Nova Q3 2021 Earnings Call Transcript

Quartr
Provided by Quartr
November 2, 2021

There are 12 speakers on the call.

Operator

Everyone, welcome to the Ortho Clinic Diagnostics Third Quarter 2021 Earnings Conference Call and Webcast. Please note that this conference is being recorded. An audio replay of the conference call will be available on the company's website within a few hours after this call. I would now like to turn the call over to Brian Brockmeier, Vice President of Investor Relations. Brian, you may

Speaker 1

Thank you, operator. Good afternoon, everyone, and welcome to the Ortho Clinical Diagnostics 3rd quarter earnings conference call. With me today to discuss our financial results are Chris Smith, Ortho's Chairman and CEO and Joe Buske, Ortho's Chief Financial Officer. Mike Iskra, our EVP of Commercial Excellence and Strategy will join us on the Q and A portion of the call. This conference call is being simultaneously webcast on the Investors section of our website and a version of Safe Harbor Fusion can be downloaded there.

Speaker 1

Before we begin, I will cover our Safe Harbor statement. Some of the statements we will make during this call about the of the Securities Exchange Act of 1934, which provides a safe harbor for such statements. Our use of forward looking statements is subject to a number of risks, uncertainties and other factors that could cause actual results to differ materially from our current expectations. These risks and uncertainties include, but are not limited to, those factors identified on Slide 2 of today's presentation and our other filings with the SEC. Please refer to our SEC filings for a more detailed discussion of forward looking statements and the risks and uncertainties of such statements.

Speaker 1

We cannot assure you that the forward looking statements we make today will be realized. We undertake no obligation to update any forward looking statement to reflect future events, developments or changed circumstances or for any other reason except as required by law. Also during today's call, there will be a discussion of some items that do not conform to U. S. Generally Accepted Accounting Principles or GAAP.

Speaker 1

Please see Slide 3 for a list of these non GAAP measures including but not limited to core revenue, Constant currency, EBITDA, adjusted EBITDA, adjusted free cash flow and adjusted diluted earnings per share. Reconciliations of these non GAAP measures to their most directly comparable GAAP measures are included in the appendix to the investor presentation and the press release issued this afternoon, both of which are available in the Investors section of the Ortho website. In addition, on today's call, we will refer to our Core and our non core business, our clinical laboratories, also known as clinical labs and transfusion medicine businesses represent our core business. Our non core business is comprised of our contract manufacturing and licensing revenue. Lastly, unless stated otherwise, all year over year revenue growth rates, including revenue growth ranges given on today's call or given on a comparable constant currency basis.

Speaker 1

Now I'd like to turn the call over to Chris Smith, Ortho's Chairman and CEO. Chris?

Speaker 2

Thanks, Brian, and good afternoon, everyone. It was another great quarter for Ortho and excited to be able to share our results. I always love to start all our presentations with this slide, which it talks about the mission and the credo of the company because every test is a life. And this is why we do what we do On a daily basis, we embrace this and it's a critical role in the role that we play in the healthcare system every single day. To give you an example, today we'll help about 800,000 patients around the world.

Speaker 2

And I just want to thank our teammates around the world for everything they do every day to make a difference in those patients With that, let's get into the 3rd quarter results. We'll start with Slide 5. Core revenue grew 13% in constant currency to 5 $109,000,000 with the strength in both our clinical labs and our transfusion medicine business. Our base business was up 16%, 3 percentage points of headwind from COVID tests, reflecting underlying strength in our base business. Therefore, we have raised our full year revenue growth guidance 15% from the prior 10% to 12% for the full year revenue.

Speaker 2

In addition to strong revenue growth, Adjusted EBITDA grew 17 percent to $140,000,000 representing a margin expansion of 25 basis points to 26.7 percent. And adjusted earnings per share is up 50% year over year to $0.21 We are very pleased with our continued resilience over the last couple of years, Even now as COVID tests have shifted to growth headwind. This continuum in our business is a clear result of our dedication to customers and the patients that they serve. We talk about the importance of lifetime customer value and the long term relationships that we build with our customers. And I'm even more confident now that this is resonating in the marketplace and is reflected in our results.

Speaker 2

I'll get into more of that later on in the call. Continuing with our Q3 performance, Let's look closely at our geographies on Slide 6. The Americas, our largest geography, grew 15%. EMEA grew 13% with Western Europe up 9%, Greater China grew 10% and the other, which is really made up of Japan and Latin America, I mean, excuse me, Japan and Asia Pacific grew 16%. In the U.

Speaker 2

S, commercial growth, excluding COVID assays, was up 13%, driven by strong instrument placements, Especially of our integrated systems, our menu expansion and our revenue reoccurring pull through, as well as our CTS partnership in our transfusion medicine business. In EMEA, growth excluding COVID assays was up 14%, driven by strength across our Clin Labs business. This is the 4th consecutive quarter of growth in Western Europe following 5 years of declines. We remain encouraged by the continued strength in Western Europe, which continued to regain ground in the market as a result of leadership changes we implemented over the last few years in our commercial excellence program. Greater China grew double digits for the Q3 in a row With particular strength in our immunoassay business.

Speaker 2

While our immunoassay business was up 20%, we have not seen full recovery in the routine clinical chemistry testing. Our installed base grew 6% and our integrated systems growth was 13% and these are very good indicators for future accelerated growth. In addition, our distributor inventory levels are at or below historic levels. We are incredibly pleased with the growth in both the developed and the emerging markets, which grew 12% 19%, respectively. And growth was particularly strong in India and Latin America.

