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

Brandon Couillard - Jefferies LLC David Westenberg - C.L. King & Associates, Inc..

Good day, ladies and gentlemen, and welcome to the Bio-Rad Laboratories Third Quarter 2017 Earnings Conference Call. As a reminder, this call is being recorded. I would now like to introduce your host for today's conference, Mr. Ron Hutton. Sir, you may begin..

Thank you, Skylar. First of all, we would like to thank you for your patience as we were experiencing some technical difficulties. We trust they've been overcome and we are sorry for any inconvenience this may have caused.

Before we begin the call, though, 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 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 it 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; Annette Tumolo, President of our Life Science Group; and John Hertia, President of Diagnostics Group.

Today we are pleased to report net sales for the third quarter of $535 million, an increase of 5.2% on a reported basis and versus the same period last year's sale of $508.7 million. On a currency-neutral basis, sales increased 3.4% when compared to last year.

During the quarter, we experienced good currency-neutral sales growth across many of our regions, most notably, Europe and Asia Pacific, as well as across many key life science and diagnostics product areas, including strong sales of our Droplet Digital PCR instruments and consumables, cell biology and food safety products in the life science group, and product for blood typing, quality control and autoimmune testing in the diagnostic group.

Also contributing to growth in the third quarter were $5 million of sales from the recently acquired RainDance Technologies and approximately $12 million of recovered sales that were disrupted by our transition to the global ERP in Europe in the second quarter.

The reported gross margin for the quarter was ahead of expectations at 56.9% and compares to 54.2% last quarter and 54.9% in the year-ago period. This increase in margin versus last year is related in part to decreases in royalty expense and amortization of acquired intangibles as well as favorable manufacturing variances.

In addition, the consolidated gross margin in the third quarter benefited by approximately $7.8 million for two corrections of items that occurred in the second quarter as we transitioned our European operations to the global ERP system. These corrections were predominately a reclassification between SG&A and COGS that has no impact to net income.

And the second was a small amount of sales that should have been recorded in the second quarter. These two items added approximately 1.2 points to the third quarter gross margin.

And, finally, when looking at the gross margin, the total non-cash purchase accounting expense recorded in cost of goods sold related to prior acquisitions was $4.9 million for the quarter and compares to $7.2 million in the year-ago period.

The decrease in amortization is related to the completion of the DiaMed-related purchase accounting in cost of goods sold, partially offset by the inclusion of RainDance. SG&A expenses for the third quarter were $196.8 million or 36.8% of sales compared to $201.5 million and 39.6% of sales last year.

On a sequential basis, SG&A expense decreased $16 million, driven primarily by a $10 million decline in spend related to our ERP project, as well as a $3 million benefit from the revaluation of contingent consideration.

This lower spend was partially offset by the adjustment to correct the ERP transition-related classification item that I just discussed, which essentially increased SG&A by approximately $5.3 million. Also during the quarter, we recorded $800,000 of severance expense for the shutdown of our GnuBIO operation.

And, finally, quarterly SG&A includes a total of $2.4 million for the amortization of acquisition-related intangibles. The increase in amortization versus the year ago period reflects the acquisition of RainDance. Research and development expense in Q3 was 11.5% of sales, or $61.4 million, which compares to 9.8% or $49.9 million last year.

During the third quarter, we made the decision to terminate our efforts to develop a targeted sequencer for the diagnostic market based on the technology acquired with GnuBIO in 2014. This decision resulted in R&D shutdown expense of $7.6 million during the quarter.

In addition, the higher R&D spend includes $3 million of a milestone accrual for our new flow cytometer for the cell biology market. Excluding these two events, the shutdown costs for GnuBIO and the milestone for the flow cytometer, base R&D expense would have been 9.5% of sales.

Going forward, we expect R&D expense to continue to be in the 9% to 10% of sales range. The reported operating margin for the third quarter was 8.7% of sales, reflecting a significant improvement both sequentially and year-over-year.

This improvement in profitability is largely driven by the increase in sales, as well as the decreased spend on ERP and professional services.

The misclassification of sales included in the current quarter results added approximately $2.5 million of operating profit, but this was more than offset by the one-time shutdown expense of $8.4 million for the GnuBIO project.

Excluding the net impact of these two unusual items, the operating margin for the third quarter would have been more than 9.5%. During the quarter, interest and other income was a net expense of $7.5 million compared to $5.4 million of net expense last year.

This increase is the result of higher foreign currency exchange costs, largely associated with our transition to the new operating model in Europe. The effective tax rate used for the third quarter was approximately 29%. This lower than expected quarterly rate reflects a discrete benefit related to share-based compensation in the quarter.

