Expert Financial Analysis and Reporting

Investment Thesis

Repligen’s operating business results continue to be very strong as second quarter bioprocessing sales increased 36%. For perspective, full year bioprocessing revenues increased 38% in 2015 and 27% in 2014. The guidance for 2016 calls for a 21% to 26% increase, which probably is conservative. Management has not commented on 2017, but my preliminary estimate calls for a 20% increase in sales. However, there is a high probability that acquisitions will accelerate this 2017 sales growth.

Despite an upside surprise in sales growth, fully diluted EPS guidance based on GAAP accounting was reduced to a range of $0.23 to $0.29 from previous guidance of $0.35 to $0.41. What gives? This reduction was due to non-recurring expenses associated with: (1) the Atoll acquisition, (2) contingency payments stemming from the ATF acquisition and (3) expenses for a convertible offering. Adjusting for these factors, the non-GAAP EPS guidance for 2016 is 0.42 to $0.48 which is lower than prior guidance of $0.45 to $0.51. However, interest expense on the convertible debt will reduce EPS by $0.04 so if we consider this, the Company guidance for non-GAAP EPS would be better than that given earlier this year.

I have described Repligen in prior reports as having the best business model I have seen in my experience in following health care companies. I would refer you to those reports for more detail. The market shares my enthusiasm as the stock is selling at 65 times non-GAAP 2016 EPS guidance of $0.45 and 53 times my estimate of $0.55 for 2017 (which could be meaningfully low if major acquisitions occur). Obviously, this makes the stock very vulnerable to a negative surprise.

So what do I worry about? The biggest issue for me is that Repligen has become a very hard company to analyze. Their products are parts of manufacturing process and it is difficult to discern microeconomic issues and competitive forces that drive results. The Company is beautifully positioned to ride the macroeconomic tidal wave factors of strong growth in the use of biological drugs and the movement of bioprocessing from batch processes to continuous manufacturing. It also has a powerful and probably not well appreciated worldwide marketing reach. This allows the Company to make tactical acquisitions whose products can be quickly incorporated into the Repligen portfolio resulting in substantial sales leverage. My greatest concern is that some microeconomic back swan factor can arise and I wouldn’t recognize it until after it occurs.

The ability to make acquisitions and greatly increase sales of acquired products is a major strategic positive and Repligen has a very strong cash position. The Company is a strong cash creator and expects to generate free cash flow in the range of $13 to $15 million in 2016, after approximately $5 million of capital expenditures. Management is expecting year-end cash equivalents of $187 million to $189 million thanks to the $111 million of net cash realized in the convertible offering. This will be directed at acquisitions.

The timing of acquisitions is obviously unpredictable, but I think that it is a certainty that the Company will make some major acquisitions in the next year or two which could create upside surprise and substantially increase the base earnings power. It is this factor that causes me to retain my Buy recommendation despite the “nosebleed” P/E ratios on 2016 and 2017 EPS projections. You may think the stock is too rich to buy, but I would recommend holding the stock if that is your view.  It has been my experience that selling or buying a stock solely on the basis of evaluation can lead to mistakes and this is doubly so for a company with a great business model like Repligen.

2Q, 2016 Results

Repligen reported another strong quarter in which bioprocessing revenues increased 36% to $29.2 million and operating income increased 29% to $5.9 million. EPS calculated with generally accepted accounting principles (GAAP) increased 6%, but this is not reflective of the strength of the quarter. The reported tax rate was a negative factor at this year’s rate was 28% versus last year’s 17%. In addition non-recurring expenses associated with the Atoll acquisition, contingency payments stemming from the ATF acquisition and expenses for a convertible offering were also major factors. Finally, recurring interest expense associated with the convertibles offering impacted EPS. Investors need to adjust for these factors and after doing so the strength of the business becomes readily apparent.

Repligen is beautifully positioned to participate in the strong growth of biological products that are manufactured with living cells. It is also beautifully positioned to benefit from the movement from batch processing to continuous processing. Its portfolio of products compete in the upstream segment in which the cells are producing molecules that are used as drugs and in the downstream segment in which these molecules are separated from waste products and purified. These factors along with a strong and expanding global presence puts Repligen in an exceptional strong growth position for the remainder of 2016, into 2017 and beyond.

For the second quarter, OPUS was most significant driver for growth and the Company is projecting a 100% sales increase for 2016. Management also cited strong growth for ATF products and growth factors. A growing difficulty for investors is putting comments like this into perspective. Repligen only reports a single line item for sales and doesn’t break out individual product lines like OPUS, ATF and growth factors. Based on my research. I have come up with estimates for key product lines. These are reflective of magnitude of sales and sales trend, but they give the appearance of precision that isn’t actual. See the following table.

Financial Guidance for 2016

The immediate reaction of the market to the reporting of second quarter results was negative. However as investors looked more closely at the results, the stock reversed and since has been strengthening. As you read this section on financial guidance, I think you will understand the reasons for this stock behavior. Investors need to look at non-GAAP results which separates out one-time, non-recurring expenses that are included in GAAP results to understand the real strength of the quarter.

Revenues: Revenue guidance was raised to a range of $101 to $105 million, which was an increase from the previous $98 to $102 million. This new guidance represents year over year growth of 21% to 26%; on a constant currency basis the growth would be 22% to 27%.

Operating income: GAAP operating income guidance for 2016 was reduced to $17 to $18 million from prior guidance of $18 to $20 million. This was the result of non-recurring charges incurred in the Atoll acquisition, contingent payments related to the ATF acquisition and the convertibles offering. The non-GAAP guidance for operating income was also decreased slightly to $21 to $23 million from previous guidance of $21.5 million to $23.5 million.

