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Bio-Rad Laboratories (NYSE:BIO)

Q2 2013 Earnings Call

August 06, 2013 5:00 pm ET

Executives

Christine A. Tsingos - Chief Financial Officer and Executive Vice President

Bradford J. Crutchfield - Executive Vice President and President of the Life Science Group

Norman D. Schwartz - Chairman, Chief Executive Officer and President

Analysts

S. Brandon Couillard - Jefferies LLC, Research Division

Daniel L. Leonard - Leerink Swann LLC, Research Division

Brian Turner

Operator

Good day, ladies and gentlemen, and welcome to the Q2 2013 Bio-Rad Laboratories, Inc. Earnings Conference Call. My name is Allison, and I'll be your operator today. [Operator Instructions] As a reminder, this call is being recorded for replay purposes.

I'd now like to turn the call over to Ms. Christine Tsingos, Executive Vice President and Chief Financial Officer. Please proceed, ma'am.

Christine A. Tsingos

Thanks, Allison. Good afternoon, everyone, and thank you for joining us. Before we begin the call, I'd like to caution you that we will be making forward-looking statements about management's goals, plans and expectations. Because our actual results may differ materially from these plans and expectations, 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.

Today, we are pleased to report quarterly net sales of $525.3 million, an increase of just under 3% on a reported basis versus the same period last year's sales of $510.4 million. On a currency neutral basis, year-over-year sales grew 4%.

During the quarter, we had good growth across many of our key diagnostic and life science markets, including $6.2 million of sales contributed by our new antibody business. Excluding currency and the addition of AbD Serotec, organic sales growth for the quarter was 2.8%.

Overall, the quarterly top line growth was impacted by continued challenges in certain areas of Europe, especially for our diagnostic products, as well as cautionary funding flows in the academic and government research market.

The reported gross margin for the second quarter was better than expected at 57.1% and is reflective of a favorable product mix, as well as increased manufacturing efficiencies, and despite an incremental $2.4 million of amortization expense related to the recent Serotec and cell sorting technology acquisitions.

For the quarter, the total non-cash purchase accounting expense recorded in cost of goods sold related to acquisitions was $8.5 million, which compares to $6.7 million in the second quarter of last year.

SG&A expenses for the quarter were $195.3 million or 37.2% of sales, which compares to 31.8% in the year ago period. Remember that in the second quarter of last year, SG&A included 2 significant one-time items that had the effect of lowering the reported expense by more than $13 million. These 2 unique items were the reduction in the value of the QuantaLife earn-out and the reversal of approximately $5 million of bad debt reserves.

In addition to these tough-to-compare items, SG&A expense related to our global SAP project increased significantly versus last year, as we are now expensing the internal and external labor costs related to the project, which in the past have been capitalized. Also recorded in our SG&A is $2.2 million for the amortization of intangibles related to acquisitions.

Research and development expense in Q2 was 10.1% of sales or $53.2 million compared to $52.3 million last year. The year-over-year increase in R&D spend is primarily related to our investment in several new technologies and instruments for the clinical diagnostics market. Going forward, we expect R&D spend to continue to be around 10% of sales.

The operating margin for the second quarter was just shy of 10%, which compares to 11.8% in the year ago period when excluding the $13 million of one-time benefits associated with the QuantaLife earn-out and the reversal of the bad debt reserves I just mentioned.

During the quarter, interest and other income was a net expense of $3.9 million compared to $7.3 million of expense in Q2 of last year. This decrease in expense versus last year is largely related to lower interest in foreign exchange costs, as well as additional dividend income typically associated with our second quarter.

The effective tax rate used during the second quarter was in line with our expected range at 27.2%. Excluding any discrete items that may occur, we anticipate the full year tax rate to be in the 26% to 28% range.

Net income attributable to Bio-Rad for the second quarter was $34.7 million, and diluted earnings per share for the quarter were $1.20. This compares to $1.26 per share in Q2 of last year when excluding the one-time benefits to operating expense.

Life Science reported sales for the second quarter were $170.4 million, an increase of 4.9% when compared to $162.4 million last year. On a currency neutral basis, sales grew 6.2%. As I mentioned earlier, sales of our new antibody products were $6.2 million for the quarter. Excluding Serotec and currency effects, the Life Science organic top line growth was 2.4%. These quarterly results reflect growth in process media and Digital PCR products, as well as good initial acceptance for our new cell sorter and next-generation chromatography instrument.

