Bio-Rad Laboratories, Inc. (BIO) Q1 2013 Earnings Report, Transcript and Summary

Good day, ladies and gentlemen, and welcome to the First Quarter 2013 Bio-Rad Laboratories, Inc. Earnings Conference Call. My name is Regina, and I'll be your conference operator for today. [Operator Instructions] As a reminder, today's event is being recorded for replay purposes. I would now like to turn the conference over to your host for today, Mr. Ron Hutton. Ron is the Vice President and Treasurer of Bio-Rad Laboratories, Inc. Please go ahead, Ron.

Thanks, Regina. 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. 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, Executive Vice President and Chief Financial Officer.

Thanks, Ron. Good afternoon, everyone, and thank you for joining us. Net sales for the first quarter of 2013 were $499.7 million, an increase of 2.8% on a reported basis versus the same period last year sales of $486.3 million. On a currency-neutral basis, sales increased 3.6%. During the quarter, we had good growth across many of our key markets and product areas in our diagnostic segment. The first quarter results also include $6.2 million of sales contributed by our new AbD Serotec antibody products. Sales growth in the quarter was partially offset by continued weakness in Europe, which posted a 4% decline in currency-neutral sales versus last year, as well as challenges surrounding sequestration in the U.S. research market, which was also down versus last year. Excluding currency and the addition of the antibody business, organic sales growth for the quarter was 2.3%. The reported gross margin for the first quarter was 54.3% compared to 57.3% last year and 54.7% in the fourth quarter of 2012. This lower margin was impacted by numerous items, including changes in product mix and continued pricing pressure, additional amortization of intangibles related to recent acquisitions, additional legal contingency accruals and the newly effective medical device tax in the U.S. Total purchase accounting and amortization expense recorded in cost of goods sold related to acquisitions was $8 million, including $1.2 million associated with the Serotec acquisition and compared to $6.8 million in the first quarter of last year. SG&A expenses for the first quarter were $185.9 million, or 37.2% of sales, compared to $171.3 million, or 35.2% of sales, last year and down approximately $3 million from the fourth quarter. As expected, absolute spending is up year-over-year, primarily related to increased personnel and ERP project-related expenses, as well as the inclusion of the new antibody business. In addition, during the quarter, we recorded approximately $3 million of onetime expenses related to an increase in our bad debt allowance and also a reduction in the workforce, primarily in Europe. The current quarter SG&A expense includes a total of $2.1 million for amortization of intangibles related to acquisitions. Research and development expense in Q1 was in line with expectations at 10.4%, or $51.9 million, which compares to $52.9 million spent in the first quarter of last year. The sequential decrease in R&D expenses is primarily reflective of the higher spend in the fourth quarter that was connected to our investment in the new cell sorting technology. With a sizable sequential decrease in sales from the fourth quarter of more than $70 million, combined with a fairly flat gross margin and a high level of fixed operating expenses, the operating margin for the first quarter was in turn significantly impacted and resulted in a f% margin compared to around 11% both last quarter and the year-ago period. During the quarter, interest and other income was a net expense of $11.1 million compared to $8.2 million of expense in Q1 of last year. The increase in expense versus last year is largely related to lower investment income, partially offset by lower interest expense. Remember, last year, we recorded a onetime realized gain on the sale of an investment of approximately $4.5 million. The effective tax rate used during the first quarter was 13%, which is much lower than is typical for us and primarily due to the onetime catch-up of the 2012 federal R&D tax credit. As we stated on our last call, excluding any discrete items that may occur during the year, we expect the effective tax rate to be in the 27% to 29% range. Net income for the first quarter was $19.5 million, and diluted earnings per share were $0.68. Life Science-reported sales in the first quarter increased slightly to $156.3 million on a reported basis. On a currency-neutral basis, sales grew 2.5% compared to last year. 