Good afternoon, and welcome to the Bruker first quarter 2017 earnings conference call. All participants will be in listen-only mode. Should you need assistance, please signal a conference specialist by pressing the star key followed by zero. After today's presentation, there will be an opportunity to ask questions. To ask a question, you may press star then one on your telephone keypad. To withdraw your question, please press star then two. Please also note that this event is being recorded. I would now like to turn the conference over to Ms. Miroslava Minkova. Please go ahead.
Good afternoon. I would like to welcome everyone to Bruker's first quarter 2017 earnings conference call. My name is Miroslava Minkova, Head of Investor Relations for Bruker. Joining me on today's call are Frank Laukien, our President and CEO, and Tony Mattacchione, Bruker Senior Vice President and Chief Financial Officer. In addition to the earnings release we issued earlier today, we will be referencing a slide presentation as part of today's conference call. The PDF of this presentation can be downloaded by clicking on the earnings release hyperlink on Bruker's investor relations website. During today's call, we will be highlighting non-GAAP financial information. Reconciliations of our non-GAAP to GAAP financial measures are included in our earnings release and are posted on our website at ir.bruker.com. Before we begin, I would like to reference Bruker's safe harbor statement, which I show on slide two.
During the course of this conference call, we will be making forward-looking statements regarding future events or financial performance of the company that involve risks and uncertainties. The company's actual results may differ materially from these projections described in such statements. Factors that might cause such differences include, but are not limited to, those discussed in today's earnings release and in our Form 10-K, as well as other subsequent SEC filings. Also, note that the following information is related to current business conditions and to our outlook as of today, May 3, 2017. Consistent with our prior practice, we do not intend to update our projections based on new information, future events, or other reasons prior to the release of our second quarter 2017 financial results in August 2017. We will begin today's call with Frank providing a business summary.
Tony will then cover our financials for the first quarter of 2017 in more detail. I would like to turn the call over to Bruker CEO, Frank Laukien.
Thanks, Miroslava. Good afternoon, everyone, and thank you for joining us on the call today. I will begin today's earnings presentation on slide four. Bruker is off to a solid start in 2017 as our first quarter revenues and operating income exceeded our expectations. Bruker's reported revenues increased 2.5% year-over-year, while on an organic basis, our revenues were still down slightly year-over-year, as we had predicted. We again improved our gross and operating margins year-over-year. Keep in mind that Q1 2016 was a challenging comparison, which included revenues from a high margin 1 GHz NMR system, a major Bruker Detection contract, and an unusually low tax rate.
In Q1 of 2017, our European revenues remained soft as expected, but European bookings continued to recover as we again saw an increase in orders year-over-year, the second quarter in a row of positive order growth in Europe. We also saw continued strength in China, further stabilization in our microbiology orders, and some positive trends in certain areas of our industrial, applied, and semiconductor metrology markets. We are encouraged with the continued stabilization we see in our business, and we remain confident in our ability to achieve our 2017 organic revenue growth and earnings objectives. Looking more closely at the quarter, we reported revenues of $385 million in Q1 of 2017, an increase of 2.5% year-over-year. Our late 2016 and January 2017 acquisitions contributed about 5.3% to revenue growth, while foreign currency translation lowered revenues by 2%.
On an organic basis, our Q1 2017 revenue was down 0.8% year-over-year and reflected the weak European orders in the first nine months of 2016, as well as last year's revenue recognition of our first shielded 1 GHz NMR and high Bruker Detection contract revenue in the Middle East in Q1 of 2016. Our Q1 2017 non-GAAP gross profit margin expanded by 90 bps year-over-year to 47.6%, and our non-GAAP operating margin was 12.8%, up 20 basis points from Q1 2016. This was a positive result as we integrate our recent acquisitions and given the challenging comparison to Q1 2016. We reported GAAP EPS of $0.13 in Q1 2017, compared to $0.14 in Q1 2016.
Our non-GAAP EPS of $0.19 in Q1 2017 was down two cents versus Q1 2016 and reflected a higher non-GAAP effective tax rate of 30.6% versus 17.7% in the first quarter of 2016. Before we move on to our group reviews, let me take a moment to update you on end market conditions. While overall demand conditions in our academic end markets remain a concern, our European orders again showed positive growth year-over-year. In the U.S., we had a slow start to the year, though it is unclear whether that is related to the current budget uncertainty in the U.S. NIH budget, which has been resolved as of Monday morning, but we haven't seen any details yet. On the industrial side, we saw select strength in our semiconductor metrology markets and some pockets of improvements in certain industrial and applied end market segments.
For example, food and beverage testing by Bruker Optics, near-infrared products, NMR, industrial research demand, et cetera. Other industrial market segments showed no clear positive market direction in the Bruker orders yet in Q1 of 2017. Overall, we still see mixed conditions in our academic, governmental, and industrial end markets, with better order growth in Europe relative to 2016 and in selected areas like microbiology, applied testing, and semicon metrology. So pleased to turn to slides five and six now, where I provide details about the performance of our three BSI groups and of our BEST segment. All growth rates that I will discuss exclude the impact of foreign currency translations. Starting with the Bruker BioSpin group, it delivered low single-digit revenue growth as solid NMR results more than offset PCI revenue weakness. PCI is preclinical imaging.
The NMR growth was impressive in the context of a challenging prior year comp, given the completion of our first shielded 1 GHz in Q1 of 2016. Favorable average selling prices and improving productivity also continue to support Bruker's growth and operating margin expansion. BioSpin's aftermarket and service business, called LabScape, once again posted strong year-over-year growth. Preclinical imaging remained weak with sales and margin lower year-over-year. Moving on to the Bruker CALID Group, it reported a year-over-year revenue decline in the mid to high single digits in Q1 2017. Daltonics mass spec revenues continued to be negatively impacted by the weak European academic bookings in the first nine months of 2016. Despite lower revenues, Daltonics margins improved significantly year-over-year as we executed on our factory consolidation and benefited from favorable product mix and cost control initiatives.
