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

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

Good day, ladies and gentlemen, and welcome to the Q2 2018 Bio-Rad Laboratories Earnings Conference Call. As a reminder, this conference call may be recorded. I would now like to introduce your host for today's conference, Vice President and Treasurer, Ron Hutton. You may begin..

Thank you, David. 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 our 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 our risk factors in our business.

The company does not intend to update any forward -looking statements made during the call today. Our remarks today will also include references to non-GAAP net income and non-GAAP diluted income per share, which are financial measures that are not defined under generally accepted accounting principles.

Investors should review the reconciliation of these non-GAAP measures to the comparable GAAP results contained in our earnings release. 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 Norman Schwartz, our CEO; and John Hertia, President of our Clinical Diagnostics Group. On the call, we will review our results on a GAAP basis and then provide some commentary and insight to our results on a non-GAAP basis.

Today, we are pleased to report net sales for the second quarter of 2018 were $575.9 million and growth of 14.1% versus the same period last year sale of $504.7 million. On a currency neutral basis, sales increased an impressive 11%.

During the quarter, we experienced good demand across many of our key product lines resulting in double-digit growth in all three major geographies. When comparing to the second quarter of last year, remember that an estimated $16 million of revenue was disrupted in association with the go-live of our European deployment of SAP in April 2017.

If we neutralize for last year's disruption as well as for a small amount of sales that were pulled forward into the second quarter of this year in conjunction with the recent completion of our system deployment in Western Europe, we estimate that currency neutral organic growth for the quarter was around 6.5%.

Now, let's look a little closer at the segment performance. Life Science sales in the second quarter were $217.8 million, an increase of 21.4% on a reported basis when compared to last year and growth of nearly 19% on a currency neutral basis.

Much of the growth in the second quarter was driven by continued strong demand for our cell biology, Digital PCR and food safety products. We also experienced another quarter of increased demand for our process media product lines. You may recall that 2017 was a tough year for growth in process media, making this year a bit of an easy compare.

With that being said, and excluding the process media sales, our core Life Science business still grew an impressive 14% currency neutral in the second quarter of this year. On a geographic basis, Life Science experienced double-digit currency neutral growth in all three of our geographies and were particularly strong in the U.S., Europe and China.

Sales of Clinical Diagnostics products in the quarter were $354 million compared to $322.1 million last year, an increase of 9.9% on a reported basis. On a currency neutral basis, year-over-year sales grew 6.5%. During the second quarter, we posted solid growth of blood typing, autoimmune testing and quality control products.

Of particular note, during the quarter, we experienced a significant increase in instrument placements for the blood typing market with the unit volume more than doubling both year-over-year and sequentially. Looking at the regional view, sales of diagnostic products were particularly strong in the Americas, China and Europe.

The reported gross margin for the second quarter was lower than our annual target at 52.4% and compares to 54.2% last year. The current quarter margin was significantly impacted by changes in the product mix, as well as certain expenses borne out of the continued transition of our European operations.

As I mentioned earlier, during the quarter, we placed a significant number of diagnostic instruments, most notably for the blood typing market. The short-term impact is a sizable headwind to margin, but longer term, these placements bode well for sustainable higher margin consumable revenue.

In addition to the product mix headwind, during the quarter, we experienced a higher level of restructuring and inventory-related expense, much of which stems from the continued transition of Western Europe to our new operating model and global ERP platform.

And finally, for the second quarter of 2018, amortization related to prior acquisitions recorded in cost of goods sold was $4.7 million, which compares to $7.1 million in the second quarter of last year.

SG&A expenses for the second quarter were $210.4 million or 36.5% of sales, an improvement versus last year in terms of dollars and as a percent of sales. Total amortization related to acquisitions recorded in SG&A for the quarter was $2.1 million versus $1.8 million in the second quarter of last year.

Research and development expense in Q2 was $47.5 million or 8.2% of sales.

When comparing to the second quarter of last year, remember that the year ago period included more than $11 million of one-time acquisition-related expense for the purchase of an early stage diagnostic device as well as expense associated with the acquisition of our new flow cytometer.

Going forward, we continue to target our annual R&D investment at 9% of sales. Looking below the operating line, the change in fair market value of our holdings of equity securities added $286.4 million of income to our reported results for the quarter and is substantially related to our holdings of ordinary and preferred shares of Sartorius AG.

Also, during the quarter, interest and other income resulted in net other income of $9.9 million compared to $2.8 million last year. This increase primarily reflects the annual receipt of our Sartorius dividend, which increased more than $3 million from last year, as well as lower foreign exchange hedging cost versus last year.

