Bio-Rad Laboratories, Inc. (BIO) Earnings Call Transcript & Summary

[Audio Gap] With all the kind of muscle building we've done internally that we are better positioned to do something maybe more meaningful in terms of size. Now I think there's some -- maybe some confusion about what that means. And just to make sure that people understand that at the end of the day, we think about our debt capacity. And we think about, okay, what's the size of something we could reasonably do today given that debt capacity. And that's probably in the, say, the $4 billion to $5 billion range if we levered up. Obviously, with the idea that we would want to delever fairly rapidly. We don't want to carry that high debt for a long period of time. And then the question is use of equity. Given where Bio-Rad's share price is today, it probably is much less likely that we would use equity. There's always a possibility of using equity to maybe top up something, maybe a small amount of equity to top up something. Or if there was something that we were acquiring that was equally undervalued, then we might think a little more about equity. But otherwise, we're, I guess I would say, very protective of that and really understand that it's, in our minds, undervalued, which brings us to the third point, of course, which is share buybacks. And we've been actively doing that. I think we're up to around $200 million so far this year. You probably saw that the 8-K we filed, I think it was this morning; we've just done another round of buyback. So we're continuing to kind of look at that. So we've got all of these 3 pieces that places to prudently deploy our capital resources.

So multiple things I want to circle back to there. First off, your comment about using a larger amount of equity or something more equally undervalued. Everyone has their own way to value Bio-Rad's enterprise given the ownership in Sartorius. You can tax effect the back out, you can give it a liquidity discount. The eye of the beholder drives the calculation. But we calculate Bio-Rad as being about 8x EBITDA. What would be -- is equally undervalued is that in your industry? What would qualify for that?

Yes. I think it's a range of things. And when we think about the value, of course, we also think about how does it fit within what we're doing? How does it leverage what else we're doing? How can we leverage what that acquisition is within Bio-Rad? So there are a number of different ways to think about that.

I would add here then that obviously from a financial metric, when you back out the Sartorius stake, we believe that we are grossly undervalued. The share price is grossly undervalued, whether it's a multiple of EBITDA, whether it's about 1x of revenue, net of Sartorius stake. So we believe that it's still kind of underappreciated relative to what we believe should be the share price. And in terms of the transaction, as Norman mentioned, it depends what are the synergies, how can we leverage our own kind of infrastructure if you think about our underutilized manufacturing footprint, if you think about leveraging our go-to-market and global footprint in terms of the commercial team. So there are many aspects, the complementarity of the product portfolio. So there are many other aspects that we have to consider when it comes to an M&A.

And Ilan, it was a newer section at the analyst event that you framed your capacity at $6 billion, and that was at a future date with cash accumulation over time. Norman, you mentioned $4 billion to $5 billion. To be specific, that size range is assuming no equity. But you would consider equity for something bigger?

So as Norman mentioned, we may top it off to get to that size. I mean if you think about the sources today, we may be thinking to leverage potentially up to 4.5x of leverage ratio as opposed to a more conservative of 3x. We would like to maintain our investment grade rating. That's definitely a priority for us. At the bottom of the sources will be the Sartorius stake, which continues to be strategic for us. So if there is anything that we need to top it off, it will be with some equity as Norman mentioned, but it's not the majority. Mostly, we will try to kind of to fulfill with that.

And Norman, you didn't mention the Sartorius stake in your initial remarks. Am I then to infer that it's not only at the bottom of the list of sources but far at the bottom?

Yes. Yes, I think that's fair. I mean we continue to feel that's a strategic asset. I mean, obviously, we do have the ability to liquidate it if something more strategic came up, but we continue to think of that as strategic.

How would you characterize your M&A pipeline today?

I think it's about the same as it has been. There are several opportunities that are in the hopper that we're looking at in the kind of the small-, medium-sized range. So it'd be interesting to see kind of going forward, whether that -- those opportunities expand as we go into next year.

And Norman, can you remind us from a financial point of view what are the filters? Does an acquisition of size need to be accretive in year 1? Would you tolerate dilution early on for accretion later on? What is your thinking philosophically there?

