Bio-Techne Corporation (TECH) Earnings Call Transcript & Summary

All right. We'll get started. Thanks, everyone, for joining us. I'm Patrick Donnelly, the tools and diagnostics analyst here at Citi. I'm going to have Jim Hippel with us, CFO of Bio-Techne. A lot to cover, but obviously, some topical news this morning just in terms of you guys closing -- or sorry, starting to close Wilson Wolf.

Yes.

So yes, maybe just a quick update on what triggered it and your thoughts?

So as a reminder for those who may not have followed it closely, we had a deal with the owner of Wilson Wolf, John Wilson. Wilson Wolf makes the G-Rex, which is a critical component in -- we think is the future of cell and gene therapy manufacturing, kind of like a bioreactor that's the size of your laptop as opposed to the size of capital room, where our proteins -- or GMP proteins are used in addition with media to grow up cells after they've been reengineers, so to speak, but before they put back in the body. And we've been partnering with Wilson Wolf and their G-Rex on a joint venture called ScaleReady, also with the Lovo Fresenius Kabi on kind of an alternative system -- closed system for cell and gene therapy manufacturing now for, I think, a couple of years. It's been more of a sales consortium joint venture where we shared sales group to sell our products as a solution. And we always saw Wilson Wolf as a great fit with our company. It obviously melds very well with our proteins. And I think it was a year, 1.5 years ago, we struck an agreement with John to eventually acquires company first with an auction that we paid him to buy 20% of the company. Once they hit certain financial thresholds and those financial thresholds was either $92 million of revenue or $55 million of EBITDA. And yes, that's $55 million EBITDA and $92 million of revenue. Very, very highly profitable company, and that would trigger us buying 20% of the company. And then once we bought 20% of the company, it was pretty much a locked-in deal that when they hit 100 -- I'm sorry, $226 million of revenue or $136 million of EBITDA, we would purchase the remaining 80%. And that 80% would be a price taking around $1 billion and the initial 20% is like $236 million, something like that. So that was the arrangements of the deal. We also said, hey, we want to make sure that if it doesn't hit those thresholds at the end that we can still buy this company at some sort of price. So it was agreed to that if by fiscal year '27, if those targets aren't met, we would purchase the company at 4.4x trailing revenue. The good news today that was announced was that, that very first threshold was hit. They hit $55 million of EBITDA in the month of January on a TTM basis. So we are now going through the legal process of closing that first 20% purchase. So it takes the optionality now completely off the table, and it's a done deal. We will own 20% of it, and we are locked-in on our earn-out to purchase the remaining 80% one way or the other, whether they hit those targets or whether time based in 5 years or so, they don't, we lock-in at 4.4x revenue, which is a hell of a multiple considering their very strong profitability. So that's really, really exciting. That's the exciting news for us this week is, anyone who -- and understandably so would have thought, hey, there's still some concern or some questions of whether that deal will actually happen, it's -- that's -- there's no -- it's happening. So...

Yes. Okay. And yes, I guess going back to the call, I mean, my take, which was obviously wrong, was Chuck seemed like maybe things were getting pushed out a little bit. I mean was it just a big ramp in February for them? What kind of played out?

The reality is, it's lumpy. In all these emerging markets, cell and gene therapy, are you liquid biopsy, even spatial biology, these are all emerging markets. And I think everyone believes these are going to be huge markets 5, 10 years from now, but they're still emerging. They're still in their infancy, and they're lumpy by nature in the early days. So you might have a couple of big orders that make -- that you don't repeat that same time for the previous order. And so it's lumpy, and that's how it has been for his business. And he had some -- based on his visibility of what customers are ordering, it's swayed over the past year of being as early as maybe September, October of last year to being as late as July or August of next year. And then all of a sudden, December came in very strong for him, and we went through the analysis of his results, and he was still just shy of missing it, but he knew January was going to be a bit stronger, and it was going to be just enough to push it over, and we validated that these past few weeks. So that's really -- the reason for the variability is simply because of the lumpiness in the early days of this business, but it's not small business by any means, given they hit $55 million EBITDA, but relative to what it's going to be, it's still small and lumpy.

