Ladies and gentlemen, thank you for standing by, and welcome to the Third Quarter 2020 Bio-Rad Laboratories Incorporated Earnings Conference Call. [Operator Instructions]. I would now like to hand the conference over to your speaker today, Director for Investor Relations, Kevin Han. And you may begin..

Thank you. Good afternoon, and thank you all for joining us. Today, we will review the third quarter of 2020.

And with me on the phone today are Norman Schwartz, our Chief Executive Officer; Ilan Daskal, Executive Vice President and Chief Financial Officer; Andy Last, Executive Vice President and Chief Operating Officer; Annette Tumolo, President of the Life Science Group; and Dara Wright, President of the Clinical Diagnostics Group.

Before we begin our review, I would like to caution everyone that we will be making forward-looking statements about management's goals, plans and expectations, our future financial performance and other matters. These statements are based on assumptions and expectations of future events that are subject to risks and uncertainties.

Included in these forward-looking statements are statements regarding the impact of the COVID-19 pandemic on Bio-Rad's results and operations and steps Bio-Rad is taking in response to the pandemic. Our actual results may differ materially from these plans and expectations. And the impact and duration of the COVID-19 pandemic is unknown.

We cannot be certain that Bio-Rad's responses to the pandemic will be successful, that the demand for Bio-Rad's COVID-19-related products is sustainable or that Bio-Rad will be able to meet this demand.

You should not place undue reliance on these forward-looking statements, and I encourage you to review our filings with the SEC, where we discuss in detail the risk factors in our business. The company does not intend to update any forward-looking statements made during the call today.

Our remarks today will also include references to non-GAAP net income and non-GAAP diluted income per share, which are financial measures that are not defined under generally accepted accounting principles. Investors should review the reconciliation of these non-GAAP measures to the comparable GAAP results contained in our earnings release.

I will now turn over the call back to Ilan Daskal, our Executive Vice President and Chief Financial Officer..

Thank you, Kevin. Good afternoon. Thank you all for joining us, and we hope that you and your families are well and staying healthy during these challenging times.

Now before I begin the detailed quarterly discussion, I would like to ask Andy Last, our Chief Operating Officer, to provide an update on Bio-Rad's operations in light of the current pandemic-related environment that we are experiencing globally.

Andy?.

the ongoing safety of our employees, continuing manufacturing operations to ensure product supply and support of our customers, and making sure we make progress on our core strategies. We have now established routine practices around the world to improve employees' safety.

We have adapted our policies and approaches to local conditions and requirements, and I'm very pleased with the productivity we have been able to achieve. Work from home continues where required. And for those in our facilities, we are continuing to implement broad safety procedures, and we continue to experience minimized case numbers.

In the U.S., we have now implemented a fast turnaround testing solution for suspected cases using a droplet digital PCR test and can rapidly deliver results back to an employee. This has enabled us to avoid significant work downtime, summing to over a full year productivity equivalent so far.

In manufacturing, our operations teams continue to be flexible in meeting the demand shift driven by the pandemic. We have flexed well to meet the high demand for our PCR products, which increased in Q3, and we have scaled back where needed, mainly for our diagnostics products.

We are now past the majority of the initial scale-up issues we encountered with supply chain disruption early in the pandemic and believe we are well positioned to meet future needs. Lastly, we continued to work on our core initiatives and strategies, in particular, in R&D, where we now have all our labs operational. Thank you.

And now I'll pass it back to Ilan..

the CFX Opus 96 and the CFX Opus 384, which strengthens our global response and contribution to the fight against the pandemic. With the launch of the CFX Opus systems, Bio-Rad also introduced access to a cloud-based instrument connectivity, data management and analysis platform.

These new PCR systems, along with our Droplet Digital PCR offering, provides a complete solution for our customers. Sales of Clinical Diagnostics products in the third quarter were $322.2 million compared to $341.8 million in Q3 of 2019, which is a 5.7% decline on a reported basis and a 5.9% decline on a currency-neutral basis.

On a sequential basis, we experienced improved performance across all regions and product lines, and we believe this reflects the recovery of routine testing trends. During the third quarter, strength in our quality controls products was offset by weakness across the rest of the diagnostics portfolio.

