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

[Audio Gap] One is the biotech portion of biopharma, smaller biotech, clearly not spending at the levels they were, not at the funding levels they were 2 years prior, which I think everyone would agree was abnormal, given the situations of free money and COVID money floating around. So coming off of very difficult comps, where our Protein Sciences segment grew 20% as in the full year, the year before was a year we never expected. And looking back on it in hindsight, a lot of that excess growth, as I would call it, our kind of low teens CAGR was coming from those smaller biotechs. So that's one aspect of normalization that's going on in our fiscal year this year. The other item would be destocking, which is not something we normally would talk about, but we do have a small component, relatively small component of OEM business within our Protein Sciences segment that has key ingredients that serve other life science tools companies many of you would know all the names of, that use namely our antibodies as ingredients for products they sell. And we didn't talk about it too much because it's not a huge customer set, maybe 20 customers or so. But not only do they buy rather large bulk purchases of antibodies as an example but we also get a nice royalty from the external revenue from those products. So we have some good insight as to what's going on at the end customer level there. And what we saw last year was some tremendous purchases of very large quantities of these antibodies under the kit COVID halo and glow thinking, this is great, this is the new normal. And then all of a sudden this fiscal year, many of those orders just completely dried up, and we're like, "What's going on here?" We started looking at our royalty run rates and they were still doing just fine. So bottom line is when you look at the historical pattern, it became obvious as the year progressed, compared to last year, and you think back on what was going on last year, well, everyone was concerned about supply chain. We were concerned about it. We were stocking up on reagents for our products. I'm sure our customers -- those specific customers were doing the same. And now when we do the math, we say, "Oh, yes, it's pretty obvious. That's what was going on." They're still paying us very nice royalties or continuing to increase, so they're clearly destocking." And our math would suggest that should go away in the first half of next fiscal year in terms of -- they'll be at a point where they have to buy it from us again. Again, not a big portion of our business, which is why it's not -- we haven't talked about historically, but it's 5% of your business and it goes from nice growth to practically 0, it's still impactful. And then the third element, of course, will be China, and that's impacted all life sciences. It's historically about 10% of our business. So when that growth rate goes from a historical growth rate of [ 20 to 25 ] down to practically flat, it's a meaningful impact. But I think we all understand why that's the case there and better yet, how they're coming out of that very quickly. So...

Great. And I'm going to ask you a follow-up on each of those. First on the biotech funding, can you remind us what percentage of sales that is for you? And how do you see that playing out as obviously, we've had a month since the quarter, and I don't want you to comment inter-quarter, but just what's your anticipation of when that starts to come back?

So we estimate -- it's very difficult when you have really hundreds of thousands of customers, so we estimate that roughly 20% of our revenue comes from smaller biotech customers. Now it doesn't mean that they're all not well funded or they're all about ready to go broke. That's not the case because we don't know what their balance sheet looks like, but smaller biotechs. The headwinds that we have seen, we can actually probably count from about 12 different accounts that bought very large purchases with a lot of extra cash last year that aren't doing it again this year. We peel those out and look at the underlying run rates, in other words, the daily, monthly, weekly purchases from those biotech customers, they're still growing, they're just not growing at the rates that they used to be growing. So we think the underlying market is still very healthy. It's just not crazy like it was maybe the 2 years prior. And the good news also is that run rate appears to be rather normalized. So going into next year, when those large purchase headwinds are no longer in the rearview mirror, it should suggest that we should be closer to a double-digit growth rate. If the funding environment gets better for those biotechs, that could be a tailwind. The bear case would be, for some reason if it got worse, then it will be a bit of a headwind. But right now, we've seen it rather normalize in the past couple of quarters.

That's great. And then on to the inventory destock. That's great insight on the royalty. I had forgotten that you guys had that. First, what is that royalty growing? Is it still healthy double digit or does it come in a little bit -- it sounds like it's -- you've got good visibility on that. And then just you said sometime next fiscal year. Just we're talking about the end of this calendar year is where you feel pretty good about destocking no longer a headwind?

Yes. So with regards to royalties, I mean, I guess what we would say there is we're doing it as we would expect them to do. They've all done different structures. Some are tiered, so there's -- it's still healthy. It's what the growth rates have been and what we expect to see. With regards to the timing of destocking, our customers won't tell us exactly when they'll revitalize but based on the math, we think roughly half of them will need to restock, starting in our first quarter and the other half will need to restock by no later than the end of our second quarter. That being said, our math would suggest that if their stock would go to 0, they may -- they shouldn't wait to go to 0 to do that, so we'll see. But the headwinds for that piece would definitely start to dramatically go down in the first half of the year.