Speaker 2

In summary, our team around the world Continue to successfully execute on our growth strategy that we launched in 2019. Next on Slide 7, We remain steadfastly focused on executing against our 3 strategic priorities to drive profitable sustainable growth and shareholder value. These priorities are product innovation, commercial excellence and operational efficiencies. We continue to make progress against each during the Q3. Let me cover just a couple of the highlights.

Speaker 2

Beginning with product innovation, as we discussed last quarter, we received emergency use authorization in the U. S. For our quantitative Turning to our 2nd priority, global commercial excellence. Our commercial excellence program continues to improve our execution. In the Q3, we delivered 16% growth in integrated installed base.

Speaker 2

This is driving strong growth in our MU assay business, which was up 14% excluding COVID related revenue. We continue to lead with service as a key differentiator. And as an example, in the recently published Service Track Awards in Service Track, as you may recall, is a 3rd party independent agency that surveys hospital customers. Our net promoter score was 22 points higher than the next closest competitor, a true reflection of where we stand in the eyes of customers around the world. And finally, our 3rd priority, operational efficiency.

Speaker 2

As part of our follow the sun approach, we're expanding our global footprint in India. Through this investment in the future, we continue our steadfast focus on innovation, customer excellence and emerging market expansion, while also bringing efficiency, scale and cost savings to our organization. Establishing shared service centers in different geographies and time zones around the world Allows us to operate around the clock and thereby innovate faster. It will also position service and support teammates closer to our customers. This center in India will allow us to anticipate and quickly meet customer needs with innovative products and industry leading services.

Speaker 2

It is designed to guide our organization to be more agile and adapted to the company and also enable continuous reinvestment in our growth. Returning to the big picture on Slide 8, I would like to highlight our strong growth trajectory and our integrated installed base growth as well as our lifetime customer value, which underpins our strategy. As illustrated in the top chart, the growth trajectory of our core business Reached an inflection point in 2019, we pivoted from a value based strategy to a new growth strategy as our integrated systems penetrated the market and pull through reoccurring revenues and our commercial excellence programs began their execution. The key driver is very clear base growth shown in the bottom chart. Our integrated installed base growth accelerated with the launch of our XT-seven thousand six hundred and the concurrent sale of refurbished 5,600s in emerging markets.

Speaker 2

This sustained double digit growth in our integrated install base drove the overall growth of our clinical lab Install base. We see a significant opportunity to carry this strength forward as we continue into the Q4 and into 2022. That integrated install base growth is important because our lifetime customer value, which is illustrated on Slide 9. Lifetime customer value is all about building long term relationships with our customers through the strong clinical performance of our assays, our instruments ease of use and our reliability of our instruments. It's also part of our best in class customer service and our low total cost of ownership.

Speaker 2

This is focused on lifetime customer value that allows us to have an average customer relationship of greater than 13 years and leveraging these long term relationships to replace our installed base of standalone systems with integrated systems and that's a key source of growth for the company. The penetration of the market with our integrated analyzers is fundamental to our growth strategy. And that's because our integrated systems pull through 65% more revenue Our integrated installed base continues to grow double digits. Given that our integrated installed base is still just 26% of our total ClinLabs installed base, we believe we still have a lot of room for growth in the coming years. Lastly, Slide 10 illustrates how we are able to pull through so much reoccurring revenue on these integrated systems compared to a standalone.

Speaker 2

In 2020, our clinical labs revenue mix was weighted heavily towards clinical chemistry with a 62% to 38% split, While the broader market was the complete reverse with 68% of the revenues from ImmuAssay. We believe this mismatch between our revenue mix and the portion of the broader market represents a significant growth opportunity for us as we continue to expand our market share within IA and as we penetrate the market with our integrated instruments. This allows us to leverage our recently expanded test menu and execute on our commercial excellence program globally. In the Q3, our MU assay revenue was up 14% excluding COVID related revenue. With that, I'd like to turn the call over to Joe to further discuss our Q3 financial results and our 2021 outlook.

Speaker 2

Joe?

Speaker 3

Thanks, Chris, and good afternoon, everyone. I'll begin with a bit more detail on our operating results for the quarter, starting with a breakdown of our revenues on Slide 11. In the Q3, we have total revenue of $523,000,000 an increase of 14.3% in constant currency. Currency translation increased sales growth by 150 basis points resulting in 15.8% reported sales growth. Core revenue, which excludes contract manufacturing and collaboration revenue increased 13% On a constant currency basis to $509,000,000 Note that the COVID-nineteen pandemic has impacted our quarterly seasonality And therefore, Q3 core revenue was up 5% sequentially from the 2nd quarter.

Speaker 3

The substantial revenue growth in the 3rd quarter was Primarily driven by the strong recurring revenue pull through on the instruments we placed over the last couple of years across our geographies in both Clin Labs and transfusion medicine. Our ClinLab business generated $12,000,000 in COVID assay related revenue, which was down from $21,000,000 in Q3 of last year, representing approximately a 200 basis point headwind on total company core growth. In COVID assay revenue was actually down 5,000,000 sequentially from Q2 of this year. Turning to our Q3 performance by line of business. Clin Labs revenue grew 10% in the quarter, Largely driven by double digit growth across all major regions excluding COVID assay revenue.

Speaker 3

In transfusion medicine, we grew 21%, driven by strong growth in the Americas, China and other Asia Pacific countries. And as a reminder, the 3rd quarter Benefited from our new partnership with CTS, which went live in Q1 of this year. Non core revenue In the Q3 grew to $13,600,000 from $7,800,000 This non core revenue in the quarter includes The benefit of an $8,500,000 final arbitration award related to one of our collaboration agreements in the U. S. Now turning to our performance by geography on a constant currency basis, Americas revenue grew 15 including 14% growth in the U.