Sales growth during the quarter was partially offset by weakness in some of our more traditional academic research lines. On a geographic basis, European sales have begun to grow, while sales in the U.S. market continued to be moderate and Asian markets have slowed somewhat versus prior periods.

Looking to the remainder of the year, we remain somewhat cautious about global funding for our research products, but are also encouraged by the strong pipeline for our new cell sorting and chromatography products, as well as continued demand for Droplet Digital PCR products.

Segment profit for our Life Science group remains challenged as they continue to absorb new businesses and technology license requirements.

Our Clinical Diagnostics segment posted another solid quarter with sales of $351.5 million compared to $344 million last year, an increase of 2.2%. However, on a currency neutral basis, year-over-year sales for the Diagnostic group grew 3.2%. This growth was led by good performance across many product lines, most notably our diabetes monitoring and quality control products.

Sales to China and the Asia Pacific margin -- markets were especially strong for diagnostics during the quarter, partially offset by a decline in Europe. Diagnostic margins for the quarter increased both sequentially and versus last year, primarily reflective of the product mix shifting to higher-margin reagents and consumables.

Moving to the balance sheet. As of June 30, total cash and short-term investments were $834 million. Cash from operations for the quarter was significantly lower than expected at $18.7 million and down from last year as a result of higher cash paid to employees and suppliers, including the recent change in expensing ERP-related personnel costs; a slowdown in collections related to our transition to SAP; and a $12 million payment to settle a royalty dispute.

Also, keep in mind that the second quarter of 2012 included the unusual one-time payment of receivables from the Government of Spain totaling approximately $20 million, which also makes for a tough year-over-year comparison.

Despite the reduction in cash flow, EBITDA for the quarter was good at $95 million or 18% of sales.

Net capital expenditures for the quarter were $23.4 million, which is a decrease both sequentially and year-over-year. This decrease relates largely to a shift of ERP-related costs from capital to expense. As you may know, in early April, we went live with the first appointment of the project. We are now in a support mode, which requires a different accounting treatment of the personnel costs. In the fall time frame, we will begin designing the second SAP deployment, at which time these labor costs will start to be capitalized again.

Given the timing of the ERP-related spend, our full year expectation for CapEx is now revised to be in the $120 million to $130 million range. This compares to our previous expectation of $140 million to $150 million.

And finally, depreciation and amortization for the quarter increased to $34.9 million as we begin to depreciate our first deployment of the new SAP system.

As we look to the full year for 2013, we remain cautiously optimistic of achieving the currency neutral sales growth guidance of 3% to 3.5% for the base business we've provided last February, as well as our expectation of a 3.5% to 4% top line growth when including the Serotec sales.

For the first 6 months of 2013, our currency neutral sales growth is 3.8%. However, we will also remind you that a continued strengthening in the U.S. dollar could lead to much lower growth rates on a reported basis. In addition, any further deterioration in Europe or funding in the government and academic markets could make our goals difficult to achieve.

On the last earnings call, we revised our operating margin expectation for the full year to be around 10%. Given the year-to-date margin of 8.3%, combined with the changes in how we currently account for the ERP project and our intentional investments in our higher growth emerging markets, the full year operating margin could be in the 8% to 10% range. While this lower margin in the short-term may be disappointing, our focus remains on the long-term health and profitability of the company and benefits that new systems and increased focus in high-growth regions will bring in the years to come.

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

Question-and-Answer Session

Operator

[Operator Instructions] And your first question comes from Brandon Couillard of Jefferies.

S. Brandon Couillard - Jefferies LLC, Research Division

Christine, just back on your operating margin, the commentary there, I mean, what aspect of the ERP timing or expenses were not, I guess, anticipated in your prior outlook? And can you give us an update on just the aggregate dollar amount of ERP-related expenses in the P&L both in the second quarter and for the full year now?

Christine A. Tsingos

Sure. So in terms of pure cash out the door, Brandon, I don't know that things have changed in terms of our expectation. Basically, in the accounting world, while we're in the implementation phases of the project, both the designing and the actual implementation, the internal and external labor costs are capitalized. Right now where we are, we've gone live with our first deployment, which you remember was kind of a small segment of the U.S., our "keep it close to home" proof of concept kind of project, and we're in the process of supporting that. And then in the fall, we'll begin the designing and implementation of the next appointment, which will be a much larger deployment. And at that time, then the internal and external personnel costs will be capitalized per the accounting rules. So I think when we originally set the budget, while -- as I said, cash out the door probably doesn't change that much, we didn't anticipate that we would have this little break in between the first deployment and the second deployment where we would need to temporarily change our accounting treatment.

