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

All right. Good afternoon, everybody. I'm Luke Sergott. I cover life sciences tools and diagnostics here at Barclays. It's my pleasure to have with me Jim Hippel from CFO of Bio-Techne. It's been a long time. We're just commenting it's about 3 years for you. I'm glad to have you back.

To kick it off, let's start off just like real high-level thoughts of what you saw coming out of your quarter. The underlying market demand going into your guidance and -- we can start there and then dig in further.

Sure. I think I'll start on a positive note, which is that our underlying demand and the health of our end markets, we believe, are still very strong. And despite this print, what makes me say that is in the last few years of COVID noise, you got to dig a little deeper and kind of on what's going on. And 1 of the things we look at both strong times and strong times is the underlying run rate of our business. And what we mean by that is our core research use reagents that be in proteins, antibodies, assays. Fundamentally, it's kind of a hand-to-mouth business where people don't order in advance. They tend to order when they need it, and they know they can get 24 to 48 hours. So it's a pretty good measure of what the really current momentum is of the underlying health of the markets, we believe. And it's proven that way for the last 9 years that I've been tracking it. And when you look at that debt -- those 3 product lines of our business began all consumables, roughly 80% of that are orders under $10,000. In fact, the average order size is under $1,000, hence, the run rate. So if you take and bifurcate the $110,000 orders from the above $10,000 orders, roughly 80% of our business is under $10,000. We measure how is that growing year-over-year. And for the first half of the year, it's double-digit growth. So it's a very good sign to us that fundamentally, the end markets are strong. We're positioned very well and we're growing and we think we've taking share. What has caused both the ups and the downs from that kind of run rate, not only in the last 6 months of this fiscal year, but more ups and downs in the year prior, where the larger reagent orders that make up that 20% and as well as the ebbs and flows of our instrument business. And I'd say there's -- I'd say there's 3 key drivers to why the company's overall organic growth rate is lower than that fundamental double-digit growth rate that we're seeing in our core business. Not necessarily, I think they're all kind of equal in their magnitude. So it's kind of one by one. The first would be biotech funding, okay? So we -- a lot of course, I was talking about that. And yes, biotech funding is not what it was a year ago, but let's be real about what it was like a year ago, right? COVID testing was at its peak, COVID vaccines were at its peak, equity markets were its peak. Our customers and even our small biotech customers were flushed with cash. And frankly, they were spending a little bit like wild children, right? So I mean they were pulling projects. They were doing some -- some crazy things that we put in the perspective, we had half a dozen customers with orders over $1 million in are reagents in a single order. That almost never happens, particularly from a small biotech company. So they were working on these very large projects. We've got one by one. In this particular example, one was looking on the next kind of next-generation COVID testing kit that could test 5 minutes on under standing the line at a stadium. But then we all know there we got vaccinated won't seem to care about that anymore. Stuff like that, you go one by one is to kind of things that we're working on out there with all this free money and they've gone by the west wayside. The good news, almost all these companies are still in business. They've just -- they're just focusing -- really focusing on higher priority things making their money stretch out. And I would say it's not so much a slowing as it is a normalization. I mean, if you actually look at the fundamental spend our biotech customers are spending with us, with growth, it's kind of on par where it was pre-COVID. So again, I think it's as much as last year was an anomaly as opposed to this year as some sort of crush and blow as it pertains to biotech. But nonetheless, those very large deals, a few large deals we had with small biotech customers cost us several points of growth, I would say, on a year-over-year basis. That's number one. Number two, is we talk about our OEM business. And if you reference our pie chart that we have posted on our investor website, we say that 80% of our business is consumables. We say 48% is biopharma, 15% is OEM. And that 15% OEM, 2/3 of it, most of it is legacy diagnostic that's our hematology control kind of medium growth, but nice steady growth and very profitable. We don't talk about so much is that remaining 5% or 1/3 of that piece. And that -- what we call it OEM, but it's actually through our business, mainly antibodies, but also some proteins and assays. And these are reagents that we sell to other life science tools companies who use them as an input to their end product. hence, kind of a OEM. Yes. While those customers behave very differently than what I would call our retail researcher who buys hand to mouth. And if you think back a year ago, besides all the cash that was COVID cash that was floating around, the other big issue or concern or highlight was all the supply chain consumers, right? So everyone is stocking up whatever they could because they were just concerned about having supply. I know we were doing that among some of our supplies, even though we didn't have supply chain issues, we were doing it to be safe. No doubt that these OEM customers were doing the same thing. And we can tell because these same OEM customers, most of them also pay us a royalty on their end product. And those royalties have been trending just fine, but their purchases have come down dramatically year-over-year, and they were up dramatically year-over-year last year. So we do believe with that customer, and we're talking about millions of dollars per quarter difference. So we believe we're getting -- we're much closer to the -- at the end and the beginning of that inventory drawdown and it bodes well, I think, for fiscal year '24, and that's all behind us. That is number two. Number three, would be China as a category clearly. And we think we all know the situation in China. The bottom line is that we are historically over the last decade, a 20%, 25% goal in China. And last 3 quarters, we've been below 5%. We've been all the rolling shutdowns. And of course, this past quarter, everyone getting sick. So I think that's understandable. And again, that particular item is also, we think, a tailwind for next year starting in Q4, but definitely in the next year. We believe there will be a lot of pent-up demand as there has been in the past and these situations have occurred. And of course, there's also extra stimulus in China, particularly around instrumentation that we think will be an additional tailwind. So those are the 3 categories that are outside the 80% run rate business we have that are driving the kind of noise we're seeing right now. That's exactly why we carve our business out these avenues that can understand better [indiscernible] . And more importantly, how we think the project going forward.