Speaker 3

S. EMEA grew 13%, including 9% growth in Western Europe Greater China grew 10% and other which again includes Japan and other Asia Pac countries grew 16%. Looking at our revenue by category, recurring revenue, which includes reagents, service and other consumables grew 14%, Driven by strength in both clin chemistry and immunoassays excluding COVID assay revenue as well as donor screening. Instrument Revenue grew 15% in the quarter driven by placement of our integrated ClinLab instruments and our immunohematology instruments. Now turning to slide 13, I'd like to comment briefly on our Q3 financial performance versus the prior year.

Speaker 3

We delivered another solid quarter of performance below the top line with improvements in gross margin, OpEx and free cash flow in the quarter. Gross profit margin for the quarter was 51.7%. This is a 360 basis point Increase versus Q3 2020, 80 basis points of which is due to the impact from the previously mentioned arbitration award And the remaining 280 basis points is made up of currency translation volume, lower manufacturing cost, partially offset by a negative impact from mix, primarily from the lower high margin COVID related revenue. Additionally, within both cost of sales and operating expenses, we have seen higher spot airfreight as we previously discussed. This trend continues, but we are actively managing and monitoring the situation and we've included these higher costs in our guidance.

Speaker 3

Moving down the P and L, sales, marketing and administrative expense as a percentage of revenue was flat year over year at 27% of revenue. Adjusted EBITDA grew 17 percent to $140,000,000 and adjusted EBITDA margin expanded 25 bps year over year to 26.7 percent, Primarily driven by positive mix in our placement of integrated systems, efficiency improvements and the successful execution of our value capture program. Now if you exclude the arbitration award I mentioned a minute ago, which was recognized in non core revenue, but we backed out of adjusted EBITDA, Our adjusted EBITDA margin would have increased approximately 50 basis points in the quarter. Net interest expense for the period was $36,000,000 a decrease of $13,000,000 as anticipated due to lower Average outstanding debt balance and lower interest rates. Our provision for income taxes was $6,000,000 compared to a benefit of $10,000,000 in the year ago period.

Speaker 3

We continue to expect cash taxes for the year to be approximately $20,000,000 Our adjusted earnings per fully diluted share for the 3rd quarter increased 50% year over year at $0.21 driven by our solid operating performance as well as lower interest expense. And on a GAAP basis, We reported EPS of $0.06 per share compared to a net loss per share of $0.20 in Q3 of last year. And positively, this was our first quarterly GAAP profits since 2019. Now turning to free cash flow, capital deployment and balance sheet on Slide 14. In the Q3, we generated $56,000,000 in adjusted free cash flow after funding $8,000,000 in capital expenditures.

Speaker 3

Our days sales outstanding came in at 41 days, an improvement of 20 days compared to the Q3 of last year. Now this includes a securitization of $75,000,000 in the U. S. That we talked about last quarter and without the benefit of this financing transaction, Our DSO still would have improved by 7 days compared to the Q3 of last year. And as I said on the Q2 call, we expect Cash generation in the second half of the year to be greater than $100,000,000 Our strong cash generation enabled us Continue to deleverage our balance sheet and reduce our net debt to EBITDA ratio to 3.7 times, down from 4 times at the end of Q2.

Speaker 3

Given the strength of our business performance, we continue to expect to reduce this leverage ratio by at least a half term per year going forward as we move towards our more normalized Leverage range of 2.5 times to 3.5 times, while maintaining flexibility for strategic M and A opportunities. We ended the quarter with cash and cash equivalents of $256,000,000 and total debt of 2,300,000,000 Turning to slide 15, let me remind you that continued debt reduction is just one facet of our balanced capital deployment strategy. We are actively evaluating organic and inorganic growth opportunities that would complement our core business, further increase operating leverage and give us new or additional exposure to high growth markets. While we are guided by our focus on the continued deployment of industry leading and innovative solutions for patients around the world, we believe that our expertise Gain through our highly collaborative partnerships coupled with our market leading position and attractive IVD space and a healthy balance sheet found in our January IPO Provide us with an excellent platform to pursue mostly bolt on acquisitions to accelerate profitable growth going forward. Now turning to our outlook for the remainder of the year on Slide 16.

Speaker 3

First, I want to provide some broader context On our Q4 and the full year 2021 guidance, we saw very strong demand through the 1st 3 quarters of this year And given positive utilization trends as well as leading indicators, including forecasted inpatient admissions, we expect continued strength in the Q4 of this year. We expect minimal COVID assay revenue in the Q4 of 2021 compared to $26,000,000 in the Q4 of last year, representing up to a 500 basis point headwind on our total company growth core growth in Q4. The 4th quarter 2020 included an extra week under our fiscal period, which we estimate positively impacted sales growth by approximately 2 percentage points. Now consequently, we are raising our 2021 guidance As follows core revenue is expected to grow 14% to 15% on a constant currency basis to $2,000,000,000 to 2,020,000,000 Compared to our prior guidance of 10% to 12% constant currency growth to $1,095,000,000 to 1,098,000,000 At current rates, current currency translation is expected to increase our full year sales growth by approximately 2 percentage points. Adjusted EBITDA is expected to grow 19% to 20% on a reported basis to $542,000,000 to $547,000,000 An increase from our prior range of $526,000,000 to $534,000 Adjusted diluted EPS is now expected to be $0.76 to $0.78 per share, an increase from our prior guidance of 0 point $7.07 to $0.72 based on a full year diluted weighted average share count of $235,000,000 Now before turning it Back over to Chris, I'd like to discuss supply chain disruptions.