And then just a follow-up on that. Is there anything that would suggest the end markets are slowing? Because you play in a lot of these emerging cell and gene therapy, all the key buzzwords. And so it seems like there's a lot of investment going on in that space, but at the same time, there was a general market slowdown. And so I just -- you guys still feel comfortable about the long-term growth of all those markets?

Yes, absolutely. I mean I think -- again, slowdown is all relative, right? So let's take cell and gene therapy as an example. So we were growing almost 2 years in a row there, we were growing over 40% as a category across all of our products within cell and gene therapy. And we were growing 80%-plus in just our GMP proteins, right? So has it slowed down? Yes, it's about half of that, but it's still 20%-plus in the category and over 40% in the GMP proteins. And that's pretty much in line with what our longer-term expectations were anyway. So again, it's not so much that this year is a bad year, it's that last year, 1.5 years were crazy years.

And then just on China, what are your expectations there? I think a lot of us were expecting a Q1 rebound -- calendar Q1 rebound in China. It sounds like that's taking longer to come back. But how quickly does that come back? And how fast does it come back?

Yes. For the record, we didn't call Q1 as being a comeback. We knew Q1 was going to still be a rough quarter for China, and frankly, because we -- all of our employees were sick. And the government was saying, not to come back until after the Chinese New Year. So Q1, the surprise to me was that the team did as well as they did at low single-digit growth. We had a 30% comp the year prior. And again, we had almost no revenue for the first 6 weeks of Q1. So the fact they came back as strong as they did was remarkable, and that gives us a lot of confidence here going into last quarter of our fiscal year, the June quarter because now everyone is back at work. And there's a lot of research that needs to get restarted. And they're buying products left and right to get that rejuvenated again. So market in China looks great. In fact, Chuck and I were just there 3, 3.5 weeks ago, and it's just hustling and bustling.

Okay. That's great. And just kind of bigger picture, you guys had laid out kind of these long-range targets several years ago. And I think you talked about $2 billion in revenue. And just have you guys updated the Street on what your expectations are? Or is there a time that once you get more comfort on what's going on in the market, that will be updated?

Yes. So when we come across this next -- end of next summer, I think we'll be pretty close to the halfway point of when we put out those targets. And we're tentatively planning to renew what those targets might look like for the next 5 years and beyond, and within that, what the intermediate might look like. We always said that, that 5-year target was -- there was a J curve in there that had a lot of variability to the exact timing of when that J curve would hit. And that J curve was both the cell and gene therapy hitting that inflection point of commercialization as well as Exosome getting that inflection point of adoption. And without preluding this, what our new 5-year targets might be, in the case of Exosome, that was before COVID all hit. And so there was a year, 1.5 years delay just because no one was going to doctors. So that was part of the downside of that number. And the cell and gene therapy, honestly, that J curve could still hit sooner, it could still hit a bit later. But the long-term prospects we've always said are, if anything, looking back to where we are now versus where we were 2.5 years ago, we feel even more confident about those markets becoming huge markets in the future and our position within those markets. So I think you're going to hear some pretty ambitious goals coming out of our next Investor Day meeting, which we hope to be at the end of the summer.

Okay, great. And then as far as Chuck's role, he's announced that he plans to retire. And can you remind us on the timing and when you start looking to fill his position?

Yes. So he announced it almost a year ago and it was basically a 2-year announcement. So his official retirement date is still essentially 4.5 quarters away, like longest retirement announcement in history, it seems like. Yes, so it's still a long ways away. Yes, the Board is starting to ramp up its search now. And there's only -- you can't ramp up too soon because it's too far away. So now that we're getting close to the 1-year mark, they are -- I know they've hired an external search firm. They're looking to fill with external candidates. I think Chuck has made it very public that there's 3 internal candidates within our company. And so that process has begun.

Great. All right. Let's get on to maybe some more interesting things. So talk to us about Wilson Wolf. That deal is -- you haven't integrated it and you've got a call option to purchase them. Can you remind us the economics? And how do you see that changing the business, the growth profile? And then what are your options with that? And what's kind of the -- how much money would you have to put in if you do decide to call?