Although clinical labs have seen a significant negative impact by the pandemic, we are now experiencing a gradual recovery from the trough of Q2 and expect incremental recovery into the end of the year. We will be closely monitoring the potential impact of the recent and then increased surgeons.

On a geographic basis, the Diagnostics Group posted declines across all regions. The reported gross margin for the third quarter of 2020 was 56.7% on a GAAP basis and compares to 54.8% in Q3 of 2019.

The current gross margin benefited mainly from better product mix, higher manufacturing utilization and lower service cost, tempered somewhat by higher logistics cost. Amortization related to prior acquisitions recorded in cost of goods sold was $4.8 million compared to $3.9 million in Q3 of 2019.

SG&A expenses for Q3 of 2020 were $198.2 million or 30.6% of sales compared to $201.6 million or 36% in Q3 of 2019. We continue with cost-saving initiatives to reduce our SG&A. Total amortization expense related to acquisitions recorded in SG&A for the quarter was $2.3 million versus $1.9 million in Q3 of 2019.

Research and development expense in Q3 was $59.5 million or 9.2% of sales compared to $47.9 million or 8.6% of sales in Q3 of 2019. Q3 operating income was $109.6 million or 16.9% of sales compared to $57.5 million or 10.2% of sales in Q3 of 2019.

Looking below the operating line, the change in fair market value of equity securities holdings added $1.58 billion of income to the reported results and is substantially related to holdings of the shares of Sartorius AG.

Also during the quarter, interest and other income resulted in a net expense of $5.5 million compared to $2.1 million of expense last year. The effective tax rate for the quarter was 21.9% compared to 22.8% in Q3 of 2019. Reported net income for the third quarter was $1.315 billion, and diluted earnings per share were $43.64.

This is an increase from last year and is again substantially related to the changes in the valuation of Sartorius Holdings. Moving on to the non-GAAP results. Looking at the results on a non-GAAP basis, we have excluded certain atypical and unique items that impacted both the gross and operating margins as well as other income.

These items are detailed in the reconciliation table in the press release. Looking at the non-GAAP results for the third quarter. In cost of goods sold, we have excluded $4.8 million of amortization of purchased intangibles and a small restructuring benefit.

These exclusions moved the gross margin for the third quarter of 2020 to a non-GAAP gross margin of 57.5% versus 56% in Q3 of 2019. Non-GAAP SG&A in the third quarter of 2020 was 29.4% versus 35.5% in Q3 of 2019.

In SG&A, on a non-GAAP basis, we have excluded amortization of purchased intangibles of $2.3 million, legal-related expenses of $6 million, and restructuring and acquisition-related benefits of less than $1 million. Non-GAAP R&D expense in the third quarter of 2020 was 9.2% versus 8.5% in Q3 of 2019.

In R&D, on a non-GAAP basis, we have excluded a negligible restructuring benefit. The cumulative sum of these non-GAAP adjustments result in moving the quarterly operating margin from 16.9% on a GAAP basis to 18.8% on a non-GAAP basis. This non-GAAP operating margin compares to a non-GAAP operating margin in Q3 of 2019 of 12%.

We have also excluded certain items below the operating line, which are the increase in value of the Sartorius Equity Holdings of $1.580 billion and a small loss associated with venture investments. The non-GAAP effective tax rate for the quarter was 22.5% compared to 25.5% in Q3 of 2019.

The lower rate this quarter was primarily driven by a change in our geographic mix of earnings and the taxation of our foreign earnings. We now estimate the full year tax rate on a non-GAAP basis to be approximately 24%.

And finally, non-GAAP net income for the third quarter of 2020 was $90.3 million or $3 diluted earnings per share compared to $48.6 million and $1.61 per share in Q3 of 2019. Moving on to the balance sheet. Total cash and short-term investments at the end of Q3 were $1.160 billion, an increase of $123 million from the end of Q2 of 2020.

During the third quarter, our inventory increased by about $12 million from the second quarter of 2020. The increase of inventory in Q3 of 2020 was driven by the continued expectation of higher demand for COVID-19-related products. We expect inventory levels to come down over the next 2 to 3 quarters.

