Good day, ladies and gentlemen, and welcome to Bio-Rad Laboratories' Second Quarter 2019 Earnings Conference Call. [Operator Instructions]. As a reminder, this conference is being recorded. I would now like to turn the conference over to Ron Hutton, Treasurer and Vice President. You may begin..

Thank you, Tiphanie. Good afternoon, and thank you, all for joining us today. Today, we will review the second quarter financial results for 2019.

With me today are Norman Schwartz, our CEO; Ilan Daskal, Executive Vice President and Chief Financial Officer, Andy Last, Executive Vice President and Chief Operating Officer, Annette Tumolo, President of the Life Science Group; and John Hertia, President of the Clinical Diagnostics Group.

Before we begin our review, I would like to caution everyone that we will be making forward-looking statements about management's goals, plans and expectations, our future financial performance and other matters.

Because our actual results may differ materially from these plans and expectations, you should not place undue reliance on these forward-looking statements, and I encourage you to review our filings with the SEC, where we discuss in detail the risk factors in our business.

The company does not intend to update any forward-looking statements made during the call today. 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 reconciliations of these non-GAAP measures to the comparable GAAP results contained in our earnings release. I'd now like to turn the call over to Ilan..

Thank you, Ron. Good afternoon, and thank you, all for joining us. We will review the results on a GAAP basis as well as commentary on a non-GAAP basis. Net sales for the second quarter of 2019 were $572.6 million, which is a 0.6% decline on a reported basis versus $575.9 million in Q2 of 2018. On a currency-neutral basis, sales increased 2.7%.

During the quarter, we experienced good demand across many of our key product areas and growth in all three regions. When comparing to the second quarter of last year, remember that Q2 of 2018 included about $6 million of sales that customers pulled in from Q3.

Q2 of 2018 also included about $4 million higher sales associated with a discontinued RainDance Myriad account, and we expected to be immaterial as of Q3.

If we exclude the Myriad's reduction of sales and the sales that customers pulled in last year from Q3 to Q2, we estimate that the year-over-year currency-neutral sales growth for Q2 of 2019 was about 4.6%.

Sales of the Life Science group in the second quarter of 2019 were $212.4 million compared to $217.8 million in Q2 of 2018, which is a decline of 2.5% on a reported basis and about flat on a currency-neutral basis. Process media, which can fluctuate on a quarterly basis, was slow in the second quarter after a very strong sales in Q1 of 2019.

All other product areas within Life Science had a solid year-over-year growth and of note, at double-digit growth in Droplet Digital PCR antibody business and in Food Safety. Our Droplet Digital PCR growth continues to have good momentum due to its high-sensitivity precision and thousands of optimized assays.

To date, it is cited in several thousand of peer-reviewed publications. Excluding process media sales, the Life Science business grew about 7.5% year-over-year on a currency-neutral basis, driven by continued BioPharma demand.

On a geographic basis, Life Science currency-neutral sales, excluding process media, were strong across all 3 regions and most notably, in the Americas.

Sales of Clinical Diagnostics products in the quarter were $357.1 million compared to $354 million in Q2 of 2018, which is a 0.9% growth on a reported basis and a 4.8% growth on a currency-neutral basis. During the second quarter, we posted solid growth of diabetes and quality-control products.

Immunology also had strong quarter, which has driven by -- sorry, which was driven by a reagent pull-through, that's very high one. We also received this quarter, an FDA approval for our BioPlex Lyme disease panel, which had been much anticipated by our customers.

On a geographic basis, the Diagnostics group posted a year-over-year currency-neutral sales growth across all 3 regions. The reported margin for the second quarter of 2019 was 53.7% on a GAAP basis and compares to 52.4% in Q2 of 2018. If you recall, in Q2 of 2018, we experienced product mix headwind and atypical inventory-related expenses.

Much of the year-over-year margin increase is driven by improvement in these 2 areas. Amortization related to prior acquisitions recorded in cost of goods sold was $3.8 million compared to $4.7 million in Q2 of 2018. SG&A expenses for Q2 of 2019 were $201.3 million or 35.1% of sales compared to 36.5% in Q2 of 2018.

Total amortization related to acquisitions recorded in SG&A for the quarter was $1.6 million versus $2.1 million in Q2 of 2018. Reducing the SG&A spend remains a focus area to achieve our 2020 goals. Research and development expense in Q2 was $50.1 million or 8.8% of sales compared to $47.5 million or 8.2% in Q2 of 2018.