Within the CALID Group, our Optics products had another solid quarter of revenue growth and margin expansion. Our CALID Detection revenue was down significantly year-over-year due to order timing and challenging comparison from the high Middle East contract revenue in Q1 of 2016. The CALID Group benefited modestly from revenues from the InVivo acquisition, which we completed in January 2017. Turning to slide six now. The Bruker Nano reported high single-digit revenue growth with contributions from our late January 2017, Hysitron nano-indenting products acquisition, strong growth in our semiconductor metrology tools, and improved results in our AXS business. Our Nano Surfaces business was off to a good start with the Hysitron integration and with these products contributing growth into Q1 of 2017. Our AXS products, which had a challenging year 2016, returned to positive year-over-year growth in the first quarter of 2017.
Our 2016 AXS factory consolidation and ongoing cost actions are beginning to improve the AXS margins. Last but not least, we had another strong quarter in our semiconductor metrology business with revenue and order growth driven primarily by auto atomic force microscopy or AFM demand in 10 nm semiconductor manufacturing. We are pleased by the progress in our Nano group. Finally, our BEST segment revenues were substantially higher year-over-year, driven by our Bruker OST acquisition in November 2016. Our core BEST business was also up modestly year-over-year after adjusting for FX. BEST had an improved first quarter of 2017 as demand for superconducting materials and the strong order book of 2016 continued to drive the segment's results.
Our newly acquired Bruker OST unit in New Jersey had revenues and margins slightly ahead of expectations, given good demand for Bruker OST's proprietary rod restack process or RRP, high magnetic field wire technology. Next, I will take a moment to highlight some important new products we launched over the course of the quarter and in April of 2017. On slide 17, at the March Experimental NMR Conference or ENC, Bruker BioSpin introduced our new AVANCE NEO platform, a next generation NMR electronics console which will help take NMR research to the next level. This is Bruker's most significant NMR console introduction in a decade, and we are cautiously optimistic that it will contribute to an upgrade cycle over the next few years and further improve our competitiveness and margins.
There are significant new capabilities on the AVANCE NEO, which include frequency range that supports 1.2 GHz and beyond, and full multi-channel, multi-receive architecture, enabling each channel of the NEO to operate as a fully functional NMR spectrometer with multi-receive capabilities. Plus other performance advantages. The NEO is available for sale to our customers now, and we already have many units in customer labs and are recognizing revenue as we speak. On slide eight, we have continued to expand our microbiology offering with high-value test innovation at the recent European Congress of Clinical Microbiology and Infectious Diseases, or ECCMID for short, which took place just over a week ago in April. At this year's ECCMID, we had several important assay introductions for the European market that further enhance Bruker's differentiated position in microbiology and should generate higher consumables margins over time.
Our MBT, or MALDI Biotyper, STAR-Carba in-vitro diagnostics kit is the first CE IVD marked assay for mass spec-based antibiotic resistance testing on the market. This Carba IVD assay runs on the MALDI Biotyper platform and tests against resistance to carbapenem antibiotics. Importantly, the MBT STAR-Carba assay is a functional test, which generates results independent of the precise genes or gene involved in the beta-lactamase resistance. This means the test will still be relevant as bacterial resistance and the underlying genetic mechanisms continue to evolve rapidly. Over time, we have plans to expand our MBT STAR resistance kit portfolio to address additional resistance mechanisms and other types of antibiotics beyond the very important carbapenem class. At ECCMID, we also introduced the first two products from our Glasgow real-time PCR asset purchase in November of 2016. Our Fungiplex Aspergillus identification and Carbaplex resistance gene assays.
Briefly, Fungiplex Aspergillus is a multiplex PCR assay that tests for the most common pathogens associated with invasive aspergillosis, a fungal infection that can have potentially fatal outcomes in immunocompromised patients. The Carbaplex assay is a multiplex PCR assay that provides information on the most common genes involved in carbapenem resistance. These tests run on standard real-time PCR readers and only take two to three hours to provide results from sample extraction and do not require any culture. We expect these tests to yield improved outcomes for critically ill ICU and organ transplant patients, and they will also help reduce the usage of costly antifungal and antibiotic drugs. Moving on to slide nine, Bruker's key priorities for 2017 are unchanged. We are driving for constant currency growth in the mid-single digits, including contributions from our recent strategic acquisitions.
We intend to resume organic revenue growth this year, and we continue to execute on our multi-year operational and commercial excellence plans, which we expect will drive further operating margin expansion. Most importantly, we are continuing our portfolio on mix transformation towards our strategic growth initiatives with fundamentally higher margins, which will be an increasingly important contributor to our ongoing margin expansion. In summary, I am pleased with our execution in Q1 of 2017 and believe we are on track to deliver on our financial commitments for the full year 2017. Now let me turn the call over to our CFO, Tony Mattacchione.
Thank you, Frank, and good evening. I will now provide some additional details on our financial performance in Q1 2017, starting on slide 11. Financially, Bruker had a solid start to the year and we are on track to meet our full-year commitments. Q1 revenue was up 2.5% year-over-year. On a non-GAAP basis, our operating margin of 12.8% expanded slightly versus the prior year, despite a very challenging comparison to Q1 2016, which included the high-margin 1 GHz NMR system. GAAP EPS of $0.13 was down a penny compared to $0.14 in Q1 2016. On a non-GAAP basis, our EPS came in at $0.19 per share, compared to $0.21 per share in Q1 2016. Free cash flow was positive at $21.1 million, versus a negative use of cash flow of $22 million in the first quarter of 2016.
Net cash was $79.7 million at March 31, 2017, which was a year-over-year decline caused by cash deployed for recent acquisitions, the 2016 share buybacks, and our $0.04 quarterly dividend. Our working capital ratio was up modestly year-over-year to $0.37 per dollar of revenue in the first quarter, largely due to an increase in the BEST inventory for Q2 shipments. Turning to slide 12, I show the year-over-year revenue bridge for Q1 2017. On a reported basis, our revenue increased 2.5% versus Q1 2016. Our recent acquisitions, including OST, Hysitron, and InVivo, all contributed about $20 million in total, or approximately 5.3% to revenue growth. Changes in foreign currency translation rates negatively affected revenues by about $7 million or about 2%.
