Ronald W. Hutton - Bio-Rad Laboratories, Inc. Christine A. Tsingos - Bio-Rad Laboratories, Inc. John Goetz - Bio-Rad Laboratories, Inc. Annette Tumolo - Bio-Rad Laboratories, Inc..

Brandon Couillard - Jefferies LLC Dan Leonard - Deutsche Bank Securities, Inc. David Westenberg - C.L. King & Associates, Inc..

Good day, ladies and gentlemen, and welcome to the Q1 2017 Bio-Rad Laboratories, Inc. 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. As a reminder, this conference call is being recorded.

I would now like to turn the call over to Ron Hutton. You may begin..

Thank you very much, Michelle. 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'll 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. With me today are John Goetz, our Chief Operating Officer; Shannon Hall, President of our Life Science Group, John Hertia, President of our Clinical Diagnostics Group; and Annette Tumolo, who heads up our Digital Biology Group.

Net sales for the first quarter of 2017 were $500.1 million, an increase of 6.1% versus the same period last year sales of $471.2 million. On a currency-neutral basis, sales increased 6.7%.

The first quarter sales results include approximately $1.9 million associated with the acquisition of RainDance as well as an estimated $9 million of revenue that was pulled forward in anticipation of the go-live of our European deployment of SAP.

If we exclude these acquired and pull forward sales, currency-neutral organic growth for the first quarter was around 4.4% and ahead of expectations. During the quarter, we experienced good currency-neutral growth across many of our key market and product areas within both the Life Science and Diagnostics segments.

Of particular note, sales of Droplet Digital PCR, western blotting, blood typing and autoimmune products were particularly strong during the quarter. From a geographic standpoint, sales in the quarter grew, most notably in Asia Pacific, China and Europe, offset somewhat by slower sales in the U.S. and Japan.

I should point out that sales growth in Europe during the first quarter was driven significantly by the pull forward of orders in advance of our system go-live in the region. However, even without the accelerated product timings, we posted good currency-neutral growth in Europe for both segments.

The reported gross margin for the first quarter was lower than expected at 54% and compares to 56% last year. This lower margin is primarily the result of $10 million of one-time expense related to the acquisition of RainDance.

In terms of the base operations, the gross margin for the quarter was negatively impacted by some duplicate costs associated with the launch of a new supply chain model in Europe, which was offset by a favorable product mix and a decrease in amortization expense related to acquisition.

For the first quarter of 2017, amortization recorded in cost of goods sold was $5.1 million, which compares to $7.2 million in the first quarter of last year. This decrease reflects the completion of amortization in COGS related to the DiaMed acquisition, partially offset by an estimate for the addition of RainDance.

As we have been guiding, SG&A expenses for the first quarter were up substantially and relates to the implementation of SAP in a new operating model in Europe. This new model includes the beginnings of a more efficient logistics footprint as well as shared services for back-office activities.

We estimate incremental spend related to those activities in the first quarter were in the $6 million to $8 million range. This incremental expense was offset by a nearly $10 million reduction in contingent consideration, which was a benefit to SG&A during the quarter.

With that, reported SG&A expense for the first quarter of 2017 was $194.9 million or 39% of sales compared to $189.7 million or 40.3% of sales last year. Total amortization related to acquisitions recorded in SG&A for the quarter was $1.7 million.

Research and development expense in Q1 was in line with expectations at 9.9% of sales or $49.5 million, which compares to $48.6 million or 10.3% of sales in the first quarter of last year. The primary driver of the increased R&D spend relates to our ongoing investment in new applications for our Droplet Digital PCR technology.

During the quarter, interest and other income was a net expense of $5.4 million, essentially unchanged from the year ago period. The effective tax rate used during the first quarter was 38%. This higher than expected rate is substantially driven by an increase in losses at some of our smaller foreign locations for which no benefit is expected.

Given this high first quarter rate and excluding any discrete items that may occur during the year, we now expect the full year effective tax rate to be in the 31% to 33% range and slightly higher than our prior guidance of 30% to 32%.

Despite the strong top-line results, net income for the first quarter was $12.4 million, essentially flat with last year, and directly related to the incremental spend on our many internal investments. Diluted earnings per share for the quarter were $0.41. And now for certain segment information.

