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

All right. Good morning, everybody. I'm Luke Sergott. I cover life science tools and diagnostics here at Barclays. With me, it's my pleasure, I have CEO, Kim Kelderman, and CFO, Jim Hippel, of Bio-Techne. It is our first time meeting. Jim, longtime listener, first-time caller between us.

So Kim, I think we'll just start off the overall macro and what you're seeing -- and any changes in the trends that you were kind of looking at the outlook for the overall calendar '24. So let's start with the -- obviously, the biotech funding environment. We're starting to see some green shoots, seeing some secondaries, just what was embedded in your guide? What were you guys seeing before? And how that would ultimately play through to hitting your P&L?

Yes, a really good question. Before I go there, thank you, Barclays for having us and always a pleasure to present. Biotech funding, I think, has been an interesting trend. Arguably, we've seen that funding slowdown in Q1 of '23, where our numbers came down. They were mid-20s for 4, 5 quarters. And then became low single digits at that time and then have decelerated over the quarters to come. We did see some sort of stabilization in the back end of the calendar year, which was our Q2. And from there, we follow the news like you guys do, and we see different analyst reports that funding in general has, in the last couple of months, seen some green shoots. It's getting better. So that gives us hope that segment at some point is going to recover. My feel is that we have kind of touched and seen the bottom. We don't think it's going to be a super-fast recovery, more like a walk recovery, especially because even the moment smaller pharmas get their money in. It will take a certain time before they deploy it, right, especially companies that start from scratch, you start looking at getting a building and your lab, it's build out, it's not the space we play in. The moment you start filling your lab with equipment and start running your machines for validation that's when we start trickling in. So with a delay of a quarter or 2, you could -- we could certainly see and hope to see new lives there, right? In the meantime, we are very certain that, that market will recuperate for us pretty rapidly. And we say that because the current machines in the markets are running on high volumes, meaning the consumables are getting pulled through at high, high speed. And we see still 20% plus role in the consumables, which really indicates that machines are getting used a lot. Now if you then would add a project or if you would add a new laboratory, I am very confident that people will again buy yet another of our wonderful instrumentation, which obviously is good for different reasons, right? They are price effective, but they are also pieces of equipment that make clunky processes automated. And then by doing so, the results are more accurate and more producible. And therefore, I think we will definitely benefit and possibly outperform competition if it comes to enjoying the exit of the lull that we have seen.

And biotech is like 15% of your business, but you have a much larger pharma exposure. And I guess I mean we see the data that the funding is good, but just from conversations with customers and with across your pharma complex between large pharma, small biotech, mid-sized guys, like what are the conversations you're having now versus, are they talking about, yes, we're actually going to start investing versus what we were doing last year, just like a sort of stable on the comps and how this is kind of like improving.

Yes, it's also a good question. So for clarity, 50% of our revenues are related to pharma, biopharma, 20% of that 50% -- no, 20% out of the 50% is actually small biopharma, right? There's just a different discussion. Both of them have to look at their wallets and difficult levels of severity. Let me start with the small ones. They are probably struggling to be alive and/or thinking how long -- how much funding do I have before I have to do more severe things. So there's really a complete halt if it comes to buying capital equipment, et cetera. Now they might still be running their main and most important project, and that's where they run the consumables. And the moment they get stimulus or new funding in, people will highly likely boost the volume of that one project or speed it up, if you will, and/or add some new programs. In large pharma, it has been clearly being frugal, right? Can we do this project also on the same automation? Can we stop a couple of programs and it's not so much about closing, but about being very careful where and if you spend your money. So it's 2 little different trends, but the bottom line, both of those bode well for us at the moment, there's a little bit more funding coming into that market.

Yes. And on the large pharma, you talked about the -- so I guess the sales cycle has been elongating. Have you seen that stabilize and maybe start to shrink? Or like what's the kind of leading indicator on the large pharma side?

Well, we've seen them getting longer at the beginning, right? So we always notice that there's a certain amount of time needed to get all your signatures for people to spend the money for a fantastic Bio-Techne instrumentation. But yes, over the last half year, 9 months, I should say, there's additional signatures and now instead of the Director of Finance, the CFO has to sign off. And there's obviously some internal controls and I bet it is on purpose, right, to not spend money that is absolutely necessary and -- put the likelihood of your company at risk. So of course, there have been -- the internal controls cranked up to protect the money outflow. And that's fine with us, it basically just means that there's a delay in purchase rather than a cancel of an order and that there is a high desire to have these solutions from Bio-Techne in your laboratory. And that is just depending on when is money rolling back. And we already mentioned. It looks like in a January, February statistics that PE funding as well as third round funding even since IPOs have been executed in, which gives us hope for the coming quarters to improve when it comes to the situation.