On an organic basis, our revenue was down 0.8% year-over-year against a challenging prior year comparison that included the 1 GHz NMR magnet and revenue from a large detection contract. Our modest year-over-year organic revenue decline reflected the soft European academic orders we experienced earlier in 2016. As Frank noted, our BioSpin, B Nano, and BEST groups all had positive growth on a constant currency basis, while CALID revenues were down in constant currency. Geographically and currency adjusted, European revenue increased low single digits, driven in part by the OST acquisition. Within our Bruker Scientific Instruments segment, European revenue was down mid-single digits on a currency-adjusted basis, reflecting soft order entry last year. Importantly, Q1 represents the second consecutive quarter that European orders were up year-over-year on an organic basis. North America revenue was up low single digits.
However, from an order perspective, we are off to a slow start to the year in the U.S. We are encouraged by the recently announced $2 billion NIH funding increase this week, but have not factored it into our planning for the entire year. Asia Pacific was up low double digits, including another quarter of greater than 20% growth in our China businesses. Within China, we experienced impressive growth from both academic and industrial customers. Japan was down in the low single digits. Overall, we are pleased with the continued stabilization in our organic revenue, despite the still mixed end market demand conditions, as Frank described. Turning to slide 17, I show our full Q1 2017 profit loss statement on a non-GAAP basis. Our Q1 2017 non-GAAP gross profit margin was 47.6%, or a 90-basis point increase year-over-year.
This increase was driven by NMR price and efficiency gains, as well as the 2016 restructurings and factory consolidations within our Daltonics and AXS businesses. These favorable drivers more than offset some market-related volume declines. Q1 2017 operating expenses increased approximately $6 million or 5%, caused primarily by the addition of our recent acquisitions in the timing of certain R&D and sales and marketing investments. This was partially offset by a favorable exchange impact on the operating expense line. Our Q1 2017 non-GAAP operating margin of 12.8% was up 20 basis points year-over-year, a result we are pleased with as we absorb the additional expenses from the acquisitions, and we faced the challenging comparison from Q1 2016. During Q1 2017, we began to see results from our previously announced two factory consolidations in our CALID and Nano groups.
Our culture of operational discipline contributed as our businesses continue to stabilize. Looking below the line, net interest and other expense was $6 million, on par with Q1 2016. For the first quarter of 2017, our non-GAAP effective tax rate was 30.6% compared to 17.7% in the first quarter of 2016. The higher effective rate was the result of the absence of the U.S. valuation allowance reversals required last year. While the first quarter rate included some discrete tax items, we continue to expect that our non-GAAP effective tax rate to be approximately 25% for the full year of 2017. Weighted average diluted shares outstanding in the first quarter were 160.5 million, down approximately 3.8 million shares or 2% year-over-year. This is the result of our 2016 share buybacks.
Finally, non-GAAP EPS of $0.19 in Q1 2017, compared to $0.21 in 2016 Q1, was down about 10% year-over-year. The higher tax rate more than offset improvements in operating income and the reduction in the share count. Turning to slide 14, we generated $21.1 million of free cash flow in Q1 2017 compared to a use of $22 million in the first quarter of 2016. Less cash needed for working capital, a year-over-year increase in customer advances, and the timing of incentive compensation payments all positively affected our free cash flow this quarter relative to the first quarter of 2016. Our cash conversion cycle at the end of the first quarter of 2017 reflected an increase of two days compared to the end of Q1 2016. That was driven by higher inventory levels related to long-term contracts at our BEST and BioSpin groups.
Now for our 2017 guidance, on page 16, I will cover the updates for the full year 2017. We reiterate our full year guidance with only an adjustment to reflect recent foreign exchange translation rates. We continue to expect our organic revenue growth to be in a range between 1% and 2% in 2017. For the 2016 and early 2017 acquisitions, we project a contribution between 3.5% and 4%, which is unchanged from when we last spoke to you in mid-February. Given the recent weakening of the U.S. dollar versus the euro and the yen, we are slightly adjusting our foreign exchange assumptions for the remainder of the year. We now expect a negative revenue impact from foreign currency translation of approximately 2.5%, and we expect Bruker's reported revenues to increase between 2% and 3.5% in the full year of 2017.
On the operating margin line, we continue to project improvement between 40 basis points and 70 basis points from a base of 14.8% in 2016, which includes an approximate 40 basis points of negative headwind from our recent acquisitions. As mentioned already, our fiscal 2017 non-GAAP tax rate is projected to be around 25%, and our fully diluted share count is expected to be around 161 million shares. Rolling it all up and considering the changes in currency rates on the top line generally have a muted effect on the bottom line, given our European manufacturing cost structure, we continue to expect our 2017 non-GAAP EPS to be in the range between $1.05 and $1.09, which is the same as the guidance we issued in mid-February. Other guidance assumptions are also given on slide 16.
In summary, during the first quarter of 2017, Bruker continued to make progress on our profitability expansion initiatives while also integrating our 2016 and 2017 acquisitions. We are off to a solid start, and we are pleased to see our core revenue continue to stabilize despite the still mixed macro and demand conditions. For 2017, we believe we are on track to deliver our full-year financial commitments, which implies 2%- 3% average organic revenue growth and mid-single-digit constant currency growth over the next three quarters. We look forward to updating you again in our Q1, sorry, in our Q2 2017 conference call in early August. With that, I'd like to turn the call over to Miroslava to start the Q&A session.
Thank you, Tony. Andrea, we are ready to open up the call to questions. In the interest of accommodating more of our analysts, please limit your questions to one and a follow-up.
Thank you. We will now begin the question- and- answer session. To ask a question, you may press star, then one on your touch tone phone. If you are using a speakerphone, please pick up your handset before pressing the keys. To withdraw your question, please press star, then two. Our first question comes from Dan Arias of Citi. Please go ahead.
Hi. Afternoon, guys. Thank you. Frank, any additional commentary on the European markets, maybe academically? If we just look by country or compare Western Europe to Eastern Europe, what is the look there if you just parse out the European commentary a little bit?
Yeah, Dan, we looked into that as well. As we said, European orders, again, second quarter in a row where they were up year-over-year, which is good. Within Europe, not that much color that's really meaningful. I would maybe highlight that Germany was pretty good and that France had a weak start, perhaps related to their elections or not, I'm not sure. But those are maybe the two observations that I would offer.
