Bio-Techne Corp (TECH) — Q3 2016 Earnings Call Transcript

Good morning, and thank you for joining us. On the call with me this morning is Chuck Kummeth, Chief Executive Officer of Bio-Techne; and Jim Hippel, Bio-Techne's Chief Financial Officer. Before we begin, let me briefly cover our Safe Harbor statement. Some of the comments made during this conference call may be considered forward-looking statements, including beliefs and expectations about the company's future results. 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 in the 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 the most comparable GAAP measure are available in the company's press release issued this morning on the Bio-Techne Corporation website at www.bio-techne.com. And with that, I will turn the call over to Chuck.

Thank you, Dave, and good morning, everyone. Thank you for joining us for our third quarter conference call. This morning, we reported revenue growth of 15% for the third quarter with the majority of our end markets remaining strong organically, plus a solid contribution from our recent acquisition. I'm extremely pleased with the achievement of 8% organic growth corporate-wide, with our core Biotech business growing 6% organically. In fact, this is Bio-Techne's strongest quarter since I joined the company three years ago, providing evidence that the strategy to reaccelerate Bio-Techne's top line by growing our core business and expanding to adjacent markets continues to gain traction. Protein Platforms increased over 25% organically in the quarter with our commercial reorganization and focused strategy beginning to yield results. I'm also very pleased with our team's operational performance in the quarter with both growth and operating margins exceeding our internal plan, driving operating margins once again above 40%, and contributing to a 14% year-over-year increase in our adjusted net income. In our Biotechnology business, overall, we experienced broad-based growth across the portfolio with proteins, antibodies, and assays all contributing to solid performance. I would like to highlight the performance of our antibody portfolio in the quarter, which grew high single-digits overall, including a 20% increase in our Novus Biologicals brand. In the U.S., our biopharma end markets remain strong with revenue increasing mid-teens for the quarter. Our biopharma customers continue to partner with Bio-Techne for the outsourcing of complex molecules with our reputation for ultra-pure, highly bio-reactive reagents driving additional business within our existing biopharma client base and creating opportunities with new customers. Our academia and government end market grew in the low single-digits, similar to the trend we've experienced in recent quarters. We've been experiencing growth in this end market since the major update of our website last summer. We will continue to invest in the ongoing evolution of our website by making navigation improvements and adding content and active links to thousands of products that resonate with our academia customers. Since the release of our updated website, internal Internet traffic has continued to increase, and encouragingly, the visitors to our site are spending more time on the site, increasing the probability of ordering. We are also investing in search engine optimization to drive traffic to our website. These investments are starting to pay off with our Novus Biologicals brand, which was the first of our brands to use the enhanced website. Seeing an upper-single-digit increase in website visits and a mid-teen increase in web-generated revenue, overall, we are making tremendous progress with our website redesign and view this as a key for long-term growth within our academic customer base. Moving on to other regions, Europe organic growth was flat overall in Q3. However, underlying trends within our European Biotech business remain healthy. Adjusting for the timing of the Easter holiday, which occurred in Q3 this year versus Q4 last year, as well as the timing of some large biopharma orders, normalized growth rates would have been a mid-single digit increase. Thus, as these timing issues reverse in Q4, we expect to end fiscal year 2016 with a solid mid-single-digit organic growth rate for the year. China remains a very strong geography for Bio-Techne with organic revenue increasing in the mid-20%s year-over-year. We are particularly impressed with the sustained growth in China, especially considering the 30% increase we experienced in this geography last quarter. Our new GMP factory for PrimeGene is complete and fully functional, giving Bio-Techne the competitive edge in our China for China strategy and supporting our expectations for continued strong double-digit growth in this geography. We anticipate the growing Chinese middle class will be driving ongoing demand for improved access to healthcare, driving additional investments in life science research and benefiting our rapidly growing business in this geography. Overall, we are very pleased with the strong performance within our core Biotech product portfolio with Q3 representing the fourth consecutive quarter of at least mid-single digit organic growth in the segment. Getting our core back to consistent mid-single digit growth has been the most challenging and complex part of our five-year strategic plan, and I'm proud of our