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 declined 1.6% versus the first quarter of last year. This decline in our base business was driven by a very challenging research funding environment in the U.S. and Europe, as well as a tough compare for our process media division. We estimate that sequestration may have negatively impacted Life Science sales by approximately $2 million in the quarter, while sales in Europe declined by more than 10% for the group. Overall segment profits for Life Science was negative for the quarter, reflecting the increased acquisition-related expenses, unfavorable product mix, continued pricing pressure and additional legal-related accruals. Sales of our clinical diagnostic products were $340 million compared to $327.2 million last year, an increase of 3.9%. On a currency-neutral basis, year-over-year sales grew 4.3% for the diagnostics group. During the quarter, we experienced growth in all of our diagnostic division, highlighted by good performance in our quality control and diabetes product line. On a geographic basis, diagnostic sales in China, Eastern Europe and the Americas were especially strong in Q1, partially offset by declines in Europe and Japan. The Clinical Diagnostics gross margin was down both sequentially and year-over-year, the result of a less favorable product mix; increasing pricing pressure, especially as it relates to foreign tenders; the new medical device tax; and higher charges for inventory obsolescence. Clinical Diagnostics segment profit for the quarter was $36.1 million, reflecting both the gross profit headwinds I just mentioned, as well as increases in our bad debt allowance. Moving to the balance sheet. As of March 31st, total cash and short-term investments were $836.8 million. The decrease in cash balances versus year end reflects net cash used for the purchase of AbD Serotec of approximately $62 million, as well as cash used typically associated with our first quarter. Despite this spending, net cash generated from operations during the quarter was $20.5 million compared to $35.3 million in the year-ago period and primarily reflective of the lower net income and lower gains on our investment. Net capital expenditures for the quarter were in line with our expectations at $34.1 million. Our full year expectation for CapEx remains in the $140 million to $150 million range as we continue to invest in ERP and e-commerce improvements. And finally, depreciation and amortization for the quarter was $33.3 million. The first quarter results are both disappointing and frustrating for us. Despite an exciting lineup of new products, the challenging research funding environment in the U.S. and Europe are presenting a mighty headwind to the top line. Even more frustrating are the challenges we faced for both the growth in operating margin. When compared to last year in cost of goods sold during the quarter, we faced product mix and pricing pressure issues of more than $5 million, as well as an increase in legal contingency reserves of more than $4 million and an increase in purchase accounting-related expense of $1.2 million. In operating expenses, we recorded approximately $3 million of increased reserves for bad debt and severance, as well as incurred an additional $4 million of ERP and IT expenditures when compared to the last year. And without the air cover of the top line, these cost headwinds are even more impactful to the margin. As we look to the full year for 2013, we are cautiously optimistic of achieving the currency-neutral sales growth guidance of 3% to 3.5% for the base business that we provided to you in February. With the addition of the new antibody business, currency-neutral top line growth for the year could be 3.5% to 4%. Of course, the continued strengthening in the U.S. dollar could lead to much lower growth rates on a reported basis, and we must caution you that further deterioration in Europe or a greater sequestration impact in the U.S. could make our top line growth goal very difficult to achieve. Given the growth and operating margin results of the first quarter and the expectation that the newly acquired Serotec business will be dilutive to operating profit of around $10 million for the full year, we are revising our annual operating margin guidance from the original 11% to 11.5% range to a new expectation of around 10%. Again, with the caution that incremental headwinds to the top line could in turn make a double-digit operating margin hard to achieve for the full year. And finally, as I mentioned earlier, we expect the effective tax rate to be 27% to 29%. And now we are happy to take your questions.

