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Bio-Rad Laboratories, Inc. (NYSE:BIO)

Q4 2011 Earnings Conference Call

February 23, 2012, 17:00 p.m. ET

Executives

Ron Hutton - Treasurer

Christine Tsingos - VP and CFO

Norman Schwartz - President and CEO

Brad Crutchfield - VP and Group Manager, Life Science

John Goetz - VP and Group Manager, Clinical Diagnostics

Analysts

Jon Wood - Jefferies

Reggie Miller - CLSA

Junaid Husain - Dougherty & Company

Jeffrey Matthews - Ram Partners

Operator

Good day, ladies and gentlemen and welcome to the Fourth Quarter 2011 Bio-Rad Laboratories, Inc. Earnings Conference Call. My name is Dana and I will be the operator for today. At this time all participants are in a listen-only mode. Later we will conduct a question-and-answer session. (Operator Instructions) And as a reminder today’s conference is being recorded for a replay purposes.

I’d now like to turn the conference over to your host, Mr. Ron Hutton, Treasurer. Please proceed.

Ron Hutton

Thank you, Dana. Before we begin the call, I’d like to caution everyone 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.

With that, I’d like to turn the call over to Christine Tsingos, Vice President and Chief Financial Officer.

Christine Tsingos

Thanks Ron. Good afternoon everyone and thank you for joining us. Today we will review the fourth quarter and full-year financial results for 2011, as well as provide some insight into our thinking for 2012.

Let’s start with a review of the quarterly results. We are pleased to report net sales for the fourth quarter of fiscal 2011 or a record $550.2 million an increase of 3.1% versus the year ago period sales of 533.7 million. On a currency neutral basis quarterly sales grew 2.4%. This year-over-year growth was fueled by continued progress for both our life science and clinical diagnostics segment with specific strength in our real-time PCR and imaging product lines, as well as quality control, blood typing and microbiology products. However, our top line growth continues to be challenged by slowness in Europe.

The consolidated gross margin for the quarter was in line with expectations at 56.5% versus last year’s gross margin of 56.2%. During the quarter we recorded approximately $3.7 million in cost of goods sold for the amortization and purchase accounting expense related to our DiaMed and Biotest acquisitions. In addition, the fourth quarter gross margin includes $2.5 million of amortization related to the recently acquired QuantaLife.

SG&A expense for the fourth quarter was $174.9 million or 31.8% of sales compared to $176.7 million or 33.1% of sales last year. The lower than expected SG&A spend in margin is primarily related to the one-time reversal of our incentive bonus accruals of approximately $9 million as we anticipate a significantly lower bonus payout for our 2011 operating results.

Amortization of intangibles related to our acquisitions reported in SG&A in the fourth quarter was approximately $3 million. Research and development expense in Q4 was 9.1% of sales or $50 million. This increase in spending both sequentially and year-over-year is reflective of our QuantaLife investment as well as focus on the development of new products for market such as diabetes monitoring and blood typing.

Interest and other for the quarter was a net expense of approximately $12 million compared to 20.6 million last year. This lower amount versus last year is primarily related to the debt refinancing completed in December 2010, and the subsequent retirement of our 2014 bonds which resulted in a one-time expense of $5 million last year as well as the resulting benefit of lower interest cost.

The effective tax rate used in the fourth quarter was better than expected at 20% primarily related to the finalization of foreign audit as well as decreases in tax reserves due to statute losses. Remember that last year the fourth quarter effective tax rate was actually a tax benefit related to the one-time repatriation of foreign earnings and the end of year reinstatement of the federal R&D tax credit.

Reported net income for the fourth quarter was $59.2 million or $2.08 per share on a fully diluted basis compared to 67.9 million last year or $2.41 per share. As you may remember, last year we estimated that excluding the unique tax related impact, diluted earnings per share would have been $1.52 in the fourth quarter of 2010.

Our life science group reported record sales for the fourth quarter of $198.9 million, a growth of 3.1% versus last year, which was also a very strong quarter for the group. On a currency neutral basis, sales increased 2.3% for the quarter. These quarterly results reflect strong sales of real-time PCR product, as well as our new line of imaging products.

On a geographic basis, sales in Asia-Pacific and the Americas were especially robust, partially offset by a decline in Europe. Gross margins in life science remains strong in the fourth quarter despite the impact of QuantaLife operations and amortization. In addition, improved SG&A margins helped segment profit for the fourth quarter reach more than $20 million, excluding QuantaLife, life science segment process was more than $27 million.