team's effort to get us there and have confidence in their ability to maintain this momentum. Moving on to our Clinical Controls division, we experienced a strong performance from our acquired business, Cliniqa, although the timing of OEM delivery dates impacted organic growth in the quarter. As a reminder, our Bionostics and Cliniqa businesses both include chemistry-based reagent product lines with longer shelf lives, allowing OEM customers to buy in bulk, introducing the potential for quarter-to-quarter volatility. Our legacy hematology controls business remains stable, growing mid-single-digits. Given the relatively shorter shelf life of our hematology control products, we view growth of these products as an indicator of stable underlying demand within our Clinical Controls end market. Cliniqa, a controls and reagent supplier for the diagnostic market that we acquired last July, continues to outperform our expectations. Importantly, the addition of Cliniqa to the Bio-Techne Clinical Controls division continues to open up additional pipeline opportunities for the business, making Bio-Techne an even more important supplier to the biopharma and diagnostics industries. Cliniqa under the Bio-Techne umbrella, we are now focused on filling and expanding the growing pipeline of opportunities for our Clinical Controls division. I would like to point out that the growth of our organic business combined with Cliniqa has created a business with critical mass and an annualized revenue run rate approaching $100 million. Lastly, the work we have done over the last couple of quarters to improve our Protein Platforms sales force and commercialization strategy is beginning to bear fruit of organic growth above 25% for the quarter. I want to update everyone on some of the positive developments within our Protein Platforms segment that give us confidence in our ability to maintain double-digit growth in this business exiting fiscal 2016 and beyond. Our strength in Simple Western sales force has been in place for two quarters now, and given the six-month to nine-month instrumentation selling cycle, I believe we are in the early innings of realizing the efforts of our strengthened commercial team. Additionally, we continue to augment the Simple Western sales force with the entire R&D Systems commercial team to generate leads, cross-sell, and demo this game-changing western blot technology. This game-changing technology continues to resonate with the scientific community, and we anticipate significant western blot share capture by automating a time-consuming, manual and poorly reproducible process that has been in place for over 35 years. We remain very pleased with the performance of Simple Plex product line within the Protein Platforms segment this quarter. As a reminder, this is the rebranded CyVek startup business we acquired a year ago in November, consisting of the Ella line of multiplex ELISA instruments and associated assay cartridges. We continue to see growing interest from our customers for the workflow enhancements that Simple Plex testing platform delivers. We remain in the very early stages of Ella instrument adoption and the associated revenue ramp, and anticipate Simple Plex to become a significant revenue contributor in future quarters. During the quarter, we strengthened our Protein Platforms offering with the launch of Maurice, an advanced imaging capillary electrophoresis, or iCE, instrument. All pharmaceutical customers utilize iCE instruments for the quantitative analysis of identity, purity, and heterogeneity. Maurice improves our legacy iCE platforms by delivering higher sensitivity, easier workflow, and shorter run times compared to legacy technologies, allowing researchers to shorten drug development timelines. We are very pleased with the early traction Maurice is gaining with biopharmaceutical customers with the initial launch exceeding our expectations. We anticipate Maurice to be a solid addition to the growing lineup of Protein Platforms instruments. We further strengthened our Protein Platforms segment through the acquisition of Zephyrus Biosciences, adding a single-cell western blot instrument we named Milo to our growing portfolio of instruments. Zephyrus is currently a pre-revenue business, although we plan to commercialize Milo in July of 2016. We view Zephyrus's single-cell western blot technology as a natural fit with our ProteinSimple business and are excited to leverage our Protein Platforms sales force to bring another innovative instrument to market. To summarize, we are very pleased with the Protein Platforms' overall performance in Q3 and believe we remain on track for continued momentum in this business in the coming quarters. Based on the sales pipeline and positive momentum in both lead generation and quote activity, we believe Q1 was the start of a new long-term trend of double-digit growth for the Protein Platforms segment. I also want to provide a quick update on our M&A pipeline. Following the Zephyrus acquisition, our pipeline of potential M&A targets remained stronger than ever with our strong balance sheet and cash flow providing Bio-Techne flexibility in our disciplined M&A approach. We plan to continue to augment our organic business with acquisitions that strengthen our position in existing businesses and geographies, or leverage our reagent expertise in adjacent markets.