Looking below the operating line, the change in fair market value of the equity securities holdings added $716.4 million of income to the reported results and is substantially related to the holdings of the shares of Sartorius AG.

Also during the quarter, interest and other income resulted in net other expense of $3.2 million compared to $9.9 million income last year. The year-over-year decrease primarily reflects the Sartorius dividend that was declared this year in Q1 versus Q2 last year. The effective tax rate used in Q2 of 2019 was 22.2% and compares to 21.2% in Q2 of 2018.

These rates are primarily driven by the sizable gain related to our Sartorius investment and in Q2 of 2019 also included tax reform-related benefits. Reported net income for the second quarter was $598.8 million and diluted earnings per share for the quarter were $19.86.

The increase in net income and earnings per share versus last year is substantially related to the valuation of the Sartorius holding. Moving down to the non-GAAP results. Looking at our results on a non-GAAP basis, we have excluded certain atypical and unique items that impacted both the growth and operating margins as well as other income.

These items are detailed in the reconciliation table in the press release. Looking at the non-GAAP results for the second quarter, in cost of goods sold, we have excluded $3.8 million of amortization of purchased intangibles and small restructuring adjustment.

The exclusions moved the gross margin for the second quarter of 2019 to a non-GAAP gross margin of 54.4% versus 53.4% in Q2 of 2018. If you recall, Q2 of 2018 included a headwind from product mix and atypical inventory-related expenses and again, much of the year-over-year margin increase is driven by improvements in these 2 areas.

The non-GAAP SG&A in the second quarter of 2019 was 33.9%, an improvement of more than a point versus the 35.1% in Q2 of 2018. In SG&A, on a non-GAAP basis, we have excluded amortization of purchased intangibles of $1.6 million, legal-related expenses of $5.4 million and small amounts for restructuring cost and acquisition-related benefit.

In R&D, we have excluded a small amount of restructuring benefit. The non-GAAP R&D in Q2 was 8.8%, which is in line with our expectations. The cumulative sum of these non-GAAP adjustments results in moving the quarterly operating margin from 9.8% on a GAAP basis to 11.7% on a non-GAAP basis.

This non-GAAP operating margin compares to a non-GAAP operating margin in Q2 of 2018 of 10%. We have also excluded certain items below the operating line, which are the increase in value of the Sartorius equity holding of $716.4 million as well as a small loss associated with venture investment.

The non-GAAP effective tax rate for the quarter was 26.4%, which was primarily driven by the geographic mix in the second quarter earnings. We continue to estimate the annual tax rate on a non-GAAP basis to be in the 27% to 28% range.

And finally, non-GAAP net income and diluted earnings per share for the second quarter of 2019 were $47.4 million and $1.57 per share compared to $49.5 million and $1.64 per share in Q2 of 2018. Moving on to the balance sheet.

In the first quarter of 2019, we adopted a new accounting standard related to leases, which requires us to recognize most leases as assets and liabilities on the balance sheet.

The right-of-use assets balance in the second quarter was $215.5 million and the associated liabilities included in other current liabilities and in other long-term liabilities. These balances primarily represent our operating lease obligations for facilities and auto leases. The adoption of this standard has a minimal effect on the income statement.

The total cash and short-term investment at the end of Q2 were $987 million compared to $850 million at the end of 2018 and $865 million at the end of the first quarter. During the second quarter, we purchased 51,398 shares of our stock for $15 million at an average share price of $291.85.

For the second quarter of 2019, net cash generated from operations was about $155 million, which compares to about $78 million in Q2 of 2018. This improvement mainly reflects the higher operating profits, improved capital -- working capital, the payment of the Sartorius dividend that was declared in Q1 as well as a tax refund.

The adjusted EBITDA for the second quarter of 2019 was $95.1 million or 16.6% of sales. The adjusted EBITDA in the first 6 months of 2019 was $196.7 million or about 17.5% compared to $180.3 million or 16% in the first 6 months of 2018. Net capital expenditures for the second quarter of 2019 were $22.2 million or 3.9% of sales.

The full year expectation for CapEx spend is at the low end of the forecasted range of $110 million to $120 million. Depreciation and amortization for the second quarter was $33 million.

And lastly, I would like to mention that we are pleased with the Federal Court's recent ruling, upholding the decision against 10X Genomics and the $23.9 million award and injunction related to our Droplet Digital PCR intellectual property. Moving on to the guidance. We are pleased with the overall performance in the first half of the year.