Life Science sales for the first quarter were $174.3 million, an increase of 5.1% on a reported basis when compared to last year and growth of 6.3% on a currency-neutral basis. Excluding the addition of $1.9 million of RainDance sales for about half the quarter, Life Science organic growth was 5.2%.

This year-over-year growth rate is even more impressive when considering that the first quarter of 2016 Life Science currency-neutral sales grew by nearly 10%.

Much of the growth in the first quarter of this year was driven by continued strong demand for our Digital PCR instruments and reagents, sales of our newly released western blot imager and sales of our PCR food testing products. We also experienced good growth of our amplification and cell biology product lines.

On a geographic basis, Life Science currency-neutral sales were particularly strong in Europe, China and the Asia Pacific region. This growth was partially offset by slower sales in North America that were impacted by a year-over-year decrease in process media revenue.

As you know, the process media sales cycle can be lumpy, especially when compared to the record sales set last year. From a strategic standpoint, during the first quarter, we made two important announcements regarding our Life Science group.

The first is the conclusion of the acquisition of RainDance, which gives us valuable intellectual property and further strengthens our current and future offering of droplet-based products for both research and clinical markets.

The second important milestone is the product launch of the Illumina Bio-Rad Single-Cell Sequencing Solution, an important new workflow that allows for a deeper view into the gene expression of individual cells.

And while it is still early days for these two important additions to our Life Science portfolio, the early feedback and product pipeline seems very promising. Sales of Clinical Diagnostics products in the quarter were $322.3 million compared to $301.7 million last year, an increase of 6.8% on a reported basis.

On a currency-neutral basis, year-over-year sales were up 7%. The overall growth rate for the Diagnostic group was positively impacted by the pull forward of approximately $9 million of sales in advance of our April go-live of SAP in Europe.

Similar to prior deployments, we offered our customers who typically have standing monthly orders or frequently used short-life consumables the ability to ensure their supply of products, while we transition to new systems and processes.

Excluding this $9 million impact, Diagnostic sales for the first quarter increased over 4% on a currency-neutral basis, which compares to a 1% currency-neutral growth in the year ago period. During the first quarter of this year, we posted solid growth of blood typing and autoimmune testing products with both lines increasing double-digits.

Our quality control also continued to grow nicely in the quarter. Looking at the regional view, sales of diagnostic products were particularly strong in Europe, China, Asia Pacific and the Middle East.

Moving to the balance sheet, as of March 31, total cash and short-term investments were $679 million compared to $844 million at the end of 2016, a decline of $165 million.

It is not unusual for our first quarter to be a heavy cash use quarter as we typically pay annual incentive bonuses and commissions, annual hardware and software maintenance costs and so forth.

But more specific to the first quarter of 2017 was also the cash payment of approximately $83 million to RainDance, as well as an estimated $20 million to $25 million of accelerated payments that we associate with the preparation for the transition to SAP in Europe.

Also impacted net cash generated from operations during the quarter was a negative $56.2 million compared to a negative $7.4 million in the year ago period. This decrease in cash flow versus last year is a result of many of the items I just mentioned, coupled with a slowdown in collections.

All-in-all it was a tough quarter for working capital, but much of it is identifiable and event-driven and not necessarily indicative of a new level.

As we exit the heavy investment year of 2017, we fully anticipate harnessing the benefits of our new operating model in global systems, in turn delivering significant incremental improvement in working capital over the long-term. Net capital expenditures for the quarter were $39.3 million and down versus the fourth quarter amount of $45 million.

Our full year expectation for CapEx remains in the $125 million to $135 million range. Finally, depreciation and amortization for the quarter was $33.7 million. And moving to the outlook, on our last earnings call, we shared our thinking for 2017.

And that is our goals for currency-neutral sales growth of 4%, full year gross margins in the 55% range, and targeting the operating margin at about 7% on a currency-neutral basis. Today, we are reiterating that guidance.

You may also recall that we indicated some caution about our ability to reach a 7% currency-neutral operating margin, especially given the significant expenditures related to the system and operating model changes in Europe, which will be occurring throughout 2017. Our caution about achieving the profit margin goals still stand.

While we successfully went live with SAP in Europe the first week in April, it is still early days in terms of system adoption. You may remember that with our last major deployment, North America in July of 2015, productivity noticeably slowed down as people learn the new processes. We fully expect that to be the case this time too.