Okay. Then maybe on the industrial business, if we just want to put a finer point on your commentary on improvement there, are you able to say what percentage of the business, what percentage of sales within that segment or end market you saw some signs of life in?
No, we don't go to that level of granularity. High level, last quarter, we said semiconductor looked good, and we continue to say that semiconductor metrology looked good. Last quarter, we weren't so sure. Now we see selected areas in our industrial and applied markets that seem to have an uptick, and we've cited some examples of that. The more global numbers, which you probably know already, is that about 17% of our revenue is industrial, including semiconductor metrology. I'd say there's selected positive signs in our industrial markets. We're incrementally more positive than we were a quarter ago, but we're also not yet saying, "Hey, all industrial is improving." That's not the case.
Okay, thanks very much.
Our next question comes from Ross Muken of Evercore. Please go ahead.
Good afternoon, guys. Could you just talk about, you obviously were quite busy on the acquisition front, you've been integrating a number of them. Could you talk about how the organization's responded to that level of activity and how some of the acquired businesses have performed? Looks like the revenue results there were pretty good.
Yeah, Ross, actually quite well. Quite honestly, we spread the work around a little bit. The biggest acquisition and that integration will be a multi-year process, and it's a bit of a fixer-upper, is the Bruker OST acquisition in Carteret, New Jersey. That had a good start. Well, I wouldn't say a good start, but a better-than-expected start. So they were busy. They had good capacity utilization. There's a lot of work to be done there over the next two or three years to improve the margins and efficiency and productivity of that business. But it's a welcome opportunity, and that's why we acquired it. So we're very pleased with that. The Bruker Nano Group
Has a relatively smooth integration of the Hysitron business, which was only acquired at the end of January, so it only contributed about two months in the first quarter. But that's going very well. That, of course, we're not integrating it tightly, but mostly into the marketing, sales, and service approach, and I think that's going really well. They're on track. Last but not least, the consumable. There's some smaller ones that were more technology-wise, but the consumables business InVivo, in Berlin, that's part of our Daltonics business now. That has done even somewhat better than expected in the first quarter. Nothing that's needle-moving, but so overall, we're really quite pleased with all the acquisitions, and different teams at Bruker are focusing now on the integration, and it's really going well.
Maybe can you talk about just the pricing environment in general? Obviously, pricing was quite a nice tailwind for you last year. How has that sort of price capture trended to start the year, particularly in some of the markets where orders have been a little bit choppy?
Well, the larger price increase from 2015, that effect is now gradually declining, relatively speaking, in 2017. It's now embedded, but it also was in 2016. We're still probably getting a little bit of a benefit from that in early 2017, but that's not a major driver in 2017 anymore. We, of course, now do some continuous industry standard, annual, no-headlines type of price increases like everyone else, and we do that throughout our portfolio, so that has an ongoing incremental effect. I hope that answered your question.
Yeah. No, that is perfect. Thanks, Frank.
Yeah.
Congrats on the improving trends.
Thanks, Ross.
Our next question comes from Brandon Couillard of Jefferies. Please go ahead.
Thanks. Good afternoon.
Hi.
Frank, any chance you could split out the growth from service and aftermarket in the first quarter relative to instruments? Could you talk about some of the initiatives you are working on to improve the attach rates there and lift the gross margin profile of those revenues?
Okay. Aftermarket, without becoming too quantitative, the growth in aftermarket was slightly higher than the overall. Well, actually, it was slightly higher than our organic growth. It was comparable to our growth overall, and was in the mid-single digits. Yes, it was higher than our organic systems growth. It was comparable to our constant currency growth, which is why I stumbled here for a moment. It grew in the mid-single digits. A lot of efforts. It had particularly nice growth in the Bruker BioSpin business, where that had been an opportunity that still has some low-hanging fruit because that was under-managed somewhat in the past. In the BioSpin group, for instance, that grew in the high single digits. We believe we have several more years of continued improvements throughout the company in generating more aftermarket service and services business.
In addition, of course, we are now starting the next trend of generating more assay consumables and software business, in part through some of the acquisitions that we are generating, and that will still be some time before they really start to contribute. That will be the next level of drivers to really substantially increase aftermarket business, including software and consumables over a multi-year period.
Brandon, just to add a quick comment to that. The aftermarket that Frank refers to is consumables, aftermarket service. It is all altogether, including service.
Correct.
Okay. That is helpful. Then a two-part question for you, Tony. Any chance you could split out the revenue contribution from the OST acquisition within the BEST unit? Secondly, could you give us the organic OpEx growth in the quarter, stripping out what the acquisitions and perhaps currency contributed to the operating expense line?
Yeah. I am not sure I will give you the exact numbers, but obviously, we absorbed some dilutive businesses, predominantly OST, in the margin expansion that we delivered, both on the gross profit and the operating profit line. OST is the biggest piece of the acquired businesses that we have in the numbers now. So, order of magnitude, most of it is the OST business and the acquisitions.
Thank you.
Our next question comes from Steve.
Let me just clarify one thing. We are just comparing notes here a little bit. It is the largest of our acquired units. It is not the vast majority of our acquired revenue. Hysitron and InVivo Biotech are also somewhat meaningful, but OST is larger than either of those.
Yeah. That is right.
Our next question comes from Steve Willoughby of Cleveland Research. Please go ahead.
Hi, good evening, and thanks for taking my questions. Frank, I was just wondering if you could comment a little bit about the new NEO NMR system, as it relates to how long you expect this to replace your older system, the potential revenue and margin impact from this new system, and any initial feedback you have received from customers that you might be able to share.
Oh, the initial feedback from customers is very positive to perhaps enthusiastic, because it is really, in NMR, it is a significant innovation. It is really a brand-new architecture and concept. I think there was probably, certainly at this research conference, I would say there was excitement about the NEO. It is shipping. I would expect that most orders going forward for research system and higher field systems would be NEOs. Of course, we also still have some other routine systems that are not NEOs. The NEO is designed for reducing the overall cost for us in COGS, from manufacturing cost, as well as installation and service cost with more built-in intelligence. I think it also further improves our competitive position, which is already pretty good. So we are very pleased with it.
It was one of these introductions where we had done extensive internal and customer beta testing to where we absolutely hit the ground running and it is going to make a difference very much this year already.