Okay. Well, the key correction I'll give you on that, and it's a new development so no offense. But as of the very end of March, we've made our 20% initial purchase. And that's really what the call option was, is the option to buy that first 20% based off of them hitting certain financial milestones, which they hit, which is why we made the purchase. And the way the contract was written once that initial 20% investment is made, there's no longer an optionality. We are now required to buy the company once they hit their second level of targets. And if they don't hit those second level targets by the end of calendar year '27, then we're obligated to buy the company at 4.4x revenue. So that's kind of, in essence, the terms. We hit the initial 20%, which was a $55 million EBITDA trigger. So that's what triggered the initial purchase. So that's -- as far as John Wilson -- John Wilson himself, the owner of Wilson Wolf, is the one who set those targets, and he thinks he can hit it as soon as 2026. We'll see. We gave an extra year just thinking -- giving a little breathing room. But it's a critical part of what we think is the future of the cell and gene therapy workflow. They already are a critical partner with ours with our ScaleReady. We call it a joint venture but it's really a sales consortium, where we partner with Wilson Wolf and their G-Rex as well as Fresenius Kabi to create a semi-closed system for cell therapy development that modularizes and dramatically cheapens and -- not makes cheap, makes less expensive and majorly increases the scalability for future cell and gene therapy production outside of what -- the way it's done traditionally today, largely using very large boxes that are very expensive to use with the patients. So it's an integral component to that. They're actually ahead of us as John Wilson has been at this for more than a decade. We've only been at it for maybe 3 or 4 years. So he's been -- Phase I, II, III clinical trials. So extremely well positioned for the future commercialization, which is why he doesn't even blink at the financial targets he was given to hit that full buyout, which is an additional $1 billion. But it's his targets, $226 million of revenue or $136 million of EBITDA by 2026, and he thinks we're going to get there.

All right. And just M&A has been part of your strategy since Chuck took over. And obviously, that's a big number that you've got to pay out at some point. Does that change your M&A strategy for the next few years? Can you still pursue other things?

Definitely. I mean we're not even at 1x turn right now. And by the time that hits, let's say it's '26 even, we'll just have that much more cash flow, that much more EBITDA organically, like you said, hopefully knocking on the door $2 billion revenue and 40% of EBITDA. So we'll have even that much more powder. So no, it hasn't even -- the thought hasn't even crossed our mind with regards to -- having said that, we've never been a company that's done majorly big deals, right? For us, the big deals are in the $300 million, $200 million to $300 million range, and that's where we're most successful and where we think we can get the best value. And I don't see that changing either, which is why our M&A -- which is why this doesn't impede our M&A strategy. Because if we were only in the market for multibillion-dollar deals, then yes, it might be a problem, but that's not the case.

Yes. You guys do have a track record of buying companies with great growth profiles, industry-high margins, but they are on the smaller side. So first off, how many more of those deals are out there? And do they really move the needle? Or have you guys gotten to a point where you do have to start looking at other larger deals like Wilson Wolf?

Yes. I mean, first of all, it's life sciences so there's always other -- there's a new mousetrap every day, it seems like, around the corner. So that's what's so exciting about this space. And that's why I personally think to be successful long term, you have to have M&A as part of your strategy. The move-the-needle aspect of it, I mean, not that big at the end of the day. We're still just over $1 billion of revenue. I mean, look at Thermo, look at Danaher, these are massive companies. So yes, picking up -- if we can go back to picking up 2 or 3 of these a year like we did pre-COVID, it racks and stacks nicely. I mean look at ProteinSimple as an example. I mean that's contributing over $300 million of revenue today. That's aside of our whole company when we bought it. So I think you buy the right assets and just having a quantity to pick from is not the problem. The problem is usually getting the owners to let go at the right price.

Yes. And where are valuations? We've heard that from a lot of folks where they're in discussions but maybe valuations are still -- people are looking for where they were 2 years ago. So just kind of you've done this long enough that you see these cycles. So where are we as far as valuations? Are people starting to come back to the table or are we not quite there yet?

I think it's starting, right? It's a process. Selling businesses is like selling houses, right? People think their house is always worth way more until they have to really settle in or something that it's not worth what it was or vice versa. But in a private market especially, it takes a lot longer for -- and the good news is what's different now from the last 3 years almost, is at least people are coming to the table. It used to be you had to be the pursuer. And if you even got them to talk to you is like, why should I do this when I can just go IPO or whatever? And now we're getting approached left and right by companies who are interested because they're already thinking ahead about their next series funding and where that may or may not come from and how successful it may or may not be. And so maybe now this is the time to exit. So that's the first stage, that evaluation realization. I think it takes a little more time. It takes a little more, maybe a few crises in terms of, oh, I can't -- couldn't get my round. And that starts to get around the rumor mill that -- oh guys, did hear about that company, they had a hard time getting their series fund." And that's in evaluations where we start to fill back in. So we're not quite there yet, but it's coming.