Yeah. Thank you, Chuck. As in our prior earnings call, I will provide an overview of our Q3 financial performance for the total company and then provide some color on each of our three segments. Starting with the overall third quarter financial performance, adjusted earnings increased 14% year-over-year to $37.6 million, while adjusted EPS was $1.01 a share versus $0.88 in the prior year. The impact of currency translation represented a headwind to EPS of approximately $0.02. GAAP EPS for the quarter was $0.81 compared to $0.65 in the prior year. Q3 reported revenue was $131 million, an increase of 15% year-over-year, with organic revenue increasing 8%. Third quarter reported sales included a 7% growth contribution from acquisitions, partially offset by a 1% unfavorable foreign exchange headwind. Please note that the components of Q3 growth do not sum due to rounding. Moving on to the details of the P&L, total company adjusted gross margin was 71.6% in Q3, decreasing 80 basis points from the prior year. Strong volume leverage and productivity gains in our Protein Platforms and Biotech divisions were more than offset by the lower margin Cliniqa acquisition and unfavorable FX impact. Excluding the impact of acquisitions and FX, core gross margins improved 50 basis points year-over-year in the third quarter. Adjusted SG&A in Q3 was 20.7% of revenue, 30 basis points higher than last year. The SG&A increase was driven primarily by investments made to improve our website capabilities and commercial execution, as well as the additional SG&A from the acquisitions made since the beginning of the third quarter of last year. R&D expense in Q3 was 8.6% of revenue, 90 basis points lower than last year, reflecting the volume leverage achieved from Protein Platforms. The resulting adjusted operating margin for Q3 was 42.4%, relatively flat to prior year and a sequential improvement of 300 basis points from Q2. Looking at our numbers below operating income, net interest expense in Q3 was $0.4 million compared to $0.3 million of net interest expense last year due to higher draws on our line of credit, which partially funded our Cliniqa acquisition last July. Other non-operating expense for the quarter was $0.7 million compared to $0.4 million of non-operating expense in the prior year quarter with unfavorable transactional FX explaining the year-over-year variance. Our adjusted effective tax rate in Q3 was 31%, down 50 basis points from the third quarter of last year due to recognition of R&D tax credits. In terms of returning capital, we continue to pay our dividend and paid out $11.9 million in the quarter. Average diluted shares were relatively flat over the year ago at 37.3 million shares outstanding. Turning to cash flow and the balance sheet, $37.1 million of cash was generated from operations in the third quarter, a 20% increase from the prior year, and our investment in capital expenditures was $2.8 million. We ended the quarter with $84.6 million of cash and short-term available for sale investments. Our long-term debt obligations at the end of Q3 stood at $157.8 million, a decrease of $5.5 million from end of Q2. Going forward, our capital deployment priorities remain opportunistic M&A, our dividend, and debt pay down. Now, I'll discuss the performance of our three business segments, starting with the Biotechnology segment. Q3 reported sales were $81.4 million, with organic growth of 6%. Foreign exchange negatively impacted reported sales growth by approximately 2%. By geography, the U.S. grew approximately 10% organically with mid-teens biopharma sales growth and low single-digit academic results. Europe was flat organically with biopharma sales in this region increasing low single-digits, offsetting a low single-digit decline in academia. As Chuck mentioned in his comments, the timing of the Easter holiday impacted our European results, representing an unfavorable 3% impact to our growth in this geography. However, this timing impact should reverse in Q4. China experienced strong organic growth in the mid-20s%, while Pacific Rim declined upper single-digits year-over-year. Excluding Japan, however, the Pacific Rim grew in the low teens. Japan remains challenged by government funding reductions and delays. Adjusted operating income for the Biotech segment increased 1% in Q3 compared to the prior year. Adjusted operating margin was 55.5%, a decrease of 130 basis points year-over-year due to the timing of certain commercial investments, partially offset by the impact of productivity initiatives and volume leverage. Turning now to Clinical Controls, segment sales in Q3 were $29.9 million, with reported growth of 50% over last year. The acquisition of Cliniqa contributed 51% to growth, while organic revenue decreased 1%. As with prior quarters, the timing of OEM shipment orders introduces variability to the Clinical Controls segment, with customer ordering patterns weighing on our Q3 segment results. Given the quarterly variability introduced by the OEM ordering patterns from our chemistry-based controls and now Cliniqa, we believe a trailing 12-month organic rate is more indicative of our Clinical Controls segment performance. On a pro forma basis, assuming Cliniqa was included in our results last year, as well as this year, the trailing 12-month organic growth rate for the segment is 8%. Clinical Controls' adjusted operating income increased 53% in Q3; and adjusted operating margin was 31.6%, an increase of 70 basis points from the prior year. The higher adjusted operating income and margin were primarily attributable to strong volume leverage associated with the Cliniqa acquisition. Moving on to our Protein Platforms segment, net sales in Q3 were $19.7 million, an organic increase of 26% from the prior year period. Unfavorable currency translation impacted revenues by less than 1%. Growth in the segment was broad-based with most major regions and product lines growing by solid double-digits. The quarter ended March 2016 was the first March end quarter to grow sequentially from the previous December end quarter in the history of ProteinSimple, including the years predating the acquisition of Bio-Techne. We believe this provides further evidence that our new commercial strategy is taking hold, and the reacceleration of Protein Platforms has begun. Revenue from Simple Plex also continues to ramp, and we remain pleased with the revenue trajectory of this business. As Chuck discussed, we acquired Zephyrus Biosciences in Q3, and anticipate to commercialize the associated single-cell western blot analysis instrument, Milo, during the first quarter of our fiscal 2017. Adjusted operating income in Q3 for the Protein Platforms segment was $1.6 million, representing an operating margin of 8.1% compared to a $1.7 million adjusted operating loss one year ago, with strong volume leverage and productivity driving the year-over-year improvement. We continue to expect additional improvement in Protein Platforms' profitability as top-line growth and productivity gains drive operating leverage in the coming quarters. So in summary, Q3 was a record quarter for Bio-Techne on an adjusted bottom-line result, accomplished by solid commercial and operational execution in all of our businesses. We expect to finish the year strong as well, with Q4 looking very similar to Q3 from a top-line perspective. However, we expect the mix to change somewhat with the Biotechnology segment, in particular, facing a rather tough comp from the prior year when they grew 7% organically. Thus, the margin profile in Q4 may not be as strong as Q3 due to a change in mix. That concludes my prepared comments and with that, I will turn the call back over to Melanie to open the lines for some questions.

