Norman Schwartz - Chairman, President and Chief Executive Officer John Hertia - Executive Vice President & President, Clinical Diagnostics Group Shannon Hall - Executive Vice President & President, Life Science Group John Goetz - Chief Operating Officer & Executive Vice President.

Brandon Couillard - Jefferies Jeffrey Matthews - RAM Partners.

Good day ladies and gentlemen and welcome to the Second Quarter 2016 Bio-Rad Laboratories Incorporated 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.

[Operator Instructions] I would now like to turn the conference over to your host for today, Ron Hutton, Vice President and Treasurer. You may begin..

Thank you. 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, 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. With that I'd like to turn the call over to Christine Tsingos, Executive Vice President and Chief Financial Officer..

Thanks, Ron. Good afternoon everyone and thank you for joining us. Also on the call today are Norman Schwartz, John Goetz, Shannon Hall, President of our Life Science Group; and John Hertia, President of our Diagnostics Group.

Today we are pleased to report net sales for the quarter of $516.8 million, an increase of 2.1% on a reported basis versus the same period last year's sales of $506.1 million. On a currency neutral basis, year-over-year sales grew 2.8%.

During the quarter we had good growth across many of our key life science and diagnostic markets, most notably in our Droplet Digital PCR and process media product lines, as well as sales of diagnostic product for autoimmune testing and blood typing and quality control.

If we look geographically, the quarterly top line growth was led by strong sales in the US, China, Asia Pacific and the emerging markets. The reported gross margin for the second quarter was below expectations at 54.2% compared to 55.2% last year.

On a sequential basis, the decline in margin is primarily reflective of changes in sales mix, as well as additional expense related to higher manufacturing costs. Additionally, the second quarter costs of goods includes $1.7 million of employee related expense associated with a planned restructuring of our European operation.

For the quarter, the total non-cash purchase accounting expense recorded in cost of goods sold related to acquisitions was $7.2 million, which compares to $7.3 million in the second quarter of last year. SG&A expense for the quarter was $205.5 million or 39.8% of sales compared to $192.8 million in the year ago period.

The increase in SG&A spending is driven substantially by discrete expenses of approximately $10 million for the planned European restructuring, as well as more than $3 million associated with various legal matters.

When comparing to last year, remember that the second quarter of 2015 reflected a sizable currency benefit which essentially lowered expense on a reported basis. Also included in SG&A this quarter is $1.7 million for amortization of intangibles related to acquisition.

Research and development expense in Q2 was 10.1% of sales or $52.2 million compared to $46.5 million last year.

The year-over-year increase in R&D spend is a reflection of additional investment in our digital PCR and cell biology product lines, as well as a one-time expense of $2.4 million for the termination of a small diagnostics development project. Going forward, we expect R&D to continue to be 9% to 10% of sales.

As you can see, the second quarter operating income and margin are below expectations on a reported basis, largely driven by the discrete situational expense items taken in the quarter.

The three categories are the restructuring of our European operation, the termination of a small diagnostics development project, and expense associated with various legal matters. These three items totaled nearly $18 million.

Excluding these charges, operating income for the quarter would have been more than $40 million and essentially in line with expectation. It is also important to note that we are restructuring our operating model in Europe in conjunction with the upcoming system implementation to create a more efficient organization.

While the second quarter reflects a total restructuring charge of $11.7 million, once completed, we hope to show a savings of $5 million to $7 million per year beginning in the second half of 2018.

During the quarter, interest and other income resulted in a net income position of $4.3 million compared to a net expense position of $665,000 in Q2 of last year. This improvement versus last year is largely related to an increase in dividend income typically associated with our second quarter.

The effective tax rate used during the second quarter was slightly higher than expected at 33% reflecting discrete items related to increased tax reserves for foreign taxes. Given the year to date effective rate of 35.6% and excluding any discrete items that may occur, we now anticipate the full year tax rate to be in the 33% to 34% range.

Reported net income for the second quarter was $18 million and diluted earnings per share for the quarter were $0.61. This compares to net income of $28.4 million and $0.97 per share in Q2 of last year.

