Ronald W. Hutton - Bio-Rad Laboratories, Inc. Christine A. Tsingos - Bio-Rad Laboratories, Inc. Shannon Hall - Bio-Rad Laboratories, Inc. John Hertia - Bio-Rad Laboratories, Inc. John Goetz - Bio-Rad Laboratories, Inc. Norman D. Schwartz - Bio-Rad Laboratories, Inc..

Brandon Couillard - Jefferies LLC David Westenberg - C.L. King & Associates, Inc. Jeffrey L. Matthews - RAM Partners LP.

Good day, ladies and gentlemen, and welcome to the Third 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 follow at that time. As a reminder, this conference may be recorded.

I would now like to introduce your host for today's conference, Mr. Ron Hutton, Vice President and Treasurer. Mr. Hutton, you may begin..

Thank you, Andrea. 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 financial future 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 third quarter of $508.7 million, an increase of 8.3% on a reported basis and versus the same period last year sales of $470 million. On a currency-neutral basis, sales increased an impressive 9.1% when compared to last year.

During the quarter, we experienced good currency-neutral sales growth across many of our regions with North America, Asia Pacific and China, all up double digits.

We also experienced good growth across many key Life Science and Diagnostic product areas, including strong sales of our Droplet Digital PCR instruments and consumables, process chromatography media, and products for diabetes monitoring and autoimmune testing.

You may remember that in the third quarter of last year, our Life Science Group faced a significant slowdown, primarily related to system and productivity challenges associated with the go-live of our new SAP system in North America.

At the time, we estimated that the system adoption issues negatively impacted sales by $5 million to $10 million in the third quarter of 2015.

Even with this relatively easier to compare to last year and assuming the impact to be at the top of the range of $10 million, currency-neutral sales would have increased more than 6% in the third quarter of 2016.

The reported gross margin for the quarter was essentially in line with expectations at 54.9% and compares to 54.2% last quarter and 56.1% in the year-ago period.

This decline in margin versus last year is related to higher manufacturing and logistics costs, increased amortization of intangibles, and a shift in the product mix, which included a higher level of instruments. During the quarter, the number of diagnostic instrument placements increased by more than 20% versus the same period last year.

This change in the product mix puts downward pressure on the margin in the short term, but bodes well for higher-margin consumable growth in the future. The total non-cash purchase accounting expense recorded in cost of goods sold related to prior acquisitions was $7.2 million for the quarter and compares to $6.7 million in the year-ago period.

The increase in amortization is related to the new flow cytometry technology purchased earlier this year. SG&A expenses for the third quarter were $201.5 million or 39.6% of sales compared to $187.4 million and 39.9% of sales last year.

While relatively flat as a percentage of sales, the year-over-year increase in expense is the result of higher costs associated with our current deployment of SAP and the establishment of our new shared service center and European headquarters as well as higher accrued commissions and employee-related costs.

In addition, we recorded approximately $5 million of expense for various legal matters. And finally, quarterly SG&A includes a total of $1.7 million for the amortization of acquisition-related intangibles. Research and development expense in Q3 was 9.8% of sales or $49.9 million, which compares to 9.2% or $43.3 million last year.

This increase primarily reflects higher investments in Droplet Digital products for the Life Science and Diagnostic markets as well as new products for the cell biology market. Going forward, we expect R&D expense to continue to be in the 9% to 10% of sales range.

During the quarter, interest and other income was a net expense of $5.4 million compared to $7.3 million of net expense last year. This improvement is the result of decreased foreign currency exchange losses and hedging costs, as well as higher investment income when compared to last year.

The effective tax rate used in the third quarter was approximately 19%. This significantly lower-than-expected quarterly rate is primarily reflective of adjustments in foreign tax credits and lapses in statutes of limitation.

These discrete items, coupled with the relatively low profit before tax, combined to have a sizable impact on the effective rate for the quarter. Excluding any discrete items that may occur, we continue to expect the full-year tax rate to be in the 32% to 34% range.

Net income for the third quarter was $18.4 million, which compares to $17.4 million in the year-ago period. Diluted earnings per share for the quarter were $0.62. And now for certain segment information. Life Science reported sales for the third quarter increased 18.4% to $178.1 million. On a currency-neutral basis, sales grew 19.3% versus last year.