Yes. Let's dig in on the China piece because you guys have talked about that a lot. So talk about your exposure there across the different end markets and how that differs versus the overall business. And then what you're seeing from a recovery already.

And I don't see this exposure. I see this as an opportunity. That was a China. So again, at a high level, clearly, the lockdown is very impactful this last quarter, everyone was home sick. But literally, there was like [indiscernible] no revenue for the first half of this quarter because they were told not to come back until after go to New Year, not just our everyone in the country. And sure enough, it's been a couple of weeks now, but since the [indiscernible] is over with, we're seeing sales ramp up. It's just not going to be enough to recover for the whole we had in the first half. When you look at the end markets, we talk about our biopharma and academic, we actually exclude China. It's in the distributor bucket that became, and it's largely because it's a very great line between academic and industrial in China because they all have some level of government funding usually, it's a matter how much. So we don't necessarily conclude that in that kind of end market view. But that being said, in terms of how we think about it going forward, our team there is feels very, very confident they'll get back to their plan in Q4, which for them would be back to normal 20%, 25% growth. Of course, we're pushing a little harder than that because in the first COVID shutdown occurred in 2020 when they fell down into like minus 6% growth, they came back at 50% growth for the following quarter. And now we're talking about 3 quarters in a row of essentially shutdowns, lockdowns, definitely lower activity, and there's got to be a lot of pent-up demand that we believe. And then on top of that, the stimulus, which was announced by the government is about $200 million -- sorry, RMB 200 billion that's directed towards life science instrumentation. And for us, instruments make up only 10% of our total company revenue, but in China, it's 50%. So that will be an accelerator, we think, for us, particularly as we get into the first fiscal -- the back half of calendar year '23 or the first fiscal half of our '24. Our team there is saying already after -- in the last couple of weeks, they're starting to see tenders start to come in for that process, but it takes 3 to 6 months for it to get through the system and translate into an order.

That's next question. So on the instrument side and the demand that you're seeing in China, is there a particular -- is it the high end? Or is it just across the end?

