Bio-Techne Corp (TECH) — Q1 2016 Earnings Call Transcript

Good morning and thank you for joining us. Also on the call this morning is Chuck Kummeth, Chief Executive Officer of Bio-Techne. Before we begin, let me briefly cover our Safe Harbor statement. Some of the remarks made during this conference call may be considered forward-looking statements. The company's 10-K for fiscal year 2015 identifies certain factors that could cause the company's actual results to differ materially from those projected any forward-looking statements made during this call. The company does not undertake to update any forward-looking statements as a result of any new information or future events or developments. The 10-K as well as the company's other SEC filings are available on the company's website within its Investor Relations section. During the call, non-GAAP financial measures may be used to provide information pertinent to ongoing business performance. Tables reconciling these measures to most comparable GAAP measures are available in the company's press release issued early this morning or on the Bio-Techne Corporation website, at www.biotechne.com. Also, you will notice this morning's press release has the stock-based compensation expense added as an adjustment to the company's non-GAAP measures. This will be an ongoing adjustment as stock-based compensation expenses are recurring to increase transparency of these costs as well as to reflect net earnings more representative of the ongoing cash generated earnings of the company. All comparisons since the prior periods reflect this adjustment as well. With that, I will turn the call over to Chuck.

Thank you, Jim, and good morning, everyone. Thanks for joining us today for our first quarter call. This morning, we reported a 4% increase in revenue for the first quarter, supported by solid organic growth in most of our end markets. The company's total organic growth was 2% for the quarter, with mid single-digit organic growth coming from our biotechnology segment and 10% organic growth from our Protein Platforms segment, balanced by timing of OEM shipments in our Clinical Controls segment. In our Biotech business, the Bio Pharma end market continued to show strong performance with overall organic growth in the high single-digit range. The European Bio Pharma market was particularly robust, with a notable rebound even in Germany. Overall organic growth in Europe was in the mid single-digit range, with Germany leading. A significant factor in our growth has been our efforts to market in customer regions and to advocate for these solutions. Our ability to produce complex bioactive molecules and our established reputation for quality have garnered recognition from our biopharma customers, who are turning to us for impactful production results. These partnerships not only support our current growth but also lay the groundwork for ongoing collaboration on future projects. Many of these developed products have now been added to our standard catalog. Meanwhile, in our academic and government end markets, we observed a multi-quarter trend of modest organic growth, with first-quarter growth in the low single-digit range following the release of our new website at the end of Q4 fiscal year 2015. We have seen an increase in website traffic. Our continuous improvements to user experience on the website, particularly as we add more product content and reference citations, are vital for long-term growth in the academic market. Our results in Asia reflect a similar trend. China performed exceptionally well in Q1 with organic growth in the mid-teens. Our strategy for China is proving effective, with our PrimeGene products manufactured and sold in the domestic market seeing nearly 40% growth. In the Pacific Rim, organic growth, excluding Japan, was in the mid-teens. However, Japan has been a hindrance to our regional results, exhibiting double-digit negative growth due to distributor stocking issues and significant currency fluctuations affecting research funding from the Japanese government, leading to several quarters of challenges. We anticipated overcoming this by the start of FY 2016, but Q1 has suggested otherwise. We maintain confidence that these issues are temporary and expect a rebound in fiscal 2016. Additionally, we welcomed Peter Breloer as Vice President for all of Asia Pacific in Q1, based in Hong Kong. Peter brings over 20 years of regional management experience from global companies like Thermo Fisher Scientific and 3M. With his leadership, we are well-positioned to capitalize on growth in the region, initially by maximizing opportunities in China, recovering growth and funding returns in Japan, and eventually establishing a foothold for growth in India. Now, regarding our Clinical Controls division, we finalized the acquisition of Cliniqa in early July. Cliniqa specializes in manufacturing and commercializing quality controls and calibrators, along with bulk reagents for the clinical diagnostics market. Their controls and reagents are employed in a variety of diagnostic tests for conditions like cardiac disease, diabetes, cancer, immunological disorders, therapeutic drug monitoring, urine analysis, and toxicology. With over 165 products holding 510(k) clearances from the U.S. FDA, Cliniqa has developed substantial regulatory expertise that we can leverage to expand Bio-Techne