Thank you. So I just want to delve into the Protein Platforms performance a bit more. Can you talk more about the components of the growth there? I know you said it was broad-based, so maybe offer some color about how much of the strength was Maurice versus Simple Western, and any color on the consumable trends as opposed to the instrument revenue trends would be helpful.

Yeah, well, Maurice has a strong take-up here as the beginning platform, but it's still not material to the overall performance. Performance of the division really is still around Simple Western. We worked hard to get the commercial team really back into place and up to speed, and focusing on lead generations and productivity and cross-selling with our R&D Systems commercial force, and that's all bearing fruit. We really thought – we're near the 60 kind of number of instruments per quarter, and that's up from the 40s or so a year ago. So, it's pretty good growth there overall. The Simple Plex is also ramping and is close to plan. Still a small business, but not a startup anymore. It's starting to bear fruit. The revenue component in Simple Plex will be stronger in consumables, the assays being a strong component because it's a closed system. We remain at about a 25% consumable rate on the rest of the biologics platform. So, really, growth is really kind of across all the platforms, with the biggest component being Simple Western. Biologics has always been a strong platform, and even the existing product platforms are still selling well and Maurice is a new category, so almost the same size in general as Simple Western, but the acceleration of Simple Western outpaces biologics, of course. We could have a surprise going forward. Maurice is exceeding our expectations, but we are still banking on the fact that Simple Western will outdo it. It's a much larger market opportunity.

Got it. That's all helpful. And then my follow-up question, can you give us an update on how you're looking at Japan?