We plan to use the cash on hand to repay the $425 million of outstanding senior notes in December. In addition, the market value of our holdings in Sartorius AG has increased, which technically may deem us as an investment company under the 1940 Investment Company Act.

While we are working on the resolution, our access to the capital markets may be restricted. We feel that we have adequate resources to effectively run our business in the near term. During the third quarter, we did not purchase any shares of our stock. We had a total of $273 million available for potential share buybacks.

For the third quarter of 2020, net cash generated from operating activities was $135.7 million, which compares to $99.8 million in Q3 of 2019. The adjusted EBITDA for the third quarter of 2020 was 22.9% of sales. The adjusted EBITDA in Q3 of 2019 was 17%.

Net capital expenditures for the third quarter of 2020 were $20 million, and depreciation and amortization for the third quarter was $33.7 million. We project that the full year CapEx spend will likely be between $80 million and $90 million. Moving on to the guidance.

We continue to be uncertain about the duration and impact of the COVID-19 pandemic, although we do assume a gradual return to pre-pandemic activity levels and business mix. With that in mind, we currently believe that the full year 2020 year-over-year currency-neutral sales to be up 5.9% to 6.3%.

We estimate 27% to 28% currency-neutral revenue growth for Life Science and estimate about 7% currency-neutral revenue decline for the Diagnostics Group in 2020. This assumes that the fourth quarter will see a gradual improvement in non-COVID-19-related product sales and a smaller relative benefit of COVID-19-related product sales versus Q3.

Full year non-GAAP gross margin is projected to be between 56.5% and 57%, R&D at around 9%, full year GAAP operating margin between 16% and 16.5%, and full year adjusted EBITDA margin to be between 21% and 21.5%. Our significantly higher operating profit over last year was driven by discretionary cost control measures and better product mix.

As our operations begin to return back to normal, we expect a gradual reversal of these benefits that we experienced in 2020. Lastly, due to the uncertain nature of the current pandemic, we will not host an Investor Day this year and instead look to host it in 2021 when business activity normalizes.

With that said, in December, we plan on updating you with our revenue growth and margin targets. That concludes our prepared remarks, and we will now open the line to take your questions.

Christy?.

[Operator Instructions]. Our first question comes from the line of Patrick Donnelly from Citi. .

Ilan, probably one for you. Can you just break out the COVID sales a bit more? The expectations going into 4Q, certainly appreciate the smaller relative benefit, but any more granularity there would be helpful.

Basically, just wondering how much was related to ddPCR versus maybe some of the more instrument build-outs? And how you're expecting that to trend?.

Sure. Thank you, Patrick. So first of all, $98 million was the incremental revenue that was associated with the COVID-19-related sales. The vast majority is associated with our core PCR and ddPCR, lesser extent, I mean, a very small number was associated with our serology test. And again, most of it were instruments. And that's the split.

And when we think about Q4, we currently believe that it will be a lower number than the Q3 number..

Okay.

I guess I was just kind of wondering, should we expect a significant step down? Or is it going to be in the same ballpark, just slightly down from that kind of, call it, $100 million or so?.

In Q2, if you recall, it was about $71 million overall with a similar kind of split between the core PCR, ddPCR and the serology in terms of the ratios. And so far, it's a little bit difficult to tell. It's going to be probably somewhere in between those two, but maybe slightly lower. But it's probably not going to be much less below the Q2 numbers.

That's what we think about right now..

Okay. No, that's a helpful way to frame it. And then on the margin side, clearly saw some nice drop-through from the big revenue beat there.

Are you able to parse out how much of the margin expansion was related to the COVID revenues coming in, obviously, well above what we expected, I think you guys expected as well versus more kind of that core expansion that you've been obviously working on with the initiatives there?.

Yes. So definitely, the COVID-related sales contributed both on the mix side as well as on the utilization, and these were the main components. There was some headwinds associated with freight, for example.

But for the most part, it is the mix and the contribution of COVID-19-related products as well as for the utilization in some of the manufacturing footprint..

Okay. And then one maybe it might be for norm, if he's there. I mean given the strong cash flow you guys are seeing, how are you guys thinking about the M&A landscape? I know over the past few quarters, you talked a little bit about being more acquisitive on the larger side. Obviously, the Sartorius stake.