Okay. Just one follow-up question to an earlier question regarding the contribution from M&A and the recent deals you have done. Given that you have done a number of deals in the latter part of 2016 and early 2017, just any feel for what your desire and pipeline looks like for future M&A at this point following the number of deals you have done recently?
Yeah. It was a bit of a confluence of events. We had never planned it that way, but a lot of these deals had been being discussed for months and quarters, and then they kind of came together in late 2016 and some closed in early 2017. Typically, we tend to do some smaller. I would expect the pace of, and the number of deals to be lower this year than it has been last year, including some of these early 2017 closings. I expect there to be some strategically oriented tuck-in M&As. Hard to say, but there might be one or two or three smaller deals still this year. But they'll be very strategically focused and if they come to close, they will be very good fits.
Okay. Thanks very much.
You're welcome.
Our next question comes from Steve Beuchaw of Morgan Stanley. Please go ahead.
Hi, good afternoon. Thanks for taking the questions. I caught in your prepared remarks, Tony, that you've taken an appropriately conservative view and not embedded any expectation for a contribution from an NIH budget release, or frankly, the presence of a U.S. federal budget, in the outlook for the year. It sort of begs the question, well, let's isolate that part of the business, and based on your past experience, one, what do you think the U.S. business could do over the balance of the year, given that we now have more visibility? And two, how much of that impact do you think can we see in 2017 versus 2018, given the transition time between orders and shipments?
What I would say is the U.S. business is down on a revenue basis, and we started off soft on orders. We haven't put our finger completely on it, but we feel a lot of that is due to some of the uncertainty around where this is all going to land. Like you mentioned, we're not counting on anything to contribute going forward in this regard. Like I just mentioned, we started the year flat, down on orders, obviously. Now, whether the $6 billion increase helps us or not, I think it's likely in 2018. With our cycle, even if we got orders today with this new funding, it would likely not affect us this year. You might recall last year, there was a $6 billion increase as well, which we didn't see a lot of that. Not a lot of people saw a lot of that.
Really, we're not counting on much lift in the U.S. from that recent event.
Keep in mind, it's not the orders to shipment with maybe just two quarters apart, but by the time the good news, which surprised many of us on Monday morning, we'll take it, but it was a bit of a surprise. Until that turns into NIH institute directors giving more funding in competitive grants to universities, that may well be six to 12 months, and only then can people even place orders. It's actually what happens before an order gets placed, before a grant gets funded in an extramural grant that is partially NIH-funded. There could be some incremental pickup in Q4, maybe from some direct NIH orders or so, which is pretty small for us.
It is incrementally positive, but mostly, I think if that starts to be a pattern rather than the somewhat erratic, unpredictable, "Is there going to be a 6% increase or is there a 19% cut?" I think that uncertainty is not good for spending. Whereas if a pattern emerges that this or some smaller increase can be expected from some bipartisan consensus in most years in the future, that would be very healthy. In short, it is mostly a 2018 story for us and it is too early to tell. But certainly very encouraging.
2 billion.
There. One other topic I want to hit before I turn it back over, and it is the NMR cryo debate. I do not know that there is anything new here scientifically or in terms of product features. But now that FEI is owned by Thermo, there is a lot of enthusiasm there about what they can do with a consolidated effort in structural biology. It would be helpful to hear what you are seeing out in the field, given that combination, and how you are thinking about the trajectory for the business, given that evolution. Thanks a bunch.
Yeah. The cryo-TEM capabilities and structural biologies that FEI has developed, together with customers are impressive, and they are clearly becoming a third leg of beyond crystallography and beyond NMR, of tools that people want to have in structural biology. Clearly, most of them do not have that yet, so they already have high-field NMR, they already have access to X-ray crystallography, so there is a lot of vying for that right now. That is not a surprise to us, that cryo-TEM funding wave, to some extent, providing wallet competition for high-field NMR that has been going on for at least a couple of years. We expect that to continue for a while.
Nonetheless, we are pretty optimistic that there are things that cryo-TEM and crystallography cannot do, which is the all-important dynamic information that is so important functionally. That is something where NMR is quite unique and certainly excels, which is why we think with some delay after the present cryo-TEM wave, we actually expect there to be also a perhaps more modest pickup in ultra-high field gigahertz NMR for structural biology with dynamics and for intrinsically disordered proteins that are not accessible to cryo-TEM at all.
Great color.
Steve, sorry, I just wanted to jump in. I just wanted to correct the funding that I quoted. Obviously, it is a $2 billion increase, which is a 6% increase. I think I said $6 billion increase, so I just want to get that record straight.
Yeah, you did. I was afraid that they were going to keep you on the hook to fill in the gap there.
No, that is why I felt the need to correct it.
Got it. Thanks again.
Our next question comes from Amanda Murphy of William Blair. Please go ahead.
Hi, this is Arco in for Amanda. Just a quick one from me. Can you provide any color on the ultra-high field backlog? And then whether there are still expectations for one shipment this year, or rather installation?
Yeah, nothing has changed there. As part of our expectations, we expect to have in revenue one of the 1 GHz systems this year. If that happens, that would be in Q4, not earlier than that. Of course, due to its complexity and timing, that could shift into 2018, which quite honestly is not a very big deal. There is plenty of other revenue drivers. I do not think it would really have a big impact on guidance. Yeah, one of them is planned for Q4, but there is always a potential that it moves into next year, given the technical complexity.
Got it. A second one from me is on the AVANCE console, I guess, what is the size of that installed base or replacement cycle that you are anticipating?
I do not have an exact number right now, but there are thousands of these systems out there. Of course, there is also consoles from our former competitor, Varian, Inc. and Agilent, and some of them have been upgrading to other vendors' electronics already. But this is probably a further impetus, as even some of their existing and still working consoles sold by other vendors are now technically increasingly obsolete. This probably gives additional impetus for them to look for upgrade budgets. That was all somewhat more qualitative. I do not think we are prepared to give a quantitative number specifically for the NEO upgrades, but it further supports our thesis that NMR for us will be a mid-single-digit CAGR business. This is one of the contributors to that, and will be for, really, for the next two or three years for sure.
Great. Thanks.
Our next question comes from Jack Meehan of Barclays. Please go ahead.