S. Brandon Couillard - Jefferies LLC, Research Division

Okay. Can you give us any numbers around that? I mean, I think you talked about incremental ERP expenses being some $15 million to $20 million in the P&L this year, any update on that figure?

Christine A. Tsingos

Yes. So probably, this change in accounting treatment to the P&L over these months where we're in between phases will be somewhere $5 million to $10 million range between what was booked in the second quarter and what we'll book in a good part of the third quarter. Again, we're looking to restart the next blueprint phase in the fall. So -- and it's flat from CapEx.

S. Brandon Couillard - Jefferies LLC, Research Division

Okay. If John or Brad are there, I would just be curious if they can elaborate on what they're seeing in the government and academic market, particularly the split between the U.S. and Europe.

Bradford J. Crutchfield

This is Brad. I'll take that. For Life Sciences, we definitely saw in the second quarter with the extramural NIH-funded accounts, basically our academic market, came back online. They were basically dormant in the first quarter. The government accounts continue to be off significantly and basically any of the intramural research or actual government labs, CDC and the like. So we certainly saw that. In Europe, it's pretty much status quo. There's overall austerity across most of the regions in Europe. And we had a fairly nice second quarter. But a lot of that was timing from shipments that really didn't make it into the first quarter. So it really is sort of status quo.

S. Brandon Couillard - Jefferies LLC, Research Division

And then, Christine, would you care to quantify the impact on the operating line from the QuantaLife and AbD Serotec deals? And if not QuantaLife, maybe just the AbD impact on OP?

Christine A. Tsingos

So both of them, obviously, are a drag to operating profit. And probably combined between the two of them -- Brandon, it's probably $5 million or $7 million. But let me see if I can get that more. But you remember at the beginning of the year, we talked about that Serotec would be $7 million to $10 million drag on operating expense and we still expected QuantaLife to be $15 million, $20 million plus, depending on our level of investment there. And I don't think anything has changed.

S. Brandon Couillard - Jefferies LLC, Research Division

And then just lastly, any decision on whether or not you'll decide to call the 8.5% coupon debt in September?

Christine A. Tsingos

Well, a good question. Obviously, it's something that we're thinking about, and they do become callable in September. I don't know that we'll be calling them on that exact date. But given that it's 8% money and we took on that debt at a time when we weren't investment grade, we will be very seriously taking a look at this and we'll likely do something after the call date.

Operator

And your next question comes from Dan Leonard of Leerink Swann.

Daniel L. Leonard - Leerink Swann LLC, Research Division

Can you give us an update on your ERP implementation now that you've got some road on your tires from the first deployment?

Christine A. Tsingos

Sure. So as I said, the first deployment was a smaller segment of our U.S. sales, probably represents 10% to 15% of the total company revenue. And I think for the most part, it's gone pretty well, especially when I hear some of the horror stories from other companies. We have a lot of people involved with it, a lot of process changed. But at the same time, we continue, didn't seem to miss a beat in terms of shipping product to our customers. Where we are now and part of this support mode that I'm talking about is really just adopting to all of the new processes and becoming efficient with those processes. And so, as I mentioned, cash from operations is lower than we've been running because receivables were up a little, our folks were focused on working on those new processes. But that's just a matter of timing. And with each month since we've gone live, we've seen that efficiency get better and better. So I think on the whole, we're feeling pretty positive about this. The lesson learned is it's hard. It is a lot of change, and part of our understanding of that is we've made the decision now for the next deployment to really focus on finishing the rest of the United States. Originally, we were thinking the second deployment, we could take our show on the road to Europe because Europe is where the greatest benefit return resides. But I think we also see benefit in staying in the U.S., and that's the deployment we'll start working on in the fall.

Daniel L. Leonard - Leerink Swann LLC, Research Division

Okay, that's helpful. And, Christine, to follow up on the cash flow portion of that, how do we think about your cash flow trending through the balance of the year? Obviously, cash flow from operations was lower than we thought in Q2. Does that reverse as you get some of these receivables under control? Or should that stay at depressed levels through the balance of the year?