Okay. That makes sense. Maybe we can jump to kind of the core business. You guys reported a few weeks ago. I know it was a little light of what you were hoping. So maybe you can talk through maybe some of the moving pieces in the quarter and then we can kind of bridge that to the go forward, maybe we cover the quarter first.

Yes, sure. Well, so I mean, first of all, I mean, China was -- it's 10% of our revenue. It's historically like clockwork a 20% to 25% grower for us, and it grew like 4%. So that's a $5 million or $6 million kind of headwind, right? We'll talk about China separately. I'm sure we will. So leave off the table for a moment. The -- I'll talk about the positives first because we have a high level of confidence in the underlying strength of our end markets and our position, not just in the future, but even today. And what gives us some confidence and the one of the things we track very closely is something we call our run rate business. And as you know, a very high percentage of our revenue profile is consumables, and within those consumables, particularly within our reagent business and our assay business, the average order size is under $1,000. So every day, we are selling tens of thousands of products to hundreds of thousands of customers. So understanding how they're buying real time gives us a sense of how strong the underlying fundamentals of the market are. And we track that and we track what order size we've arbitrarily picked like $10,000 order size. If it's under $10,000, it's considered hand-to-mouth kind of run rate. If it's over $10,000, they're probably buying it for a project or something large. So bottom line is that, and that -- by the way, that run rate business of our consumables, as I talked about, proteins or antibodies or assays, it's roughly 75% of that total is run rate business. That run rate business has been double-digit growth for us the past 2 quarters, the first half of fiscal year '23, despite our reported results. So where we've had headwinds from a year-over-year perspective has been on our large reagent orders and on our instrument side of the business. And in some ways, they act similar and that they're large orders, so they require approval processes internally and so forth. But when we actually looked at the reagent side and dug deeper, it was really interesting to kind of see that literally, there was half a dozen or so orders that occurred last year that were over $1 million a piece that did not reoccur again this year. And those -- one was an antibody order. There was an assay order. There's a couple of protein orders. The only common thread was that they were all smaller biotechs. And one was for a vaccine start-up, one was for a therapeutic start-up. And what they were working on, they felt like they had success, those orders would continue. But apparently, they didn't either have success or they've prioritize something else. I think only 1 of those 6 companies that we know have actually went out of business, the rest are still buying stuff on a daily run rate basis. And your next question might be, how did you not have more visibility to this? And frankly, that large reagent order business is probably the piece of our business we have the least forward visibility on. And the reason for that behavior of our customers, when they want to buy a very large order of reagents from us, unless it's custom, they know we have it in stock because it's still not very much volume in our freezer. And they'll come at the very end of the quarter and place an order on us, and they know they can get it without having to tell us way in advance. So that's part of the reason we didn't have the visibility. The good news is that as we looked at last year and started looking at these large orders we have from these small -- these handful small biotechs, they do become less as the year progresses. So as we get into Q3 and Q4, there's less of them. So the headwinds become less going forward. They're still there, but there's less of them. Flipping over the instruments. So we look at our instrument growth last year across our 3 main platforms, which is the Maurice biologics platform, Simple Plex platform, Simple Western platform. Collectively, all 3 of those grew 30% last year, and we've never message at that our instruments will grow 30%. So it was kind of a crazy quarter for us. And you step back even more big picture, you look about a year ago, what was going on? Vaccines were at their all-time peak. COVID testing were at their all-time peak. Private equity money or equity money in general portfolio in small biotechs were it's all-time peak. So our customers, particularly in biotech, were flushed with cash, and they were pulling in research projects. They were doing additional research projects. It wasn't normal. And what's happened now a year later is, we're getting back to normal. It's not the biotech is going off a cliff, it's back to where it was pre-COVID, honestly. And our run rate business within the biotech is just as good as it's always been as good as anything else. So it is -- last year was just abnormal for the reasons I just mentioned, and it was reflected in our instrument portfolio. We went and looked at our instruments. 40% of our growth last year in instruments came from the small biotechs. A lot of those were going into a vaccine stuff. And like I just mentioned, for the large bulk reagents. I see it as very positive for our business and our -- and the industry as a whole that we were able to not -- we didn't shrink. We were actually able to hold our own year-over-year, despite those biotech customers not reordering instruments this year. They're ordering consumables, but not ordering instruments, and we were able to replace those with new customers and hold ourselves even while we get past that difficult comp. So that's really what's playing out. It's tough comps, but I'm trying to give you some color as to why they're tough comps, and why underneath -- once we get past those top comps, the underlying momentum the business will shine through ultimately.