Great. Let's turn to China. Another kind of major growth driver for some business in the industry for the last 10 years plus now all of sudden it's kind of the bad guy, so talk about the clients that you've been seeing, but really also the stabilization you talked about in the quarter, where you're seeing that when we think about the recovery or any type of industry or project or customer class that's actually more insulated versus not kind of the state of the year.

Yes. I think China is probably the headwind that will be around the longest. Overall, however, China, we see is still country with over 1 billion citizens with health care on their top priorities of the agenda. It is and will be a country that outperforms the Western world in growth for sure. So that means we want to be positioned very well. At the time being, government funding has been going elsewhere, right? The pandemic has slowered up most old funds related to health care. And now there is a little bit of a drought and hesitation in continued funding and that is definitely a period that hurts us, right? In the meantime, if I look at our positioning, do we have the right products, cell and gene therapy is extremely important in the country. All the ingredients that we have been building in our core such as antibodies and proteins to participate in the cell and gene therapy is super important. Health care for the country is super important. So we feel that we are well positioned to also recover there. Now once there is the recovery, and we've seen some news that the government is thinking of stimulating life sciences again. Once there is this money, I think we're well positioned there to also pick up some of the business. We have a feel that China might go a little bit more towards buying in China. So the good old phrase, China and China, I think it's finally becoming something of importance. And for that reason, we have -- we are in the process of building a protein GMP facility in China. And it's now halfway and it's well on its way to be operatable in September -- as of September, the validations begin. So think about the end of the calendar year where we could start producing there. And then we'll have a separate brand as well as separate price point, specifically to play in China, the way that the country likes to do business. So we will have a very nice combo of high-tech products that are very hard to get anywhere else than in Bio-Techne that we would export and then the more common products with the higher volumes that we would create in China for China with the specific price points. So that's kind of the strategy there. A date for when it exactly turns around, we can't give you, I mean it's China, right? They're going to, at some point, announce the funding, and we will all applaud, but we will not know what Xi Jinping has in his mind until then. And we -- the only thing we know for certain is that it is more a when rather than if.

Yes. I think. That's fair. On the -- you mentioned the GMP portfolio over there and building out from the capacity, like any type of guidance or framework that we can think about as that -- would that raise your China exposure 1 or 2 points as we -- just help us size what kind of volumes or revenue we can expect from that GMP facility?

I think at the moment, China is around 10% of our revenues. It's dipped tiny a little bit. If the facility starts cranking in, we want to go to our normal entitlement. And it really depends on pickup of these GMP proteins in the recovery of the cell and gene therapy on how it unfolds, but I think it will certainly have a positive effect on the growth. And therewith, I would hope that we will come back to historic growth levels. We feel that historically, the growth levels have been great, but that they would not recover exactly to there. And we are trying to make a situation where it would be just one step down, but serve the market a little bit better so that we can get close to what we're used to. We might be a couple of percent points off, but it will be our fastest-growing region for the portfolio again.

Yes. And I guess in the LRP before we get back to the GMP, Think about the -- in the LRP. Is there any type of update, you just talked about like how it was historically. But when you think about your LRP, how does China fit in over the next 3 to 5 years and within that contract?

Do you want to take that?

Long range plan?

Oh, I'm sorry. Yes, long range plan.

No, I mean I think I kind of said, I mean we believe in China long term. And right now, the government is in a funding drought. They spent the last 3 years giving COVID test to 1 billion people every day and hanging out vaccines and meanwhile those people weren't working, they were locked up in their apartments. So there was no tax revenue coming in. So once that money, people -- we were there recently in December, the local China activity is bustling again despite what you hear in the news and so forth. It's the foreign investment that's weak. So it's going to take longer, in past economic downturns for, I think, the Chinese funding to come back. But when it does, health care will be prioritized. We firmly believe that. We're not the only ones, I think many in our industry are saying the same thing who have even bigger exposure dollar-wise than we do. And we're well positioned to reap the rewards of that when it does come back. And so it's a very important part of our long-range plan. And it may not be the 20%-plus grower that it has in the last 10 years for reasons Kim said. But I think by investing there, continuing investor particular, particularly in our GMP factory, it gives us a better odds of getting much closer to that than what we otherwise would be. So we feel very confident about China in our long-range plan, but it might be a year or 2 before we get back to those levels that we were used to seeing.

Yes, makes sense. I want to go back to the GMP on the proteins. You continue to invest in the portfolio there. Just where are we in that portfolio expansion? Are we at the critical mass where you're like, "oh, we don't need to add as much", or just kind of the CapEx or the investment that you guys look at going forward over the next 3 to 5 years again.