If we exclude the $10 million of system-related revenue impact in the year-ago period that I mentioned earlier, Life Science sales still grew an impressive 11.8%, with all regions and product groups up double digits versus last year.

Of particular note, sales of our Droplet Digital PCR products continued to do well along with our western blot and process chromatography product families. On a regional basis, sales in North America, China and the Asia Pacific region were particularly strong for Life Science during the quarter.

Our Clinical Diagnostic Group posted quarterly sales of $327.1 million, an increase of 3.5% compared to last year. On a currency-neutral basis, sales grew 4.4%. Growth during the quarter was primarily fueled by good demand for our diabetes monitoring products, Bio-Plex instruments and panels, and our quality controls.

On a geographic view, China, Asia Pacific and North America posted good growth versus the year-ago period. Partially offsetting this growth, our European markets continue to be negatively impacted by the challenges from lab consolidation and pricing pressure as well as seasonality, resulting in a decline for the quarter.

Moving to the balance sheet as of September 30, total cash and short-term investments were $810 million. Net cash generated from operations during the quarter was $52 million compared to $77 million last quarter and $82 million in the third quarter of last year.

This decrease in cash flow versus last year is substantially related to higher payments to inventory suppliers and professional fees in the current quarter, remembering that last year at this time payments were delayed in association with the North American deployment of SAP. EBITDA for the quarter was $67 million or 13% of sales.

Net capital expenditures for the quarter were $39.1 million, which represents an increase both sequentially and year-over-year.

This increase in capital spend for the current quarter is related to costs associated with our European deployment of SAP, the increase in reagent rental instruments placed during the quarter, and investments associated with our future operating footprint in Europe.

Year-to-date CapEx spend is approximately $96 million and in line with our revised annual estimate of $130 million to $140 million for the full year. And finally, depreciation and amortization for the quarter was $38.5 million.

Moving to our outlook for the remainder of the year, we continue to anticipate top-line growth ahead of our original guidance. At the beginning of the year, we estimated currency-neutral revenue growth of 2.5% to 3%. Through the first nine months of 2016, currency-neutral revenue growth is substantially higher at 5.2%.

Looking to the fourth quarter, we anticipate continued sales growth for Diagnostics as consumable streams related to instrument placements continues to build. On the Life Science side of the business, we anticipate continued demand for many of our key product areas.

However, posting quarterly growth year-over-year may prove difficult for the Tools business and will likely be down versus the fourth quarter of last year.

Just as we saw a relative easier to compare in the third quarter, the corresponding tough to compare will likely be illustrated in the fourth quarter, remembering that in the fourth quarter of last year, we were able to make up substantially all of the backlog that occurred after our ERP-related slowdown.

Even with this growth challenge in the fourth quarter, we anticipate that for the full year, currency-neutral sales growth will be above 4% and ahead of our original guidance.

From a profitability standpoint, our original annual guidance has been for consolidated gross margins of 55% and a currency-neutral operating margin of around 8% for the full year. On our last earnings call, we stated that meeting the 8% operating margin target was not achievable on a reported basis.

But when we excluded approximately $18 million of one-time expense, the currency-neutral operating margin for the first half of the year was estimated to be 7%. Through the first nine months of 2016, the reported gross margin is 55% and the reported operating margin is 5.1%.

However, we estimate that the currency-neutral operating margin, excluding approximately $23 million of one-time charges, is 6.9%. As we look to the fourth quarter, our typical pattern has been for consolidated gross margin to be somewhat lower, reflecting a product mix shifting more towards instruments. That will likely be the case this year as well.

With that in mind, we anticipate gross margins for the fourth quarter to be in the 54% to 54.5%, leading to an estimated full-year margin of 54.5% to 55%.

From an operating profit view, we are working to make progress in the fourth quarter despite the anticipated decline in gross margin and hope to achieve a currency-neutral operating margin for the full year, excluding the highlighted one-time charges, of 7%, if not better.