Speaker 3

Global supply chain challenges combined with the strength of our business over the last several quarters It is putting increased demand on our supply chain. Our teammates have done a fantastic job implementing many initiatives In early 2021 to mitigate our exposure caused by the global pandemic as well as our accelerated growth in our core business. We have factored in expected supply chain challenges into our guidance. With that, I'll turn the call back over to Chris to make a

Speaker 2

few summary comments. Thanks, Joe. Great update on the quarter. And look, we've shown this slide before, but it really is the investment thesis. We continue to believe that Ortho is A fantastic investment.

Speaker 2

Number 1, because we are pure play IVD and it is a highly attractive and growing market. Obviously, the second thing, we think we have very unique Clear differentiators in the market, especially around our lifetime customer value, our service and our reoccurring revenue stream, which is now approximately 90 About 93%. And we have strong momentum with renewed focus on profitable growth, which we continue to show in the quarterly results. On that, let me take the call back to Brian, and we will turn it into Q and A.

Speaker 1

Okay. Operator, we'll take the first question. Okay.

Operator

Thank you. Our first question comes from Tycho Peterson of JPMorgan. Your line is open.

Speaker 3

Hey, thanks. Hey,

Speaker 4

Chris, I want to start with Last quarter you talked about it being slower to return. I know you were still up 10% in Greater China, but obviously there's a lot of focus on procurement, tenders, local competition, Kind of two things, China 2025 and the local competitors and then kind of these volume based tenders where they're trying to capture some of the high value, low volume tests, similar to what they did with Pharma and 4/47. So maybe can you touch on those dynamics? Are you viewed as a local competitor in China at this point? And then how do you think about the tender process?

Speaker 2

We're still not, Tycho, viewed as a local. And I think that's one of the reasons we've created our 2 partnership agreements or localization strategies, 1 around instrument 1 around assay development. We're now about, I don't know, 6 months, 9 months into those partnership agreements, which we think will help us. As far as the tender, you're exactly right. I mean, that is starting to occur.

Speaker 2

As you probably know, we did participate And really kind of the first tender that was out there. And the interesting thing Tycho, everything has been tender always. I mean, hospitals in the United States are tender, Europe's tender, Middle East. But China, this was relatively new. 2, as you probably know, 2 major multinationals chose not to participate.

Speaker 2

Now for us, it actually worked out quite well. We didn't see a significant decrease in price and we believe because we were awarded we'll pick up share there. And so we do think that will But we feel like we're learning a lot as we went through that process. And we believe that our ability that so much of our business is outside the United States and has been part of tenders across We feel pretty well positioned there. But as you know, it grew double digits again.

Speaker 2

We base a lot of where we think the business is going on Install base growth and integrated install base growth and both of those are really robust for the quarter. And I think the other thing that's nice is that, Look, we had gone through a situation where distributors are really starting to destock and we're now at kind of a place where we're at or below where distributor Stocking was. So we still feel really comfortable with where our growth is and that will continue to be in double digits going forward. I don't know if I answered all your questions. You had a couple of others, but I hope I got them all.

Speaker 4

That's great. And then I want to follow-up with Joe on the supply chain comments. Really, it's about your ability to pass on higher freight costs and things to customers if they're under multiyear contracts. Can you maybe just touch on that? And then any kind of input These are things you're going to have to deal with on the other end?

Speaker 3

Yes, Tycho. Yes, we are passing on price increases to our customers where possible. I mean, you're right. We can't do it in all cases, but we're certainly where possible we are doing it. And as far as what are the areas That we're seeing shortages.

Speaker 3

It's no different than what others have said on calls microchips, resins, plastics. And so we've got a lot of initiatives in play that I mentioned in the prepared remarks. We're strengthening our relationships with Our industry contract manufacturing partners were taking over portions of the distribution network. We're bringing in additional key Suppliers for key components, so there's a lot of activity going there and we feel that there really wasn't a significant impact And our Q3 results.

Speaker 4

Okay. I appreciate it. Thanks.

Speaker 2

Thanks, Tycho.

Operator

Thank you. Our next question comes from Vijay Kumar of Evercore ISI. Your line is open.

Speaker 2

Hey, Vijay.

Speaker 5

Hey, guys. Hi, Chris. Hi, Joe. Congrats on a good print here. Just on the Q itself, 16% core growth, that's about 8 points above fleet models.

Speaker 5

I'm curious, were there any one offs in the quarter? I mean, this is Really, really strong. It doesn't seem like COVID had a big, big role here. Maybe talk about the underlying trends Sure, on what growth of 16%.

Speaker 2

Yes. Joe, do you want to take that and maybe talk about this what happened in the quarter?

Speaker 3

Yes. Vijay, I think, as I noted in the comments, in the included non core revenue, Which obviously rolls up in the total revenue. We had an arbitration award, which was $8,500,000 Clearly, that's Something that wouldn't have been planned or forecasted. And then, yes, the COVID assay related revenue in the quarter was $12,000,000 So probably Maybe a little bit stronger than maybe what some had expected.

Speaker 2

Yes. And you know, Vijay, we had originally put none in the second half. And so obviously, we're getting Some depending on where your model is built, but COVID coming around 12. Joe mentioned the one off, but really it's just I always talk about this in This being a portfolio business, but right now we're just really performing well everywhere across the world. And so I think what you're seeing is That's strong execution being pulled through all regions at

Speaker 3

the same time. But Vijay, just to be clear, I mean, but Excluding that non core collaboration revenue that I spoke about and the COVID, the core revenue is up 16%. So it's just a strong quarter. And again, as Chris said, it was across all regions.