To your point there, it's gotten so big, you kind of have to look at some different regulations on the investment side. If you wanted to monetize that, clearly, a lot of dry powder.

So how should we think about your activity, what the pipeline looks like? And again, your appetite maybe on the larger scale, given your flexibility there?.

Yes. I think as you know, over the past several years, we've done a few more of these early stage things. And I think it is fair to say that our appetite and the kinds of things we're looking at today are a little larger in size and more established companies as opposed to these technology plays that we've invested in.

So again, we've got several things in the pipeline, see if we can land 1 or 2 of them..

Okay. And one last quick housekeeping one. Ilan, I know you mentioned in December, we'll get something on the revenue side. I guess what venue -- is it going to be just -- you're going to press release new 3-year targets? I just want to make sure we are thinking about that right..

Yes. So we plan to press release some financial measures. And stay tuned. But we'll follow-up with several calls as well..

Our next question comes from the line of Brandon Couillard from Jefferies..

Ilan, maybe to start with you. SG&A leverage, obviously, pretty good in the third quarter.

Should we view this as kind of a new base that you think might be sustainable kind of under the 30% range? And maybe if Andy could chime in and touch on some of the areas where you see opportunity for additional cost savings in the business and any specific priorities that you're looking at right now would be helpful..

Thank you, Brandon. I'll start, and Andy will chime in. Generally speaking, we definitely continue to enjoy some of the lower discretionary expenses, although some of these expenses did start to come back, but they're definitely not at the level of pre-pandemic.

So assuming that we'll get back to pre-pandemic level, SG&A will continue to be higher from the prior quarter. And some of it was associated also with employee-related expenses.

So if you think about the mid-30s level that we were there, we continue with our cost-saving initiatives that we started before the pandemic, and we are very successful in terms of realizing savings there. With that said, we believe that currently, we run below our normalized level of SG&A. So I expected some more kind of in between..

Yes. I think certainly, Brandon, we -- this does give us an opportunity to rethink some of the way we operate. I think that -- I think we've all seen how successful we've been working in a remote environment, and it wouldn't surprise me if -- as we return to normal, there is somewhat less travel than we've experienced in the past.

And I'm sure there's some other areas like that, that we can think about where we can continue to work on our SG&A..

All right. Maybe one for Annette. Would love to get some color from you on a few areas of the ddPCR business. Number one, just around the wastewater opportunity, whether that's really the -- a need of more of a niche application. I know there are multiple other kind of technologies that are also being dabbled with out there for that application.

As well as any color you might be able to share for sort of a non-COVID-related areas of demand, particularly the QX ONE. And I'd be interested if you're looking at the upgrade program for that system right now..

Okay. Thanks, Brandon. So the wastewater surveillance market is a brand-new opportunity for us for COVID. And we're doing some background work to try and understand the size of the market opportunity.

But we think the need for surveillance to detect early community outbreak is likely to be a longer-term need, and we're very well positioned to support this with our ddPCR products.

Yes, there are other technologies that you can use, but looking for that needle in the haystack in an environment with a lot of inhibitors, as you might imagine, is a situation that ddPCR can really serve quite well. So we're pleased with the uptake we've taken so far, and we're really taking a harder look at what the longer-term opportunity is.

Second question -- oh, so non-COVID. Like the clinical diagnostics market, we're seeing some gradual return to normal. We're not quite there yet. But sequentially, we see the improvement of revenue coming in from our core products. And this means people are back at the lab doing experiments, western blooding, things like that. So we're optimistic.

I think like our own R&D teams, I think research labs around the world are figuring out the right algorithm to have people come back in the lab and stay safe and get some work done. So I think we're starting to see that as part of the return to normal..

Got you. And then last one, I don't know, maybe Ilan or Andy.

Maybe update kind of where you think you stand with 10X Genomics litigation right now and when you might actually expect to receive some of that cash that's been accrued that they owe you?.

So this is Andy. I mean we're not typically commenting on the litigation situation with regard to 10x. And so I think we'll kind of continue to work through that litigation. And we'll obviously report when there's something that we feel we can disclose..

Our next question comes from the line of Jack Meehan from Nephron Research..