As has been our practice in prior years, we will share our thinking and outlook for 2017 in February during the fourth quarter earnings call. And now, we are happy to take your questions..

Thank you. Our first question comes from the line of Brandon Couillard with Jefferies..

Thanks. Good afternoon..

Hi, Brandon..

Perhaps, this is probably best for Shannon, but in terms of the Life Science's core revenue growth in the quarter, understanding that about three-quarters of that business is tied to global government and academic markets, which have been, let's say, less than robust for others so far this period, what do you think contributed to your outperformance in the period? Number two, to what extent, if at all, was some of the strength in the third quarter pulled forward from the fourth? And outside of Digital PCR, which is somewhat unique to Bio-Rad, can you sort of speak to demand trends or what you saw in the other parts of the business?.

Okay. So starting backwards, I guess, we saw demand across the board for our product mix in the third quarter as all the product groups did really, really well, and that includes things like quantitative PCR, real-time PCR, cyclers, reagents. They all did really well.

Western blotting and electrophoresis, which is a core technology for Bio-Rad, really, really strong. So, I would say, there's not just Droplet Digital that's doing well, but it's amongst a bunch of very successful products. You asked about the academic market.

And I've observed that we're doing pretty well in the academic markets in North America and in Europe and had pretty strong performance there. And I know that's not the same as what everybody's seeing.

And what was the third...?.

And Brandon, your question about the revenue being pulled in from fourth quarter..

Yeah..

I don't think meaningfully. And what I will tell you is from the beginning of the year, we've worked with our commercial organization to really concentrate on trying to smooth out the sales cycle through the year so it's not as back end loaded, and they've worked on that all year.

But I don't have any evidence that anything meaningfully got pulled in from Q4 into Q3..

No, no..

Shannon, on the Droplet Digital PCR demand, can you speak to any particular areas or specific applications as to where you're seeing the biggest uptake? And was there, by chance, a large contract that you booked in the quarter that we should view as kind of one-time in nature at all?.

No, not for one-time. And this is a truly enabling technology and it can be applied in a lot of really interesting and exciting ways. I'd say, the leading application right now is in the liquid biopsy technology space. So, it's very, very attractive and it's doing things people really want to be doing..

And I think part of the growth, Brandon, was good growth for process media, which historically could be a pretty lumpy business, but I think what we've seen now that we're spec-ed in to so many drugs is that they're able to continually achieve pretty good growth every quarter.

While any given customer may have an annual order or a lumpy order, there's enough overlapping that it's really starting to smooth out and be consistent growth..

Thanks. Christine, one for you.

In terms of the full-year guidance, could you give us what you're kind of expecting in terms of the FX impact to both revenue and the operating income line?.

Well, it's interesting, Brandon, because I think that it's been a bit of a headwind through the first nine months of the year, although it's becoming less and less of a headwind. I think the headwind in Q3 to the top line was about $4 million.

And I can't predict what currencies are going to do over the next couple of months, but certainly if they stay where they are, we may experience for the first time a currency tailwind – for the first time in a long time, a currency tailwind in the fourth quarter.

So, net-net, if we're currency-neutral up 5.2% year-to-date, and I'm hoping to stay above 4% – we're hoping to stay above 4% for the full year, then I think we'll see a little bit of a slowing of growth in the fourth quarter because of the tough to compare, but should help neutralize some of the headwinds that we've seen in the first nine months of the year..

Super. And then, maybe one for John Hertia. I noticed that you finally got the IH-1000 Blood Typing instrument approved in the U.S.

Now, with that behind you, could you sort of share your go-to-market strategy for that instrument? Any feedback to speak to coming out of the AAB (sic) [AABB] Conference? And any chance you could you give us a sense of sort of what your near-term funnels look like in terms of potential placements maybe over the next year and general pricing strategy with the launch?.

Well, we were pleased to finally get approval. The good news is it came at the very beginning of the AABB show in Orlando and there was a lot of customer excitement. It's important to remember it's just the first step in a series of steps.

I mean, the good news for us is that North America is the largest blood bank market and we introduced infinity last December and got FDA approval. We have FDA approval now for the IH-1000. It's a longer sales cycle.