Speaker 5

I guess, and that Segways to my next question, right, because I'm going to speak to you clearly execution was above our trend. At Q4 guidance, I understand some of the comp issues. And was there any timing element because I'm getting a sequential step down of almost 14% rate. I think they implied us close to $470,000,000 revenues in Q4. Was there any pull forward of revenues from Q4 into Q3?

Speaker 5

Or like why shouldn't we see assistance of these strong trends? The comps don't seem that hard. It seems to be about 5, 6 points harder in Q4 sequentially. Why shouldn't Q4 be High singles, double digit core growth quarter for Q4?

Speaker 3

Yes. Vijay, If you take the we gave the full year guidance and obviously just sort of imply the Q4 numbers out of that, you're going to get In the range of 2% to 6% total, but excluding COVID, it's going to be 6% to 9%. That's the range. So the midpoint of that range, again, you're in 7% to 8% growth on the top line excluding COVID. So it is very much In the high single digit range in Q4.

Speaker 3

So we do feel like that growth is continuing.

Speaker 2

Yes. I think, Vijay, we also remember we had pretty significant headwind in Q4, I mean, we're look, we're this COVID is always a moving. We had a very strong COVID quarter of Q4 last year. There's not a lot in the Q4 forecast for us right now. It's minimal.

Speaker 2

So I think That would be obviously one factor to take in. But we've built in, for example, challenges in the supply chain and stuff into our numbers, If that makes sense. So think about it probably as 4 ish plus Total and ex COVID 8 ish? Yes, high single digit.

Speaker 5

That's helpful guys. Thank you.

Operator

Thank you. Our next question comes from Derik De Bruin of Bank of America. Your line is open.

Speaker 6

Hey, good afternoon. Hi. So, really impressive 14% to 15% Constant currency revenue growth. Obviously, for this year, I mean, this obviously begs the question on thinking about trends as we go into 2022. And you're tracking well above where we had you in the deal model and Certainly, the outlook seems to be very good.

Speaker 6

I mean, can you give any initial thoughts on how to sort of thinking of the puts and takes on to 2022 mid single digits sort of like core growth still in the cards, when you sort like to do all the puts and takes. Just any high level thoughts would be appreciated.

Speaker 2

Yes. Obviously, we won't do guidance for a bit, but kind of to give it to High level, Derek. I mean, look, I will say a couple of things are happening. We continue to believe we should be growing at or above market. And I think because we believe we're moving share And we're winning more than we've ever won before.

Speaker 2

And I think that's reflected in both the installed base growth as well as the integrated installed base growth. And remember integrated installs Could be first time wins, but if we're changing a standalone and moving to an integrated, it's a net 0. So when you see 4% or 5% On the standalone growth or the installed base growth, that's really market share wins. And then where I think you see the rest of the business coming, I think people have really underestimated Our ability since we expanded this menu on the IA side to pull through a lot more revenue when we convert a That's why you hear in my statements and Joe's everything's around integrated. We're really excited about where the integrated growth was because it lets us pull through so much more revenue.

Speaker 2

So I think when you take that combined with winning market share, that's why I think you're seeing the wins that you're seeing across the globe. And part of this has been this pivot in our strategy To not only go out and win accounts, but really expand our field organization globally with lab specialists or med techs that are in the hospital working for us To focus on pulling through that IA menu, which we really hadn't done as much until a couple of years ago. And I think we're really starting to see that gain traction.

Speaker 6

Got it. Yes, that was high level. Thanks. So just out of curiosity, I mean, when you sort of think about the China tenders and just the competing products there, I mean, obviously, you have the DriSlide technology, which is Technologically differentiated from a lot of the other clinical chemistry and immunoassay technologies out there. Is that Seen as an apples to apples sort of like compare product or is it differentiated because the technology is really is not substitutable Or for the other technologies.

Speaker 6

I'm just sort of curious like, is that a competitive advantage and sort of going into some of these arguments, some of these

Speaker 2

I think it is. I'm going to let Mike take this one in a second, who runs our global commercial. But I definitely think it is an advantage We get differentiation. Historically, we've gotten better reimbursement. I mean, obviously, you don't have the water issue.

Speaker 2

So I do think that that having that I'll also say that our leadership team there, particularly the woman who runs China for us is Very astute and I will say deep into the understanding of the market dynamics and helping as we go through tenders. But Mike, do you want to I know you've been pretty close to IRIS As we've gone through this, you want to share just some views on that around the dry chemistry and then also how they're handling the tender situation there?

Speaker 7

Yes. Derek, it is a differentiator. Chris hit on the main reasons why. The other thing when you think about the China market, we have It's a little bit different for us in that market is we have a very large presence in the stat lab market in China and a big part of that is the dry slide, the reliability of slides. Actually on chemistries, it's pretty fast turnaround time compared to our competitors.

Speaker 7

And so all those things combined are what helps with the differentiation Chris did mention, there is reimbursement benefits, that we do see in China. But again, globally, Customers, particularly customers that have used DriSlide and see the benefits, those attributes and the benefits they get Can be written sometimes into tenders, which makes it very difficult for wet systems to compete.

Speaker 2

Yes.

Speaker 8

Okay. Yes.

Speaker 2

And our view, by the way, Derek, is to participate in those tenders. I know some of our competitors are viewing it differently. But look, we believe it's the real world. It's going to happen, and You got to play ball. And so our view is we're going to participate because we believe our share upside is significantly better than whatever pricing downside we would face.

Speaker 6

Great. Thank you very much.

Speaker 2

Thanks.

Operator

Thank you. Our next question comes from Matt Sykes of Goldman Sachs. Your line is open.

Speaker 9

Hi, everybody. Thanks for taking my questions. I just want to focus on the commentary in the slide you have on the integrated installed base growth. It obviously continues to be impressive and it's great to see in that teens. It's also gone from 14 to 15 to 16 over the last three quarters.