Our clinical diagnostic group recorded sales for the quarter of $347.3 million compared to 336.5 million last year an increase of 3.2% on a reported basis or 2.5% currency neutral. These sales were led by continued strong performance in the quality control and blood typing product lines as well as solid growth for BioPlex 2200 revenue.

On a geographic basis, sales in Asia-Pacific and the emerging markets remained robust but were somewhat offset by a decline in Europe our largest market. Despite this lower sales growth, reported fourth quarter segment profit for diagnostics was a record $53.7 million an increase of 44% when compared to last year.

Looking at the full-year results, we are pleased to report annual revenues of 2.74 billion an increase of 7.6% on a reported basis. On a currency neutral basis, sales for the year grew 3.1% which is below our original expectations and primarily reflecting weaker economy in many of our markets most especially Europe, which finished the year down in constant currency.

Our life science group posted good annual sales of $694.7 million an increase of 7.2% versus 2010 and 3.4% growth currency neutral. The higher sales were primarily fueled by growth in our core markets of electrophoresis, imaging and gene expression as well as good growth in the Americas and Asia-Pacific.

During the year we introduced a record number of new platforms and consumables including our new line of thermal cyclers and real-time PCR instruments that are touch based, and more than 50 new targets for our BioPlex protein expression analyzer.

As you know during the fourth quarter, we acquired QuantaLife and their new innovative digital PCR technology. We have begun shipping these instruments to customers and while it will take time to build the top line scale, we are very excited about the long-term potential for this new generation of PCR in the lab.

For the year, clinical diagnostic sales were 1.363 billion and annual growth of 7.8% on a reported basis and 2.9% on a currency neutral basis. This growth was fueled by continued momentum and blood typing, quality controls and diabetes monitoring products. On a geographical view, Asia-Pacific including Japan and Americas showed good growth for the year.

Our immunohematology division performed especially well in 2011 as evidenced by strong demand for our new IH1000 systems throughout Europe and Asia and a nearly 20% increase in sales of Biotest blood typing products in North America.

Total company gross margins for the full-year were 56.8% essentially in line with our original guidance and about flat with last year. Total amortization of intangibles and purchase accounting recorded in cost of goods sold in 2011 was $17.5 million which includes 2.5 million related to QuantaLife.

Research and development expense in 2011 was somewhat higher at $186.4 million or 9% of sales including 2.5 million of QuantaLife expenses recorded in the fourth quarter. Historically, we have targeted R&D to be in the 9 to 10% of sales range. Looking to 2012, these expenses maybe closer to the 10% number primarily related to our increased investment in digital PCR.

SG&A expense as a percent of sales was 33.6% for the year and better than we estimated at the beginning of 2011. The two primary drives of this better than expected results are later in the year launch of the ERP project and the sizable reduction in the incentive bonus accrual.

The combination of slightly higher gross margins and lower than expected SG&A spend led to operating margins much higher than originally anticipated. Remember that at the beginning of 2011 we guided the consolidated operating margins to be in the 13 to 13.5% range. As you can see, final results for 2011 produced an operating margin of 14.2%. Additionally, it is important to note that included in SG&A expense is $11.7 million of acquisition related amortization.

Net income for the full-year was $178.2 million versus last year’s net income of 185.5 million a decrease of 3.9%. As we guided at this time last year, the full-year decline in net profit primarily relates to our investment in new system, and the unusually low tax rate used last year. The effective tax rate for the full-year 2011 was 24%, which compared to an annual rate of 15% in 2010. For 2012 we expect that the effective tax rate will increase to around 31%, primarily reflecting the expiration of some previously implemented tax planning [data goals].

For 2011, Bio-Rad’s balance sheet remains strong. As of December 31, total cash and short-term investments were 813 million compared to 1.25 billion at the end of last year. Net cash generated from operations during the fourth quarter was $78.6 million and 259.8 million for the full-year 2011. The year-over-year increase in cash flow is the result of lower interest cost and cash taxes as well as improved operation. EBITDA grew to record levels for 2011 finishing the year at nearly $410 million. Net capital expenditures were $35.6 million for the quarter and 102.7 million for the full-year at the low end of the 100 to $110 million range estimated at the beginning of 2011. The increase in the fourth quarter is primarily related to our investment in ERP as well as facilities.

Looking to 2012, we estimate that CapEx spending will be in the 130 to $140 million range primarily reflecting our increased investment in a new global ERP system. And finally, depreciation and amortization for the quarter was $32.8 million and 121 million for the full-year.

We are pleased with our 2011 operating results especially in light of some challenging economic headwinds for both tools and diagnostics in many parts of the world. And we anticipate that this challenging economic environment will likely continue throughout 2012 offset somewhat by new product opportunities including the QuantaLife digital PCR system.