Yes. So we would tolerate some dilution in year 1 or year 2, but it should quickly become accretive for us.

Does that apply broadly year 1 or year 2? Or are we specifically talking about revenue-generating assets? Because...

Yes, revenue-generating, revenue-generating. Because you're right, we have invested in a number of earlier-stage things that are pre-revenue which we feel have kind of tremendous opportunity for us, but it will take a little longer for those.

Understood. Well, I checked off all my bullets on the capital deployment section of the discussion. Perhaps we can now move to the meat of the business. You just reported Q3 results. Would -- I don't know if it would be a question for you, Andy; or you, Norman; or you, Ilan. It just highlights from Q3, you want to -- the key messages you'd want to make sure investors leave with from the Q3 results.

Yes. So I think for us, it was characterized by high demand, but supply chain constraint, I would say. And similar to Q2 in that regard, we did see improvement in our supply chain dynamics as we progress through the quarter. I think on the P&L side, we did incur slightly higher costs in the -- cost of logistics. We were expediting a lot, searching for electronic components, and so we're trying to move components in faster and product out faster. And overall, I would say as we move into Q4, out of Q3, we saw our supply chain improving. September was quite a strong month for production, and I think that's reflected in our Q4 and full year guidance as we finish the year. So we see no change really in our demand dynamics. We were -- in Q3, it was really a case of managing through supply chain. Ilan, do you want to add anything more to that?

Yes, some derivatives. Obviously, the elevated inventory level that we ended up the quarter, that will take us maybe a few quarters to work on, which comes with some elevated cost of components with these elevated inventories. So it will take 1 or 2 inventory turns to flush it into the P&L. Then the other dynamic maybe to call out is the foreign exchange impact. For us, generally speaking, we are not fully naturally hedged, but about 80%, 85% of the P&L is naturally hedged. I mean on the third quarter, we had about 5% impact on the top line headwind from the foreign exchange, which was translated to about, I believe, about $37 million. When it came down to the operating income, it was only about a $4 million headwind. So about 80%, 85% of that is kind of naturally hedged throughout the P&L. Andy mentioned the logistics, the elevated logistics, which it is a derivative of the supply chain constraints. And despite the fact that we do see some logistics costs basically and mostly in the ocean, that is coming down for us. Probably it's going to continue to be elevated. We still have some expedited shipments and more kind of air shipments, so that may take a little bit longer. And it was part of our lower gross margin that we guided for the fourth quarter. And obviously, we are mitigating it by managing our operating expenses, so we have not changed our operating income guidance.

So I want to follow up on the supply chain challenges, both as they relate to the P&L as well as operationally. But first off, on the P&L impacts, Ilan, I think you have north of 200 days of inventory on hand at any given time. So does that mean we ought to think about the elevated material cost inflation impacting the P&L into first half of 2023?

It might continue to impact going into 2023. I mean we haven't rolled up our detailed 2023 plan. But yes, as I mentioned, it will take 1 or 2 inventory cycles to flush it into the P&L, and it will be some headwind there. Obviously, there are other aspects that we need to take into account when we think about 2023 and beyond. And specifically for 2023, the revenue growth and the benefit of the utilization of the manufacturing footprint. So there are different aspects there, I mean, before we see kind of the overall gross margin for next year. But the inventory itself will continue to be some headwind to -- going into 2023.

And then from an operational perspective, Andy, what are the countermeasures you can put in place to try to combat the supply chain challenges and material cost inflation you're seeing?

Well, certainly, there's a price -- product pricing, which we have implemented, although that's taking some time to flush through because of the size of the backlog on some extended backlogs on instrumentation. So we do expect to see that improve a bit as we move forward. We put a lot of effort into procurement just like all our peers do. And actually, as we sit right now, we see an improvement in electronic components, and we expect that to continue through Q4. So I think we're pretty disciplined on procurement at this point in time. The components are faster to resolve on the Life Science side than they are on the diagnostics side simply because of the regulatory requirements when you're seeking alternative second, third source suppliers. So Life Sciences will certainly improve on instrumentation more quickly than the diagnostic platforms. So as we move into next year, we're looking at trying to improve pricing a bit to offset inflationary costs. But it's with inflation running in kind of mid to at least high single digits. You won't offset it all through price.