Well, the same way everybody else is, with a lot of prayers. So, we've been hearing that they're aimed at a new consortium of funding pharma. The government is starting to release funds. We're starting to see early, I guess, data from that. It's as much an issue of easy comps as anything, probably, but it's still early. I just – we don't – we're not banking on any strong, fast recovery in Japan, to be honest, and I don't think anyone else is talking about it either. I don't think we're worse off than anybody else; it's just a matter of waiting on funding. We're still growing. Actually, our team just came back from the Protein Platforms division, and they had a positive report on some uptake in Japan. But in general, it's kind of steady as she goes and just not enough happening, waiting on funding.

Thanks for the question. Jim, can you just verify, did you have any change in selling days in the quarter? I get the Easter impact, but were you kind of same year-over-year in terms of the number of days in the quarter?

Yeah. We didn't have any drastic change due to any kind of 4-4-5 calendar because we operate on a normalized typical calendar. However, admittedly, there was an extra day with leap year. So leap year was the extra day in February, which did provide an extra day of revenue there. It may have had a 1% or so lift. It's hard to say exactly.

Okay. So pretty minor, though. And just, moving over to – I guess, sticking with Jim, I guess, looking at the segment margins, given the moving pieces with Cliniqa and some of the, I guess, deals, I guess, can you just help us think about the segment margins maybe in the next couple of quarters? How should we think about modeling those?

Yeah. From a segment margin perspective, I would say that with regards to our Biotech and Clinical Controls divisions, fairly steady margins from what we've seen. It's more around Protein Platforms that we can continue to see some expansion there with the margin pull-through – with the net revenue pull-through. So like we saw from not only year-over-year, but quarter-over-quarter perspective with Protein Platforms, we saw some nice – very nice margin expansion there with the additional revenue. And as they continue to recover on the top line, we should see some continued leverage on their cost base. So I'd say steady – Chuck put it as steady as she goes in two of our three segments with some increasing margin pull-through in Protein Platforms. But also, keep in mind, the overall mix, with that reacceleration of Protein Platforms' revenue, the overall mix will be a bit of a headwind due to the low margin overall of PPD versus our Biotech division.

When you start doing the math, when you start doing your math on CCD, you're going to see the strong component tradition here from Cliniqa. We had a huge quarter for them. It didn't count organically, but it's there in the numbers, and it's big. It is a lumpier business, and we're going to go to a TTM kind of number. It won't sustain at that run rate this quarter. It's going to be up and down just to realize that. That would be – you're going to – $29.9 million is not a typical quarter for this segment.

Got it. Okay. Thanks, guys. That's helpful. Nice quarter.

Hi. Good morning. Just a couple of quick ones. So, first, I don't think you mentioned the Fisher distribution agreement specifically, I guess how that's gone this quarter. I know it's kind of been a little bit back and forth in terms of how much contribution it's had, so wondering if it was helpful and how you're thinking about it long term.

Well, we're still low single-digits in academia, which is still way better than it used to be. I think it's kind of steady as she goes there. I would say the Fisher performance as a component of that was marginally better than last quarter; still not as good as it was in the first early quarters in our relationship. Now, we are starting to hit some size issues here. It's becoming a larger and larger percentage share of our channel in the academia sector. I think if you compare it to their results overall, and we study their results and we talk to them, I'd say we came in under where they were at in their own performance. So, we're working through that. All-in-all, though, better than last quarter, so we're optimistic. And it is still a crucial element to our channel strategy and helping us keep our costs down in our commercial organization, and the attitude is good, cross-selling is good, and the teams get along. So, we're hanging in there with that. And it would be nice to see them break it out and do at least as well as they talk about their entire segment as a company at Thermo, but we have not yet achieved that.

Is there any specific driver of that slowdown or is it just a function of kind of being early in the relationship and working through, and as you said, just similar size?

No, it's not only that. I think we had some great preliminary results for five quarters, six quarters in a row, really. And I think what changed was a couple – the dynamics within their own company as they integrated Life Tech. One, you've added a lot of the portfolio. They've got a much bigger bag to sell, and it opened up opportunities internally, I think, for a lot of their rock star salespeople and their technical people. So, they've had more internal turnovers. So, people are jumping from the Fisher side to the Thermo Fisher division. And so we're having to train and retrain and get a more – more of a rhythm going with their salesforce. I think as a bigger issue, it's how much is in the bag and staying current with their technical workforce. Our portfolio is – it doesn't sell itself. It's very complicated technical reagents, and we trained their entire technical sales force from the beginning and we've got to keep the pace with that. And I think that's probably why it's been a little bit different the last couple of quarters, but it's coming back. We've identified the issues there, and they are very supportive and we're working on that.

