QuidelOrtho Corporation (QDEL) Earnings Call Transcript & Summary

All right. Thanks, everyone, for joining us. My name is Tejas Savant, and I'm the Life Science Tools And Diagnostics Analyst at Morgan Stanley. It's my pleasure to host Quidel this afternoon. And from the company, we have Doug Bryant, CEO; and Joe Busky, CFO. Thanks for doing this. Before we get started, a quick disclaimer here for important disclosures, please see the Morgan Stanley research disclosure website at morganstanley.com/researchdisclosures. If you have any questions, do reach out to your sales rep.

So with that, Doug, we'll get started. '22 has been quite a transformational year for the Quidel story. Beyond the close of the Ortho transaction, can you highlight some of your key accomplishments year-to-date and just give us a high-level overview of what you're most excited about as we look to '23?

Sure. I think the most important thing to say is -- from an accomplishment perspective, is we've risen to the challenge that we were faced with in terms of ramping up manufacturing of our products, and we were successful there. And we were able to close the transaction on May 27 as scheduled, and that was certainly an accomplishment. And I would say we're running ahead of schedule on the integration side. And I think a lot of people, probably, correctly have suggested that when you put 2 companies together, the integration piece is often quite a challenge. But in this particular case, I don't think I've run into a situation where there's absolutely no product overlap. So I'm going to claim that we're doing an awesome job, but it really isn't as hard as you would think because we don't have to shut any factories. I don't have to decide what products that we're going to retain, what we're going to divest. There's none of that going on. It's simple straight up ERP, order to cash. I'm going to -- Joe is not going to like this, but I think he's got it. I think this is well within what he's capable of doing, and I'm comfortable. So those would be, I think, the highlights of what's happening so far this year. We're continuing, again, to ramp back up manufacturing, as I've said in the previous meeting, mainly to service the retail segment, which interestingly is starting to spark up again. So I think those are the main things I would point out as our accomplishments. Thanks.

So since the deal closed in mid-May, you achieved a lot of the integration milestones. You've outlined a number of projects underway. Can you just provide us a brief update with where things stand on each of those to date? And how are the 2 cultures coming together?

Yes. I'll let Joe jump in on some of the specifics with regard to integration milestones, things that we're measuring. But to focus on the cultural piece, I would say that my principal concern going into this was putting people together and making sure that we identify the right people for the right sets of jobs. I think we've done that successfully so far. We're actually running slightly ahead of schedule. What I could point to in terms of how successful I think we've been in that endeavor is to say that our retention rate across the globe is super high and higher than we had planned. So never our intent to harvest synergies through personnel reduction. We had plenty of other things that we can get done. But I'm happy to say that the people that we really want to retain have stayed on board, and we have very little negative personnel turnover.

Got it. Joe, anything you'd like to add there?

Yes. I would just add that there's been over 240 integration projects -- sorry, milestones that we've achieved, 120 projects that we've completed. We've got the ERP road map in place. So we know where we're going with the combined company. ERP, we haven't had any hiccups on commercial. We brought the U.S. organization together. So I would say, to add on what Doug said, things running [ overall ] very well.

You've talked about, I think it was $90 million in cost synergies and $100 million in cross-selling over the next 3 years. Can you just talk about the linearity of that over the next 3 years?

It's really ratable. I'll let Joe jump into how we do that '23, '24, '25.

Yes, the $90 million of cost synergies we expect to achieve even over the 3 years, call it, $30 million each year. We've already recognized 75% -- or realize 75% of that first year, $30 million. We have that in the bank. And so the remaining, call it, $10 million or so will pick up in the '23 annual operating plan. And the quick wins we've gotten are things like just duplicate management -- senior management down to duplicate boards. We've RFP-ed insurance, RFP-ed audit fees. We're looking at travel cards, travel systems, all the low-hanging fruit. That's a lot of the early wins we've gotten to get where we are right now.

Got it. And then on the revenue side, I mean, what do you view as the low-hanging fruit here in terms of the lead sharing, account overlap? I think you've done some retiering of accounts as well.

We're really encouraged, post close, to discover without putting it through a clean room. We were pleased to discover what the mix in the United States actually looks like. And we actually think there's an upside there because the 80% of our volume that is represented by the typical 80-20 rule by 20% of our customer base, compared with the same analysis done on the previous Ortho stand-alone business, the overlap is 0. And so we are going through a process right now here of looking at the cross-selling opportunities. And they look to be, at least in the United States, better than we had thought. Ex U.S., I think it is about what we had thought. And I would say the only thing that we are surprised by is the attitude in Europe of the commercial organization there, their feeling of what they could do with our Triage product line. Never having had the point of cardiometabolic products, I think the Ortho -- the former Ortho folks on the commercial side in Europe are pretty excited about it. Other than that, no surprises so far. The big thing I would say, obviously, that drives that revenue synergy number is the Savanna launch. About 80% of that is in that number. What would you add, Joe?