Christine A. Tsingos

Well, so good question, Dan. And the receivables is only a small part of it. I mean -- and if you look historically, our cash flow is pretty backend loaded. If you look at our historical results, because there's a lot of cash obligations at the beginning of the year and then, of course, last year we had that windfall from Spain. But so I think seeing improvement from here would be within our historical pattern. And again, I think the receivable growth is more transition and timing in nature and not indicative of some sort of change. And then, obviously, in the second half of the year, we're starting in the fall time frame when we are back into the designing and implementing of the second deployment of SAP, all of these internal and external personnel-related costs will be capitalized, which will affect the investing cash flow, but not the operational cash flow. And so that, obviously, will help as well.

Daniel L. Leonard - Leerink Swann LLC, Research Division

Got it. And then my final question is a 2-part, one for Brad. Brad, could you help me understand how you're looking at the Asian market for Life Science tools in the back half of the year? I think there was some commentary that it had slowed down a bit. And then secondly, the new Digital PCR product, what are the differences versus the initial version?

Bradford J. Crutchfield

Okay. Yes, I think if you look at the Asian market, Japan is off. I mean, most of us have seen that. And it's kind of in a shift in the way that they fund their research. We expect that to come back a little bit in the second half of the year. We also expect our business in China to build in the second half of the year, as it always does. A lot of the tenders and government contracts seem to come due in the last quarter. So overall, in general, Asia will continue to build in the last 2 quarters. As far as the Digital PCR, we have invested very heavily in taking the original product, which is the QX100 and transforming it into a new-generation, the QX200. The principal change there is that we drastically expand the type of chemistries that can be used in Digital PCR and allow customers to adopt a lot of different workflows to it, using some of the intercalating dye instead of some of the other specific TaqMan probes. So overall, that's the biggest change. And again, it gives us a lot more flexibility. We moved one of the sort of the challenges that we had or one of the objections that customers had when we brought this product on-market in its original form.

Operator

Your next question comes from Brian Turner of Levin Capital Strategies.

Brian Turner

Question on the operating margin. Essentially, on the last quarter, we were talking 10%, 11%, and we're a little bit under that now. You said, when discussing that operating margin, that going forward, you're going to be able to move to a margin that's back up to mid-teens, if not something better. So the question is, have we troughed for sure? And when -- if you could just provide a sort of a map to when we should start to see the improvement in the margin, that would be terrific. And then, the second question is, could you just give us a little bit more color on Europe? I know that you sort of opened up the call with it being a little bit challenged. But at the end of the call, you sort of -- in your prepared remarks, you said that it was getting better. So if you could just give us a little bit more color what you're seeing, et cetera, that would be very helpful.

Christine A. Tsingos

Okay. So, Brian, on the operating margin, you're correct that at the beginning of the year, we talked about an 11% to 11.5% target on the margin. And given the margin on a reported basis, and all of this is good old GAAP reported margins, given where we were in the first quarter, we brought that down to be around 10%. And what changed a little bit since that and now we're saying, well, maybe 8% to 10% for the year is taking this time to do the support phase of ERP brings operating costs to the P&L that originally were assumed to be capitalized. And on top of that, we continue to be cautious in watching the top line. You know that our margin is impacted pretty significantly by whatever goes on, on the top line. So I think our caution for the remainder of the year, given that we're halfway through the year and we're still in single digits in terms of a GAAP reported operating margin and we know that we have a few more months of ERP as an operating expense rather than a capital expense, and our caution with what -- watching the top line has led us to have a range of thinking 8% to 10% for this year in terms of a full year GAAP operating margin. Now having said that, a lot of this is being driven by the fact that we continue to be in investment mode here at Bio-Rad. And systems is one investment, that's clearly a sizable investment. We're also investing in building our presence in some of these higher growth emerging markets where we're putting up pretty solid double-digit top line growth. But again, it's an operating expense that we're absorbing today for a benefit in the future. Our longer-term goal, when we get ERP behind us, of getting our operating margin back to that mid-teen, we were at about 14.8% before we turned on the investment spigot, that hasn't changed. And our goal to get back to that level we were, if not higher, the mid-teens to the higher teens is still there and still achievable. And, of course, it's just a matter of timing and a matter of getting through the ERP, which continues to be a multiple year project. And a good portion of the return, as I said earlier, sits in Europe. And we -- it will be a few more years before we do the European deployment, which stretches out the timing of getting to that mid- to high teens level. But the proposition and the underlying assumptions of what can be achieved has not changed.

Brian Turner

And a commentary on Europe?

Norman D. Schwartz

Yes, Europe. This is Norman. I think it's pretty much the same as it has been in the last few quarters. I think that it's kind of tough sledding in Europe. You've got laboratory consolidations going on in some regions on the diagnostics side. And on the life science side, as Brad said, budget constraints. That all applies to Western Europe. Eastern Europe seems to be going better, still some pretty good growth out of there, good expansion in those markets. So that's basically the picture that we have in Europe.