Okay. A lot to go through there. I guess kind of picking up right way you left off there in terms of that underlying growth, right? You kind of remove some of the moving pieces, you remove the comp. You said, we're getting back to normal. I guess, what is normal? I think when you look at your guys' long-term guide in terms of the teams, right, in terms of the revenue side. So is that what you're seeing kind of as you said, like the reagents piece that's growing still that? And then you just have some noise on the instruments and the large piece? What's the right way to...

Well, I'd say, I wouldn't maybe call it biotech normal, but it's more like the funding environment for biotech is kind of back to where it was. I'd say, for us, it's more about what our longer-term expectations were and are we still following that trajectory of longer-term expectations? 2 years ago, when we usually came out with our revised 5-year plan, we said, hey, in the first half of this 5-year plan will be low double-digit growth. And when these emerging markets are selling gene therapy in particular, as well as liquid biopsy, we really start to tether inflection point in the outer part of that 5-year period, that's where you see the growth accelerate. I guess what I'm saying is that if you look at it on a multiyear CAGR basis, you take out the anomaly of last year, we're actually on that same trajectory that we thought we would be.

Okay. Yes. Okay. And then I guess another kind of logical jumping off point is just that small biotech piece, right? Maybe just talk through what the exposure looks like there. Obviously, that's been a focus for a little while now just in terms of funding. So how do we think about your exposure? Where is it kind of most pronounced? And what is it for the whole company?

I mean, I think we have a decent exposure. Exposure is something that's a bad thing. We actually see it as a good thing. But academic is tomorrow's biotech, biotech's tomorrow big pharma, right? So we don't necessarily see it as a negative, but yes, I mean, a good -- we put it this way. Our source of revenue from smaller biotechs relative to a lot of other life science companies in our space is a lot higher. We're in a discovery mode. So we have highly valued products by those customers, close relationships with them like we do with academic, and so it's a natural translation for us as they compare to like some -- call thermal, for example, where they are much more heavily bent downstream towards bioprocessing, things of that sort. So they're going to have as a percentage of the revenue much higher -- a much higher proportion of big pharma. That all being said, what I would like to tell you, we obviously sell to all the big pharma as well. Our top 30 or so pharma customers had over 30% growth last quarter. So we're doing very well there, too. It just happens that our mix is slower, is more on [indiscernible]. We are still foremost a discovery-based company and that's where more discovery in totality happens in biotech than it does firm.

Okay. And then you were kind of talking through, obviously, the [comp set] dynamic last year. Maybe some of the, I don't want to say over-purchasing, but money was a lot easier to come once back then. I guess where do you think we are in the digestion period of that, right? I think 2 quarters ago, you guys had some issues in China, then it was Europe. Looking back in hindsight, was some of that related to this? And we're almost out of it? What's the right way to think about just the visibility into -- is it just getting through the comps? How do you think about just the recovery path of those markets?

Yes. I mean, I do think it is about getting past that bolus of, I call it, COVID halo revenue. We were one of those companies that called out COVID specifically, even though we could have tried to come up with something. But the reality is, it was that we had a halo effect like others have as well indirectly, if not directly. And it's a matter of getting really over that hump. And as it pertains to these larger reagent orders, we see less of those in the back half of our fiscal year than we had in the first half. In the case of our instruments, the good news by our instruments is that the actual funnel for instruments is the largest it's ever been. So the interest in our instruments is as high as it's ever been. And you may have heard Chuck or one of us mentioned in the last earnings call that the cycle for closing that funnel has lengthened. But you got to kind of step back and say, relative to what, right? Relative to what it was pre-COVID, it's probably about the same. Relative to what it has been the last couple of years, yes, it's lengthened because it was abnormally short the last couple of years because everyone was like desperate to get what they could because they were afraid they couldn't get it or in the case of our instruments, which provide massive productivity into their labs, if they couldn't be in their labs 5 days a week, they wanted that instrument to get that productivity up. And they wanted to get it now as supposed to wait for 4 or 5 months because they were concerned that maybe they wouldn't get it 4 or 5 months at the parts [indiscernible], even though we never gave them a reason for that concern. So I think it's really about getting past that anomaly of halo that we had last year.