With that in mind and coupled with the pull forward of revenue into the first quarter, it would not surprise us to see a slowing of sales in the short-term, while still bearing the burden of significant investment. As I mentioned earlier, we completed the RainDance acquisition in the middle of February.

While we're still getting our arms around the business, we currently anticipate the addition of RainDance will add $18 million to $20 million of sales for 2017. Regarding the impact to profitability, our best estimate at this time is that the consolidation of RainDance could negatively impact operating income by $7 million to $10 million in 2017.

A portion of this projected impact is related to purchase accounting and integration costs, but nonetheless could bring our total operating margin below our 7% target. We're hoping to bring the RainDance acquisition to accretion within the first 18 months to 24 months. And now, we're happy to take your questions..

Our first question comes from Brandon Couillard of Jefferies. Your line is open..

Thanks. Good afternoon..

Hi, Brandon..

Maybe this one is for John Goetz on the ERP deployment. So far so we're a month into the go-live.

Could you just give us an update on sort of the status of operations? How smoothly it's gone, sort of, relative to your expectations and perhaps relative to the prior to go-live experiences?.

Sure. Well, we're happy to say that we're able to take our orders from customers and process them through the system, ship and invoice, relieve inventory, and do all of the things that we need to do. And, for me, that's a real good positive.

Having said that, we're experiencing all the usual things you might expect in a go-live of this magnitude and complexity from how we enter orders, processing, changes to the master data, so that we could process them all the way through to shipment. It's all of the usual things.

But if you just take a 30,000 foot look at it, I feel really good about where we are. We still have some months ahead of us to stabilize the system fully. And, as Christine mentioned, adoption is the big thing we're after right now. But, for me, I'm considering this a pretty good situation..

Yeah. Brandon, I'll echo a lot of that. I think that all the preparation that went into this, our buddy (17:27) system on the ground, when we went live and trying to take advantage of lessons learned from the first two deployments served us well.

And as we now go through the process of running the day-to-day business and soon we'll be going through the close process, et cetera, productivity just naturally slows down from the very beginning of making product all the way through collecting.

But you may remember with the second deployment in the summer of 2015, while it did slowdown in that first quarter and we ended up with more backlog, we were able to make it up fairly quickly in the following quarter. So, hopefully that would be the cases as well. But the pull forward in this deployment was more sizable than in the second deployment.

And coupling that with the natural slowdown in productivity, that's what kind of leads to our near-term caution. But we did reiterate our outlook for the full year fully expecting to make that up..

Yeah. It's helpful. And staying on that topic, why was there no pull forward in the Life Sciences business out of curiosity? And then, I think, Christine, you mentioned that the incremental ERP expenses year-over-year were $6 million to $8 million.

How does that trend – what that trend look like over the balance of the next three quarters?.

So, in terms of pull-through, remember, we're going live in Europe and the vast, vast majority of the manufacturing in Europe is all Diagnostic products. And they are products for the blood typing market, for the blood virus market. And many of these consumables are very critical in the process.

Whereas for the Life Science group, much of their manufacturing is here in North America or in Asia and that's why you see it heavily skewed to consumables in the diagnostics space.

And can you tell me again your second question?.

Yeah. The incremental ERP expenses you said in the first quarter were $6 million to $8 million. Curious what that looks like over the next three periods..

Oh, good question. So, it's more than just ERP, when you think about that $6 million to $8 million. I mean a chunk of it is the project and project related but then also right now we're running some duplicate costs as we spin-up our new warehouse in Europe and we spin-up shared services at our regional headquarters.

All of that contributes to incremental spend without the relief of kind of letting go of the old model, which obviously had to run the business in the first quarter and will continue to be a support through the second quarter. So, that – I would expect that increment would continue in the near-term.

But our plan is that as we get to towards the end of 2017 and exit 2017, a lot of that duplication of head count, of warehouses, et cetera, really starts to go away and sets us up for incremental improvement in 2018..

Thanks. That's helpful and then maybe a two-part question for Shannon and John.

If you could speak to – give us an update on how the – some of the new product launches are going, in particular on the Diagnostics side, the new IH-1000 and would love to hear your comments on how the Illumina partnership has gone so far? Anything can you tell us in terms of like order book or placements or just customer activity would be useful.

Thanks..

Okay. So, John can speak to that and maybe Annette can talk about the Illumina partnership..

Sure, Brandon. A little bit about blood typing in hematology. Overall, across all of our selling regions, the business is strong for the first quarter. As you know, we got IH-1000 FDA approved at the tail end of the last year.