products into the clinical diagnostic market. We are thrilled to welcome Cliniqa as part of Bio-Techne, enhancing our offerings to our clinical controls and diagnostic customers, who are essentially the same clientele from the Clinical Controls business. Following the acquisition of Cliniqa, Clinical Controls segment revenue rose compared to last year, although organic revenue orders were lower due to shipment timing issues. Despite this, our outlook for the business remains strong. Our legacy hematology controls business grew in the mid-single digits this quarter. We believe this business segment, which features products with short shelf lives, reflects genuine demand for clinical controls products. The longer shelf lives of Cliniqa's blood glucose, blood gas, and blood chemistry diagnostics enable bulk purchasing, making sales volumes more variable from quarter to quarter. Nevertheless, our strong relationships with customers provide insight into their ordering schedules. We are optimistic about our visibility into these schedules and the performance of our legacy hematology controls, giving us confidence that this division will continue to achieve at least mid-single-digit annual growth in the long term. In conclusion, our Protein Platforms segment concluded Q1 with a 26% revenue increase, achieving 10% organic growth. Although we anticipated this growth, we believe it will improve further. As mentioned in our Q4 call, we faced several setbacks mainly related to the integration of CyVek and commercial attrition. Now that integration issues have been resolved and commercial roles are filled, it takes more than a quarter for a larger sales team to replenish the order pipeline. We are taking this opportunity, aided by new sales leadership, to reevaluate our go-to-market strategy to capture the majority of the western blot user market, with a keen focus on aligning with the previous ProteinSimple sales engine. This entails optimizing lead generation and sales closure strategies. We just completed our annual strategic planning session with our leadership team, and our view of the market potential for this innovative platform remains unchanged. Our teams are dedicated to ensuring long-term value for our customers. Finally, I want to touch upon the company's operating margin performance in Q1. Jim will provide segment-specific details later, but overall, the decrease in operating margin from last year is primarily due to the timing of our previous acquisition and, to a lesser extent, foreign exchange impacts. We acquired ProteinSimple at the end of July last year, resulting in minimal revenue contribution for its initial quarter. As seen in our Q1 results this year, we accounted for an additional month of SG&A and R&D expenses without corresponding revenue. We also acquired CyVek in November of FY 2015, which is essentially a startup generating limited revenue that is not expected to break even until sometime in FY 2017. Furthermore, with the acquisition of Cliniqa in July of this fiscal year, all these businesses are profitable but do not yet contribute margins comparable to our established clinical control businesses. The optics look favorable this quarter, but the underlying 12-month operating performance for these entities is improving and will continue to develop as a vital and prosperous part of Bio-Techne. Before I hand the call over to Jim, I want to provide further context on our leadership position this quarter. As discussed in previous calls, our overarching strategy is to deliver transformative solutions to our customers through innovation. Some innovation will stem from our internal efforts, while additional will come from our acquisitions. We have cultivated a successful culture that fosters collaboration across various departments, business units, locations, and countries. Over the past two years, we have doubled our workforce and expanded our geographical presence, enhancing our collaborative culture. We have appointed a new VP of human resources, transformation, and integration, who specializes in change management. I previously mentioned this, but I feel it's important to highlight, especially regarding the traditionally robust sales in Q1. His name is indiscernible, and he has moved from the UK to Minneapolis to join our executive team. He comes from a global consulting background focused on assisting companies and individuals in managing change, bringing over ten years of experience and unique skills to our team. As I mentioned last quarter, the core challenge for Bio-Techne will relate to the pace at which we can align businesses and teams to collaborate and lead in comprehensive solutions combining reagents and instruments in our strategic markets. Emphasizing change management, culture, and collaboration will accelerate our scientific goals. We are excited to have various partners on board to help us enhance our performance. With Peter indiscernible now part of our executive leadership team, it is complete. Many new members come from larger organizations and have previously held substantial roles regarding revenue expectations. They are motivated by the potential and opportunities here and are enthusiastic about building a remarkable company that enables scientific advancement. Now, I will turn the call over to Jim for more detailed financial insights before we open the line for Q&A.