I think that the portfolio right now is a good basis portfolio. But as you noted, there's always reasons to add flavors of ice cream, right, to the ice cream store. So there is in a different speed, but we will continue to add specific GMP molecules that people would like in different type of win signals and other pathways where there are specific proteins necessary. I think the bigger investment really comes in 3 things. One is we are building out a GMP facility in the U.K. for small molecules. So you can also offer up small molecules for the cell and gene therapy solution. That is a completely new step for us. That's also in the build in construction and it will take another 9 months or so for it to be open, but that would be a real GMP win. I just talked about the China facilities, so that you get a real protein, GMP proteins for cell and gene therapy solutions in China for China. And then the last one is that in our portfolio, GMP antibodies would also be important. So to your question, are you going to build out a bigger portfolio of proteins? Yes, but we will also build out a portfolio of small molecules and portfolio of GMP antibodies and then China for China, the proteins as well.

And on the media formulation, the gene expression, is that the U.K. facility? Is that how I think about that? And then the GMP antibodies, just kind of dig in there about where the use case is and kind of the type of volumes. I imagine that this is a lot of the bioprocessing material and how you get that out from the chromatography purification?

Yes. No, the GMP antibodies obviously are used for identification and activation of the cell, right, and have a very similar use case as -- or in a very similar setup of our G-Rex in the middle and their cells that we're growing with all our proteins and small molecules, and you could use the exact same chamber to really add our antibodies and use them for the specific results you want the cells to end up in and that's the tool we're missing right now, and that's what we're definitely filling.

And with that -- so when I think about it, it's like just in addition to your cell and gene therapy portfolio, the holistic approach that you guys go on that whole workflow?

Yes. Basically, to make the G-Rex, which we will own over time, the G-Rex is container where you grow yourselves and where you going to need to add all these different ingredients to do so. Optimally, those ingredients, that list of ingredients is what we are building out.

Yes. Okay. Jim, I want to talk a little bit about margins here in the last minute, 45 seconds. So you had a pretty big step down in the last quarter. So talk about the puts and takes there, the kind of the drivers, and then what's embedded in guide and how you can bridge us to that step up?

Sure. Well, I mean it's top on the last earnings call, about half of that step down was attributable to our acquisition of Blue, for which we knew we expect that typically happens when we do a new acquisition. And as that business gets ramping up, we expect that dilution to be less and less going forward. But this year, it's successfully a hit to margins. The other half was a combination of investments we knew we were going to make because we still have these growth pillars. They're going to carry us and they've been carrying us even through this downturn, whether it's our instrumentation portfolio or whether it's our cell and gene therapy or Spatial Biology, those pieces of our portfolio have been still performing very well, and we continue to invest there. And inflation hasn't gone away and especially on the wage front, still 4% or so plus, so if you're not growing more than 4%, you're actually going to have some contraction there. So there's been -- I think very much more fruit in our investment as everyone is in this type of downturn. But between the investments we're making and then just the deleveraging. We obviously have a very -- particularly on the reagent side, we have a very, very high-margin product. And so you reap the benefits of that when you're growing, but you suffer when you're not growing, and that's been the case in the last quarter or 2. So as the growth comes back and just pure volume comes back, which is why we're feeling better about the second half of the year because our volumes in general are seasonally higher in the second half of the year. So we'll have more pull-through and better margins because of that. But we've also been using this, call it, this lull in growth to even sharpen the axe a little further with regards to looking whether it's -- when the water levels recede you see old boulders, right? And so it allows you to clean house a little bit. We've been doing that and doing the focus in terms of productivity actions to make ourselves leaner and meaner when the money gets come back and the growth comes back. And some of the benefits of that -- those productivity actions, we'll also start to see here in the back half of this fiscal year and into the remainder of calendar year '24.

Yes. And as -- I mean, you're talking about the reagents coming back. Like give us a sense of -- I know you have a massive reagent portfolio, but just overall incremental margin when that -- on those reagents when you're 75 or 80...

Well, I mean our core proteins and antibody, some of those contribution margins are north of 90%. So it gives you a sense of what the pull-through can be.

So you guys are 30% to 35% operating margin.

Correct.

Fantastic.

And that's why we actually feel pretty good about staying above 30% when you have a quarter that you actually didn't -- weren't able to grow your reagents. We feel pretty good about that in terms of how we're managing our costs because it stings when the growth is not there, but it's beautiful when the growth comes back, and it will come back.

Great. That's all the time we have. Thank you again.

Thank you.