When comparing to the third quarter of 2016, remember that last year's rate was unusually low, at 19%, and related to an increase in foreign tax credit. Excluding any discrete items that may occur, we continue to expect the full year tax rate to be in the 30% to 31% range.

Net income for the third quarter was $27.4 million, which compares to $18.4 million in the year ago period. Reported diluted earnings per share for the quarter were $0.91. As I mentioned earlier, the reclassification between SG&A and cost of goods sold does not impact net income.

However, the $2.5 million of revenue that was included in our current reported results added approximately $0.06 to earnings per share for the third quarter, while the $8.4 million expense related to the GnuBIO action negatively impacted earnings per share by approximately $0.19.

In looking to the segments, Life Science reported sales for the third quarter increased 8.7% to $193.6 million. On a currency-neutral basis, sales grew 7.6% versus last year. This strong quarterly result reflects growth in all regions for Life Science and across many of our key product areas.

Of particular note, sales of our Droplet Digital PCR products continue to do well, along with our more traditional gene expression products. Sales of cell biology and food safety products also performed well for the third quarter, with both up double-digits versus last year.

Life Science sales growth in the quarter continued to be negatively impacted by lower sales of process media, a decline of approximately $6 million in the quarter versus last year. We expect this downward trend for process media to begin to turn around in the fourth quarter.

Our Clinical Diagnostic Group posted quarterly sales of $338 million, an increase of 3.3% compared to last year. On a currency-neutral basis, Diagnostic sales grew 1.2%. Growth during the quarter was primarily fueled by good demand for our blood typing products, BioPlex instruments and panels and our quality controls.

On a geographic view, Europe and Asia Pacific were the growers for Diagnostics in the quarter, while the Americas was down compared to last year. Much of this decline is attributed to the continuing weakness in our blood virus testing business. In addition, while it is difficult to quantify, we believe the tepid growth for Diagnostics in the U.S.

during the third quarter was also partially related to sales lost due to the hurricanes as well as a general slowing as some of our customers digest the recent PAMA regulatory changes. Moving to the balance sheet as of September 30, total cash and short-term investments were $721 million.

Net cash generated from operations during the quarter was $28 million compared to $62.4 million last quarter and $52 million in the third quarter of last year. This decrease in cash flow versus the second quarter is substantially related to our ERP transition in Europe. Not unlike what we saw with our second deployment in the U.S.

during the summer of 2015, collections are down in the near-term. In addition, payments to inventory suppliers are up as we prepared for our fourth quarter. EBITDA for the quarter was $80 million or more than 15% of sales. Year-to-date EBITDA is nearly $184 million or 12.1% of sales.

Net capital expenditures for the quarter were $20.3 million which represents a decrease, both sequentially and year-over-year. This decrease in capital spend for the current quarter is related to the lower spending on our ERP project as well as the completion of some key European infrastructure projects.

With year-to-date CapEx spend of approximately $85 million, we are revising our full outlook to be slightly lower in the $115 million to $125 million range. And, finally, depreciation and amortization for the quarter was $35.4 million.

Moving to our outlook for the fourth quarter, we are pleased to see acceleration in sales in some of our key markets and product lines during the third quarter, especially on the life science side of the business. And while we are somewhat cautious about the slowing of diagnostic sales in the U.S.

in general, we are seeing good demand for key product lines such as our BioPlex 2200 family of products and our IH-1000 blood typing business. With that in mind, we are anticipating full company net revenue for the fourth quarter of 2017 to be in the $615 million to $625 million range. This estimate assumes using current foreign exchange rates.

From a profitability standpoint, our original annual guidance had been for consolidated gross margins of 55% and a currency-neutral operating margin of around 7% for the full year.

On our last earnings call, we affirmed our annual gross margin guidance, but we've revised our operating margin target slightly to be between 6% and 6.5% for the full year, including the acquisition of RainDance.

Today we are affirming that full year guidance which anticipates the fourth quarter gross margin to be in the 54.5% to 55% range and the operating margin to be in the 9.5% to 10.5% range for the fourth quarter. As has been our practice in prior years, we will share our thinking and outlook for 2018 in February during the fourth quarter earnings call.

And now, we're happy to take your questions..

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

Thanks. Good afternoon. Christine, appreciate all the detail on the margin puts and takes. Just to be clear, I guess first of all, could you help us understand in terms of the GnuBIO shutdown, I think that business had been spending about $25 million a year in investment.