Thank you, Jeff. As on prior earnings calls, I will provide an overview of our Q1 financial performance for the total company and then provide some color on each of our business segments. As mentioned in this morning's press release, there is a slight modification to our segment reporting in this current quarter. This modification is the movement of the company's Bio-specific business into the biotech segment, which completely reflects the recent acquisition of Cliniqa and its commonality to the customer end market for Bio-specific influence. This change reflects the management and employee changes. All comparisons to prior periods will reflect the new reporting structure as this existed in the prior reporting period. So starting with the overall financial performance for the first quarter, adjusted earnings was down approximately 10% compared to the prior year, at $29.4 million. Bio adjusted EPS was $0.79 a share versus $0.88 in the prior year. The impact of currency translation was a headwind to EPS by about $0.03. Under GAAP, EPS for the quarter was $0.61 compared to $0.64 in the prior year. On the top line, Q1 reported sales were $112.4 million, an increase of 4% year-over-year with organic growth of 2%. First quarter sales included approximately 6% growth from acquisitions and a 4% impact from foreign exchange. Moving on to the details of the P&L, total company adjusted gross margin came in at 70.6% in Q1, down 150 basis points from the prior year. Approximately one-third of this decrease is due to the impact of currency translation, and the remaining decrease is due to product mix exchange associated with the acquisitions that occurred since last year. Excluding the impact of acquisitions and foreign exchange, gross margin modestly improved year-over-year in the first quarter. Adjusted SG&A in Q1 was 23.2% of revenue, and R&D was 10.1% of revenue, 360 basis points and 100 basis points higher than last year, respectively. The increases in these operating expenses were driven by the acquisitions made since the beginning of the first quarter of last year and have increased adjusted operating expenses for the quarter due to organic net investments that were under $1 million. Resulting adjusted operating margins for Q1 were 37.3%. Adjusted operating margins excluding the impact of acquisitions and FX were approximately flat compared to Q1 of last year. Looking at our numbers below operating income, net interest expense in Q4 was $0.4 million compared to $0.1 million of net interest expense last year. The increase is the result of drawdown on our line of credit that was partially used to fund acquisitions in the month of July. For the down of P&L, adjusted other non-operating income for the first quarter was $1.2 million compared to $0.5 million of non-operating expense in the prior year quarter. The improvement on this line is due to favorable transactional currency exchange fluctuations. Our adjusted effective tax rate in Q1 was 30.9%, up 20 basis points from the first quarter of last year due to acquisition mix. In terms of returning capital, we continue to pay our dividend, totaling $11.9 million for the quarter. Average diluted shares were up less than 200,000 shares in the first quarter, but there are 7.3 million shares outstanding representing less than 1% dilution from the prior year as a result of stock option grants. Turning to cash flow and the balance sheet, $31.8 million of cash was generated from operations in the first quarter, and our investment in capital expenditures was $6.1 million. We ended the year with $83 million of cash and short-term available-for-sale investments, down $24 million sequentially from the end of Q4 of FY 2015. Our long-term debt obligations at the end of Q1 stood at $164.4 million, an increase of $52.4 million from the end of Q4. Both the decrease in our cash position and the increase in our debt obligations were driven by the acquisition of Cliniqa this quarter. That rest of my comments on total company performance for the first quarter, now I'll discuss the performance of our three business segments, starting with the Biotechnology segment. Q1 reported sales were $75.7 million, with organic growth of 4%. Foreign exchange negatively impacted reported sales growth by approximately 5%. By geography, both the U.S. and Europe increased in the mid single-digits organically, with Biopharma sales continuing to be strong with growth in the high single digits and academic and government growing modestly in the low single digits. China experienced solid organic growth in the mid-teens while the Pacific Rim was down 8% year-over-year. As Chuck noted earlier, excluding Japan, the Pacific Rim grew in the mid-teens. Adjusted operating income for the Biotech segment decreased 3% in Q1 compared to the prior year, and adjusted operating margin was 51.9%, a decline of 100 basis points year-over-year. Foreign exchange currency translation negatively impacted adjusted operating income by 7% and operating margin by 150 basis points. Thus, excluding the impact of foreign exchange, adjusted operating income growth this quarter is commensurate with organic revenue growth. Turning now to our Clinical Controls segment, sales in Q1 were $20.4 million, with reported growth of 7% over last year. The acquisition of Cliniqa accounted for 18% of the growth, while organic revenue declined 11%. As Chuck discussed, the decline in organic revenue was due to the timing of OEM shipment schedules, and therefore we believe is not indicative of the current market conditions or future revenue growth expectations for this division. Adjusted operating income for the segment decreased 23% in Q1, and adjusted operating margin was 23.1%, a decrease of 890 basis points from the prior year. The decrease in adjusted operating income was directly attributable to the loss of contribution margin on lower product sales. Meanwhile, the lower adjusted operating margin is attributable approximately 50-50 to lower volume leverage of fixed costs and the acquisition of Cliniqa, which currently has a lower margin profile than our organic business. However, we expect these margins to improve substantially with larger OEM orders we ship later in the year. Moving on to our Protein Platform segment, net sales in Q1 were $16.3 million, with reported growth of 26%. Revenue from acquisitions, specifically from ProteinSimple for the month of July and from CyVek for the entire quarter, accounted for approximately 21% of the growth. The negative impact of foreign exchange translation decreased revenues by 5%, resulting in organic growth of 10%. Organic growth in the quarter was driven by the Biologics product line as well as consumable sales within the Simple Western product line. Adjusted operating profit for Q1 was a negative $1.2 million compared to positive $2.6 million one year ago. As Chuck explained earlier, the additional month we had from ProteinSimple this year that is in July, had relatively small sales as many instrument businesses due in the first month of the quarter. The month of July had full SG&A and R&D expense run rate alongside it. Additionally, the operating expenses of CyVek were not in our figures this year for Q1, creating an impact. Thus, ProteinSimple's July results together with CyVek's Q1 results added $2 million of revenue for the quarter year-over-year but decreased adjusted operating income by approximately $3.9 million. The first quarter of the fiscal year is historically the lowest revenue quarter for this business. Thus, we expect the Protein platform to be profitable for the full year as revenue increases sequentially in the following quarters. That concludes my prepared comments. And with that, I will turn the call back over to Tina to open the line up for some questions.