For the 2012 full-year operating results, we are estimating currency neutral sales growth to be in the 3.5 to 4.5% range. This estimate includes approximately $20 million of digital PCR sales which will likely be more back-end loaded in the year.

I should point out that foreign exchange maybe a significant headwind during the year when compared to 2011 and could result in little if any top line growth during the year on a reported basis, especially in the first half of 2012. In addition to currency it is also noteworthy to mention that the first half of 2012 will be somewhat of a tough compare due to some large one-time diagnostic orders that occurred in the first half of last year. With regards to margins, we are hoping [to fold] full-year gross margin around 56% despite adding $10 million of QuantaLife amortization and an expected decrease in HIV royalties.

Looking to the operating margin outlook, we view 2012 as the year of investment and thus are estimating a significant increase in spend during the year, including an incremental $15 million related to our ERP project, and an estimated $25 million operating loss related to QuantaLife including the amortization expense.

In addition, please keep in mind that as the dollar stage relative strong and mitigate top line growth, this could lower operating income by another 15 to $20 million due to lower translated sales on a reported basis. The net result of these investments and currency headwinds will likely produce an operating margin in the 11 to 12% range for the full-year.

And finally, as I mentioned earlier, we anticipate a full-year effective tax rate of 31% and CapEx spend of 130 to $140 million for 2012.

And now I will turn the call over to Norman for a few comments.

Norman Schwartz

Thank you, Christine. I guess I do want to emphasize little bit that our cautionary outlook for 2012 reflects what I’d call investments in the business rather than business fundamentals. While our markets are a little tougher, with all of the economic uncertainty that’s going on around the world today, I think our underlying business is healthy. We certainly continue to have a wealth of opportunities and new products to drive the business in 2012 and beyond.

We are as you know, making two significant investments in the business, the first it has mentioned its global ERP system, which obviously will help us to realign the synergies of our size in historic term and longer term. Ready to give us the scalability as we move forward and grow.

Second, is the recent acquisition of QuantaLife, I think this gives us access to digital PCR technology which we feel is poised to take DNA amplification to the next generation or next level I guess that maybe a next generation outlook. So, I think while these will temporarily dampen our margins, we feel both of these investments bode well for Bio-Rad in the longer term, both in terms of top line and certainly bottom line expansion.

So, I guess with that we will open it up for questions.

Question-and-Answer Session

Operator

(Operator Instructions) The first question will come from the line of Jon Wood, Jefferies.

Jon Wood - Jefferies

Did you book any QuantaLife in the fourth quarter?

Christine Tsingos

It was very little. Maybe 4, $500,000.

Jon Wood - Jefferies

And Christine, would you remind us, you talked about ERP expenses going 15 million what were they in 2011 so the step up in 2011?

Christine Tsingos

Yes, so I think in 2011 they were probably around 13 million or so on the operating side and this year there is probably another incremental 15.

Jon Wood - Jefferies

Okay. How do you see that, do you have line of sight into beyond ’12 at this point or too early to tell.

Christine Tsingos

Yes, it's probably a little early to tell. I think part of the reason why spend this year becomes so much more significant one that the project now is at full steam and fully staffed. We are going to be working on our first implementation while simultaneously completing a more detailed design for what will be the second phase implementation. And as we said all along, I think 2012 and potentially 2013 will be the heaviest spend years of the project.

Jon Wood - Jefferies

Okay. Are you willing to disclose the royalty hit in gross margin, you alluded to on the prepared remarks.

Christine Tsingos

Probably not.

Jon Wood - Jefferies

Okay. I look at the fourth quarter gross margin and do you back our QuantaLife, it was the highest number since I think ’01 in my model. So, just any commentary you can offer on mix there. Just seems like the gross margin are holding in pretty well. And I guess beyond the QuantaLife and HIV royalties, why wouldn’t that level persist in 2012 if you will.

Christine Tsingos

That’s a good question, and you are right. I think the margins especially for it's been a fourth quarter for us were quite strong. And product mix continues to play a part of that and we thought for some now, for example on the life science side of the business that we have been able to manufacture many of our products at a lower cost and that’s helped the margins significantly. But as we move into next year, we do have the headwinds of the amortization the 10 million and COGS and not so any significant drop in HIV royalties that are impacted. A lot of it Jon, depends on what happens on the top line and how much currency may or may not impact that. But our goal is to try and hold the gross margins around 56% despite all of the headwinds.