And we continue to maintain the annual guidance range. We expect a full year-over-year currency-neutral sales growth of 4% to 4.5%. We continue to target a non-GAAP gross margin in the 55.5% to 56% range for the year, and non-GAAP operating margin range of 12.5% to 13%. And with that, we will open the line to take your questions.

Tiphanie?.

[Operator Instructions]. And our first question comes from Patrick Donnelly with Goldman Sachs..

Maybe one for you Ilan, your margins came in ahead of our expectations again this quarter. You're clearly gaining some momentum with the internal initiatives there. Can you just give us an update on what you're seeing to date? Obviously, you've been on the seat for a little while now.

And then expectations going forward as we think ahead even to the 2020 target.

What are the key leverage or initiatives you have yet to kind of capitalize on that help you get towards that target?.

Yes, sure. Good question. So being here for a few months. Obviously, Norman, myself and also Andy, we looked at the initiatives that are ongoing to achieve the 2020 target model. And we are also looking at additional initiatives in order to achieve the 2020 margin. For the most part, we are focused on the SG&A-related items.

And to a lesser extent but also an incremental extension of the gross margin but again, the main focus is on the SG&A line..

Okay. And then maybe just on the growth side, flat organic and Life Science was actually pretty encouraging given the comp there. Can you just talk through what specific areas you're seeing strength? And then maybe specifically on the DD PCR, that seems to be continuing to gain momentum.

Can you just help frame that opportunity for us? And what type of sales are you seeing to date, if you're willing to break that out? Just trying to get a better hand on how significant of a growth driver that can be for you guys going forward?.

This is Annette. Yes, well, we're seeing good growth across all of our core product lines, and that's really encouraging to us. But in particular, genomics lines and Digital PCR is really leading the way there.

We are getting really good traction in the BioPharma segment for sure, and we're moving -- we have a lot of our customers adopting and validating our platform for lab-developed tests, so we're moving into the clinics along with some of our cleared products. And we're just starting. So we really see the traction in those segments.

And we are very optimistic moving forward..

Okay. Maybe just one last one, Ilan. I know you briefly touched on the litigation side. Can you just maybe parse that a little bit on the update? We saw last week obviously talking about 15% royalty, some sort of injunction.

Maybe just give us your thoughts on what you expect to kind of be finalized on that front? Maybe timing, once we'll have kind of -- again a conclusive, definitive outcome there..

This is Annette again. I'll take that. We generally don't like to talk a lot about ongoing matters in litigation but there is -- there's been some public announcements there. The Delaware court recently confirmed the jury verdict that the 10X's products infringed the patents that we asserted and awarded us damages.

At the judge follows that with a ruling issuing an injunction. The way it works though is the court has to finalize that order and that's what's happening now. And we imagine, in the next days to weeks, we'll get the final issuance from the court on what exactly the details of that injunction are..

And our next question comes from Mitch Petersen with Barclays..

Maybe first off, just on Droplet Digital, I was hoping, you could update us on the timing of the new products that you're developing there?.

Sure. We are launching our next-generation integrated system with 4 colors probably in the fourth quarter of 2019..

Got it. That's helpful.

Maybe similarly, just on that business within Droplet Digital, could you comment on how big your business is in single cell today? And then relatedly just on, I mean you called a double-digit growth for Droplet Digital as a whole, just as a clarification, does that include the headwind from RainDance in the quarter?.

Yes, definitely. It does include the headwind from RainDance. And usually, what we disclose is kind of the double-digit growth as we mentioned..

Got it. And then lastly for me. I noticed that you didn't call out Blood Typing in the script.

Could you just comment on how that business trended in the quarter?.

This is John Hertia, I'll take that. Our Blood Typing business did grow year-over-year. It just wasn't at highlight level. But we continue to see strong placements of both the IH-1000 and IH-500 around the world and strong reagent pull-through..

And our next question comes from Dan Leonard with Deutsche Bank..

Can you please elaborate on market conditions in China across both your business? That seems to be a point where we've seen softness from a number of peers in the quarter..

This is Andy. I'll take that and others can certainly add. Generally, we've pleased with our China performance. We're not experiencing any material impact the way that some others may have reported. And subject to any major geopolitical shifts that may occur, we continue to see China as a positive for us across the portfolio..