How much of that you're going to drop to the bottom line? Is there any benefit from that in the fourth quarter? And then lastly is in terms of the fourth quarter operating margin guidance, you said 9.5% to 10.5%.

Just to make sure that we're clear apples-to-apples, that would compare versus, to the 9.5% I think you said would be core in the third quarter.

Is that correct? So a step up?.

So taking it from the last question, essentially, yes, because that outlook assumes current exchange rates and they moved a little bit over the third quarter, but certainly different than what it was at the beginning of the year. So regarding the GnuBIO shutdown, I think, you're right.

We were spending in kind of the low $20 millions a year on that operation. And so there will be some savings in fourth quarter, but the bolus of the savings will come in 2018. We do plan to redirect some of the R&D spend into areas like liquid biopsy where we really are getting a lot of demand and we have some great new technology going on there.

But certainly the bottom line will benefit in 2018 and we'll talk about that more at our Investor Day on November 28..

Thanks. And this is maybe the first time, I guess, in recent memory I can recall that the European diagnostic business is actually up year-over-year in the third quarter. Be curious if you think we're finally starting to turn the corner there on what's been a long period of pricing headwinds and peaking market share..

Yes. Brandon, I mean that's a good question and there are puts and takes in Europe. I think part of what was driving that growth is this make-up of sales that were disrupted in Europe during the transition during the second quarter. Not all of that $12 million that we made up was in Europe, but the bolus was.

And the bolus of that was probably diagnostics. So that did contribute to some of the growth in Europe. Having said that, if we strip that out, Europe was at least flat, so I guess that could be a good sign going forward..

Super. And then one more.

In terms of the fourth quarter guide, does that contemplate that you recoup what I guess is another $4 million or $5 million of outstanding backlog from the second quarter disruption in the fourth quarter?.

Yes. So there's probably a small amount of catch-up. When we estimated in the second quarter that, $15 million to $17 million, we were also kind of estimating a normalized level. And I think we're really getting back to normalized now as we're running through the fourth quarter.

So there may be a small amount of make-up, if you will, from disrupted sales. But, frankly, it's now hard for us to decipher that, because the business is flowing along and products are being made and shipped and what have you. And so I think we feel good about having recovered.

And as we look to growth in the fourth quarter, much of the driver is really in the base business..

Good to hear. Thank you..

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

Hey. Thank you for taking the question. So I had a little bit of technical difficulty with my cell dialing in, so sorry if I missed this. But you did note that when you strip out some of the stuff in the quarter and certainly the GnuBIO charge, operating income would have been 9.5% or operating margin. And then, in the Q4 guide, it's from 9.5% to 10.5%.

The Q4 is usually a pretty good quarter in terms of operating margin.

Was there something – can you talk about kind of why that's the case here?.

I'm not sure I fully understand where you're going with the question, Dave. Sorry.

What is the case? Why is the margin stronger in the fourth quarter, or?.

Yes. So usually, I mean, like, when you look at your performance, usually, your best operating quarter is the fourth quarter. And when you strip out GnuBIO, I think you did better than what I was anticipating, and I think a lot of what everyone else was anticipating. So I don't know. I guess I'm seeing a lot of improvement right here.

And then, I kind of would think that the cadence would continue improving, particularly into Q4, which is typically the strongest quarter for you, guys..

Yes. So, well, I mean, I think we do feel like the strength in the margin will continue into the fourth quarter, thus discussion about the 9.5% to 10.5%.

And I think it helps to look at kind of the year-to-date results, because some of these reclassifications that we talked about were just really between Q2 and Q3, but puts us on solid footing for the year-to-date results. And looking at where that is and then moving into the fourth quarter, I think you'll see some of that growth..

Okay. And then, just a question for perspective purposes. So when you – let's say, on your Q1 call, when you were laying out sort of a – remember Q2 is the ERP related go-live quarter, keep your expectations in check.

And now that we've cleared Q3, can you talk about where you are, where you think the company is relative to your expectations maybe going into the year? I don't know if you can give any like quantitative data on that or qualitative data on that. I guess it doesn't matter.

I'm just trying to just really piece together your perspective relative to what you had in Q1 or when you reported Q1 and you said all hands on deck. It's go-live time..

So perspective on the top line is your question or....

Yes, both in terms of top and bottom line. I'm mostly referencing where you are in terms of – your thoughts in terms of ERP related disruption relative to your expectations in Q1..

Okay. Well, let's see. Where should we take this? So you're right. In Q1, there was a get ready, we're going live. There was also the acquisition of RainDance. Both would kind of change the original outlook for the year.