Hi, thanks. Good afternoon. I wanted to ask about the BioSpin growth. I was impressed, low single digit on tough comp. Was there anything worth flagging on the NMR side, despite the weakness in preclinical imaging?
No, it is just generally healthy. The nice thing is it is not so dependent on these signature 1 GHz deals. I really wouldn't highlight anything in particular, or at least no one system deal in particular, because not one of them made the difference. NMR, not unlike some other parts of our business, have seen continued strength in Chinese academic spending. Since we earlier talked about selected highlights in industrial research, we have analyzed the data. Over the last 12 months, the NMR orders for industrial research by NMR have clearly picked up from the prior 12 months period. So maybe those two market and geographic trends, rather than single customers, all bode well for a healthy NMR business, independent of price increases and independent of Europe or any other particular 1 GHz customers. It is a pretty healthy market right now.
Good, thanks. I also wanted to follow up on the Daltonics commentary with MALDI. I got the order book commentary. Was the revenue decline more of a function of the tough comp? Maybe could you just comment on what the expectation is for 2017 there? Thanks.
Yeah, correct. It was very much a function of the tough comp. Daltonics actually had a pretty really quite good Q1 of 2016 as well. And only in later quarters last year did the weakness in European academic orders really hit them. And an even bigger effect actually was the one large detection contract which we revenued in Q1 2016 in the Middle East. That was sizable. So to your last part of your question, really, we are pretty optimistic that Daltonics will develop well this year. And, to our delight, their margin improvement efforts showed very good traction in Q1 already.
Great. Thank you.
Our next question comes from Doug Schenkel of Cowen. Please go ahead.
Hi, this is Chris Lin in for Doug today. Thanks for taking my question. So I believe if you exclude the 1 GHz NMR headwind from the year-over-year comparison, organic growth this quarter would have approximated 1%. Is that about right? And just relatedly, your full year guidance is for 1%-2% organic growth. The growth comparisons become much more favorable over the next several quarters, and if our math on the 1 GHz order is correct, then it seems like you are embedding only slight growth improvement over the balance of this year. So is this largely a function of being conservative since it is still early in the year, or are there other incremental headwinds that we should be thinking of?
Yeah, I would just go back to our prepared comments there. You are right. If you exclude the 1 GHz magnet in Q1, we would have grown organically in Q1. But, like I said, based upon our guidance and what we reported in Q1, we are expecting on average 2%-3% growth for the remainder of the year. I would not expect that in every quarter, but that on average is what will get us to our guidance that we feel confident with. We do not feel like there is a tremendous amount of upside or downside to that. We are reiterating our guidance. Do not forget as well, we called out a large detection order in Q1 of last year as well that affected the comp.
Got it. Maybe just, could you just provide a bit more detail on the China strength, which end markets were particularly strong, and then just how sustainable is that growth rate there?
China is kind of on fire for us. We have had a couple of 20% + quarters. I was there in the beginning of the year, and we are getting higher business levels in both academic and industrial. The 13th Five-Year Plan is two years in, and a lot of the priorities there are, a lot of it is nationalistic type of priorities, where some of the funding that the eastern part of the country got, in terms of building capabilities, is now being focused on the western part of the country and the northern part of the country. So there is a lot of focus on basic research in those underdeveloped areas, and we are the beneficiary of that type of stuff. So, like I said, both academic and industrial is up.
Most of our businesses have seen increases in China, and I think the 13th Five-Year Plan is one of the big factors fueling that.
Got it. Thanks so much for taking my questions.
Our next question comes from Isaac Ro of Goldman Sachs. Please go ahead.
Good afternoon, guys. Just one on NIH. Since it's been a big topic, I think maybe there's been a lot of focus on the headline news there, the $2 billion, which obviously is important, but if you look within that, it does seem like there's also some changes going on with regards to how the dollars get allocated, and I'm curious if you could remind us, typically, when an NIH grant is received, how do those dollars find their way to an order for one of your instruments, especially at the high-end? Because if I have it right, there's some new conversation out of NIH just in the last day or so, where they might cap the grant support for any given recipient, and if that were the case, just wondering the extent to which people sometimes pool their grant dollars or need larger grant awards in their R01s.
Would that be a factor to watch when it comes to orders in that specific part of your customer base?
Oh, that's been an issue for NMR and cryo-TEM and other big-ticket items for a while, and there is and always has been, a limit to the maximum grant size. These larger systems are almost never purchased on a single grant, but almost always stitched together with some state, some university, some endowment, some foundation, some industrial. NIH grants, it's very rare that really big-ticket items, let's say, above $2 million or so, are funded on a single grant application. Unless there's some fine print that I haven't seen yet, that's really been the case for a very long time, for a decade or more. People have adjusted to that. Deans and faculties and universities have adjusted to that, and they stitch it together.
Okay. Got it. Yeah, no, I think the R01 grant math, it's evolving. Again, there's no specific step, but I think they are talking about capping it at like 31 points or something like that. The other question I had was on margins, Tony, which is, if I look at operating leverage, continues to improve. I'm wondering if for some reason you guys are at the lower end or maybe a little light of your organic growth goals, can you guys still hit your margin expansion targets this year? It seems like there's enough operating changes under the hood that you should be able to expand margins even without much help on top line. I just want to clarify the operational gearing in the model this year.
No, I think you have that right. We had good expansion of gross profit margins of 90 basis points. There were multiple factors. There wasn't any one thing. There are multiple things that fueled that. Buy has been priced to continual operational efficiencies that we're getting in that business, the restructurings that we've done in Daltonics and AXS, the facility consolidations. We do have the offset of the funding, the dilution with the acquired businesses. We'll manage through that. But we've done a pretty good job of delivering on our commitments on profitability, and we feel that we can modulate the spending based upon the business levels that we see to be able to deliver that. So, this quarter, there was some timing with some investments in R&D and sales and marketing that will smooth out over the course of the year.
I think comfortably, we're in the position to deliver what we put out in our guidance, to your point, with the organic growth that we put out as well, which is approaching market base and not there yet this year.
Got it. Thank you, guys.
Our next question comes from Tim Evans of Wells Fargo Securities. Please go ahead.
Thanks. One more on China really quickly. I think APAC in 2016 was 28% of your revenue. How much of that is China? In other words, how big is your China business now?