Yes. Okay. And then maybe on the -- kind of on the biotech orders. I know in Protein Sciences, you called out some of the kind of the bulk orders that haven't necessarily reorder. You talked a little bit about that. I mean do you have visibility into when that kind of comes back a little bit? Is it dependent on biotech funding? What's the right way to think about kind of as you analyze and look and say, all right, that happened last year, maybe just doesn't come back when we just get back to a normal baseline.

Well, and again, it's tough to say. We still have bulk order, right? And 25% of our, call it, our wet reagent business and the assays is still bulk orders. It's just to have that size and concentrated view is what was unusual. I think it almost the type of orders that you would expect to see a few years out when cell and gene therapy really starts to max and you get some really big volume orders, not necessarily now when most of us in preclinical and early clinical stage. So I think that's what we expected all along and that's kind of thing we expect going forward. Some of this stuff was, I would say, pulling because it wasn't -- most of it hasn't been selling gene therapy. It was other types of therapeutic drugs that were being explored, but there was just a lot of maybe speculative stuff going on because there was a lot of money flushing out, right?

Okay. Makes sense. And then China, obviously, a big topic with you guys. When that recovers? What it looks like? I think Chuck were joking about it earlier. I think he used the word explosive. It's coming. So I guess, what do you guys seeing there? Have we bottomed out? What's the recovery path look like? Again, obviously, Chuck is thinking it's pretty steep, but why don't you talk about what you're seeing there?

I think it could be very steep. I mean, I think why would Chuck would say that is if you step back and look at -- there's a number -- there's 2 or 3 factors to this. The first is, if history is any lesson and usually it's a good lesson to start with. Go back to the spring of 2020 when COVID first hit in China, and China was basically shut down for a quarter. And then COVID quickly faded away from China, and they immediately reopened, and we went from minus 6% growth to 50% growth in -- practically in one quarter. It was that kind of -- there was this massive pent-up demand to get caught up in the research projects and so forth. And I think we think our customers were working double shifts and everything else. If they're working, they're buying our stuff, they're using our stuff, right? So we've seen that happen in the past. And I think why we're even more bullish about coming out of what's happened here recently is because this wasn't a one quarter shutdown, this has effectively been a 2- to 3-quarter rolling shutdown first caused by the government shutdowns and then finally by COVID itself. So you can argue that pent-up demand is even greater, and we'll take later for -- it will take longer for that pent-up demand even get caught up. If using the analogy, people are working double shifts to get caught up, it will take longer to catch up from where they were. And the third piece of this for me is, the integrity of our team there in China. They've been spot on through this whole crisis with regard to the ups and the downs, the ebbs and the flows, and they told us at the end of Q2 that we got a one more tough quarter in Q3. It's going to be a tough quarter because people are still sick. They're getting well, but they're still sick. And by the time they -- most of them start getting well, we'll be well in the Chinese New Year, and no one's coming back until after the Chinese New Year. So it's going to be a heck of a deficit in the first half of the quarter, but their bet was to become roaring back in the second half of the quarter, just not enough to make the quarter look good, but it sets up very well for Q4. And here we are, whatever it is, 2 weeks or so past that Chinese New Year kind of cleaned back, and that's exactly how it's playing out so far knock on wood. So it gives us a lot of optimism. And then you add on top of that, the whole stimulus potential, which is more around our instrument business in China. And that's another layer of tailwind that we see more so as we get into fiscal year '24.

Right. Okay. So kind of as you were saying, right, January, you had between COVID and the New Year, very low growth as Chuck kind of talked about on the call. But since we've seen kind of the "reopen," things are tracking well in terms of that sharp ramp that you guys...

Correct. Correct.

Okay. And then I know even in terms of in-house, I think you guys talked about like 80%, 90% of employees had COVID. What are you seeing kind of inside your own company? And then again, just the trends generally that you're watching? What are the right metrics we should be looking at in terms of China recovery?