Has there been any impact on some of the efficiency and restructuring initiatives that you've targeted as a result of supply chain constraints?

I would say that our distribution network has improved. We announced at beginning of last year, I think it was the consolidation of our French plants out into Singapore, which we've been enacting in the middle of the pandemic and the supply chain constraints. Remarkably, I think, it has gone extremely well. And that initiative is generally well on track, and so we'll start to realize the full impact of consolidating that manufacturing into Singapore on the diagnostic platforms towards the second half of '23.

Second half of '23?

Yes.

And that is on track. I think at one point, I thought it could be a second half of '22 event.

Well, there's been a little slowdown because of inventory component issues, so we're extending our production in France for a further couple of quarters as we work on burning down the backlog. As components become available, as we're scaling up in Singapore, we have an inventory backlog, and so we've extended our manufacturing in France for a couple of extra quarters.

Understood. And we've touched on '23 piecemeal, but maybe just to take a step back. As you're thinking about the forward year here in mid-November, what are your broader -- or do you have any broader framing thoughts on 2023 that you'd be willing to share with the audience?

Yes. I would say that, first of all, with the current global environment, we may be sitting here 8 weeks from now, and many of these assumptions will be different, so it's a unique situation in my mind. But we are generally still in the kind of initial phase of our planning for next year, so we'll communicate more in the next earnings call, I mean in the beginning of the year. I did [ share ] some of the dynamics that is associated mainly with the supply chain constraints. I mean these are more, in our mind, transitory. Generally doesn't change our thinking in terms of our overall organic initiatives, whether it's the restructuring or the go-to-market and the growth areas. And it has to do even with our 2025 kind of target model that doesn't change anything in terms of our thinking about the goals and the targets that we laid out.

So a lot of uncertainty?

So far.

Yes. But I think a little less uncertainty than we've had in the past 2 years, so I think the markets seem to be pretty robust. People are coming out of COVID. I would think that you think about government spending, kind of a lot on the COVID side in the last couple of years, and I would think that money would be freed up from that now to continue to invest in health care and in science. So I think that's, for me at least, I think, a positive sign. You've got inflation. How is that going to work into the mix? Maybe a little bit of a headwind, but we will see.

I'd like to add a comment on that. I mean the strategy we laid out in the Investor Day at the beginning of the year is a very solid strategy. It's a multiyear strategy. We see no change in that. We see robust demand across the focus areas of the portfolio, the market segments we're focused on, new product initiatives that are coming behind to support some of those key areas. We just recently launched a new droplet digital PCR platform. We've got another one that we're working on. So macro level economic uncertainty is always the variable. But our focus, I think, is pretty well laid out at this point in time.

And to clarify, Andy, no change in the 2025 targets you laid out in February?

No, no. I think we feel pretty good about those targets right now.

That was coincident with the time Ilan top-ticked the deck market.

Yes, yes, yes.

I lean on you, Ilan for macro forecasting since that event.

Yes. It was a good timing, obviously. And we'll try to use it wisely, right? I mean that's the goal here.

So let's talk about some of those product categories that you're excited about, which drive the really robust revenue growth number you publicized for the business between now and 2025, and we'll start off on digital PCR. How material do you think the launch of the QX600 is to the growth curve? How important will the Dropworks product be? Just any sort of framing considerations to provide the audience comfort and the durability of that growth rate in the face of admittedly heightened competition.

Yes. I think they're both meaningful platform introductions. We've got a multiyear platform strategy for our Droplet Digital PCR and as we've got market segment penetration and we've got application expansion. I would say that the QX600 is more focused on application expansion. As a principle for us, it's got more capability for higher multiplex experimentation relevant for both biopharma and translational research. When we look at the Dropworks acquisition, it is much more about a market segment penetration, which is the high end of the real-time PCR market. And that's slated for the second half or late '23, and that's a sizable market. So as we introduce these platforms through time, they're extending application and they're changing market segment and price points. So you can see a more comprehensive and holistic platform strategy to go after an ever-increasing opportunity for digital PCR.