Thank you. So first of all on your operating margin, you've talked in the past, excluding further acquisitions, you expect this business to be about a 40% operating margin business. I just want to clarify is that – does that expectation now include or exclude stock?

It excluded before and it excludes now. So...

So it's a cash number.

Right.

Okay. And then my follow-up question, Chuck, can you give us a little bit more color about how we should think about the cadence of the Protein Platforms business throughout the year?

So we are looking to ramp up our operations in the north direction. As we mentioned last quarter, we faced several challenges with our commercial order base and experienced a loss of about 50% of our sales force during that transition. However, we anticipated some of this and the startup environment in Silicon Valley contributed to the changes. While we did see some employee turnover, we also experienced growth. We have a new leadership team in operations that I previously mentioned, which has brought us back to the full capacity we needed this quarter to move forward. We improved our approach to leveraging order invasion and have engaged our R&D systems since we have a significant customer base and dedicated following that aids in collaboration. We're integrating more of this into our market strategies. This quarter has started off well, and we believe it won't take more than one or two quarters to rebound to our desired goals, particularly on the western side. The Biologics market remains strong, and we do not foresee any issues there. I believe we should be ramping up again; despite the challenges, the situation is still better than last quarter. Our objective is to achieve a 20% growth rate quarter over quarter, and we are confident that we will reach this by year-end.

That's helpful. Thank you.

Amy, good morning.

Yeah, me too. So I guess...

Good morning guys. And thanks for the color on the segments and the moving pieces there. But I guess can you give additional color on the margin progression by segment through the rest of the year? I think a lot of them kind of struggle to model the first quarter, but how should we think about the margins progression through the rest of the year?

I'll let Jim handle that.