Yes, I remember our instruments based [indiscernible] most instruments are woven in [indiscernible]. I mean the open [ 50,000 ] to [ 150,000 ]. So generally speaking, there are low-cost instruments begin with. And I'd say it's across the board, but I think our Maurice instrument, which is geared more towards the bioprocessing production side is the fastest of the 3. Simple Plex, I'd say a close second.

Yes. Okay. On the academic government funding side, you talked a little bit about NIH exposure. I know it's a little small story, but how are you guys factoring that into your for next year? And any type of near-term conversations that you've had?

Yes. I mean, so again, as you mentioned, it's a lower piece of our product than it used to be. It used to be 50% of our business. 10 years ago, now it's 22% of our business. And not because we've lost business in academic, we just focus on other higher growth areas. I'd be honest with you, with our business and in the lost decade I've been here, we have never seen a very tight correlation between NIH budgets increasing and our relative growth. It's not to say it doesn't hurt or help. If it went big time negative, it would be a problem. But whether NIH goes 2% or go 7%, we don't see a tight correlation to our growth in academic. And I think the reason for that is that it's where that money is being directed from a ramp perspective is actually more important to us than the absolute dollar amount. And even though the budgets were -- the growth, I should say, the growth increases were higher during the COVID years, it appears and it wouldn't surprise me that, that was geared more towards infectious diseases because of COVID, our specialty, our suite spot is oncology and immunology. So even in an environment where budgets might be -- the growth might not be as high as it's been in the past in terms of increases, if it's being redirected more towards oncology and immunology, our growth rates could be -- we can see actually a tailwind from that. So it remains to be seen where that money gets allocated. But we [indiscernible] -- we feel like we're positioned very well space and generally speaking, COVID may have come and gone, aha, but cancer is still with us, right? So...

Yes. All right. And so talk about those higher growth areas that you guys really leaned into mostly on the biopharma side. So we have one of my favorite charts is the cell and gene therapy, the workflow that you guys have in all the different products. So talk about that piece of the business and how that's been impacted by the weaker biotech funding and then we go in more from there, too.

Yes. So when we talk about our cell and gene therapy, you talked about kind of a number of different ways, which obviously could be probably a bit confusing. We talk about it from like our business unit perspective because we actually have a business unit that's 100% directed towards the cell and gene therapy end market because the products are oriented almost 100% towards that market. And that would be our jewel -- our crown jewel or GMP proteins, but we also have media. We have our TcBuster tool and some other small molecule GMPs, much of different reagents that kind of feed in that space within that business unit. But the reality is cell and gene therapy is in itself the next kind of generation of called pharmaceuticals in general, therapies in general. And therefore, it touches our entire portfolio. So many of our instruments were being sold into cell and gene therapy companies because they do have a place in that workflow. Even our RNA scope is selling cell and gene therapy customers. So it actually does touch across our entire portfolio. And I think we did see particularly in our instrument side, we saw some outsized growth from that last year where the biotech funding was very strong. But because at end of the day, cell and gene therapy -- 90% of cell and gene therapy companies are smaller biotechs. So they kind of go hand in hand. But at the end of the day, our cell and gene therapy business unit still grew double digit last quarter on top of what was the 80% growth quarter of the year before. So even with the "slowdown", it's pretty tremendous growth considering dynamics we're talking about, about super amounts of funding last year.

Yes. And you both the GMP and the proteins and the other inputs. So you're involved in the clinical development. When does that stop? And obvious sudden go to see GMP and that's when you would lose the customer. And do you have any appetite to go further downstream?

Well, ultimately, our goal would be for our products within cell and gene therapy is part of the production process. And is a good chance they will be because if they're locked in the clinicals that no wants to change anything if it gets you through approval, you're pretty much locked in for commercial. So that's kind of the -- that's the end game is to get these into the taxable commercial therapies, and that's where the massive volume and frankly, that's why we built the GMP factory dedicated to this because we believe that we'll have shots on goal to get there. You're talking about a customer that might -- a big customer today that might buy $100,000, $200,000 worth of GMP protein for a year that could turn into $15 million a year, I think let's say go commercial. That's kind of scale. I'm sorry. So I'm trying to go back to the question of...