Excluding the approximate $18 million of accounting expense that I mentioned earlier, we estimate that net income would have been $30.4 million and earnings per share would have been $1.03. Life Science sales for the second quarter were $180 million, an increase of 5.5% on a reported basis compared to last year.

On a currency neutral basis, sales grew 6%. These quarterly results reflect strong growth of our digital PCR products both instruments and reagents, as well as our process media and cell biology products. On a geographic basis, sales to the US, China and Eastern European markets posted sizable increases for life science during the quarter.

We are pleased with the strong demand for our digital PCR and cell biology family of products and will continue to invest in expanding those opportunities. During the quarter we launched several new multiplex screening kits for the detection of cancer mutation using the Droplet Digital PCR technology.

And finally for the Life Science segment, we continue to make good development progress for our Illumina partnership in the single-cell analysis area. Our clinical diagnostics segment posted quarterly sales of $333.7 million compared to $332.1 million last year, an increase of 0.5%.

On a currency neutral basis, year-over-year sales for diagnostics grew 1.3%. This growth was led most notably by sales of blood typing and BioPlex 2200 products, as well as quality control products. On a geographic basis, currency neutral sales to the US, China and Eastern Europe markets were especially strong for diagnostics during the quarter.

Perhaps more noteworthy is that for the first time in more than three years we recorded a small uptick for sales of diagnostic products in Europe.

While we continue to experience significant competition, price pressure and lab consolidation in this important region, and one quarter certainly does not make a trend, nonetheless, it is good to see some signs of life in Europe.

And finally for diagnostics, during the quarter we continued to expand our family of quality controls with the launch of Amplichek II, the first in a series of infectious disease controls for the molecular diagnostic testing market. And moving to the balance sheet as of June 30, total cash and short-term investments were $795.8 million.

Net cash generated from operations during the quarter was $77.2 million, compared to a negative $7.4 million last quarter and $38.5 million in Q2 of last year. This significant increase in cash flow is substantially related to improved customer collections as well as higher investment income.

EBITDA for the quarter was $70 million or just under 14% of sales. Also during the quarter we experienced excellent improvement in both day sales outstanding and day sales and inventory when compared to the first quarter. On a worldwide basis, DSO improved sequentially by nine days and is in line with historical levels.

DSI significantly improved with the reduction of 26 days sequentially. Our long term target is to reduce DSI even more as we take advantage of a global ERP system and better inventory management.

However, it is important to remember that in the short term inventory levels will likely grow in anticipation of our typical yearend sales trends as well as the upcoming deployment of SAP in Europe. Net capital expenditures for the quarter were $31.5 million. Our full-year expectation for CapEx has been in the $140 million to 150 million range.

Given the year to date spend of around $57 million, we may likely be under that estimate in the $130 million to $140 million range.

And finally, depreciation and amortization for the quarter was $37.6 million, up both sequentially and year-over-year primarily related to increased appreciation associated with our ERP project as well as the $2.4 million write off of the diagnostics R&D project I mentioned earlier.

Moving to the outlook for 2016, we see both bright spots and challenges. As a reminder, our annual goals have been for currency neutral sales growth of 2.5% to 3%, full year gross margins in the 55% range, and targeting to hold the operating margin flat at about 8% on a currency neutral basis.

We have also highlighted that currency headwinds could negatively impact sales growth by $50 million to $75 million and subsequently the operating margin by 50 basis points or more.

And finally, I also want to reiterate what we have been saying about the numerous challenges to maintain a flat year-over-year operating margin during what will be a year of even greater investment in systems and infrastructure.

Looking to the remainder of the year, we are pleased with our year to date topline currency neutral growth of 3.3%, which is ahead of our annual guidance. And the continued strength of certain product lines and geographies bode well for growth in the second half of the year. Our year to date gross margin is 55.1% and in line with our guidance.

And we are cautiously optimistic about maintaining that level in the second half of the year despite anticipation of continued pricing pressure as well as our typical pattern of the product mix shifting towards instruments in the second half of the year.

Looking to the outlook for operating profit and margin for the remainder of the year, and including the significant discrete charges taken in the second quarter, it is clear that we will not be able to achieve an 8% annual operating margin on a GAAP basis.