[Operator Instructions] And your question today, your first one comes from the line of Brandon Couillard with Jefferies. S. Brandon Couillard - Jefferies & Company, Inc., Research Division: Christine, could you clarify the P&L impact or contribution from the Serotec deal? I know revenue was $6 million, but what was the negative EPS impact in the quarter?

I think the negative EPS impact in the quarter was probably around $1 million. We didn't own it for the whole quarter, and we're just now ramping it up. So I think we anticipate that the quarterly drag will be a little more than that going forward and probably around $10 million for the year. S. Brandon Couillard - Jefferies & Company, Inc., Research Division: Okay. And then in the release, you mentioned increased royalty and license accruals. I mean, could you break that down between that bucket and then obsolete inventory impact?

Well -- so I think I just talked about kind of the increase in the legal-related accruals was about $4 million. I think that obsolescence was about $2.5 million. S. Brandon Couillard - Jefferies & Company, Inc., Research Division: Alright. And then was there any revenue contribution from the Propel acquisition?

This is Brad. There was just a slight amount. We essentially placed one system in the quarter.

Your next question is from the line of Paul Knight with CLSA.

This is Bryan Kipp on behalf of Paul. Just a follow-up again on the cost. You guys said that manufacturing cost again is a headwind. Is that something you expect going forward? Or is that kind of something you just saw in the quarter?

So what hit in cost of goods was the additional legal accruals, the additional amortization margin pressure that came from pricing pressure.

And I guess -- I don't know if I missed it, I heard part of it, I heard the geographic breakdown of Europe minus for organic. But can I just -- by segment, again, U.S. versus Asia and Europe, can you give the breakdowns?

So we really didn't talk about every single region. I think in -- what we can say is that many of the emerging markets, Latin America, Eastern Europe, Asia Pacific, continue to be growers for us and the mix changes between Life Science and Diagnostics from country to country. But in general, they turn -- in turn, are growers for us. But the U.S. and Europe remain slow to down, and that's a big portion of our sales.

[Operator Instructions] Your next question comes from the line of Justin Bowers with Leerink Swann.

You mentioned in your outlook for the rest of the year, you kind of reiterated the organic growth outlook and talked about the U.S. academic and EU still being a little weak. I'm just curious if you're seeing any -- still early in the quarter, but any kind of change in customer behavior there that gives you confidence for the rest of the year?

This is Brad. I'll take this from the Life Science perspective. Certainly, the first quarter, we saw most grants put on hold until they could decide how to deal with that. We have seen in April that the grants are being released, and we're seeing that in terms of customer spending. So that is somewhat optimistic. But nobody believes that this is going to be a short-term thing. This is something that we'll probably go through 2014 as far as somewhat across the board, 6% to 8% cut. But at least now the money is flowing back into the system.

Okay, great. And then just real quickly, on AbD Serotec, the 6.2 came in a little higher than we were looking for. And are you -- I guess the question is are you still expecting $20 million to $25 million in sales or maybe a little higher for that for the full year?

No, I think that $20 million to $25 million is still the best estimate. It's uncertain to us how the business unfolds throughout the year. I think that's still the right estimate.

Your next question is from the line of Brandon Couillard with Jefferies. S. Brandon Couillard - Jefferies & Company, Inc., Research Division: Christine, ERP expense is still expected in the $15 million to $20 million range for the year in terms of the P&L.

I think so. S. Brandon Couillard - Jefferies & Company, Inc., Research Division: All right. And then any chance -- any color you could give us around how the Digital PCR revenues performed in the quarter, either sequentially or year-over-year?

So we're not -- we don't disclose those sales anymore that -- I'll let Brad give some colored commentary on the business, but the business was up year-over-year double-digits. But now that we've rounded the corner and considered organic, we're not going to disclose the specific numbers.

Yes. Just the prospects. Certainly, as Christine said, they were -- there was growth, obviously, in the first quarter, certainly impacted overall by the slowness in some of the grants being released. But the demand and the acceptance of this technology is still very, very strong and is a big part of our future plans in both growing and where we invest in the business.

And Brandon, the $15 million to $20 billion, I assume you were talking about the incremental spend on those -- the projects this year versus last year, not the total spend.

And ladies and gentlemen, as there are no further questions in the queue, this will conclude the question-and-answer portion of today's event. I'd like to turn the call back over to management for any closing remarks...

I don't mind if you want to poll one more time for questions.

Sure. Absolutely. [Operator Instructions] And we do have a question from the line of Jeffrey Warshauer with Sidoti & Company. Jeffrey Warshauer - Sidoti & Company, LLC: I was just hoping maybe to get a little more color on both the gross and operating margin, some of those onetime expenses, to try to back those out to get a better apples-to-apples comparison. So we're looking at $8 million in amortization and COGS, $2.5 million obsolescence. You had $4 million in contingency, legal contingency. Was there a $1.2 million onetime charge?