China is greater than 10%. It's in the low teens. I don't have the exact figure right now. Maybe 11% or 12%.
Okay, close enough. Frank, could you elaborate a little bit on the preclinical business? I think that was, if my memory serves me correctly, fairly weak all through 2016. Do you see an inflection point at some point in 2017? Also, how big is that business now, roughly speaking?
Yeah. Just generally, that business is less than $100 million. It has a couple of weak years, and the initial setup this year is not strong either. I think the big difference is once we really have the Oncovision acquisition integrated and have all the PET/SPECT, CT and PET NMR products that we have been developing and continue to develop on our roadmap, I think that will make a positive contribution. But that is a little bit more longer term that maybe for the first half of. After two weaker years, the first half of that business this year is not strong. It is relatively flat. So, it is a little bit of a disappointment. But we have also taken the cost actions in that business already.
It has its own cycles that are really not related to anything else, and some of that is also simply the way our own product roadmap, particularly in nuclear medicine, PET and SPECT, is evolving, to where I think we may see an acceleration in orders in the second half of the year. Actually, that is what we are expecting. But until that business is really back in growth mode, probably will be 2018. Luckily, it is of a size to where the good performance in aftermarket and NMR and EPR and the applied and industrial magnetic resonance product lines in BioSpin still overall make up for that, and the BioSpin group is doing quite well despite that one weaker division.
Have the struggles with that business been more market related? Or is it kind of a competitive issue? What is just your high-level takeaway on why that struggle went along for a couple of years now?
A mix of the two. I think there is some new smaller competitors that are sometimes not taking that much business, but have left a little bit of price erosion. And there has been some major changeover in the preclinical PET/SPECT business with the former market leader, Siemens, a few years exiting that business and some other exits of other players. There is almost a complete turnover of who the competitors are, and that is still sort of sorting itself out.
Okay. Thank you.
Our next question comes from Tycho Peterson of JP Morgan. Please go ahead.
Hey, thanks. Maybe one for Tony, just kind of circling back on some of the margin questions. Can you maybe give us a sense this quarter, the gross margin expansion, how much of that was NMR and pricing versus some of the efficiencies? And as we think about some of the other themes you have hit on in the Q&A between price and aftermarket services, how should we think about gross margin trends for the course of the year?
In the quarter, in terms of the expansion, like I said, it wasn't any one thing, it was a collection of things. BioSpin price and the efficiencies there was a big piece of it. But another significant contributor was the restructuring action. Those are the major two drivers. Going forward, the model obviously counts on volume, so the organic increase that's embedded in the second half of the year, we'll get benefits in the margin from that. But we'll stay focused on the continuous process improvements that we have in place, and we'll be facing some difficult comparisons, like some of these other things in the BioSpin side and roll-off, but we believe that most of the operating profit margin contributions will come from the gross margin improvements.
Maybe I'll add to that, Tycho. The driver that's getting bigger and bigger beyond taking out cost, restructuring efficiencies, as you call them, and resumption of growth as some of our markets have less headwind or strength. The bigger and bigger driver will be the changeover in our portfolio. With our growth initiatives and strategic growth initiatives that we've been investing in, they really fundamentally have higher growth characteristics and margin characteristics, and as over time, they become a bigger part of our business over time, maybe not so much yet in 2017, but certainly in the outer years, they will become one of the bigger drivers of our further gross margin, and therefore operating margin improvements. It's portfolio and cost and growth, not just cost and growth.
I guess thinking about growth drivers for Nano, I know you're still somewhat reluctant to call for an inflection in semi, but AXS has gotten better, metrology's gotten better. Maybe just what's baked into guidance for a semi improvement in the back half of the year?
Oh, semi, we're pretty positive about. There's other industrial where there's selected strengths and other areas that are not getting worse, at least. But the rest of industrial is still a little bit mixed with some positive signs. Semi is pretty positive in both orders and revenues, and obviously baked into our forecast, but we were pleased with the orders in Q1 and with revenue. Semi, I think it was a good year last year, and I think it's going to be an incrementally even better year this year. The semi metrology trends are healthy for us, even though the big volume or capacity buys for 7 nm, of course, are a few years away.
But already now with 10 nm and memory and so on, and some technology buys for early evaluations of 7 nm, and in some cases even 5 nm, although that's more research phase, we're doing quite well, and we're setting ourselves up for doing really well once we get into capacity buys in a couple of years.
Tycho, just keep in mind that the semi growth is more back-half loaded.
Understood. Thanks.
Our next question comes from Derik de Bruin of Bank of America Merrill Lynch. Please go ahead.
Hi. Great. Thanks for getting in. Two questions, one's fast and then one's a little bit longer. The short one, unless I missed it, Tony, could you give me the FX impact for the BSI and the BEST segments? How was that split?
It was mostly BSI, and it was very small. It did not move the numbers at all. Sorry, Derik, are you talking about the
On the top line, what was the FX headwind? What was the revenues? What was the FX headwind to revenues?
- 2%.
Yeah, - 2%.
Is it split evenly between both segments?
It is mostly BSI.
Okay. All right, great. Then just one other longer question. Whenever I see the phrase upgrade cycle, it makes me want to ask three questions, which is, what is the size of your installed base? How much of that installed base is amenable to upgrade, and then what is an ASP? Just trying to put a revenue number around it.
For the NEO? For the NMR console?
For the NEO, yes. For your NMR NEO. Mm-hmm.
I don't have an exact number right now, but it is several thousand consoles. It may be 2,500 to 3,000 consoles. I don't have an exact number. Actually, the number is probably somewhat larger, but of course, we'd also have to look at those that generally are seven or more years old.
Yeah.
Someone who bought one in the last two or three years still have a pretty modern system and, of course, continued support, so they may not be able to upgrade yet. An ASP for these type of console upgrades where people keep the magnet. Very often they buy some additional probes with it. It can be anywhere from $200,000- $500,000, depending on what's included in the package. Let's say, an ASP, maybe, let's say $300,000 is a number in the ballpark, and I think that's probably as much detail as we can give you at this point, but maybe that helps you.
Yeah, no, that is great. That puts some reference around it. Thanks, appreciate it.