GAAP EPS: Repligen expects GAAP EPS for 2016 of $0.23 to $0.29 on a fully diluted basis which compares to previous guidance of $0.35 to $0.41. This includes a $0.19 impact from the Atoll acquisition, the contingent consideration paid in connection with the ATF acquisition and non-cash interest expenses associated with the convertible offering.

Non-GAAP EPS: These are expected to be in the range of $0.42 to $0.48, a change from previous guidance of $0.45 to $0.51. However, this includes a non-expected but recurring $0.04 per share impact from cash interest expense and $0.02 for foreign exchange expense. Without these charges, guidance would have been increased to a range of $0.48 to $0.54 from $0.45 to $0.51.

Cash Position: Repligen expects to generate free cash flow in the range of $13 to $15 million in 2016, after approximately $5 million of capital expenditures. Management is expecting year-end cash, cash equivalents and marketable securities of 187 million to 189 million.

OPUS

OPUS is the brand name for a line of chromatography columns used in separations of drug product from waste material in the downstream purification process. Their use ranges from bench-scale clinical applications through production-scale purification. Repligen can deliver just the columns or the columns packed with resin. OPUS is one of the leading single-use technologies that are being adopted for their convenience, flexibility and reliability as bio manufacturers seek ways to increase productivity while reducing facility size and cost.

Repligen has experienced a significant uptick in demand for OPUS columns. Led by the OPUS 45 and 60 centimeter format, unit sales of which have more than doubled in the first half of 2016 versus the same period in 2015. Repligen now estimate the OPUS line will grow approximately 100% for 2016. A major macroeconomic factor is a migration of big pharma to using pre-packed columns, a trend that emerged in the second half of last year.

Repligen made a decision in 1Q, 2016 to increase capacity. A new manufacturing suite came on line in April and two more suits will be up and running by the end of 3Q, 2016. This brings the total number of suites to five. They are booked through Q3 on OPUS and are making sure that customers get orders on time.

ATF

The XCell™ filtration systems is used upstream to increase cell retention and accelerate cell productivity, resulting in significantly higher product yield from a bioreactor. ATF is a platform technology that is being used in both late clinical development and commercial processes. It has a strong list of key accounts that have adopted ATF over the last few years for clinical usage and this should lead to strong growth as they scale to commercial processes.

New product development has focused on a single use ATF system that will be rolled out in September 2016 but for which some orders have already been received. They also have upgraded and launched the next generation version of ATF controllers which added features requested by the customer base. Strong growth is expected through 2017as the pipeline is strong led by the launch of single use ATF. Also manufacturing was put in place last year to support this demand.

Growth Factors

Management also cited strength in growth factors as a positive in 3Q, 2016 results. The majority of sales comes from commercial drugs with which they have been involved for a number of years. Some of these customers are now developing second generation or next generation molecules and transferring production to new facilities that leads to increased volume and this is the major drive of growth. They continue to focus on building out the pipeline, but it's a long and fairly slow process. The growth factor business is really driven by the commercial drugs and those that are in late stage development.

Protein A

The Protein A ligands business came in as expected for the quarter. The direct tie of this business to the production of monoclonal bodies continues to provide strong growth. There have been six monoclonal antibody drugs approved this year, one of which was a biosimilar version of a blockbuster drug. Repligen’s business is driven by unlit volume and the Company believes that the increased use of biosimilars will be a positive for them

Acquisition of Atoll

On April 1, 2016, Repligen’s Swedish subsidiary acquired Atoll. Repligen issued 538,700 shares stock valued at $14.1 million and there was an upfront cash payment of $10.2 million so that the total purchase price was $25.3 million. Repligen incurred $1.1 million in transaction costs.

Atoll is a manufacturer of pre-packed chromatography columns. This acquisition strengthens and complements the OPUS product line, and provides an important customer-facing center in Central Europe.

The first step was to train the Repligen sales force on Atoll products and that was completed in early 2Q. They have also studied accounts that Atoll has done well with and saw a fair amount of overlap. They are driving sales of Atoll products with the more powerful Repligen sales team. The whole portfolio will be branded under the OPUS name. The integration is going well and the goal is to have the Atoll portfolio fully integrated into the OPUS family brand by the end of this quarter.

They achieved the Atoll sales target in 2Q, 2016 and are right in-line with the deal model. The guidance for Atoll continues to be 3.0 to 3.5 million of sales for 2016.

Convertible Note Offering

On May 24, 2016, Repligen issued a $115 million of 2.125% convertible notes due June 1, 2021. The net after deducting the underwriting discounts and commissions and other related offering expenses was approximately $111.3 million. Prior to March 1, 2021, the notes are convertible into common shares at a price of $32.07 per common share which could result in roughly 3.6 million shares. Repligen can redeem notes prior to June 19, 2019 at a price that is 130% of the average price for the 20 prior trading days. The annual interest expense is $2.875 million and the quarterly is $0.718 million.

Review of Sale of Intellectual Property to BioMarin

In January 2014, Repligen sold its histone deacetylase inhibitor portfolio to BioMarin and received an upfront payment of $2 million. The Company is entitled to receive up to $160 million in potential future milestone of which about $60 million are related to clinical development and 63% or $100 million to commercial sales. Royalties start in the mid-single digits and are tiered upward for the lead drug and are less for backup drugs. This is just to remind you of this remaining asset from Repligen’s days as a biotechnology company.