Yes. I mean I don't know what metrics are made public to really to follow. We're fortunate we've got a 200-person-size team there that is a good barometer, and they have a very good insight into their customer base. Everything we've learned all along is that what's consistent with -- what's happening with our employees there is really consistent with what's happening with our customers. So yes, up to 90% of our employees at one point all had COVID, and they said, as far as they could tell other customers were in the same way. Fortunately, very fortunately, none of our employees lost lives, unfortunately, some of them [ losing ] their loved ones, but no lives were lost, and they were hearing the same from their customers. So if you're hearing about a less fatality rate, all that appears to be true based off of our small sample size, which is all good news as well. And so -- and again, what our teams are telling us is that people are rapidly getting well. In fact, there's way more people well now than there is sick. So they're also saying that locally, they believe there might not even be a wave 2 or wave 3 that wave 1 was so big that it kind of took care of itself. So that's kind of what they're saying, and they're saying that it's going to come back strong, filing the reopening after Chinese New Year. And again, we're only a couple of weeks into it, but so far, so good.

Okay. And maybe just remind us just in terms of the exposure in China, what you guys sell over there relative to the corporate average? And anything jump out that's worth talking to?

Yes. I mean within our Protein Sciences segment, we sell everything. We sell in Europe and the U.S. we sell there. As well as our spatial biology platform, the NGS we sell there. We are more instrument focused there. So even though as a company, our instruments are like 10%. In China, it's close to 50% of our revenue in instruments actually. And while that's interesting or perhaps, important in the near term is because the stimulus that they're coming out with, which was like $1.7 trillion, but more importantly, I think RMB 200 billion is earmarked towards life science instrumentation given that, that's a large percentage of our profile there, that bodes well for us in terms of our absolute China growth opportunity in fiscal year '24.

Yes. And yes, maybe on that stimulus point. I mean, is some of that baked into guidance? How do you think about capturing as much of that as you can? What's the right way to think about how you guys are approaching that in terms of strategy?

Well, we're going to go after it, and we can, of course. I think we'll be able to quantify this a lot more definitely by -- I'd say, definitely by the end of our fiscal year here. We'll just be kicking off our planning process next month and real time, what we're hearing is that tenders are starting to come in. Our team did tell us they expect the tenders to start flowing in after the Chinese New Year, and that's starting to happen. And by the time we get to the end of our planning process in May, June, they should have a pretty good handle on what that volume looks like, what the pace trajectory is, what the customer mix looks like and what that then means for '24. And we'll message that as softly as we do -- at the end of the fiscal year.

Okay. So the stimulus part, probably more fiscal '24 just given where you're...

Yes. I mean, I think we talked about. Some of it could be pulled into the end of Q4, but the reality is, is that it can be a 3-, 5- to 6-month tendering process because you first got to go out and -- you got to determine what you want to get. You got to get quotes for what you want to get. Then you got to send it to the government for an application, and it is government and so that takes time for that to come back with an approval and then an order and so that's why it's a 3- to 5-month cycle.

Okay. It sounds encouraging on China. Maybe on Europe, I know that had some issues over the last couple of quarters as well here and there. You guys actually performed really well there over the prior few years. So maybe just update us on what you're seeing there. I think you opened a new facility in Ireland and things like that. So maybe just kind of updated thoughts on Europe, what you're expecting in the next quarter or 2?

Yes. I mean, Q1 and Q2 was a little bit a tale of 2 different quarters for Europe. Q1 was a very rough quarter for Europe. We shrank the mid-single digits. I think what was unique there was twofold. One was the whole situation around energy concerns around that with Ukraine War and so forth, and that really tightened the reins on spending across the board in Europe. So I think that was a bit unique to them versus, say, North America. We talked about this vacation impact that I think was real. I think there was more pronounced in Europe than it was in the U.S. So that was something that was more unique to them. And then in Q2, they rebounded very nicely and had mid-single-digit growth as opposed to downward growth in Q1. Obviously, the vacation headwind is behind them, and arguably, the energy concerns were abated. They're not even gone away, but it didn't pan out to be nearly as bad as what they were worried about. So I think that was a tension release that allowed funding to free up in general. So I think they're now behaving more similar to, call it, North America, which is -- they have the same challenges in biotech that North America has. That's not a North America unique situation. They're strong in pharma, just like our U.S. business is strong in pharma. And interesting enough, our academic business is actually stronger than our academic in the U.S. So that's actually held up pretty nicely. So it's Europe and it's always an area that because it's not one entity like the U.S. is, it can be a lot more variability, but we do feel like the worst is behind us in Europe as well.