The effective tax rate used during the second quarter was 21% and compares to 24% in the first quarter of this year. This lower than expected tax rate was driven by the sizable gain related to our Sartorius investment, coupled with a benefit of tax reform in the U.S.

Excluding Sartorius and any discrete items that may occur during the year, we continue to expect the full year effective tax rate to be in the 26% to 27% range. Reported net income for the second quarter was $268 million and diluted earnings per share for the quarter were $8.87.

This significant increase in net income and earnings per share versus last year substantially relates to the valuation of our Sartorius holdings.

With the change in accounting regulations for equity securities, coupled with the multiple atypical events and charges, it is important now for us to review our results in a manner that is more reflective of our base operations.

As we look at our results on a non-GAAP basis, we have excluded certain atypical or unique items that impacted both our growth and operating margins as well as other income. These items are detailed in the reconciliation chart in our press release.

Looking at the non-GAAP results for the second quarter and cost of goods sold, we have excluded amortization of purchased intangibles of $4.7 million as well as $1.3 million of restructuring cost related to the shutdown of a small manufacturing facility in Europe. These adjustments move the gross margin for the second quarter from 52.4% to 53.4%.

This non-GAAP margin compares to a non-GAAP margin in the second quarter of 2017 of 55.6%.

As a side note, I'd like to reiterate my earlier comments about the substantial impact of change in product mix toward a higher number of instrument placements as well as the increased inventory cost related to our transition to a more optimized operating model in Europe.

If we were to further normalize the non-GAAP margin for both the product mix effect, which is estimated at 70 basis points, and the atypical quarterly expense for inventory, which is estimated at 100 basis points, we calculate the gross margin would have been approximately 55.1% for the quarter.

In operating margin expense on a non-GAAP basis, we have excluded amortization of purchased intangibles of $2.1 million, legal-related charges of $5.1 million, acquisition-related costs of $1.5 million and a small credit to restructuring cost of about $0.5 million.

Of particular note, we would highlight that we continue to make progress on the SG&A margin on a non-GAAP basis, as evidenced by the 200 basis point decline just from the first quarter of this year to 35.1%.

The cumulative sum of these non-GAAP adjustments result in moving the operating margin for the second quarter 2018 from 7.6% on a GAAP basis to 10% on a non-GAAP basis. This represents a significant improvement over our non-GAAP operating margin of 3.5% in the second quarter of last year.

We have also excluded certain items below the operating line, which are the quarterly increase in value of our equity holdings of $286.4 million as well as $405,000 of loss associated with venture investments that are recorded on the equity method of accounting.

With all of these various items in mind, we adjusted our tax provision for these exclusions, resulting in a non-GAAP effective tax rate of 27%. And finally, non-GAAP net income and earnings per share for the second quarter of 2018 were $49.5 million and $1.64 per share, which compares to $18.8 million and $0.62 a share last year.

Moving to the balance sheet, as of June 30, total cash and short-term investments were $824 million compared to $761 million at the end of 2017. For the second quarter of 2018, net cash generated from operations was nearly $78 million, which compares to $63 million in the year ago period.

Perhaps more noteworthy is to point out that cash generated from operation in the first half of 2018 has already exceeded the cash flow in all of last year.

This positive result reflects our higher operating profit as well as good improvement in both collections and inventory management as we continue to make progress towards optimizing our global operating model and systems. Also noteworthy, the adjusted EBITDA for the second quarter was $101.5 million or 17.6% of sales.

For the first half of 2018, adjusted EBITDA is just over $183 million or 16.3% of sales. Net capital expenditures for the quarter were $22.6 million and in line with our full year expectation for CapEx in the $100 million to $110 million range. And finally, depreciation and amortization for the quarter was $34.3 million.

Also of note on the balance sheet is the significant increase in other investments, which now include the mark-to-market of the ordinary voting shares of Sartorius.

Associated with this is the significant increase in other long-term liabilities for the tax on our Sartorius gain as well as the increase in retained earnings reflected in stockholders' equity. Now, let's move to the outlook for 2018.

Given the strong year-to-date top line performance, today we are raising our currency neutral revenue growth guidance to be 4% to 4.5% for the full year, up from the previous outlook of 3.5% to 4%.

This new target range incorporates our growth in the first half of this year, but also continues to reflect what may be a tough to compare in the second half of 2018.

Remember that the third quarter of 2017 was positively impacted by approximately $12 million of revenue that was recovered following the ERP-related disruption, and is on top of what is typically a challenged quarter due to seasonality.

It is also worth noting that the fourth quarter of 2017 was a substantial record sales quarter for the company at more than $620 million, making year-over-year growth in Q4 uniquely challenging.