Speaker 9

Is that a trend that we should expect? Are you seeing accelerating growth in an integrated installed base? I mean, I think being mid teens is great. But I'm just wondering if there's any additional trends that you could highlight that maybe is resulting in accelerated growth of the integrated installed base?

Speaker 2

Yes, Matt, I think that's been an interesting phenomenon. If you look back at 2017 2018, I think a lot of that would have been a conversion from A standalone to an integrated. I think the difference you're starting to see now and why we're seeing some of that growth is we're winning with integrated. So I was at a large hospital system in Florida, I don't know, 3 weeks ago, 4 weeks ago, a big system. You're talking a system that's doing 2 point 1,000,000 plus a year and we won that from a competitor, but we only did integrate it.

Speaker 2

So they've never had a standalone of our analyzer. So when you look at that, that would be not only increasing our install base, but it also increased our integrated install base. And so I think some of that is that tip of the spear Why you're seeing it? I would say that our demand is higher for our integrated. As we manage the supply chain, that's one of the things that we're staying close to with our instrument manufacturers trying to make sure that we stay out in front of it because the business has been good.

Speaker 2

So I think it's a little bit of both. Mike, again, do you want to comment Any more that maybe you see?

Speaker 7

No, Chris. I think you're on it, right? One of the things when you listen to the narrative, you We keep saying some of the same things over and over, but it's really the playbook. And I think when you See this, we're now executing that globally. So what was happening in the U.

Speaker 7

S. And a few other markets, now you see globally. And it is both using integrated to move standalone instruments up, but to win new business. And so it's not just one market either. I think that's what's helping

Speaker 9

And then just You continue to take down the net debt and you put yourself in a position for M and A. You've talked about exploring the market in the past. Just anything involved in your thinking? How does the landscape pipeline look? How are you thinking about valuations here?

Speaker 9

Just any thoughts on M and A at this point?

Speaker 3

Joe? Yes. Matt, I don't think a lot has changed since we talked about this last quarter. I mean, we're still looking primarily In the areas of specialty IA, molecular and point of care and we're still primarily looking into the areas of bolt on Niche acquisitions, nothing transformational here. We are getting pretty darn close to Our desired leverage range of 2.5 to 3.5, we're at 3.7 now.

Speaker 3

We're going Probably tick down a little more as we move to the end of this year. So we're getting pretty close. So it's just a matter of Continuing to look and find the right deal at the right valuation. So I don't think there's been a whole lot of change in philosophy.

Speaker 9

Great. Thanks very much. Appreciate it.

Speaker 3

Yes, sure.

Operator

Thank you. And next we have Patrick Donnelly of Citi. Your line is open.

Speaker 5

Hey, Patrick.

Speaker 8

Hey, guys. Thanks for taking the questions. Joe, maybe one for you on the margin side. You continue to put up Good performance there, guidance suggesting it's going to continue. Obviously, we keep hearing about inflationary pressures, supply chain logistics issues, etcetera.

Speaker 8

Can you just talk about the moving pieces there, dynamics as we go through 4Q and into 2022? I mean, it feels like expansion should continue, but just want to talk through the different pieces there.

Speaker 3

Yes. It's actually a very good question. We did have a good quarter in Q3 from A gross profit margin expansion perspective and laid out by the factors I talked about in the prepared remarks. I just want to remind you that 80 bps of that was driven by that arbitration award of $8,500,000 that we put in non core revenue. But The rest of it was a combination of some FX tailwinds and mostly operational.

Speaker 3

As we move though into Q4 And this is something I've been talking about on every quarter call. Q4 tends to be a quarter where we do more heavily Heavy mix of instrument revenue, which is typically lower margin than the recurring reagent revenue. So Built into the guidance is an expected decline in gross profit margin for the Q4. And that's again, we've seen that Every quarter for several years now and wouldn't expect anything different this year. But when you think about full year, For sure, we're still very much in line with the guidance that we put out of The increase in gross profit margin of at least 30 to 60 basis points annually.

Speaker 8

Okay. That's helpful color. And And Chris, maybe just on Europe EMEA. I mean, Western Europe has been a really good story for you guys. Can you just talk about what you're seeing there, expectations going forward?

Speaker 8

Just general trends there would be helpful.

Speaker 2

Yes. Look, I think when we got into this business, we kind of went through our leadership change a couple of years ago. I think our view was Europe had been going backwards Consistently for 5 years. So our first view was we'll get it to flat to 1% growth. But I will say that that team has really done a nice job Of changing out not only the leadership, but the team that we have there.

Speaker 2

And I would say in our countries where we did have strong leadership, In Italy, where we didn't make changes, they continue to perform a little bit above the market. And I think we're again, I come back to I think we're just winning more. And part of this goes back to Philosophy that we've kind of had that this will to win. And I think under J and J, it just wasn't a desire. And so we continue to I will say that one of the nice things we saw for example we saw in the Middle East, Russia, Eastern Europe all up double digits In the Q3, that would have been that's a change in a new leader in the last 12 months.

Speaker 2

And if you look at places like where we have to win in places like the U. Spain, where we had not won before, again, great close double digit growth type of thing. So I think we're seeing it Not just coming from one place, it's really coming from that whole region under Sean Martin's leadership.

Speaker 3

Hey, Patrick. Hey, it's Joe again. Can I go back to your margin question for a second? I addressed the sequential Impacts to the gross margin Q3 to Q4, but I probably should have mentioned also the year over year impacts Q4 being I mentioned this in the prepared remarks, but again we did $26,000,000 of COVID assay revenue in Q4 of last year. And as Chris said a minute ago, we have minimal COVID revenue in our guidance for the remainder of the year.