We don't release data on a geographic basis, but I would say that we're pleased with the traction we've received so far in the U.S. We had favorable expectations of how customers would react to simplified workflow and the largest line of gel cards offered in the U.S. And so far we're getting echoes of positive response across all of them..

Yeah. So we've always talked, Brandon, about it being a very long sales cycle. It's a very sticky business, as you know. But I think that the feedback is good and in terms of really contributing and moving the needle. For that, we've always looked to late this year and then going into the future.

And then, Annette, on the new Illumina Bio-Rad Single-Cell?.

Sure. So we launched the product in late January and early February. And we've gotten great feedback from the field so far. They're very happy to have a new tool to sell. Good customer acceptance, really strong promising pipeline that the sales force are delivering.

I think one of the most – aside from great enthusiasm for the customers, the interaction in the field between the two companies, which was an experiment for us, if you will, has been really, really good.

Good cooperation with the Illumina and Bio-Rad sales organizations to really give the customer a seamless experience, when they're interacting with both companies about the technology. So far so good..

Thanks. And if I could squeeze one more in with respect to your announcement, I guess, in early March, you spoke to pointing to developing a target leverage ratio. And I'm just curious if you could help us understand.

When those plans might be formalized and if it's reasonable to believe you could be in the market buying back stock as early as the second half of this year?.

So, good question, Brandon. And I think it's more than just leverage. We're looking at the overall capital allocation framework. And, as you know, we have a new board of directors that was elected a few weeks ago and – or a week ago.

And so one of the first things we'll be doing is working with them to get their input, advice and ideas on capital allocation framework. And, obviously, first, we have to get them up to speed on Bio-Rad and the business, our goals and objectives.

So, what we're targeting is late this year having an Analyst Day and sharing more information at that time, after we've spent some time with our board of directors..

Super. I'll hop back in the queue. Thank you..

Our next question comes from Dan Leonard of Deutsche Bank. Your line is open..

Thank you.

First off, Christine, could you characterize your incremental confidence in the top-line target for the year of the 4% given the way the markets have transpired over the past three months?.

Well, I think that we're still targeting the 4% top-line growth that we talked about in late February when we had our earnings call. And then, obviously, the addition of RainDance could add up to a point of that growth. What's been going on since then, one day, there is no NIH budget, the next day there is a budget and it's going up a little.

So I think that, we'll keep watching. There is some encouraging things, Dan. Obviously, if the NIH budget is growing, that's good for us, because the majority of our Life Science sales are still into the academic research world, government and academic research world.

It's nice to see pretty good signs of growth in Europe, even without this pull forward, that was primarily a European event, still very good base growth for both Life Science and Diagnostics. Granted it's an easy compare, in some cases, because we've struggled in Europe for some time, but that's also very encouraging for the future.

In some of the emerging markets, we'll have to wait and see. Hopefully, the economies hold up. China continues to be a good, strong market for us. So, I think, it's too early to change our expectation, but we're off to a good start..

Okay. That's helpful. And then just a clarification.

Does that 7% operating margin target – does that include contingent consideration reversals like you saw in Q1?.

Because the charge in cost of goods was pretty much an offset to what went on in contingent considerations, they kind of neutralized each other out and kept us for the base business at around that 7%.

I think going forward because this was kind of a large one-time event for contingent consideration and I'm not anticipating anything quite that sizable going forward..

Okay. Thank you..

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

Hi. Thanks for taking the question.

So, can you talk about some of your new board members? Actually specifically what you were looking for when you picked out these new board members and how you see them as an asset on a go-forward basis?.

Sure. So, very exciting to have the new board and had a good opportunity to spend time with them last week. When we were looking at where we're headed as a company in terms of continuing to expand globally, we're getting to the end of – or certainly far along in our ERP deployment.

It was important to have board members who were really well-suited to help us for – with our next level of growth and opportunity. And that is extracting the benefit from these very sizable investments that we've been making, not only in terms of systems, but how we run the business in a more efficient way.

And many of the new board members come from backgrounds where they've gone through this ERP type of implementation and extracting benefit.

I think, having their experience on the capital allocation side, as we move forward and see a little light at the end of the tunnel to start to expand our margins, our cash flow will expand, and it becomes even more important for us to focus on the appropriate framework and use of that. So those are a couple of the reasons.