So, it probably isn't going to be until maybe the second half of next year that it begins to have a significant sales impact, because of just the complexity of the instrumentation, the need to validate it as you go through the selling process. We had a lot of excited customers at the AABB.

Following the IH-1000 North American gel, we have future plans to introduce manual instrumentation, the IH-500, so that we'll have the most complete line of the immunohematology systems in the market..

Thanks. I'll hop back in the queue. Appreciate it..

Thank you. Our next question comes from the line of David Westenberg with C.L. King. Your line is open..

Hi, guys. Thanks for taking my questions. So, first off, we've seen the NGS sort of bellwether (20:42) take a couple – take a big hit two weeks ago, and it sent valuations sort of across the space down. Number one – related to that, two questions.

Number one, are you seeing any decrease in demand with maybe the slowdown with bellwether's (20:53) business? And number two, if the valuations across the board in some of these NGS ancillary technologies are cheaper, would that make you more likely to maybe acquire one of those in the future?.

So, you're talking about kind of the group that's doing the next-gen sequencing and that's where they've been getting a lot of their historic growth, and probably not a market we've played a lot in.

Is that kind of where you're coming from, Dave?.

Exactly..

So, historically, it hasn't been a market that we've been very involved in, which sounds like it may be a good thing right now.

But certainly, as we continue to sell – and Shannon, you can comment on this, too – the Droplet Digital PCR into the biopharma market and maybe working on certain things and using that technology, they continue to expand their research..

Yeah. I guess I was trying to grasp the specific question..

So, number one, I mean, if you have less alumina placements, I mean I know they're a little bit more on the higher end, and I know your Droplet Digital PCR is probably more around the next-seq than the high-seq, where they're having the most struggles.

But I guess what I'm asking is, if you're seeing a slowdown demand in next-generation sequencers, I mean how do you anticipate it hitting the Droplet Digital PCR instrument?.

We haven't seen a slowdown..

Okay..

So, it's just robust demand. I would say, people are still developing ideas about how to put this technology to work into interesting science..

Got you. All right.

And then, just in terms of the NIH, how do you anticipate a lot of that spending will come in the fourth quarter, this particular fourth quarter? Are you seeing any changes with NIH?.

I mean, I think academically-funded research has been doing pretty well for us. And so, I'd expect to be really successful in the fourth quarter along the same lines, but it remains to be seen..

Got you.

And then lastly, just a clarification, was that $5 million in legal fees that you called out?.

Yes..

Thank you..

Thank you. Our next question comes from the line of Jeffrey Matthews with RAM Partners. Your line is open..

Hi. Thanks very much.

Can you hear me?.

We can hear you, Jeff. Hi..

Hi. Three things. One, you talked about Europe was weak. Is there any difference between Western economies and Eastern economies there? And then related to that, Russia seems to be getting better as an economy, and I wondered if you're seeing any signs of life there as far as tenders go..

Yeah. I know, a good question, Jeff. I think it's Western Europe that has been kind of the bigger challenge for us in recent years, where we're seeing a lot of pricing pressure from these tenders and lab consolidation, et cetera.

As you point out, Eastern Europe, especially on the Diagnostics side and also on the Life Science side, saw some good growth in the third quarter, but it's Western Europe for Diagnostics where we continue to see a lab consolidation and pricing pressure..

Okay. Then you called out Asia Pacific. Does that mean Japan is doing better? And if I remember correctly, you haven't called that out for a while..

Yeah. No, Japan continues to be kind of a mixed market for us, and for the company was down year-over-year. But when we talk about Asia Pacific, we really are looking at kind of the Pacific Rim and from India through Southeast Asia, et cetera. China is a big enough market for us that it kind of stands on its own, and so we'll call that out.

But Japan, we're seeing some tough growth – tough ability to get growth on the Diagnostic side; and for Life Science, it's been fairly flattish..

Okay. That makes sense.

And then third, on the ERP, where are you in that? What will you be doing in 2017? And from what you've already done so far, Christine, is it making your life any easier in terms of rolling out the P&L, handling working capital, all that good stuff?.