Speaker 3

So you are going to see a headwind on gross margin year over year due to mix, dropping that COVID assay revenue, which is fairly high margin revenue. So that year over year, we will see a headwind.

Speaker 8

Right. Yes, that makes sense. Thank you, guys.

Speaker 3

Okay. Thanks.

Operator

Thank you. And next we have Tejas Savant of Morgan Stanley. Your line is open.

Speaker 10

Hey, guys. Good evening. Joe, maybe to stick with the margin theme here. As Patrick was just mentioning, there's a bunch of moving pieces here with inflation and freight costs and the mix of cash versus reagent And then there's the COVID comp as well. I mean, you have some COVID revenue this year, Less than last year, but presumably as you guide for next year, you'll assume sort of 0 COVID contributions like you have here in the 4th quarter.

Speaker 10

So as we look at sort of margins in 2022, is 30 basis points to 40 basis points of margin expansion still a fair way to think about it? Or should we be considering some incremental downside from some of these dynamics?

Speaker 3

Yes. Taehas, I think you'll definitely see The tailwinds continuing that we've talked about all year and that is the value capture program that It targets $25,000,000 of savings annually, most of which end up in gross margin. You'll still see the tailwinds of gross margin Coming through from the strategy of shifting customers to integrated, which drives more immunoassay, higher margin revenue. But we the drop in the COVID assay revenue is going to be likely significant in our view. To your point, you just said, if you assume it's 0, we're going to go from roughly, call it, mid-60s of COVID assay revenue this year To 0, that's 3 points of top line growth and a lot of headwind on the gross margin.

Speaker 3

So I think the best way to think about the gross margin expansion in that 30 to 60 basis points annually for next year is ex COVID. If you exclude COVID, for sure given the value capture program and the tailwinds we get on the integrated strategy, we can get there.

Speaker 2

And if COVID ends up playing through, look, I think we're we talked about it on the quant assay. And quant we're not There's not a lot of movement going on with quant assay yet. We're the only ones that have something that will measure your immunity level. I will say researchers are really interested and A lot of clinical trials that are going on. And I think if that ends up getting some traction with regulatory bodies and the ability to Identify immunity levels before you get your booster or to give you an example, I got my booster on Monday and I didn't know I should have tested with our own device and know where my Immunity level is and I didn't.

Speaker 2

But I think we may see some opportunity with that test with COVID next year that we just don't have built in yet.

Speaker 10

Got it. And then a quick one on emerging markets for you, Chris. Can you share some incremental color on the strength you've seen in India and Brazil? In the past, I think you've noted at least for India that a lot of it is in the base business and not so much from COVID testing upside. Just curious as to how you see those 2 geos evolving you heading into 2022?

Speaker 2

Yes. Look, I think when we look at like I would say kind of our big three On the emerging would be not including something like China, but that would be Mexico, Brazil and India. And again, those are all up high double digit growth In Q3 continuing like they were. And it's not COVID, especially in those markets. And I think there's a couple of things Happening.

Speaker 2

I would say if you look at Mexico and Brazil, which report to the same leader, he has done a fantastic job Of leading with integrated probably before we did anywhere else in the world except for maybe the U. S. So you're seeing great Reagent revenue pull through there. They're doing a fantastic job of selling the full menu as opposed to just chemistry. And that's why we've seen consistent, I think, growth Like that coming out of there.

Speaker 2

If you look over in India, I think the thing that's really started to play incredibly well is that we've always been the number one service provider, but I don't that was as important to hospitals, so we started to go through the challenges with COVID and some of the challenges large multinationals had servicing their customers. And our field engineers are direct. Our field organization is direct. We have 7 distribution centers in India. It's a high Presence market for us.

Speaker 2

And I just think that's again a situation where we're selling the menu, but I think it's more about we're Winning more than we won before and the team has just done a really nice job there. So I see all three of those markets continue with very nice growth as we go In the next year, and it's about how do you take some of those lessons learned and put it into other of those emerging market countries.

Operator

Thank you. And next we have John Stauber of UBS. Your line is open.

Speaker 2

Hey, John.

Speaker 11

Hi. Thanks for taking my questions. I guess just maybe digging a little deeper on supply chain. I think previously, Some of the highlight was maybe 100 to 150 bps of pricing pressure there. Given the supply constraints and inflation, is that Still the right way to think about the diagnostic market?

Speaker 11

And then I think that ortho also might use more contract manufacturing than some of your competitors. Anything to highlight there?

Speaker 2

Yes. I'll let Joe take the first one kind of around pricing, and then I'll take the second one kind of around contract manufacturing.

Speaker 3

Yes, John. I would say that the typical annual price erosion we're seeing has not changed. It's still in that 150 basis Point range. No change there.

Speaker 2

Yes. John, I think as Joe mentioned earlier, there are places in contracts where we are able to push through some pass along some price increases, Looking at things like COVID surcharges and things, but I think that's a good model. Look, you are right that we use contract manufacturers, but on our instrument, We don't do it on any of our assays. And we believe that that's one of our key differentiators is our assays. It's core competency in the development and manufacturing of that.

Speaker 2

On the instruments, decision was made at the carve out to outsource that. But I feel really good about the partner we chose, the largest in the world and Deep relationships, give me an example, because of supply chain challenges, they're doing stuff for Tesla and airlines. But I have a call every single week with the CEO of that company and talking about where we are in the process because we've raised our demand significantly with them Because our business has grown. But, look, I think it's something like any business. You're probably I probably spent a lot more time on it now than I probably It would have 2 or 3 years ago, but I think you go to where the opportunities are or where the issues may lie and you try to manage those.