Having somebody with good governance and regulatory background – we're in a highly regulated market, as you know, all over the world. And Arnie Pinkston brings tremendous amount of experience in that area, having spent his career at Allergan and Beckman and Lilly. So all of that's very valuable, as we continue to expand and grow globally.

Those are a few of thoughts off top of my head, very exciting..

Right. No, this is very helpful. And then just a little bit of a continuation of Dan's question.

Did you see any weakness specifically in Q1 to the NIH funding? And if so, do you anticipate maybe a stronger Life Science sales in Q2 and Q3 as people feel a little bit more comfortable? Knowing that I mean obviously it's just funded till September, but still maybe was there any maybe a relief bump in Q2 or....

Yeah. So, well, too really to know about Q2 and it's hard to say in Q1 how people may have behaved if there was uncertainty around the budget, were they hanging on to their money, just in case. That's hard to peel back the onion and know for sure. What we can do is we can look at our specific business.

And especially in North America, there was a very large year-over-year decline in process media. And, again, it's just a lumpy business. Our outlook remains very strong for that. But it certainly was enough to move the needle.

At the same time, you look in North America for some of our very core products, amplifications and cell biology, as well as the new imager in western blotting and all of that and there is real growth going on there.

So, hopefully, the combination of a good product lineup and more certainty around the funding environment will bode well for North America going forward..

Great. Thank you.

And on the capital deployment front, is the focus in the next couple quarters ERP? Or are we still looking at maybe small tuck-in acquisitions? Is that at the table during the next couple quarters or is that still on the table?.

I think it's always still on the table. I think acquisitions are an important way for us to bring new technology to the company and expand our product portfolios in the markets that we serve. Having said that, there are – some are opportunistic, some are more targeted, but they're not quite as frequent as even we would like them to be.

But they're certainly on the table and we'll continue to look at opportunities in both Life Science and Diagnostics. In terms of the more certain capital investments that we're making there, we'll continue to move forward investing in systems and the build out in Europe as we expand our new process footprint, if you will.

So more of the same of that, but certainly we'll continue to look for opportunities in acquired technologies products businesses..

Great. And if I can just sneak in one more.

What would be some of the puts and takes if ERP were to, let's say, drag on a little bit further than you like and maybe in the early next year? I mean what would be some of the causes that would be responsible for it?.

When you ask about ERP dragging on, are you referring to the project continuing or are you referring to the business slowing down, while people adopt to the systems..

Both actually..

So I'll start with the business slowing down as they adopt to the new system. Again, we've seen this in our prior deployment, so wouldn't be unexpected or unusual for it to happen now. It just takes time for people to learn something new and get very proficient at it.

When we went live in North America, we ended up that first quarter of go-live with an $8 million to $10 million backlog and we made it up in the following quarter.

My only caution here would be, while it could put a fair amount of pressure on our second quarter, then we move into the third quarter, which is a seasonally slow quarter in Europe – do they really make it up right then? I don't' know. That's to be seen.

And I have no reason to believe one way or another, but as I'm thinking about the seasonality of that business versus North America, there is that one element. As far as spending on the project, I mean the project will continue and we will continue to implement around the world and bring our commercial businesses into this single instance of SAP.

The change though in spending is what we really have in front of us now, our commercial operations, I don't want to say they're easy, because nothing about this is easy, but they are certainly less complex than the manufacturing operation.

So our plan is to move forward in kind of very deliberate byte size system-by-system approach with the implementation and that will probably go on for the next two years or three years as we look at these commercial operations. And then we're going to look at them individually and judge the ROI.

More importantly, though, I think we are hoping that that much of this implementation we're going to be able to do with the knowledge that we have now built internally having gone through three very sizable deployments. And using our own people should allow us to finish off these implementations at a lower cost. So, this year, a fair amount of spend.

I'm always wanting to remind people that once we go live, all of the labor is expensed, whereas when you're going through your deployment, it's capitalized. So we have that in front of us right now.

But then as we move to 2018 and beyond, we'd like to be able to incorporate both the project and the cost as part of our ongoing business over the next few years..

This has all been very helpful. Thank you so much..

And I'm showing no further questions. Please proceed with any closing remarks..

Great. Thank you, operator, and thank you, everyone, for taking the time to join us today. Stay tuned for more information about our upcoming Analyst Day. Bye-bye..

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