When thinking about our guidance for the full year operating margin, today we are maintaining our previous outlook, that is 10% on a reported GAAP basis, or 11% to 11.5% on a non-GAAP basis. Our non-GAAP operating margin for the first half of the year is 10% and behind the annual outlook.

Today's reiteration of operating margin guidance assumes our expectation that the second half of the year will have improved gross margin results, returning to a more normalized 55.5% to 56%.

This gross margin improvement along with top line growth and continued expense control in SG&A are expected to result in an annual operating margin that is within the range of our guidance. And now, we're happy to take your questions..

Our first question comes from Dan Leonard with Deutsche Bank. Your line is now open..

Thank you.

So, first off on the revenue guidance, Christine and Norman, is it correct to infer that you're assuming no organic revenue growth in the second half of the year? And is there anything to flag outside of the comparisons?.

So, I think it's correct to assume that there's much lower growth in the second half of the year on a currency neutral basis. I wouldn't say no, but certainly very, very different than what we've experienced in the first half of the year..

Okay.

And Christine, could you offer your latest thinking on the impact of currency on your operating margin target for the year?.

So, it's a good question. I mean, as we looked at our targets at the end of Q1, we saw that we still had a bit of a benefit. I think now, as we look to the second half the year, we're getting to a more neutralized currency impact on the operating margin.

And you may recall, Dan, that in the Q1 call, when we took our 10% GAAP goal – operating margin GAAP goal and moved it to 11.5% on a non-GAAP basis, that was really incorporating some positive currency impact and some of that's gone away. And that's why we're now looking at 11% to 11.5%..

Okay. Thank you. And then my final question, I just want to make sure I better understand the variance in your gross margin in the quarter.

So you flagged upside in placements of diagnostic instruments, but aren't those typically reagent rental and thus capitalized? So can you, I guess, better help me bridge the variance there and correct my understanding on the reagent rental math?.

Sure.

So, you're asking about kind of the downdraft in the second quarter that we just reported to margin?.

Yes..

Yeah, so great question. And as I mentioned, it was a record number of placements for us in the quarter. Some are reagent rental, but there's also a sizable amount that are also sold.

And you may recall that last year, our model in China for instruments changed and we no longer do the reagent rental program in China per some of the government regulations that they have there, and a high number of the placements this quarter were in China.

And typically, as you're pricing these long-term contracts, the recovery of the gross margin is more on the reagent, the sustainable reagent flow not the instrument itself..

Well, and I guess I have a follow-up then on that comment.

So if you had outsized instrument placements in China in diagnostics, do you think any of that was maybe pull forward as a result of customers placing orders in front of potential tariffs or do you think there's any relationship there at all?.

Yeah. It's a great question and I had that same question for the person who runs our entire region there. And he does not believe that that's the case. That it is, in fact, the demand for the product itself and customer accounts that we've been working on for some time..

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

Thank you. And our next question comes from Brandon Couillard with Jefferies. Your line is now open..

Thanks. Good afternoon. Christine, appreciate all the gross margin detail you shared with us between mix and inventory costs.

Just curious when do you expect those inventory costs related to the ERP transition to actually go away, should those start to abate in the second half of the year, or will they be with us kind of into 2019 to some extent?.

No, Brandon, I think quite a bit of it was just related to actions in this second quarter. And that's why I wanted to call it out. We didn't non-GAAP it out because it really is part of our ongoing business operations, but it was very outsized for the quarter itself. So, we wanted to kind of, quote, normalize that in.

There may be a little bit more that continues in the third quarter, but I don't think it continues late in the year and certainly not into next year.

Part of what we're doing is transitioning along our plan of a more optimized supply chain and we're moving more warehouses, for example, into our two main warehouses that we've established in Europe, and bringing that model along.

And as such, sometimes you have inventory adjustments that go with that, and part of it relates to looking in more countries into our global ERP system..

Thanks.

And then, with respect to the second half outlook on the gross and operating margin line, anything you can share with us in terms of your expectations for the cadence of gross and operating margins between the third and fourth quarter? I mean, the fourth quarter is typically one of your more profitable periods; it's a higher revenue seasonally.

But anything you can share with us in terms of the pacing of the margin improvement between third and fourth quarter?.

Yeah. I'm glad you asked that question, Brandon. From our visibility that we have right now, I think that we're looking for more of the improvement in the fourth quarter.

When you think about the instruments that we've placed in the second quarter, and generally it takes 60 to 90 days to complete installation and customer acceptance and really start to see that reagent revenue flow, which could make for some challenge to continue on the gross margin in the third quarter.

But we hope by the fourth quarter, that higher margin reagent revenue is starting to flow through the top line. So some improvement in Q3, but more of it in Q4..