Now, the upgrade cycle in that, it is not like Illumina bringing out their latest sequences and everybody upgrades.
Right.
This is in NMR world, that is spread over multiple years. Quite honestly, it is spread over five years, but of course, it tends to be maybe a little bit more front-loaded in the next two or three years.
Right. But that is what is giving you confidence in the overall mid-single-digit growth rate CAGR for that NMR business.
Yeah, that and ultra-high field picking up our ultra-high field backlog that we have once it's technically feasible to build these type of 1.2 gigahertz magnets, and the nice growth in aftermarket and the nice growth in applied industrial and clinical research markets. Plus pharma growth for NMR. Actually, it's nice that NMR, the BioSpin story, it's not a one-trick pony, thank goodness. But this is another nice contributor.
Great. Thank you very much.
Our next question comes from Dan Leonard of Deutsche Bank. Please go ahead.
Thank you. I was hoping you could size the kit opportunity for the Biotyper, what the ramp curve could look like, and any timing you could offer around additional menu expansion plans.
Okay. Starting with the last one, probably further expansion. The American Society for Microbiology meeting is coming up same week and pretty much before ASMS in New Orleans. Of course, with FDA clearance, that always tends to be two or three years later than IVD CE, so there's always some differences in what we offer in Europe already and what we then end up offering in the U.S. when we get FDA clearance.
So right now it's primarily a European story. Keep in mind that of the roughly 2,500 MALDI Biotypers that are out there, roughly half of them are in Europe, because that's where we started originally with the business. So with that microbiology business, the installed base is unusually large in Europe, with actually right now, still slightly more than half of it in Europe. The ramp-up on these kits will not be needle-moving for our financials this year.
These are modest numbers. If that ramps up, maybe we get EUR 1 million or EUR 2 million in this type of business, it's these type of numbers. But over time, obviously, that can build up. And initially, it will take some missionary work to convince the labs that these fairly cost-effective solutions that they get from us without needing a culture have a clinical value and have a good clinical workflow. I think price performance will play a significant role, particularly in the more cost-sensitive European clinical microbiology market. We think all these drivers will be very positive over multiple years, but it's not going to be needle-moving for us this year.
Okay.
If that helps you.
Thank you.
Yep.
Our next question comes from Puneet Souda of Leerink Partners. Please go ahead.
Hi, Frank. Thanks for taking my question. As we head into ASMS here in just a few weeks, I just wanted to see if there is anything in Daltonics which you would highlight in the mass spec business, either on the top end and going into the pharma or anything else that is worth noting there. Then just briefly on the NMR, I mean the ultra-high field, 1 GHz plus 1.2 GHz and 1.1 GHz. From what appears to us, most of those orders are outside U.S. With the NIH funding in place now, does it give you any more sense compared to before that the pendulum could potentially shift to maybe one order in U.S. or more? Any color on that would be helpful. Thank you, and thanks for taking my questions.
Sure, Puneet. As we discussed, you were at ENC, and we had a little bit of a discussion starting with the second question. I find the additional $2 billion, and again, 6% increase in NIH budget, and the fact that this was apparently bipartisan and is about the only thing we may get bipartisan buy-in on, I find that pretty encouraging. But I am probably paid to be an optimist, so I think that is good. I think that should give some university consortia or some deans of departments or schools of science or medical schools additional confidence. Anecdotally, they were all very distraught the last few weeks, and, "My God, are we going to see a small increase or a 19% decrease?" That uncertainty, I think, was pretty toxic actually, at least in anecdotal conversation.
That is only one more year, but nevertheless, a trend could emerge where NIH funding might get bipartisan support for healthy increases. So I am optimistic that that could lead over time, I do not know whether it is this year or in future years, to more U.S. ultra-high field business. I think that is a good medium-term driver. It will not help us this year. To ASMS, do not mean to frustrate you, but of course, for competitive reasons, do not preview or discuss what we may release at conferences. But I am sure ASMS will be interesting for us and our customers.
Operator, next question, please.
Our next question comes from Bryan Brokmeier of Cantor Fitzgerald. Please go ahead.
Hi, good afternoon. Frank, you commented on the new resistance assay and the MALDI Biotyper a little bit. I was just curious, is that going to create any new instrument opportunities, or are the labs largely penetrated at this point, so the impact will be more seen in higher utilization and consumable revenue?
Yeah, a little bit. You don't need a new instrument to run this assay, but as they see more and more labs see increasing utilization, and as some of these newer tests, they do take a little bit more instrument time. There are more laser shots. So over time, this may lead more labs to buy more kits, but also perhaps upgrade to our newer instruments, for instance, the MBT smart, which has three times higher throughput and more uptime. So this will be incrementally positive also for additional instrument demand. It further enhances the competitiveness of our platform, as we obviously have a much larger vision of what one can do on a MALDI system, and I think our customers are acknowledging that.
I think it has a few other benefits from competitiveness, to perhaps also driving a little bit of an instrument upgrade cycle or perhaps the desire to buy a second instrument for a number of our customers that have pretty good utilization already.
Okay, on the NEO, how long does it take to convert an order into revenue? Also, is it consistent with some of the other comments you've made around new products that you're introducing, that are NEO's margins higher than sort of the overall margins you've had in NMR?
Typically in NMR, from order to revenue tends to be about six months. Of course, it's much longer for a high field system, and it can be shorter for a relatively straightforward chemistry, 400 MHz system, where it could be three to four months only. Yeah, we've designed NEO, it's nothing dramatic. It's not that its COGS are dramatically lower. But obviously, COGS have played a role in its design and built-in intelligence that makes servicing and installations easier. So we expect a small but incremental margin effect also from the NEO.
Okay, thank you.
This concludes our question and answer session. I would now like to turn the conference back over to Ms. Miroslava Minkova for any closing remarks.
Thank you for joining us this evening. During the second quarter, Bruker will participate at the Deutsche Bank Annual Health Care Conference in Boston tomorrow, the Jefferies Healthcare Conference in New York, the William Blair Annual Growth Stock Conference in Chicago, and the Goldman Sachs Annual Health Care Conference in Rancho Palos Verdes, California. We invite you to meet us at these conferences or to visit us at our headquarters in Billerica, Massachusetts. Thank you and have a good evening.
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