I wanted to probe a little bit more on the COVID expectations going from the third to the fourth quarter.

Is there any color you can provide around your capacity on the testing assay side? And within -- you expect overall sales to go down sequentially, but do you assume that piece is stepping up in the year-end?.

So I mean Annette can certainly chime in as well on the back end of my comments. But as you probably know, the majority of our COVID-related sales are instrument placements since we don't have an established molecular diagnostics franchise. So our sales are more related to capacity building than they are test pull-through.

So our point of view on Q4 is demand is there. We think it's going to be overall a bit softer than Q3..

Great. And then on the -- oh, go ahead, Annette..

No. Sorry, I was just going to add we're somewhat new to the molecular diagnostics market, but we have submitted a qPCR test to the FDA for an emergency use authorization. So stay tuned for that..

Would you need an EUA to be able to launch a test to the market? Or is it -- could you actually roll something out in advance of that?.

We need the EUA if labs choose to create their own LDT through components, put full insulin together. They're at full liberty to do that, and that's obviously why many are buying our system and then building their own assay..

Got it.

And then as you look across both businesses, is it possible to quantify at all if there was any potential catch up in investment in the third quarter from the second quarter?.

Yes. It's a good question. It's nothing that's evident to us. That's not to say that there may not have been a pocket of catch-up here and there, but nothing that we would say that we -- is evidenced whilst it's been material to Q3, the Q3 results..

Got it. And then on the quality control side, I know you called that out as kind of an area of strength in diagnostics.

So I was wondering if there was anything that stood out from a menu perspective? Do you think COVID testing could have helped that?.

I don't -- I'll start to add on to my initial response, which is that, no, I think our quality control business, very broad-based across routine testing and COVID-related controls are really only a small component. So it's more indicative to us of sequential improvement in routine testing across the board..

Got it.

And last one, if I can squeeze it in is, how is progress going with Celsee since the acquisition? And any updates in terms of time line for new products there?.

I think we'll pass this one to Annette..

Sure. So it's certainly early days with the technology, but we are seeing some traction in the market. We are investing in a new next-generation platform, and the work is progressing quite well. We're also developing a series of application-based kits for the single cell market. So we're very excited about the R&D that's going on in Ann Arbor.

And like I said, supporting that with significant investments..

Our next question comes from the line of Dan Leonard from Wells Fargo..

So my first question for whoever wants to take it, how much time are you spending on contemplating and thinking about how to better leverage your larger installed base of PCR equipment in molecular testing post pandemic? How much of a focus is that for you?.

Yes. That's an interesting question. Certainly, we've spent a fair amount of time thinking about that, and it's an obvious opportunity for us. And as Annette said, we've got an EUA in the FDA now on the shorter term. But yes, we are thinking about longer term what more could we do..

Okay. And then just trying to frame the potential risks as we have a renewed wave of shutdowns. It seems like that's happening in France. I have just stuck in my mind that you're over-indexed to France, but that could be a 15 years' old memory.

So can you mark me to market kind of where do you see your greatest exposure from a renewed wave of closures and how are you trying to frame that?.

So I think that, that's pretty global. I don't see any one particular geography that's where we're more or less exposed. And again, it's an area that we're watching very closely to -- quite aware of the fact that this thing isn't going away..

May I add an extra dimension to that? I think -- so obviously, the resurgence is something that we need to kind of keep our eye on extremely closely, though. I think we're also experiencing that many people have learned how to work now with COVID as the backdrop.

And so unlike the first surge of the year, we think it's likely to be more moderated, but it's certainly not going to go without impact. And so it's much harder to gauge how much impact there might be from this current resurgence that's going on..

Okay. And then maybe my final question for Ilan. Ilan, you mentioned some technicality that might get Bio-Rad classified as an investment company.

What would be the implications of that?.

Yes. Thank you, Danny. It's a great question. I mean, basically, in the near term, we don't think it has any impact on our operations. And obviously, we are currently working on the resolution. So that's our thinking right now..

There are no more questions at this time..

All right. Okay. Thank you, everyone, for joining us today, and we look forward to connecting with you in the next quarter. Thank you..

Ladies and gentlemen, this concludes today's conference call. Thank you for participating, and you may now disconnect at this time..