The original top line outlook was for the base business currency-neutral of around 4% and adding perhaps up to a point, maybe 75 basis points with RainDance. As we talked about on the last call with the headwinds of process media, which is probably the biggest change from the original plan that we would be at lower in that.

And I think that may still be true on a currency-neutral basis. But currencies are starting to come to parity, if you will. So I think, again, using current FX, we are in that range for the top line growth.

In terms of business interruption for the ERP, day-to-day operations with every day that's passed since we've gone live, that becomes smoother and smoother. And you can see that in catching up of the, what we call, disrupted sales and getting to a more normalized level.

The part that takes time – and we saw this with the prior two deployments – is really more evident on the working capital side, if you will, in terms of both the collection process and invoicing and all of that, as well as add some of the spend that has come along with this transition.

But like we saw with the first two deployments, after you get through that first three to four quarters that really smooths out, evens out, and not only gets back to normal, but that improves from there because of the efficiencies that we've built into the system.

Does that answer your question?.

Yes. Definitely the second part, the more qualitative part was actually, yes, incredibly helpful for me.

And then in terms of RainDance and its contribution, I mean you don't need necessarily say quantify, but can you talk about how much synergy you've had with RainDance and your own Digital Droplet PCR system relative to sort of expectations there?.

You mean synergy in terms of technology?.

The sales back synergy. I'm more looking at like sales synergy there..

Okay. Well, so I think we've talked about this before with the RainDance acquisition. First and foremost, it was very much a technology-driven, intellectual property-driven acquisition. Having said that, they do have a good base business. The vast majority of it is a single customer, Myriad Genetics, and so they represent the bulk of the sales.

But our plan was and continues to be really to focus the market on the products and technologies that we've been developing and selling in our existing digital biology group and adding some of that talent and technology and IP on top of that as we move forward.

And perhaps, Anette, if you'd like to add anything in terms of the value of the business in RainDance and where we're going..

Well, sure, Christine. I think you described it really well. We certainly have overlapping products. And as it turns out, the original Bio-Rad products really had much larger share and uptake in the market.

But RainDance had developed a lot of very good technology and really important intellectual property which we think was very, very important for us moving forward. So that's mainly, I think, how we're going to leverage that acquisition..

Yes.

And the other, Dave?.

Great. And -.

Sorry..

Finish your thought..

Okay. Yes. The other thing I was just going to add is when we did the acquisition, the goal was, while it was a bit of a negative on the operating income line, initially the goal was to get that to contributing within 18 months. And we did write off part of the purchase price early on, which added the additional drag this year.

But I think we're well on track to have it be contributing by the second half of 2018..

Great. I appreciate it. Thank you very much and look forward to seeing you at the end of the month..

Okay..

At this time, I'm showing no further questions. I'd like to turn the call back over to Christine for closing remarks..

Sorry, Skylar. Can you just poll one last time just to be sure? Because we had the technical difficulties at the beginning, I just want to make sure. And otherwise, I'm happy to wrap up..

We have a follow-up from Brandon Couillard with Jefferies. Your line is now open..

Great. Thank you. We can't end on that note. Would love to hear from John Hertia, Christine. You spoke to the blood typing business seeing some traction in the U.S. John, would love to get your perspective on how that launch is going.

Anything you can tell us in terms of placements and whether many of those instruments are actually starting to generate recurring revenues, consumables revenues yet, or if that's still on the cusp for 2018?.

Sure, Brandon. It's going well. The traction that we were hoping for is taking place. Although I can't give out specific system numbers, I can tell you that we're going to be at or a little ahead of what our forecasts were for 2017, which we think is good news. As you have to remember with these systems, they're large.

There's a lot of validation that goes in. And so the reagent flow will begin taking place this year, but you'll begin to see more of the impact of that in 2018..

Very good. Thanks..

And we have a follow-up from David Westenberg. Your line is now open..

Thank you for taking the follow-up.

So just on the acquisition front, any thoughts to whether you would aim for more towards the Life Science segment or aim more towards the Diagnostic segment? Can you let us know why that would be where you'd target?.

So we do have a pretty interesting acquisition pipeline right now.

I'm going to save the answer to that question for Investor Day on November 28 because we are going to be talking about it, as we have the management presentation from both Annette Tumolo on the Life Science side and John Hertia on the Diagnostics side and myself and John Goetz and Norman Schwartz.

And so, that's definitely part of the conversation, so I think I'll save that for then if that's okay, Dave..

No problem. Thank you so much..

Okay. Well, everyone, again, our apologies for the technical difficulties at the beginning of the call. As always, we're here and available to answer any other questions you may have. And thank you again for your time and your interest. Bye-bye..

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