Excluding these charges, we estimate that our currency neutral margin for the first half of the year is just over 7% and evidence of the challenges to maintaining flat year-over-year margins. Still, we will continue to target and work toward achieving the 8% margin excluding of course the $18 million of second quarter discrete charges.

If we are successful in achieving this operating profit goal, much of that will depend on at least maintaining if not improving the gross margin during the coming months. And now we are very happy to take your questions and I ask that you bear with us with AACC happening this week.

We have management dialing in from various locations, but we will do our best to make sure that all your questions get answered..

Thank you. [Operator Instructions] And our first question comes from Brandon Couillard from Jefferies. Your line is open..

Thanks good afternoon. Given ACC this week, I'll just start there, I mean, pleased to see a real barnburner showing in the European diagnostics business.

I mean, John is there one or two things that you would attribute the - albeit modest improvement but you positive experience in Europe? And you've taken share there has been a couple of big tenders perhaps that you picked up recently and given you are out of date on the ACC right now, if you could just sort of give us your view of the global landscape, sort of across the geographies what you're seeing in your business would be helpful?.

Sure. We don't actually disclose it's a growth by product line, but I would say that last year we did introduce two major platforms, both the D-100, the new diabetes instrument and the IH 500 for blood typing and Europe and both of those it had a really solid up-tick in systems.

We've also seen some stabilization in the consolidation of labs, particularly in France. We don't know if that's as finalized, its shrinkage, but it seems to be lessening, and we're hoping that's a good indicator for the future..

Super.

Christine, you mentioned you spike out the process chromatography strength in life science business in the quarter, could you sort of parse that out for us realizing is somewhat lumpy just the effect that it had on growth either dollars or percentage basis?.

Sure. So we don't typically disclose our sales by product line, and you are right that it's a - can be a very lumpy business, but each quarter with posted pretty good double-digit growth in that arena as we have now been expect more than 40 drugs that tends to have a somewhat smoothing impact.

But so far this year we have been able to post growth in that area.

Shannon, I don't know if you'd like to add anything to the process media commentary?.

I guess, I would just say we're pretty consistent in our growth profile and we have the kind of portfolio that appeals to a lot of interesting medicines manufacturers at this time. So it's been good..

Super.

One more for you, Christine, in terms of the guidance outlook for the year, it was a clear whether or not you are raising the revenue forecast for the year the 2.5% to 3% range and then secondarily could you parse out the effect of FX on the operating income dollar line in terms of dollars in the quarter?.

Sure. So that's a good question about the top line guidance. I think we're off to a good start for the year and there's a lot of positive things for the rest of the year, but also a lot of challenges. And in terms of competition, price pressure and things like that. So I am not sure that we want to raise our range.

That's been up at 2.5% to 3%, but certainly I think we're feeling better about the top end of that range.

And tell me again Brandon your question about foreign exchange impact?.

Yes, just with the effect of currency was on the operating income line in terms of dollars in the quarter?.

For the quarter, it was just around $2 million for the quarter..

$2 million, negative..

It’s about $2 million negative. I think year-to-date the headwinds on the revenue line are around $23 million and about $5 million on the operating income line. And that's really consistent with this kind of 20% to 25% of the top-line impact being felt on the operating line..

Super. And then back of the diagnostics business, John, coming back to you.

Any update you could share with us on the status of the IH 1000, and then just any update there?.

Not too much new. We have turned in all the information to the FDA that they have requested. They had a couple of small follow up questions. Those were sent in. We think we have finalized all the information we need to send to them. At this point we are just waiting..

Super. I will get back in the queue. Thanks..

Thank you. And our next question comes from Jeffrey Matthews from RAM Partners. Your line is now open..

Hi, thanks.

Can you hear me?.

Hi, Jeff. We can hear you..

Good to hear you.

How are you?.

Good..

Three things. One, Christine, you called out three items and you said that they were discrete charges. And my question is, in the legal cost in the quarter, are those a onetime charge or will they recur because I assume the legal stuff is it going away anytime soon?..

I would characterize them more as one time rather than recurring. I mean, obviously, we always have certain legal things that can come and go from time to time. But these are specific to various matters..