What kind of investments do you need to get to that GMP though?

I mean all those investments have been made. So it's in that $50 million GMP factory we built the feel for part about that is the yields that are coming out of that keep the better and better as we perfect making our proteins in a large scale [ Biotech ]. When we first built that sector, we thought it could make up to $200 million worth of GMP. Not all the minimum based on the increased yields we're getting in our first runs, the minimum is $400 million. And depending on the mix, it could be well over $1 billion. We may never even have to build on the GMP factory only for a very long time. both issue right now on that facility. It's still fairly low. But even though it's low, it's our GMP protein still has the highest gross margin Again, it's -- what you're talking about is depreciate that equipment. I think there's all 12 people in the factory. It does not -- it's all -- it's the overhead absorption developments.

All right. Let's switch gears to talk a little bit about the Wilson Wolf, you guys closed that. Walk us through the -- where that fits within the portfolio and initial plans for that business from the integration side.

I mean in some ways, it's already being -- from a commercial perspective, essentially isn't -- that was the whole scale ready. It's called the scale joint venture legally, but it really operates like a commercial consortium with really a joint sales force to a solution and end solution for the growth of sales in a bio [indiscernible] or in a cell culture device, which is what the G-Rex is with our proteins and our media and the closed environment. And it's what makes the G-Rex special is that number of very small size, not much better than your laptop or the different sizes and the amount of yield you get out of that is 10x, minimum of 10x that's out there because it operates to be contention as confection as opposed to the solution in terms of getting oxygen to those cells. So which is why, for example, we more familiar alternative that Rex would be using bags in these moving machines. You have to get air in there. Again, the G-Rex is at least 10x more yield than that on a per volume basis. But more importantly, as we -- Tom Wilson will tell you he is an expert in this area, has his own cell therapy companies in addition to G-Rex cells don't like to grow when they're moving. They don't like movement, they like to go still. So the G-Rex sits there into convention, the oxygen fills up. So it's -- again, the only reason why you get such a tremendous yield in a very small space, and the amount of those devices you can put in any given rooms, it's a multiplier on the throughput you get. We believe that G-Rex together with our reagents, becomes a standard or one of the standards it's what will make commercialization of these therapies actually possible because the now allows them to scale.

Okay. Yes, that's -- that's interesting. So then when -- as it's within a portfolio, is that just going to -- do you have opportunity there to scale it outside of the cell and gene therapy or just pretty much lean into that?

I think it remains to be seen. But right now, it is primarily in cell and gene therapy. I mean I think there could be some other applications for this for sure.

I think in general bioreactors.

Yes. Yes. I mean there's some -- we don't talk about it much because it's still a little bit of a car out there idea, but the technology would lend itself to a lot of different possible applications.

Okay. Turning the page here on a little bit on the margin side. You guys talked about that head count. Talk about some [indiscernible] elevated turnover in the industry. not being somewhat of a headwind to you in getting those people replaced and ramped up. Where are you in the development there?