Yes. And just the funding over there, you feel pretty good about the visibility. I know there's questions over the past 6 months about just generally to your point, given the energy potential crisis seems mostly...

As long as that stays abated, I don't see anything unique outside of -- at the end of the day, they're pharma companies or global pharma companies, just like U.S. global pharma companies, their biotech is going through the same funding normalization that our U.S. biotech is. If there's any differences because it's based off of government funding, it would be on the academic side. And like I said before, their academic has actually been more or less stronger than the U.S., actually, interesting enough. So yes, barring any deterioration there in the macro environment, I don't see any major headwinds ahead of them.

Okay. No. So I mean it sounds like both geographies doing pretty well. Obviously, in the U.S., we have a pretty good handle on. I mean I think there were some concerns after the quarter. Yourself, probably your biggest fear, both at kind of subdued results, and there's this fear that whole market is kind of pull it back. Doesn't sound like that's your belief, it sounds like there's more comp dynamics that things should recover.

And that's -- I'll go back to what I started with, which is that's why we monitor that run rate business so tightly because we feel like that really does give us a good handle on fundamentally what's going on as well as our order book or our funnel, so to speak, for our instruments. And those dynamics are still very, very strong to support a double-digit growth rate in the intermediate and longer term. So it gives us confidence that it's one thing to say you have a tough comp, there's nothing to really understand why it's a tough comp and why it won't necessarily repeat. And I think we have a much better handle on that now. Arguably than we did last year when it was actually occurring, and that maybe didn't start to [indiscernible] a little bit in terms of the good times last forever. But I think our 5-year plan was based on very fundamental longer-term macro conditions within our industry and our -- more importantly, our position and the strength of our platforms and the low market penetration, and that hasn't changed.

Yes. Okay. That's good to hear. And maybe just we can flip over to exo for a bit, and I definitely get to the margins and other stuff for you as well. Maybe on exo, just talking about the trends you've seen, it seems like the volumes are doing pretty well. I think you got some expansion on some coverage last week or 2 weeks ago. So maybe just talk about that business, what you're seeing and some expectations there?

Yes. I mean that's by far the bright star we have in our entire portfolio right now. It's going to be 3 years behind schedule. We thought we would be initial we bought exosome, but we had faith in that platform with that technology, and we have faith in our team to be able to execute. And once we could particularly pass these COVID headwinds, we're really seeing it start to materialize in a big way. So yes, you mean 70% growth -- more than 70% growth in our test counts. That's been consistent now for 4 or 5 quarters in a row. More than 100% growth in our revenue. The reason why the revenue growth is higher is because we're getting more for tests, we're being more and more private coverage. It's helping that average test price come up. We talked before about what's driving this. It takes time, but it also takes the right message, the right marketing. We have the right team with the legacy surgeon management team now in control of it, and it's just -- it's really just rapidly getting implemented into the urologist workflow. And what excites me the most is still be the untapped potential of it. So despite these growth rates we've had in the past year, 1.5 years, we're still like barely scratching the surface of what opportunity is out there. We estimate that somewhere between 15% to 20% max of all urologists out there haven't even tried our product once. So there's a whole 85% to go after there. But even taking that off the table for a minute, I call that upside. And the reason why I call that upside is because if you actually look at the urologists who have used our test more than once, which means they're starting to adopt it into their workflow, the average test per doctor per quarter is right around 5 tests per quarter. But you look at our doctors that have been with us the longest, it approaches 30, 40, 50 tests per quarter. So we're talking about a potential somewhere between 5 and 10x potential improvement just within the doctors that we currently serve as they continue to adapt that into their workflow. So it's going to be huge. And on top of that, I'll mention -- we just recently got the approval from Medicare for the recurring monitoring use of this test. So even after you've had a negative biopsy, if the parameters for taking this test still persists, you can still have this test done every year. And that opens up another 1 million patient per year opportunity for us.

Okay. And maybe just on like the private payer ramp. Like you said, it's been a little slower than expected initially. But I guess talk through where we are, maybe it's percentage of test getting paid, whatever it is and how you continue to build that out over the next few years and where we can get to in the near term?