Thanks. And then, maybe a question for Annette, if she is with us. Life Science's growth, I mean just exceptional even outside of ddPCR and chromatography. Outside of really cell biology and some of those newer growth areas, it looks like the legacy portfolio of relatively mature product lines is growing pretty nicely, high single, low double digits.

Can you sort of walk through what some of the biggest drivers are of that growth resurgence and some of the product franchises where you think you may be picking up some share, doing a little bit better than the underlying market?.

So, Annette is not with us, but I think you're absolutely right that even the classic lines, product lines seem to be pretty strong. And I think that part of that comes from strong regional performance around the entire world, and then various of those product lines seem to be doing pretty well..

Yeah. So, Brandon, one of the interesting ones for me to always look at is our more traditional thermal cycling, real-time PCR business. Even in the face of continued strong demand and growth for Digital PCR, our more traditional gene expression business is growing very, very well. And then, some of the western blotting and continuing in food.

So, as you point out, really, kind of hitting on all cylinders..

Helpful. And then, one last one for you, Christine, nice to see the working capital start to taper off a little bit here in the second quarter.

How should we think about that trending in the back half the year, I guess, in terms of inventories or AR on an absolute dollar basis from here?.

So I would hope that we would see continued improvement. Obviously, first and foremost, it starts with the operating profits of the company. And so, having the top line growth and margin expansion, as we expect, will help drive that. At the same time, we'll continue to whittle away on those improvements.

I don't know that'll be as dramatic as we've seen in the first half of the year, but I would hope that we will continue to grow the cash flow and reduce the working capital..

Very good. Thank you..

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

Hi. Thanks for taking the questions and congrats on this absolutely terrific quarter.

So, can you give us any update, and I apologize if there's a press release or some news flow that I missed, the latest update on the COO role?.

Yeah. There hasn't been a press release. We've continued to look. The idea is to find, obviously, the right person for the role and that's a continuing process..

Okay.

And then just in terms of large orders, is there any necessarily – or is there any large customer concentration on the new orders or was it just a number of large orders across the board in either Diagnostics or – I know you called out Diagnostics, but for orders, but also Life Sciences?.

I think just across the board, it's pretty broad in terms of the – where the orders are coming from. Obviously, the process chromatography was fairly strong in the quarter and that business tends to be concentrated in fewer larger customers. But otherwise, yeah, it's pretty broad..

And maybe, John, do you want to....

Okay. And then, Europe has been a little bit challenging in the past.

In terms of a European macro, is that improving, and then, any expectations in the back half of the year with ERP in Europe, any change in thinking kind of there, broadly?.

I think broadly on the Life Science side, it seems to be pretty solid. I think we continue to struggle as most people do on the diagnostics side. We've got a lot of, still a lot of kind of consolidation, control the health care costs.

So, I don't know, John, anything to add to that?.

I think it's maybe a combination of three things. Some of it for Europe this year was just timing of some larger orders with channel partners. So it's been a general softness we're seeing across the IVD industry. And we're working through the introduction of new processes for D3. All of those are contributing..

Great. Thanks. And then maybe just last one on the acquisition front. It's been a little while since you made a larger one. Is there any sort – type of maybe business that you're homing in on or anything close in terms of acquisitions here? Thank you..

So we continue to have opportunities both across Life Science and Diagnostics and we're continuing to pursue those things..

Thank you very much, and congrats on a great quarter..

Thanks, Dave.

Should we poll one more time?.

And our next question in queue comes from Dan Leonard with Deutsche Bank. Your line is now open..

Thank you. Just one clarification, want to make doubly sure. So, Christine, the new organic growth guidance of 4% to 4.5%, that assumes the 11% organic growth in the quarter, right. You're not using that normalized 6.5% organic growth number in the new guide..

No. I mean, it does assume what was reported on a currency neutral basis..

And the bridge from the 11% to the 6.5%, it looks like about 3 points of that bridge was the comp and the shift in the base. And then, there was another point that you said there were some small pull forward into Q2.

Is that about a point of growth?.

It was actually about 1 point of growth. And that relates to – in early July, we hooked in the rest of Western Europe into our global ERP system, and our practice has been always in the past, we offer our customers with standing orders, the opportunity to bring those forward in advance of our go-live.

And I think the small pull forward is in $5 million to $6 million range..

Okay. Thank you..

But that also then makes Q3 even tougher..

Of course. Thanks..

And I'm showing no further questions in queue at this time..

Okay, great. Well, everyone thank you so much for your time today. As always, we appreciate your continued interest in Bio-Rad, and we look forward to the next time we speak. Bye-bye..

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