Speaker 2

And I think our team has done a fantastic job putting things in place to manage through it, but we are but we're spending time doing it. And there's I think there's a lot of things that we continue Like taking over our distribution center in Memphis from K and N. We had outsourced that to K and N, Cunanango, but we believe that's part of the customer experience, the shipping of our product. So we want to own that and we took that over and we'll do it for less than we were paying them to do it. And so back to Joe's point next year was Probably that will improve margins, but it also improves service levels.

Speaker 2

So I think the things that we think are core competencies, we want to own those and do them ourselves, but other things that we think aren't, We have outsourced some of that.

Speaker 11

Thanks. And maybe just one follow-up. Is the target there still 8 to 10 assays per year? Is that the right way to think about it? And any area to discuss on where you

Speaker 4

may be focused on menu expansion?

Speaker 2

Yes. Mike, so I think we've talked about 20 to 30 new or improved assays in the next 3 years. But Mike, do you want to give a little more color Around that?

Speaker 7

Yes, I think that's right, the right number to think about, 30 assays over the next 3 to 4 years. It's a combination of menu expansion, new items, some Enhancements and improvements. I think we're as you see, we have some assays that we've released in parts of the world, But we have yet to release in other places. So as an example, HIV combo, we're just getting through the regulatory approval in China. Procalcitonin, which we've launched Worldwide, with the exception of China, we're targeting for next year.

Speaker 7

So there are things like that, that have been Big drivers of growth for us in many parts of the world that we still have markets to open. We have a few, assays we're working on, for instance, hemoglobin On a micro slide, we think will be a difference maker we're pretty excited about for launch early next year, things like that.

Speaker 11

Got it. Thanks for taking my questions.

Speaker 1

Operator, we have time for one more question.

Operator

Thank you. Our last question comes from Chen of H. C. Wainwright. Your line is open.

Speaker 9

Thank you for taking question, could you comment on whether the supply chain issue is limited to certain geographic area or present in your worldwide markets? And whether the issue is primarily related to manufacturing or shipping logistics?

Speaker 2

Yes. Listen, I think that's Look, a good question. I would say, I think there's challenges in both. I would say that the logistic issues are readily manageable with price. So as you probably know, spot rates have gone up significantly.

Speaker 2

And I think You have the ability to get the products where you need the products to go based on what you're paying. I would say one of the things I think we've done a good job of is that we do have a pretty broad distribution network across the world. We use 2 primary distribution 1 in Memphis and 1 in Strasburg, but then we go as close to the customer as possible. And so I think that's helped us a lot. I don't know if you picked this up, but we're carrying more inventory than we have carried.

Speaker 2

And I think that's one of the other reasons we're being able to do that is to make sure that we do not have logistic issues. So I'd say that's one, but we've managed that pretty well. If you look at the manufacturing one, look, I think it's the same thing. I think what you're seeing at least with us and I don't know about all the Companies you follow, but our view has been to get as far in front of it as possible. So Joe mentioned this.

Speaker 2

For example, we have relationships with suppliers that we Have felt very good with for years. And we may have a primary and a secondary, but we historically maybe wouldn't have carried a third. We are now engaging that. And look, I think our view has been that we think we again have to be out in front of it. And so I would say there's a lot more contracting Going on a lot more vendor fairs or we go out and see our vendors.

Speaker 2

So I think it's actually impacted both parts candidly of our business, but I think they're all Manageable, as long as I think we're out in front of them.

Speaker 9

Thank you. And just a quick follow-up. Do you believe the COVID related revenue to Could continue to decline in the coming quarters?

Speaker 2

I'm trying to think where we did Q2. What did we do in Q2? 17. Yes. So we did 17 and we did 12.

Speaker 2

Look, I think we see it's minimal. So we're planning for less in Q4. I think a lot On what happens with the quant and how quickly we can get some of those innovative clinical trials Published and getting some government bodies to look at that. It's interesting, a lot of people like it. They just don't know what to do with it yet.

Speaker 2

And so what we need is we're working pretty close candidly with the CDC and NIH on some things around the quantitative test. But I would say that as we look at next year, I would say that our COVID projections are to be significantly less than they were this year Currently. Okay. Got it.

Speaker 6

Thank you.

Speaker 2

Hey, listen guys, it kind of brings us to the end of the time and But I did want to let you know one other quick point is that we know that you probably look, we have never had an Investor Day As a public company, so we're going to do an Investor Day. We know people want to do it in Rochester in January, but we have chosen To do it in New York City on March 21. So we'll send out more information, but we're really excited about that because what we want you to do is, one is, Pali Chokaleng is here with me. He's our Chief Innovation Officer. Pali is going to really give you some insight into where our new technology is going.

Speaker 2

We got some exciting stuff that will release at the end of next year from an instrument perspective as well as some things that we're working out on 4 to 5 years. And then we're going to have a couple of regions. In particular, we're looking to have China, hopefully China is open and Iris Lin, who runs that market for us and Warren Stone, who runs the Americas, Be able to spend some time with you to give more color into those. And then Mike and his team will really kind of focus around the business units and giving you really nice insight And how we're running the business in the transfusion medicine and the Clin Labs. And then finally, we'll let Joe bring it home and give you more insight on the financials.

Speaker 2

So we think it's going to be an exciting day. We probably will provide lunch, so you're going to want to definitely get there. But look, we'll send out more information as it gets closer. And again, we appreciate you taking the time today on the call and we look forward to seeing you guys out in the market. Take care.

Operator

Thank you. This concludes today's conference call. Thank you all for participating. You may now disconnect and have a pleasant day.

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Earnings Conference Call
Nova Q3 2021
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