Sure. I mean, the biggest -- I think the biggest catalyst or lever we have for us going into next year has been a recent hire that we did in the last 3 or 4 months, where we really got some really strong expertise in the industry, who comes from the other side of the big 5 players and knows exactly how they think and what it takes to get to solve the goal line. And I mean already, he's -- this individual is getting meetings with the big nationwide insurers that we can never get a meeting in. So he knows the exact steps we need to take, what process you have to follow, what they're going to ask for, what we need to provide them. And he's got -- he knows him all and he's got a reputation, personal relationships, which goes a long way in this area. So we're able to recruit him in and you can see saw the upside potential of it all, and so we're very encouraged that we'll see some inflection points there as well in the next year to 18 months on that private payer side.

Yes. Okay. And exo is a pretty natural progression into margins since that has caused some noise in there. I guess maybe we can start there. How do you think about the exo? Obviously, it's been a headwind. It's getting better and better. That's the right way to think about that impact on margins and then we can kind of segue into the fall.

Well, as exosome continues to grow like it has been, it's no secret that it's still not making money, it's still losing money. But relative to what other diagnostic companies lose, I'm telling you it's a drop in the bucket. And we intend to keep it that way, meaning not get anywhere ever that worse that and soon return -- or soon get to profitability. And the reason why we have confidence in that is even just with the prostate test, which is going to be our main revenue driver for the next 5 years, hands down, that there's not a whole lot of additional investment we need to make there to make that successful. The good thing about the urology market is that it's very centralized in key centers throughout the country. So I think we have a -- we actually -- we paused hiring in our sales force all through COVID because there was no point. And in the last 6, 9 months, we've almost doubled our sales force. But we're not talking about hundreds of people, we're talking about 50, right? And that's -- our team believes that's pretty much all it takes to make -- to get the right coverage. And so there's not a whole lot of additional investment that's needed commercially. And as that revenue ramps, what that means is, at a very high gross margin, by the way, you're talking about 80% gross margin on those kits much of that drops to the bottom line. So we see within -- I'd say within a year or so of breakeven and then beyond that, some nice contribution to the bottom line.

Okay. And then that was obviously one variable in the quarter -- recent quarters in terms of a headwind, bigger that becomes the headwind is kind of notable. Maybe just talk through the other moving pieces in terms of the margins. Obviously, pricing is one that's kind of on your side, things like inflation. You mentioned hiring. You guys were hiring aggressively. You couldn't even find enough people. So maybe just talk through the moving pieces and that kind of thing.

Yes. So I'll kind of explain kind of -- even though our margins in Q2 were slightly better than they were in Q1 and we talked about improving going forward, they were down year-over-year. So as a reminder as to why they're down year-over-year. It's not as simple as just one thing. It would be nice easy if life was that simple, but it's a number of things. And one is, we did do the Namocell acquisition. So we have an acquisition that wasn't there last year, and that's a temporary drag on margins. We have FX, which has been a major drag on margins because the FX headwinds that you see on the top line, 80% or so of that from a margin perspective falls to our bottom line. So that's a big headwind on margins. The inflation dynamic. I call it inflation pricing dynamic has been a headwind. So wage inflation was obviously very real this past year and to be competitive, we had to pay up. But we've also raised prices to cover that, but we've covered it on a dollar basis, not necessarily on a margin basis. So we're covering our inflation dollars per dollar, but when you cover it dollar for dollar, that's a drag on margins, right? So we have that headwind. And then a couple are another small nuances, but I'll mention another major driver, which is the profile of our hiring. So last year, everyone was still in the miss of not being hire fast enough, retention issues, and we had a growth plan to hire 350 or some people like -- something like that last year throughout the year. Almost all of them came in the last 4 months of the year. I mean that's when finally some of that retention was starting -- issue was starting to get better. We were starting to break loose on getting some good hires, and we caught up quite significantly, but we caught up in the very back end of the year. So none of that was in our -- said another way, our margins were a little bit artificially higher last year in the first half of the year because we had planned to have those headcount, and they weren't there. And we had a lot more folks leave the company that we anticipated also. So you can argue that our -- that part of our decline is more about last year being a little bit overinflated as opposed to this year being under, but those are the 3 main components of why the margin is lower year-over-year. More importantly, looking ahead, and we've been consistent on this message, we see it improving as the year progresses. FX, while still a headwind in Q3, it's a little bit less so. But in Q4, it becomes a much more minimal year-over-year impact because a lot of the drop in the foreign exchange rates occurred in like June of last year. The price inflation dynamic will be with us still, but the biggest driver will be that headcount that was not in our -- it was not in our run rate the first 2.5 quarters of last year will be in our run rate last year. Meanwhile, if nothing else seasonably, our revenue in the back half of the year is always higher than in the first half of the year. And so with higher revenues and kind of holding our headcount relatively consistent, we'll automatically see some margin improvement. And you may ask, well, keeping your head count relatively consistent, why is that? Well, obviously, our growth is slower so that's the reason. But a more important reason is, we hired all these people at the tail end of last year, and it's actually more than just these 350 people because retention was so difficult for everyone last year. It's like a big rotation. They call it -- it's really the great rotation is what it was and that people leaving work. The workforce I would say, they're all rotating, especially young people. We ended the year and we still have today roughly 3,000 people. We actually hired 1,000 last year, but only netted 350. So the fact that we were actually able to accomplish what we did last year with 1,000 people moving around is quite incredible. That's luckily have stabilized a lot, but now it's about getting that 1/3 of our workforce integrated, getting them productive, both on the innovation side and the commercial side. So there's really not a need for any kind of massive investment in new headcount right now. And because of that, we'll see our margins expand as our revenue continues to lift from here.