Jon Wood - Jefferies

What is the FX hit to the top line. I mean you said 15 to 20 million and that you said flattish and you implied 3.5 or so percent on a top line is that right?

Christine Tsingos

So, who knows, right. I don’t have a crystal ball the foreign exchange rate, so basically the way we do planning, we try and plan on a currency neutral basis and then we will take the plan and rerun it at December 31 range. And then December 31 the euro for example was 1.30. And when we rerun the plan at kind of that year end rate, you can see the decline in sales is 80 to $100 million which is 15 to 20 million on the operating line. Again who knows where rates will really turn out.

Operator

The next question comes from the line of Reggie Miller, CLSA.

Reggie Miller - CLSA

Can you talk about the performance of the electrophoresis during the quarter. And the trends in where you saw that performance which we think about it for 2012.

Brad Crutchfield

This is Brad, I’ll take that question, our electrophoresis and western blotting and imaging product line we look at that as a work flow has been particularly strong this year as Christine pointed out relating to imaging, but overall electrophoresis line has grown significantly higher than the market rates, so we are very confident in 2011 that we took market share and pretty optimistic on the run rate.

Operator

Next question comes from the line of Junaid Husain, Dougherty & Company.

Junaid Husain - Dougherty & Company

Christine, just big picture question for you, on 2011 pricing environment for both tools and diagnostics and maybe John or Brad can chime in. Which of the segments do you think you have the most leverage to squeeze some pricing gains?

Christine Tsingos

I’ll just give some peanut gallery comment and then Brad and John are probably better due to the answer the question, but clearly in a challenging economic environment, pricing pressure is even higher than normal and certainly we saw that in 2011 and anticipate that pricing will still be an important factor in 2012. As a rule we are continually looking to find ways to produce our product at lower cost that we have some pricing flexibility, but it doesn’t impact both sides of the business and I will let John and Brad also comment.

John Goetz

This is John, on the diagnostic side, what Christine had said is very accurate, we are seeing buying patterns with customers extending tenders beyond just the normal one, two years to three and four years and that’s a lot of pressure on the supply side to make sure you don’t lose out on those. So, we are seeing that particularly in our virus business as well as our blood typing business.

Brad Crutchfield

This is Brad, on the tool side, one of our largest businesses is QPCR, generally amplification, and the last couple of years we have grown our market share significantly and our unit volumes have grown substantially. But we see a lot of our competitor’s traditional leaders in this market really have only one solution and that is to lower the price. And in tough economic times, our customers are looking sometimes for prices and element and we are having to lower our prices continue to grow the market. So, I think we do have a fair amount of headwind and pricing especially in markets like Europe where there is really compression on people’s budgets.

Junaid Husain - Dougherty & Company

John, can you help us understand some of the dynamics going on in your segment. The business seems to have slowdown just a little bit in the fourth quarter. Can you walk us through all of the different pieces, what part of it was just due to something tough comps, what part of it was due to economic uncertainty etcetera, etcetera.

John Goetz

Well, at the end of the year, particularly I’d fourth quarter we experienced softness in Europe and particular in some of our emerging markets where normally we would have some fairly decent shipments there, effectiveness in areas that prior period we never really had been effected before. So, it's just a general softness that has affected that result.

Christine Tsingos

And don’t forget Junaid that Europe and Eastern Europe represent about 45% of our business.

Junaid Husain - Dougherty & Company

Okay, got it. And then Brad, I guess big picture question for you on tools. When you look at the puts and takes with a different customer segments for 2012 be they academic or industrial, where do you see the big opportunities and perhaps maybe some of the challenges.

Brad Crutchfield

Generally, the compression of the pharma market maybe the shift of pharma R&D spend to China. Now those trends have been going on for couple of years. I mean overall, our academic spend is probably more sensitive in Europe again as governments look to (inaudible) measures and it certainly reflects the government sponsored spending. I don’t see a dramatic change in terms of 2012 compared to 2011. One specific upside is the digital PCR product, our QX100 product in pharma market. Any of the pharma markets especially involved in either diagnostics or cancer research or cancer pharmaceuticals have really taken into this technology.

Junaid Husain - Dougherty & Company

Fair enough. And then Christine, one last question for you just a quick financial one. Could you tell me your DSO in Europe and Europe versus U.S. for example.

Christine Tsingos

Well, obviously we don’t disclose our business to that level of detail, but not surprisingly we talked about this in the past. Traditionally Europe has always been a bit slower collection environment than the U.S. and through the last several quarters especially in Southern Europe, we kept very cautionary eye on that part of the world, because that’s where we have seen the biggest slowdown in collections if you will.