Got it. Very helpful. Thank you.

Good morning. Congratulations on the strong quarter. A couple of questions from me. First, so if I'm understanding, in the Clinical Controls segment, you had some benefit with timing on shipments in the third quarter. Just trying to calibrate what that means for Q4. Is it – are you expecting something similar to Q2 at $25 million, $26 million or something similar to the year ago period with maybe a few basis points of growth so that would be closer to $21 million?

Yeah, Matt, well – we're not going to give a specific guidance by segment. I think what I would share with you is that it is lumpy and it's – so, in fact, we had strong orders out of Cliniqa, which doesn't count organically, but I mean, out of our legacy chemistry-based controls business, which, in fact, is organic. And going forward, it could be lumpy as well. But again, at a high level, what we will share is that we expect our overall company revenues to be similar in Q3 – or Q4. The mix between the business units could change a little bit. I think it will change somewhat in the sense that PPD overall revenue will be likely a lower percentage that's a negative mix impact. That's what we'll share.

And we will also – the hematology component has been and have been, and remains and will remain steady as she goes at 5%-ish growth rates, very much a run rate.

Hey, guys, it's Bill March on for Paul Knight. How are you guys doing?

Good.

Good.

First question, maybe if you could – you saw mid-double digit growth in the biopharma segment, what's driving the growth from that end market?

Okay. Well, a couple of things. When we worked hard at getting our core back in place, I mean, we certainly took some arrows over ProteinSimple a few quarters ago. But the harder part of this company turning around and getting it going has been getting this core because it is just so fragmented, as you know. We still don't have really any reagent products over 2 million, and we still have a customer base that is 1% or less in general. We typically have done a lot of prioritization since I've come here around what we're going to make and why, instead of just throwing 2,000 or more new products at the wall and see what sticks every year. We're substantially down from that now, somewhere around 1,500, but a lot quicker time to revenue. A lot more focus on the marking end of it and why there is going to be quick take-up. And part of that has been the trend, I think, in CRO. There's been a lot of custom in the industry, and Abcam reported a lot of custom going on as well. We're seeing it too. So we're getting on the Biotech pharma side. We're getting a lot of requests because we're a quality producer, we've got great scientists, and we were, in some cases, the only game in town for the things we make. And they're coming more and more for special things. We try to put as much of that into the catalogue as possible. It doesn't all go. If it doesn't go, it's always still a recurring revenue stream with that partner. And the thing I like, it's immediate sales. You're not waiting at all. So we've had a dramatic improvement in our vitality index. If you remember, though, our first year here, we reported about $2.4 million in first year sales. Last year, we reported $5.8 million. This year, we're probably well over $10 million, we're thinking. So it's been a dramatic improvement in the core, but also from custom and everything else, and it's largely Biotech pharma, which has been driving this double-digit growth rate when you start adding the numbers up.

Great. And then secondly, in terms of end markets, maybe on the academic side, what are you seeing from that end market in terms of with the new NIH budget and maybe what you see for the rest of the calendar year? Thanks.

Yeah, we're seeing kind of what everyone else is reporting on. I don't think we've seen too much of a take-up yet from that extra funding and spending. Maybe a little bit, but we're not really seeing a lot of evidence. We're – like everyone thinks, it's going to be really occurring mostly in the second half of the calendar year here. And we're hopeful. It should be – we've talked about what it should give us. When you roll it all through, when you go through our analytics with our customers, it should be about a 1% overall improvement for us. Is it there yet or not? Well, we had a record quarter, maybe a little bit there. It's hard to start separating the stuff under 1% like that.

Understood. Thanks, guys. Have a good day.

Well, very proud of our team. It was a great quarter. I'm sure hope it continues. We see a lot of – we see a very bright future here. People are having fun, and we'll talk to you again next quarter. Thank you.