Yes. Yes. And I guess as you look into kind of next year and beyond, it seems like you took on a lot of margin headwinds issue. It seems like it's almost spring-loaded for '24, but how do you think about that path? I think you guys have the 40% number out there. How do you think about that path near term? Is just these headwinds abating? Exo, obviously, is probably a pretty big variable, but maybe just talk about that path.

Yes. And I'll be able to give much more near-term view on that as we get through our planning cycle for this year and see what people want to do for investments in that return. But it's -- if we end the year in that 38% range or so, like we believe we will, that's not that far from 40%. And I think we can still make some -- the investments we need to fund our future growth and be able to squeak out enough margin expansion each and every year to get to that 40%. We can make conscious decisions to get to 40% overnight almost if we want to, but we're balancing margin with growth. And we've always taken that very seriously, and we don't grow just for the sake of growing at the expense of margins, but we also will make the right investments to make sure we are a growth company. And I like to tell our leaders and our employees, it's one thing to grow, it's a whole other thing that have quality of growth. That's something that we pride ourselves on. So one thing you can always count on with Bio-Techne is, we will always take very seriously quality growth, not just growth for the sake of growth.

Yes. So maybe on that point, if you do see, let's say, China comes roaring back and you see some nice topline upside, how should we think about kind of letting some of that flow through to the bottom line versus investments? What's kind of the thought process there?

Yes, we're going through our prioritization process as we speak to get a sense of how the investment ideas rack and stack and what makes sense. So I really can't give any more color on that until we get through that process, except to tell you what our overriding philosophy is and theme is. And I think our track record for the 9 years proves that out. We've made 15-some acquisitions, which for a lot of companies that would destroy their margins. But for us, yes, we've had temporary dips in margins, but they've always come back as we have to run those businesses the right way, and we make money when we grow, not just grow.

And maybe one quick last one. Just on M&A, obviously, the Wilson Wolf deal. I mean how do you think about your strategy here? Does that eat up some capital in your -- on the sidelines? Are you still kind of looking? And what is the pipeline?

Well, we've got plenty of dry powder still even with the upcoming 20% purchase of Wilson Wolf. We've got a line of credit of $1 billion. So we barely tapped into that. So we got still plenty of powder and the opportunity set is the largest. It's always been active, but what's different -- feels different now is, there's more of a call actionable bucket or potentially actionable bucket. Whereas in the past, it was the last 2 years of COVID, but it was -- yes, we'll talk to you. Here's the price, if you don't like it, we're going to go for our next series around or IPO. There was no real discussion after that. Now there's real meaningful discussions around how you can grow together, create synergies, be part of something bigger. And so it's kind of like it was pre-COVID so it's still a lot more opportunistic in terms of the opportunity.

Okay. We'll leave it there. Thanks, Jim.

Okay. You bet. Thank you.

Thanks.