So, good questions, Jeff. So, to answer your question, in 2017, I think most important, we're hoping to go live with our third deployment, our major Western European, if you will, deployment of SAP in the springtime. And all eyes are focused on getting ready for that.

And it's not just about designing the system, but really getting the organization ready to catch the ball and catch the new operating model, and a model that's going to have us operate as a single region in Europe, if you will.

So, that work will continue at the beginning of 2017, and then we're hoping in the April-May timeframe to go live with the European deployment. And after that, based on prior deployments, I'm sure that it'll be all hands on deck, helping with the transition and people getting used to using the new system.

It wouldn't surprise me to see a slowdown in productivity in the short term as we've seen here, just because it's new and it's different. But we're trying to take advantage of lessons learned.

We've created a system where our power users that are here in North America are ready to go and sit side by side with the new users in Europe when we go live and get through the transition.

Your question, has it made my life easier? I think in a lot of ways, yes, absolutely; although we transition from one thing to the next, and so we're not slowing down.

But if I take a breath and really look at what we've been able to achieve in North America, we did move to a shared service center for transactional accounting, and that's helped with the efficiency. It's helped with the audit. It's helped with the analysis of the numbers.

So, perhaps, more importantly, for the company, it's helping with working capital. And after, I'm hoping, we get through the transition of going live with the third deployment in Europe next year – and it will take them a good nine months, if not more, to really take advantage of the system.

But I'm hoping to see those same benefits ripple through to that deployment, because once we're there, Jeff, we will have substantially all of our manufacturing around the world on SAP as well as 70% of our revenue. And from there, we really hope to move the needle..

Great. Thanks very much..

Thank you. And we have a follow-up question from the line of Brandon Couillard with Jefferies. Your line is open..

Thanks. While we're on the ERP topic, I don't know if Christine or perhaps John Goetz, this might be better for you.

I mean, we've talked a lot about the cost opportunity at length, but could you discuss whether you see ERP as potentially enabling incremental revenue opportunities as well, either through better strategic pricing visibility or perhaps discounting control from the sales force?.

Yes, certainly. This is John Goetz. I guess, the short answer is we are expecting gains in each one of those areas that you're outlining.

It's really part of one of the reasons why we wanted to go with this system at single instance to begin with, which will give us this opportunity to look globally at our inventory, wherever it is, to optimize its location, and its quantities where we need it.

Same thing then we intend to be able to do with our planning process to optimize how much we build, so that we're not overbuilding or under-building. And these are really huge improvements, we think, in how we operate the company, and we're expecting those to begin once we get through this third deployment.

Frankly, at the moment, those opportunities that we're looking at are post E3 and all of our energy and focus is to get through E3 in one piece.

And following on Christine's comment about our preparation for that, we're doing everything we possibly can to make sure that we don't have a negative impact on the business when we do flip that switch in April..

Thanks. And then one more, Christine, for you, back in terms of the third quarter.

Any chance you could break down the bridge in the gross margin in the period, specifically, perhaps quantify the drag from the heavier instrument placements in the third quarter on the gross margin line?.

Well, I can, Brandon. I think the year-over-year decline in margin is about 120 basis points. Isn't that right, about 1.2%? And the majority of that, I would say, relates to the shift towards instruments.

And it's not just the margin being a little lower on the instruments and placing these in reagent rental and taking on the depreciation, but also in terms of the warranty costs and the logistics costs, those correspondingly go up as well. And those are the primary buckets that created the change.

So, in some way, I can relate the majority of the differential year-over-year to the increase in instrument places and the corresponding costs..

Thanks. Last one for Norm.

Any update in terms of how you're thinking about the current backlog or what's in the M&A pipeline, and your appetite to execute a deal over the next year through the ERP rollout, and whether you see any potential values floating around out there?.

Yeah, absolutely. We've got a pretty good book of things that we're looking at evaluating. And certainly, I'm really hoping that it's something that will come to pass in the next three to six months..

Great. That's it for me. Thank you..

Thank you. I'm showing no further questions at this time. I would now like to turn the call back over to Christine Tsingos for any closing comments..

Okay. Great. Thanks, Andrea, and thank you, everyone, for taking the time to join us today. We truly appreciate your interest. Bye-bye..

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