Got it, okay. And then, the improvements in receivable and inventory, just sequentially, pretty eye-popping.

Are they a result of the benefits of the ERP system in the US kicking in or is it a catch up from inefficiencies caused by the ERP implementation that have disrupted things you're not getting back to normal, or is it just the focus on cash flow?.

Well, good question. I think a lot of it Jeff is just kind of the way the business cycle works. In terms of typical patterns could that you would see in our first quarter or second quarter.

I will say that I think the first quarter of this year was probably higher for those metrics than typical, and that's related a little bit to how the operating cycle works in the first quarter, but also as you point out, to stabilization and adoption of the system.

And I think as time goes on, we continue to smooth it out and are more efficient on invoicing customers which then helps us be more efficient collecting from customers and so on. But our CSIs and CSOs are kind of business cycle driven through the year depending on typical quarterly patterns.

The caution about the short term is, we will typically build inventory for a sizable sales projection that comes late in the year, and then as we move into next year, our goal is to go live with the European SAP system the first early April time frame and so it wouldn't surprise me if there was a little bit of inventory build in anticipation of that transition.

But certainly, our long-term goal is significant improvement in TSI..

Got it. Okay thanks and then third thing Eastern Europe is surprising - opposed Life Science the diagnostics, and I recall I think it is even at the Jefferies conference in June that it just seemed like Eastern Europe have sort of copy slow growth Western Europe bug.

What happened there? What kind of customers are these? Are these country tenders, why did they come back so quickly relative to where they have been?.

So I think, I'll take the easy part of that answer and some of it is comparison from last year which last year at this time was a fairly tough quarter for both Life Science and Diagnostics. But not to the gate what is real growth going on over there.

So I guess John Hertia I am not sure if you have anything specific to add about growth in Eastern Europe? For either of the groups..

From a diagnostics perspective, probably the two dominating parts of Eastern Europe are Russia and the Middle East.

And we did have some pretty good sales growth in Middle East, and we were able to work through some of the registration issues that have been affecting us in Russia, and we were able to ship out a little bit more than we had anticipated for both of those were a little better than we had expected..

I think what you heard from John Hertia pretty well encapsulates the uptick there that we saw and what we're calling Eastern Europe. I really don't have too much more to add than that..

Okay. That's perfect thank you very much. Thank you..

Thank you. [Operator Instructions] and we do have a follow up question from Brandon Couillard from Jefferies. Your line is open..

Thanks. Christine to buy question for you. First, you quantified I think the cost savings you expect from the restructuring which you beginning the second half of '18. Are there any near term cost benefits from the terminating the R&D project that you spiked out? And then, I got a follow up on the ERP after that..

Okay sure. So I think taking the second half of your question, the Road project probably doesn't have a lot of savings for us going forward. These are Road was expensed all along, and we will just turn our focus to other opportunities within the diagnostics segment. So I don't anticipate that giving too much savings in the shorter term.

And tell me again on the restructuring Brandon your question..

You called out the restructuring or the cost savings you expect from the restructuring program I think you said $5 million to $7 million during the second half of 2018.

Is there some reason that it wouldn't kick in sooner?.

Well, primarily because to do a restructuring in Europe is a long process. There is a notification period etc. and we don't anticipate a lot of changes in the structure or employees until after we have gone live with the system.

And so a lot of that will happen throughout '17 if you well, and perhaps even somewhat into '18 all that I think the majority of it is '17. Because of the long notification period, we had the appropriate accounting to take the restructuring charge at this time, but the process of doing that will occur over the next 12 to 15 months..

And then one more for you while we're on the topic, with respect to the ERP program, you talked about getting back to mid-teens, 50% type margin was the system is fully go live globally.

Can you just help us think through the bridge, the mechanics, spots in the P&L areas of the business that get is really from where we are this year in terms of 7%, 8% GAAP operating margin to that 50% level pretty soon after it is done..

Sure, absolutely. We haven't really disclosed dollars or percentages specifically by category.

But I can tell you that moving from 7% or 8% to 15% or even better starts at the cost of goods line and improving gross profit, and that through not only not better inventory management as I mentioned earlier, but having a smaller more appropriate footprint within our distribution channel and our savings there and some of that relates to this restructuring having regional European wide regional purchasing power it’s not global purchasing power on many of the direct and indirect materials that we buy.