So let me go over them again because the $8 million is total amortization that hits COGS. The incremental piece is $1.2 million. And so that -- the $8 million, most of that has been hanging around for some time. I think in terms of this quarter, we did talk about... Jeffrey Warshauer - Sidoti & Company, LLC: And the tax, how much was the tax?

How much was the tax?

Excise? Jeffrey Warshauer - Sidoti & Company, LLC: Sorry, excise tax? You lump in the...

Well, the med device tax was about $1.2 million, $1.5 million, around there. The increase in legal contingency reserves was over $4 million. There was a $3 million noncash charges related to our bad debt allowance, as well as some severance for some rightsizing we're doing in Europe. Jeffrey Warshauer - Sidoti & Company, LLC: Okay. That was on the SG&A, right?

Yes. That one was SG&A. The rest of these are primarily cost of goods. And then when we talked about -- about $5 million is kind of what we can identify related to product mix and pricing pressure changes during the quarter. So $5 million headwind to cost of goods or gross margin related to product mix and pricing pressure. $4 million related to some legal contingency reserve increases, $1.2 million purchase accounting in cost of goods. The obsolescence of about $2.5 million and the med device tax of $1.2 million. Those are kind of the categories we called out for headwinds to the gross margin. And then on the operating margin side, the $3 million onetime expense related to the bad debt allowance and a reduction in force is one of the biggest items. And then, of course, we have incremental spend related to ERP and IT of about $4 million, but I wouldn't call that onetime. Jeffrey Warshauer - Sidoti & Company, LLC: Right. And you mentioned the $2.1 million amortization in that line. Was that incremental?

Right. And so that -- so in SG&A -- no, that's total. So the incremental was a few hundred thousand.

Your next question is from the line of Sam Siegal [ph] with Senator [ph].

Just to add on to Jeff's question and a follow-up. So it seems like in aggregate, these numbers amount to over $10 million of what I think you and -- we could call onetime or extraordinary. Is that -- I guess is that fair? And then two, just talking about the severance in European restructuring, is this something you'd planned heading into the year? Or is this something that you guys chosen to enact as the quarter evolved?

Okay. So I think you're probably right. I mean, hopefully, the $10 million to $12 million of unusual items but I can't predict it in terms of what the future holds. But there's just a lot of little things that kind of all came together on that. In terms of the changing of the European organization, it is something that we've contemplated from the beginning of the year, knowing that Europe was a bit of a headwind for us and a challenge. I think that the market has become even more challenging in the first quarter and the timing has become more compelling.

Your next question is from the line of Jeffrey Matthews with RAM Partners.

Is the legal reserves something that might recur? Or is this just a one-shot deal?

So I think there's always a number of legal issues that we're looking at, and hoping they resolve. And I think we thought it was appropriate for us to put some reserves relating to specific events and issues on the books right now. And I guess they could increase until final resolution, but these situations are very fluid.

Sure. And then on the bad debt, I'm just curious why that's a Q1 issue when it's not something you'd have cleaned up at the end of last year, at the end of the calendar year.

Yes. Now a good question, and it's something that -- this is something you look at every quarter based on your business. In this particular case, it relates to a change in a distribution model that we've undertaken. And again, I think it's the appropriate thing for us to do on -- from an accounting standpoint.

Okay. And then third question, was there any Japanese yen damage in the quarter?

It certainly is a headwind to the top line and impacted their growth. On the expenditure side, it actually can be a benefit. So from the standpoint of sourcing products in Japan, it didn't hurt.

And then in all of this, are you losing share in any particular product line, do you think? Or is this all macro?

Well, I'm not the right person to answer that one.

We're -- okay. So in selective product areas, maybe there's a gain or a loss, I think. But in general, it's -- I think of it more as a macro issue.

I don't know...

Okay. Well, any areas of growth that you'd highlight, Norman? Anything good out there?

Any areas of growth?

Growth.