Brian Turner

Okay. And just one last question, as it relates to your holding in Sartorius, is there anything -- has the position stayed the same? Is there any update you can tell us about your investment there? That would be helpful.

Norman D. Schwartz

It stayed about the same. I'm sure we've maybe acquired a few shares over time. But it remains relatively the same.

Operator

Your next question comes from David Cowen [ph] of Sinca [ph].

Unknown Analyst

Regarding Sartorius, I wonder if you could actually give us the amount of shares and the preferreds you earned. Also, if you could tell us what the tax basis are of the shares, and then also just any plans on the shares and business relationship between Bio-Rad and Sartorius?

Norman D. Schwartz

No, we're not prepared to comment at this time on that.

Operator

Our next question comes from Sam Siegel [ph] of Senator Investment Group.

Unknown Analyst

Christine, in terms of the margin guidance, I recognize you don't give quarterly guidance. But could you at least give us a feel for how to think about the balance of the year? Because if you're a little bit above 8% year-to-date on a reported basis, seasonally, you would expect a stronger fourth quarter margin number. Does that suggest that, I guess, given some of the accounting changes and timing that Q3 margin is -- will be a bit below Q2? So just some insight there, and if not numerical, at least qualitatively, if you can give us some direction. And just in terms of this refinancing, given the size of your cash balance, why not just pay down the debt outright? Because you have substantial dry powder, and I think, we're all supportive of that. But to pay any money in the form of interest expense to preserve that, given that you're sitting on, even net of paying it down, almost $0.5 billion of cash doesn't seem necessary. So maybe just a little bit of your philosophy on whether it's a refi or if it's paydown.

Christine A. Tsingos

Okay, Sam, good questions. In terms of the trajectory in the operating margin for the remainder of the year, you're right. We don't really give specific quarterly guidance. Again, our historical pattern is we do have a more attractive margin generally in our fourth quarter. And I fully anticipate by the fourth quarter, we will be back into full implementation on the ERP side, which should relieve that cost burden that we're bearing right now of the internal and external labor on the projects. So that ought to help the margin. Q3 is always a little more difficult margin quarter for us because of seasonality in Europe and things like that. But other than that, that's the most clarification I can give you in terms of this 8% to 10% range. Obviously, we'd like to be at the higher end, not the lower end of that range. Regarding the debt and the refinancing, I think you're right, and the things that we're looking at now are options. We recognize that we have a fair amount of cash on the balance sheet. For sure, we don't want to carry 8% money, especially in this interest rate environment and our credit quality. And the decision-making process that we're going to be going through now is looking at our options of taking the debt out or refinancing it all or part or, frankly, even more. And the balance that we're going to strike is looking at the investment opportunities that we see on the horizon, especially on the acquisition front, and balance that with the ability to lock in some relatively attractive long-term money. So we -- those are the -- you hit it on the head. I mean, I think we can argue it both ways, but we're going to sharpen our pencils and work through this and make some decisions here over the next couple of months.

Unknown Analyst

Christine, just to follow up on that, is your cash -- what's usable, what's not usable? I know a lot of companies have issues with trapped cash, and obviously, you want to have substantial working capital-type cash. But I mean, if you give us a sense of how much of the cash and the short-term investments is actually accessible, how much is trapped internationally, and what's the comfortable level just to have from a safety perspective.

Christine A. Tsingos

So the majority of our cash is actually here in the U.S. and very usable, as you say, but even our cash that's offshore, again as I mentioned, we are investing in many of these high-growth markets, and so finding use for the cash there in terms of investing for the future. So -- but 75% plus of our cash is held here in the U.S., and even of the 25% that's outside of the U.S., a lot of it is used for operating activities or acquisitions. We -- the Serotec acquisition, for example, that we acquired at the beginning of this year, we were able to use our foreign cash.

Operator

[Operator Instructions] We have no further questions at this time, so I'd now like to turn the call back over to Christine Tsingos for closing remarks.

Christine A. Tsingos

Okay. Thanks, Allison. Thank you, everyone, for taking the time to join us today for the earnings call, and we look forward to hopefully seeing you soon. Bye bye.

Operator

Ladies and gentlemen, thank you for your participation in today's conference. This concludes the presentation. You may now disconnect. And thank you, and good day.

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