Okay. And a couple of product-specific questions in Diagnostics for John.

John, can you update us on the autoimmune Diagnostics test environment in the U.S., specifically in the competitive environment? And then secondly, can you help us frame how you're thinking about this Lyme test opportunity? It seems like there's more in the news about that lately..

Okay. Let's take autoimmune first. It's kind of a fragmented market. We have the only fully automated, integrated multiplex system for autoimmune testing. We're seeing an evolution of manual IFA slide testing through automated systems. And that's the heart of our BioPlex business, which is doing quite well year-over-year..

And then on Lyme?.

On Lyme, we just introduced -- we just got FDA approval for the Lyme test. It's a large and growing market. There's a lot of dissatisfaction in Lyme right now. There's multiple court cases going around the world because of the lack of sensitivity and specificity in the market. It's a hard disease to diagnose and it takes a long time.

We have a very novel assay design that gives us better sensitivity and better specificity than anything else on the market. And it's a fully automated solution..

[Operator Instructions]. Our next question comes from Brandon Couillard with Jefferies..

Annette, maybe starting with you. Could just give us an update on where you stand with your cell analysis portfolio? Going back a year or 2, you're kind of cobbled together your imaging sales order and the flow cytometer.

Just update us on where uptick is with that platform? And then would you still expect process media to be a headwind to Life Sciences in the back half as well?.

Okay. So we are seeing really strong uptick in the BioPharma segment of our Cell Biology products, in particular, our ZE5 flow cytometer, flow analyzer. So we continue to invest. We think it is a perfect time to develop new tools for our customers in this era of Cell Biology. So we're optimistic about the future of the products we have.

And we're looking to expand our market share in that area. With regard to process chromatography, we think the second half of the year, we're going to see incremental and year-over-year growth. And we think that will end the year with growth over 2018. We've said this before, quarter-to-quarter, it can be little bit lumpy.

So it's hard to compare quarter-over-quarter results sometimes..

And Brandon, I'll add to that for process chrom. I mean, in the first half, it was about flat relative to last year. And we do anticipate most of the incremental revenue to come in, in the second half, as Annette mentioned..

One more on Droplet Digital, Annette. There's been some newer entrants in the Digital PCR space coming and with company platforms.

Could you sort of speak to the advantages and disadvantages of your Droplet system versus other digital platforms?.

Well, I can say that our platform and our optimized assays, which we have thousands of, have already enabled a lot of breakthrough research.

And given clinicians, new options in liquid biopsy and Precision Medicine, and we've got thousands, as Ilan mentioned, of peer-reviewed publications that support the scientific utility of the Droplet system and clinical utility of the Droplet platform that we developed.

So I think that our focus moving forward is to make sure that we're developing new platforms in that area that will both expand the applications and the relevance to new market segments for Digital PCR and build on the already-compelling value proposition that we have.

Droplets are a really good test tube for this assay and they are very, very scalable. And given our success in this market that we created, it doesn't surprise us that people want to join in with us, but we think that we're in a position to just continue to build on the really strong lead that we have..

Maybe one for you Ilan. Cash continues to build on the balance sheet. Appreciate that you did $15 million of buybacks in the second quarter. But that's a tiny fraction really of what you generated just in the second quarter in terms of cash flow.

Just curious like why that's not a bigger priority for you given the operating cash flow improvement and where the underlying valuation of the stock is here when you strip out the Sartorius valuation, just curious what you're thinking there?.

Yes. Great question. Generally, we continue to be opportunistic in terms of the buyback. The Board authorized us $250 million plan, we did about $65 million so far. And we plan to continue to be opportunistic and the way we think about it is, how do we kind of bundle it as part of the overall capital allocation model.

And specifically, we admire inorganic kind of opportunities that we keep looking into..

Last one for Norman. Just -- an update from your end in terms of how the M&A pipeline is shaping up right now? Again, balance sheet is most over-capitalized, has been in quite some time.

Are you any closer today to perhaps finding a bolt-on deal or not?.

Yes. Yes, I think we've certainly got some possibilities out there and are encouraged by what we're seeing and the progress we're making on a couple of fronts. So hopefully, we can put more of that capital use in the near term..

And I am currently showing no questions in queue. This concludes our Q&A session. I'd like to turn the call back over to Ilan Daskal for closing or further remarks..

Thank you, everyone, for joining us today. And we'll connect again in the next quarter's call..

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