Yes. So for the better part of 1.5 years coming into the end of Q4 fiscal year '22, it was -- I think everyone saw this hit back across all industries, but life sciences for sure, was saw a big time was the amount -- first of all, everyone was everyone was in for growth mode. So everyone was trying to hire. And as a result of that, plus the whole COVID situation, particularly people great rotation right? It seems like everyone under 5 years was -- so we were fortunately not immune to that, and there was massive break implementation. So not only could we not hire enough to support our longer-term growth plans in fiscal year '22, but we were trying to tread water and keeping up with our excess employee base. That started to dramatically improve we got in the back half of last year and especially we pretty much got up to fall where we expected to be, not quite to what we expected to be from a plan perspective in Q4. And so now we're focused on just getting those folks getting productivity out of them, right? I mean, we have 3,000 -- we ended the fiscal year with 3,000 people. We still have about 3,000 people a day because we had a total of new hires, even though the total head increase was about 350 people. We actually had 1,000 new people in the company. That's how much turned over to us. So think about that for a second 1/3 of our workforce was brand new going into fiscal year '23. So not only is it a cost headwind in terms of -- a lot of those people not being in our numbers in the first half of last year, but there's a productivity hit as well. And so this year is all focused about getting those folks productive, and therefore, seeing the margins ramp back up throughout the year. And therefore, Q1 being the lowest, but then in terms of the year-over-year perspective and then improving from there. And by the time we get to Q4, we still think there's line of sight to get to at least, if not as much as 100 basis points improvement in Q4 versus the year prior.

And the turnover, does that happen across the board? Or is there a particular...

Yes. I mean as you would expect, there are certain areas that get hit harder than others. I mean your scientific your engineering areas, particularly on the Bay Area, software engineers. Salespeople work [indiscernible] the hardest, but it was it was a dynamic across all functions. I mean those -- and it wasn't company specific. We go well enough talking to all of our peers that Frankly, we were we were selling other people's people as other people are still not feeling but rotating [indiscernible].

It sounds like the sell side.

Yes. Exactly exactly. The good news, but what I like to say is that it's improving. Now we did an improvement in Q4, but we've been able to keep our workforce at 3,000 purposely. So that tells you the attrition rate to drop off quite significantly.

Yes. And the reason I was asking about deposit salespeople it takes them roughly what 3 or 6 months to get up a speed.

That's the productivity comment.

Yes, absolutely. Yes. You really set up...

We're not making that [indiscernible] we have reasons -- specific reasons to what numbers are where they are. But my point is it can get better because of...

Yes. And it sets you up for a good ramp in the next year.

Absolutely.

Yes. last one here on M&A. You guys have always been acquisitive. Talk about some of the areas of your portfolio that you'd like to fill we've talked on a lot of these higher-growth areas. We didn't even touch on the 10 unit margins underneath the hood. So talk about stuff that you guys are looking at right now in valuations across the board.

Well, in terms of what we're looking at, it's how I describe it as we're not a consolidator. And even though we've done a lot of acquisitions, that's not our ambition like this to be a consolidator. And our vision life is to provide the broadest range of high-value tools to our customers that are close to the science that we know with the portfolio mix being the core of it, right? So that might sound on a high-value proteomics at its core, most of your science may sound on the surface relatively narrow, but it's actually quite a wide net because proteomics is the reagent in particular of the core of so much life science research in general, which has allowed us to get an instrument either reagents allow us to get into assays that our genomic some DNA and RNA, which basically that's what proteins come from, right? So it's actually still a pretty wide net, and we have that still cast quite wide for opportunities that fit that scheme. But I would say you're looking for a more specific answer, I mean, obviously, areas around cell and gene therapy in general. And yes, we have, I think, a very good chunk of it already. But there's always ancillary pieces of it that we don't have that would be interesting so -- so there's that space in general, I'd say, on the spatial biology side. We still think we have the best technology in the translational and eventually the clinical space. what we don't have is any kind of automation platform. And we're still in the evaluation phase as to how much we need that or don't need them because right now, our model is partnered with all the automation players. But there might be a time and a place to where having our own automation makes sense strategically. So that's an area we're keeping our eye on, just if there's a last trap out there that we think is the best one of that ourselves to a bill, another example. And then there's just the reagent space in general, and let's call out antibodies is a good example. Antibody is still a huge space and very fragmented opportunity for I said we're not a consolidator, but some consolidation there just in terms of getting into more areas deeper than we are today within.

All right. Great. That's all we have time for. Thanks again, Jim.

Okay. Thank you. For sure.