Sure, there's -- yes. A number of our product lines. I think, as Christine mentioned, are growing and doing well and Brad talked a little bit about the newer products and the ones that are just being introduced. I think those we're seeing good traction with. In the diagnostics area, there seems to be several of the product areas that are doing -- continuing to do well, although obviously at, overall, at a slower rate than we've seen it in the past. But yes, we've got some bright spots.

Okay. And then my final question was could you just talk about some of the -- I look back on the acquisitions to -- you've made over the last few years. Anything that stands out as being a real plus for you at this point?

A real cost?

A plus. A plus.

Okay. Well, certainly, I think the QuantaLife acquisition on the top line has been good for us. Obviously, we're still investing in that business and don't expect to have a bottom line on it this year. But okay, so it's a brand-new technology and I think as Brad said, it continues to be kind of well accepted in the market. I think at the Serotec acquisition, Brad maybe you can talk a little bit about the upside to that?

Yes. Well, Serotec is -- again, it's a great opportunity for us in terms of accessing the content specifically. And we -- the other acquisition was the Propel or the cell sorter, and that was a product line that we acquired that was essentially in a final prototype. Since acquisition, we've actually brought that into our manufacturing facility and released it effectively right at the end of the quarter. We basically had one placement. But we have obviously now to look forward to begin to place that. So the combination of the content that we can place on the cell sorting instrument, the content that can go on our own platform, that's what AbD Serotec really brings to us. And our experience early on is some really nice content, including a very nice technology to make rapid -- antibodies very rapidly for difficult targets. And so we're -- this so-called HuCAL technologies, that's proving to be very interesting for us.

You want to talk -- you want hear about diagnostic side of the acquisition?

Yes, I'd love to.

This is John Goetz. Okay. So we've had some pretty good success in our business, particularly on our diabetes business. We had some great placements and businesses going in, in Asia. In the U.S., we continue to make great inroads in our immunohematology business, which was part of the acquisition of Biotest. And overall, our business in blood typing continues to grow and solidify around our market-leading position. So we feel pretty good about that.

Your next question is from the line of Doug Cohen [ph] with Sinca [ph].

It's David Cohen [ph]. I wonder if you could just comment. 10% operating margin is just way off line from the company's target and also from comparables in the industry. If you can talk about where and when you expect to get that back more in line?

Sure. So our -- obviously, this quarterly result operating margin is a confluence of what happens on the top line and the gross margin and several of these onetime expenses that we've talked about. But even with this quarter notwithstanding, we have moved our operating margins from the 14% -- the 15% range, now down to the 10%, 11% range really as part of our targeted investment in new systems, primarily a new ERP system, but we're also investing in other technologies for the business. In addition to that, we've taken on several acquisitions, which are pretty significantly dilutive in the short term, both from the business operation standpoint and from the amortization of intangible standpoint. So if you look over the last 2 or 3 years, the combination of these targeted acquisitions and these targeted internal investments have moved the operating margin down to this 10%, 11% range. Obviously, these investments are done with the future in mind. And as we do our acquisitions, it's very much on a cash flow basis and we look for that return. And the same is true as we invest in new systems. And our goal is as we put these investments kind of behind us, we'll be able to move our operating margin back up at least to the mid-teens, if not something better. And I guess, David, the last thing I would say to your comment of comparing it to our peers, I'd ask that you keep in mind that we are still GAAP reporters. And so our margin come fully loaded with everything and the kitchen sink. And sometimes, when you make that comparison, people are using adjusted numbers. And so I would encourage you to kind of go to a GAAP to GAAP analysis as well.

And what is the timing of the return back to the 15%-type target?

So great question. I think our ERP project is a pretty lengthy one, again with a very deliberate investment and a deliberate global rollout. Best guess that I can give you right now in terms of us seeing -- a good improvement from that investment is probably not until the 2016 time frame. In the meantime, we hope that the business and some of these acquisitions that we just spoke of on the QuantaLife side, on the Serotec side, continuing growth in blood typing, all of those will begin to contribute even more or at all to profitability certainly before that 2016 time frame. And for now, it's a matter of top line scale versus the investments that's required to launch into the markets around the world.

Well, there are no further questions in the queue at this time.

Okay. Everyone, thank you very much for taking the time to join us today. Bye-bye.