Yeah. Hi, Jeff. So if you look at the price segment, the way we think about it is our overall Biotech segment. I think the margins where we are at today are consistent with where you would expect to be going forward. They could go up 100 basis points perhaps in that range without any material difference in the Biotech division. From a Clinical Controls perspective, we have some of the OEM shipments come through that will have a nice pull through and leverage on margin. So I would quantify that our margin profile in that business should creep up to the upper 20s. It won't hit 30 because Cliniqa has a lower margin profile than other businesses did historically, but I would say upper 20s this year is kind of our expectation. Jumping to Protein Platforms, again with the first quarter being the lowest one we usually see, we should see some nice leverage pull through on that going forward. Our operating margin expectations would be in the mid-single digits, I’d say.

Okay. That's helpful. And just on the revenue side, given the shift in revenue between the segments, can you give us an update on how we should think about the organic growth by segment over the next few quarters?

Organic growth for Biotech, we have kind of been where we felt we expect to be in mid-single digits, and we will continue in that range for Biotech. There are possible upside opportunities based on new deals, new things we are working on, new products, and new strategic directions, but mid-single digits is the estimate. I think again, mid single-digits will remain at or slightly higher single digits in Clinical Controls, especially with the OEM shipments starting to significantly impact overall performance. The biggest impact will be coming from Protein Platforms as James just mentioned. If we can get back to those 20% growth rates or better in the Simple Western platform, we think we can reset to mid-teens to nearly 20 overall. This expectation is very possible. Last year in this quarter we had 30%. Given the early cycle of this business within the company, it’s hard to pinpoint exactly, but we expect at least 20% by year end as we have strong technology that is being leveraged in this aspect.

The only thing to add is that we expect double-digit growth overall across segments if we can align our resources strategically. The last quarter was flat, and we expect growth to pick up steadily in the quarters to come.

Got it. And just one quick last one from me, on the Japan business. What gives you confidence that that's going to see some recoveries? Is it just what you are seeing on the government funding side, or is there something else there?

Really good question, and we've dug into this hard. Overall, taking Japan out of the equation, the rest of the Pacific Rim looks great. We had the best quarter we’ve had in a while, and despite Japan's issues, we are already having Peter in there digging in. He has strong contacts due to his experience. The whole AMED thing, or the consolidation of their three organizations that act like the NIH here are supposed to be bearing good results, we are seeing improvement in funding going forward in the next quarter and maybe the second quarter after that—the restart is beginning to happen. That gives us confidence. Plus, there aren’t any incumbent suppliers in Japan, everyone has to import. Hence, they are running out of stock. There was a de-stocking issue that really happened for two or three quarters due to massive changes in currency, but that’s going to change and correct itself soon. We see some of that already, but it is definitely taking longer than we thought; then again, it always takes longer than expected in Japan. My entire crew is aware of these issues. We have navigated this challenge and are confident it will recover.

Thanks. Good morning, guys.

Good morning.

Good morning.

PrimeGene, you guys have obviously been pretty strong there for the past year while some other tools companies have struggled. Can you walk us through the confidence on why that's going to be sustained, and should we expect an acceleration back up to the 20% level?

Sure. I'll give you some color on that. In the last quarter, we had a really great quarter in China, 35% incremental growth. Thus, segments have a bit of balance, in terms of market demands, we’ve shifted our portfolio greatly. PrimeGene is doing better than we originally planned—it’s wonderful, with another quarter of around 40% growth in China for domestic output. Jim and I were just there about a month ago, finishing up at the new GMP-ready factory, which is gorgeous. We have audits occurring already, and that’s why people are gravitating towards us. So it’s going to continue to role as an R&D systems kind of branded counterpart in the region, with quality being foremost. While we have OEM relations with more products increasingly picking up, we are very close to our acquisition model. Overall, we are at our trajectory in terms of PrimeGene growth going forward.

Okay. And then on the acquisition front, has there been enough multiple contraction over the past couple of months for areas that you thought were out of reach that may be in play now?

No, this question has come up in several peer calls and it’s too early to tell. People are better off now. We are really happy that valuations have come down, and there are fixed year little changes we’re considering for acquisitions. There remains a lot of deals, and we are continuously augmenting our product and offerings. While some good synergies from new offerings are appearing, we're still not simply pointing to the discounts we’re seeing now, but we will explore potential acquisitions cautiously.

Thanks, guys.