Am I to infer the application expansion angle of the QX600? To me, that also sounds like it could come with a larger -- a longer sales cycle because you have to develop the applications, prove the applications. Am I interpreting that correctly? Or do you think there'd be an offset.

No. I don't think that that's necessarily true. The -- I think there's a pent-up demand for taking the capabilities of Droplet Digital PCR into higher plex experiments, and so we just launched the platform in Q3. We see a very robust pipeline already, and that's a mix of existing customers who want that extra capability and new customers. So I don't see a significant shift in sales cycle on that.

And is that market opportunity where you start to encroach on the territory of next-gen sequencing?

I would say the low end of next-gen sequencing, where it's being used for known targets, I think that becomes within the reach of high-plex digital PCR.

And sticking with the broader new product theme, you have a couple of single cell applications in development. Can you remind us where you are in the development cycle? What we ought to expect in 2023?

Yes. We introduced, in Q2, one of the first products out of that called Celselect, which is an enrichment platform for circulating tumor cells. So that was introduced in, and we're starting to build a pipeline for that offering. As we move forward, we're still working on and looking towards introduction of single cell sample prep for sequencing. We see that in 2023. And then beyond that, there's potential, whether it's in [ NanaWalls ] or in droplets, to be looking at protein-protein interactions, cell protein interactions, kind of more multiomic opportunities in either droplets or NanaWall technologies that came from the Celsee acquisition we did a couple of years ago.

What are you doing to try to monetize the installed base of thermocyclers you placed during the pandemic?

Yes. The main action that we've taken on that front is the fairly significant deal we did with Seegene. Seegene has been a long-term partner of Bio-Rad and has been using our real-time PCR platform as part of their overall diagnostics offering, and we signed a significant agreement to access the North American market, leveraging their advanced assay capabilities on our core real-time PCR systems. So that's -- I would say that's the main focus that we have, and that is progressing as expected right now.

This would be Seegene's content on your instruments?

Yes. Seegene's content, Seegene's assays on our platforms in North America.

And how would Bio-Rad benefit from that?

We will be taking it fully to market.

Okay. So there'd be a distribution?

It's a distribution agreement. Yes, sorry, I didn't mention that. It's a distribution agreement, yes.

Understood. Could we talk for a moment about process media? That is a smaller product line for Bio-Rad, but it's a fast-growing product line, and that has probably been the top controversy during this earnings season across your peer set. What are you seeing in the process media market from a demand perspective? How can you gain comfort that the inventory stocking that some of your peers have seen isn't influencing at all the demand you've seen and you can be facing an inventory burn-down situation?

Yes. So far, we have not seen any evidence of that, and I think there is some distinction. We're more niche. And we're further down in the -- in the workflow, meaning we're doing cleanup of the proteins. We don't extend as far back up into the bags and some of the cell by processing. So a lot of our exposure is in advanced clinical trials or even commercial products. We have a relatively low exposure to COVID vaccines for our process chrome. So when we look at the demand for that, we still see a solid double-digit growth rate for process chrome.

Appreciate that clarification. So we only have 90 seconds left here, probably the time to ask a margin question. We spent a lot of time talking about products. You reaffirmed your 2025 targets. But perhaps for you, Ilan, can you speak to your conviction on expanding the margins of Bio-Rad?

So when you think about our organic initiatives and everything that we laid out in the Investor Day, I mean a lot of it is still in flight. I mean we accomplished a lot in the last few years, but I think everything else is still on track. I mean a lot of it still will depend on continued growth of the top line and the fall through, whether it's to the gross margin or through operating expenses to the operating income. But as I mentioned earlier, I think if you look at the growth areas, whether it's process chrome, as you mentioned, and DDPCR and on the diagnostics side, the molecular diagnostics and kind of the change in the overall growth profile for each of the business groups, we continue to be encouraged with achieving the 2025 target model.

Great. We're on time. We'll leave it there. Andy, Norman, Ilan. Thank you so much for your time. Thank you everybody.

Thanks for having us.

Thank you.