Operator

The next question comes from the line of Dan Leonard, Leerink Swann.

Unidentified Analyst

(inaudible) for Dan today. Thanks for the question. Actually only have one, other ones were answered but can you talk about what you are seeing in terms of customer behavior in you key end markets so far in 2012, has it changed at all. I assume not overall, because you said you are anticipating the challenging environment continuing throughout 2012, but I’m wondering if there were any specific markets that were experiencing headwinds that may have started to show improvement.

Norman Schwartz

No, I think it's pretty much business as usual. I don’t there is, there hasn’t been since the end of the year any dramatic shift one way or another. And I think to certain extent it's too early to tell for 2012.

Operator

(Operator Instructions) we have a question on the line from Jeffrey Matthews, Ram Partners.

Jeffrey Matthews - Ram Partners

Norman, I’m just curious long-term, what this (inaudible) in genetic testing might ultimately mean for diagnostics business.

Norman Schwartz

There are lot of people who have talked about this as, personalized medicine and just seems like there is a lot of opportunity out there, exactly when and how it will be realized I think is still open to question but certainly I think that’s where the potential is and why everybody is so interested in it.

Jeffrey Matthews - Ram Partners

Do you see it as a potential risk to the core business that is now long-term.

Norman Schwartz

Well, all of our businesses continue to evolve in terms of their technology I think and this always a challenge for everyone, not only us but everyone in these markets to remain competitive as to stay, close to the technology and where it's going. And certainly I think we are in a good position to do that and continue to have our fair share, but we do expect the businesses to evolve technology wise.

Jeffrey Matthews - Ram Partners

Okay. It's probably way too early in the process to make a judgment, but I’m wondering Christine, how confident you are in the ERP rollout as it stands now. How you think it will evolve and whether the benefits will occur.

Christine Tsingos

Okay, I don’t know if the confidence in getting the ultimate benefit, I think the confidence remains high for us whether it's in the ability to do shared service and reduce some of the redundant expense in our business or the ability to better manage inventory or the ability to better manages our taxes, and tax exposures. If that’s your question.

Norman Schwartz

Jeff, just add to that. In this whole first phase project the project where we put a lot of people on the project and have done an incredible amount of work to get through this last year. I think I’d say that we are very encouraged to at least I’m very encouraged by the kind of the level of work that’s been done, and the attention to all of the right things that would help us to get to those paybacks in the future. So, we feel pretty comfortable with it so far. There are always some hitches in the road on these things, but I think Christine had said before, we have the benefit of hindsight in having been able to learn a little bit from mistakes others have made and we do have the team on this projects and it seems to be well managed so far.

Jeffrey Matthews - Ram Partners

And the patient is now rejecting the transplant.

Norman Schwartz

No, in this case the patient is embracing the transplant with open arms, it's interesting because the people in the operations do see the advantages of this system. So, I think that’s pretty good for us.

Christine Tsingos

Yes. And one of the most encouraging sign, Jeff, is as Norman said the folks in the operations they are not digging in saying while I have done at this place forever I want to continue to do it, xyz way. They are very open to best practices and more efficient ways of running their corners of the world.

Jeffrey Matthews - Ram Partners

My final question on state of the world. Anything new different surprisingly good, surprisingly not as good coming out of Asia, and I’m wondering how healthy is Japan these days and towards the future how China is looking to you?

Norman Schwartz

Obviously the last year was little bit of blow with the tsunami, and that affected some of our life science business, and probably a little bit of the diagnostic business as well. But Japan seems to be pretty stable and pretty good shape actually. The rest of the Asia of course, continues to motor along. Lots of opportunities, it's for us to realize those opportunities. So, for Asia it's for us Asia continues to be very encouraging. I think I’m also little bit encouraged by that kind of stability in the U.S. that we are starting to see.

Jeffrey Matthews - Ram Partners

Could you elaborate a little bit on that Norm?

Norman Schwartz

Just in general there seems to be a kind of little better tone, I think if you go back three or four months ago, where there were all of these big questions about what was going to happen with the NIH budget, that seems to stabilize now. I think people seem to be a little more relaxed. It's just the return to the good old days, probably not yet, and then they talk about employment levels maybe stabilizing a little bit. And obviously that should have a little better outlook for the diagnostic side of the business. So, those I guess that’s the underlying thought.

Operator

And there are no more questions at this time.

Christine Tsingos

Okay. Well, thank you everyone for taking the time to join us today. We appreciate your interest and support and hopefully we will see you soon. Bye.

Operator

And ladies and gentlemen thank you. This concludes today’s conference, you may now disconnect and have a great day.

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