Those are just some of the areas where we can have savings in the gross margin. And then, as we look at SG&A, a lot of that is about people. You've heard us talk about over the last many years that in Europe we have a pretty significant opportunity to restructure and run the business more efficiently.

It's a region where we've grown up centrally over time with a lot of our own locations and then we've layered on numerous acquisitions, and the result of that has been a fair amount of redundancy, especially in the back office.

And so with a single system, we will be able to run the region much more efficiently, run it as a region rather than individual operations.

And they are you will see the savings and certainly in employee related costs, but also hopefully we will gain efficiencies in the commercial organization by having more shared service operations for order entry and obviously in the finance organization by being able to take advantage of the single system, and again create shared sources for transactional accounting.

So those are some of the broad categories where we will see the savings. In addition to that, they are spending today on very complex IT environment.

We know when we started this journey we started with 39 ERP systems around the world, and as we move more towards a global SAP system and trying to get that 39 number down to hopefully something under 10, then we'll eliminate the costs associated with running all of those systems all over the world.

So lots of different areas Brandon for us to achieve savings and return to the profitability levels we were at a few years ago if not even better profitability..

Extremely helpful, thank you. I haven't heard from Norman on the call. Just curious if what you're seeing in the M&A pipeline if there's anything interesting out there and sort of your appetite is for perhaps a larger deal as you sort of start going down the ERP effort in Europe? Thank you..

Yes, very interesting certainly there are, if you see there seems to be kind of more interesting things in the pipeline. Certainly nothing we can talk about yet, but I am encouraged that there do seem to be a few more opportunities..

Thank you..

Thank you. [Operator Instructions] And we do have a follow up question from Jeffrey Matthews from RAM Partners. Your line is open..

Hi. Thank you. On European restructuring Christine I'm kind of curious what triggered it now as opposed to say year end last year when you are doing your planning for the year ahead.

Is it related to the ERP implementation planning, or did something come up for you just said let's do this?.

I think it is very much related to the ERP planning, and again, the ERP will give us a foundation to run our business much more efficiently. It is as I mentioned a long process in many countries in Europe to do something like this, and you really can't started to see in.

And we are meeting the continue to run the business until we are able to transition to a new operating footprint if you will. And a lot of focus frankly that we're going to have over the next several months is making sure that while we are transitioning through this period that we don't lose sight of running the day-to-day business today.

But the timing is somewhat tied to an anticipation of going live next spring, but also being very cognizant of the process requirements in Europe..

Do you think it's likely that you have more charges down the road? You've been there for so long it's been such a big operation you're somebody people and facilities there, or did you try to just handle it all in one charge?.

We did try to be very thoughtful and think about the long-term. I'm not going to say there won't be any charges for anything in the future. But we really did try and think about our future footprint and structure right down to the position, and that's related to this $11.7 million charge.

If there are other infrastructure changes that we make, footprint reductions that we make, they may or may not have a charge associated with them. It’s not something I can estimate at this time. But certainly I hope we have been able to the bulk of the employee related charge..

Sure. I understand. And then on China you called it out as being especially strong.

And I'm wondering either John or Norman where China stands in importance relative to other geographies, and what do you think it can be 5 to 10 years from now?.

Norman, do you want to take that?.

Yes I could. Certainly, we even though sometimes China seems to be kind of in fits and starts, we do think the outlook for China is very good. We continue to see and feel that there would be good growth over the long-term, both in the life science and diagnostics arenas.

So I think you do start to see a little bit of drawbridge mentality in China with respect to the registration of new products in that kind of thing.

They are becoming a little more kind of, I don’t know what I would call it, strident in their approvals performed goods and so you see a little bit of that, what I call the [indiscernible] business in China, but it's something that yet I think we can well navigate..

All right. Thanks very much..

Thank you. And I am showing no further questions at this time. I would now like to turn the call back over to Christine for any further remarks..

Okay. Great. Thanks, Dominion. Thank you everyone for taking the time to join us today, and hopefully we'll be seeing you soon. Bye-bye..

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