Hey, good morning, guys. Just a follow-up question on ProteinSimple. In terms of what you touched on, you've seen some sales and changes, but is there anything else we should be aware of? I don’t know if there is anything on a competitive landscape that’s changing in terms of maybe people leaving before or not—anything else driving that variable?

That’s really a great question. As far as competition, regarding the team and quality, I can assure you that proactive engagement is fundamental here. Any concerns that arose in previous quarters related to production cycles have been resolved now. I think we have everything back on track. Thus far we haven’t experienced any technical issues; the development team remains firmly intact. We anticipate concerns around competitive assurance will fade soon. I see no other real risks outside of general commercial operations. Overall, our team is now back to full strength and transitioning well.

Got it. Okay. Thanks. And then, obviously, the questions usually around purchasing patterns—some of the smaller biotech companies have contributed to concerns. You're not directly involved with the techno companies, but can you refresh my memory on what you're seeing regarding those smaller biotech companies’ R&D type spending patterns?

There’s not an overarching soft slide impacting new warnings that would give us cause for concern.

Yes. Okay. And then just last one on the OEM shipments. I think you mentioned the business would deal with this, and while they'll come through the P&Ls, can you project where the distribution will primarily be next quarter or should we consider this a more dynamic issue going forward?

I’d confidently say that the OEM trend was something we discussed that would be a balance based on tremendous shift during the next couple of quarters, along with how we are adjusting teams for overall performance. We have a plan for accomplishing this and while the impact may be somewhat irregular, the long-term outlook remains strong for the Clinical business due to what we have in our pipeline, which we remain optimistic about yielding a solid performance.

Hi, Chuck, how are you?

Great, Paul, how are you doing?

Good, I don't need to press star one or just press one in the future. You had mentioned, Jim, the talk around the gross margin impact from these OEM shipments and ProteinSimple costs, etc. What was that both from diagnostics and from ProteinSimple?

What I can share is that for the Protein platform segment, gross margin basis, if we average margins by over 300 basis points on the acquisitions. And for our Clinical Control division, the gross margin impact of the acquisition was actually slightly positive but operating margin saw over 300 basis points drop—almost 400 basis points.

Okay. Very helpful. Thank you. And then where do you think you are on your online capabilities right now? While Abcam has been deploying this strategy for a long time, I know you've been building that capability up; are you in the first innings or the third innings? What’s your comfort level on this go-to-market strategy?

Let's start from where we were two years ago, needing to regain momentum with a website that gives customer experience and something better than before. I would estimate we have gained traction and are likely six years behind Abcam, who had begun much earlier. But in these two years, we have come a long way; we’ve caught up by around two years at least. It's not the quantity of products but rather the quality and data behind those products. We need to develop that component over time. With the Novus Group here, we're doubling our IT team to handle what we need now, and we're in acceleration mode. But in terms of innings, if we are talking baseball, we are probably in the third or fourth innings at best. The best is yet to come, and we've already started seeing benefits—our traffic is increasing, and I firmly believe it's early yet.

And then lastly, regarding the level of contribution from acquired revenue in the remainder of the year, what's your round number on that?

Are you referring to Cliniqa?

Yes.

What I can tell you about Cliniqa is that when we acquired it, it was approximately of the size of Meldas in terms of revenue.

Good morning, gentlemen. Just a couple of questions. First, can you quantify or give us a ballpark for the OEM shipments that pushed from Q1 to Q2? Are we talking a couple million dollars, or was it even more than that?

Our organic rate was around 2% to 3% and should have been in the—should have been in the quarter. So we’re talking a couple million or a little less.

Okay. And then with those shipments, it sounds like a majority anyway from Q2; is that simply based on how you've modeled Q2, or does the push-out to Q2 reveal delays that might impact reorder schedules?

I would generally say that our profile right now for this division has a higher stake in revenue in Q2 and Q4.

Okay. All right. And then one last question, regarding the new antibody you recently announced—how should we think about how those antibodies will ramp? Is this a model like before, almost an annuity-based stream, or is it going to be a little lumpier?

I think it will be steady and low and consistent like we are known for.

All right. Well, thank you everyone for attending. Should be an interesting quarter going forward. And we will be talking, I am sure, throughout the day here as well. Thank you.