I would just say that the fact that we now have this very large global commercial team from Ortho actually derisks the Savanna rollout greatly. So you take the base business, roll out plus the synergies that Doug just mentioned, I think we've derisked that quite a bit.

Got it. And Doug, do you have any early read on what you expect to generate in terms of those synergies in 2023?

We do have a forecast, not something that will show up on a slide here, but we have a forecast for 2023, and it's pretty consistent with what we had thought early on for the launch, even before Ortho. With the exception of -- we've obviously been pushed out, like everybody else in our space on the diagnostic side. We had the same supply issues, building instruments and all that sort of thing that everybody else has experienced. So notwithstanding that issue, I would say we're pretty much on track with what we expected to see. And we've been pretty pleased with what we've done in Europe with the Savanna launch early on, and I would say it portends well for the rest of the globe. What we had thought was a gap in the marketplace in terms of what was being provided for customer use has turned out to be that important. We're ramping right now, right now for the launch in the United States. We expect to go out in a limited way to customers that we've already identified in the fourth quarter. So I -- we're pretty much, I think, on track -- notwithstanding that manufacturing delay, I think we're pretty much on track with what we had planned.

Got it. And then on that point on Savanna, what really underpins your confidence in demand over the next -- in terms of scaling up to roughly about $300 million over the next 3 years. And can you just elaborate on the relative positioning in the marketplace and the value proposition versus Abbott or Cepheid or perhaps even at GenMark?

Sure. What exists today in the marketplace generally is thermal cycling equipment that runs high-volume molecular. That's not us. You also have lower-speed analyzers like the BioFire product, which does very large panels. There are several competitors in that space. I would say it's getting a little bit crowded. Actually, you've got -- if it's okay, I'll just name some of the other guys in the space. You've got Luminex. You've got QIAGEN. You've got GenMark. So you've got several offerings there. And then at the low end, you've got -- traditionally, you've got the older technologies like the Cepheid product, which does a single PCR in a cartridge. So what that means is you have the ability to do 3 analytes in the control. So we're slightly different because I would call us mid-flex. We have the ability to run 4 PCRs in a cartridge, which means we can do 12 analytes, each with internal control. And that seems to be the sweet spot when you consider what's going on with reimbursement, if you consider what's going on with cost in the big integrated delivery network systems. There is a need in the marketplace for a product that's easy, quick, economical, reimbursable, potentially CLIA-waivable so that we can further democratize testing. And so that's what we're seeing. We don't see, at this stage, anything differently than our market research said that we would have seen.

Got it. And what about sort of on the inventory build-out, what is your manufacturing output for Savanna today? How much do you intend to scale this ahead of launch?

Well, we're ramping that. We're building boxes now at an increasing rate, and they're already spoken for. We're going to move into 2023. We expect to manufacture thousands, and I don't think we're going to have a problem there. So I know people think about inventory. But if we have more customers, then we have to go to make boxes, we probably won't have much inventory. And so we might be in a situation where we have to pick and choose what segments we go into at least early on in the first couple of years.

Got it. And to your comment, Doug, on sort of positive feedback out of Europe, early days, but still positive. And then you've got sort of the typical sort of budget plus sort of dynamic to a degree as well. How are you thinking about contributions from Savanna in the fourth quarter here? I mean are those baked into your forecast? Or is that all upside?

It's in the forecast that we had suggested when we did our last earnings call. And I think we've pegged it pretty closely to what we're going to see. He and I, we look out on -- we're pretty conservative.

Got it. Fair enough. And then any clarity on the timing of the submissions for, I believe, the -- for additional 510(k)s that you had planned got pushed out a little bit.

Pushed out a little bit. Can you help me with what [indiscernible]?

I think the question was more around like for 2023, how are you thinking about the menu? And by when do you expect to have all of these panels of 510(k) approved? Will that be ahead of the U.S. launch?

For Savanna? Okay. Thank you. Thank you. I just wanted to [ up the ante ]. Okay. Perfect. We expect to be submitting for 510(k) shortly on the respiratory panel. I don't think that the clearance is as important as we once thought because originally, we thought we were going to be in a situation where beginning January, any of the COVID products that previously had an EUA would need to be 510(k)-cleared. But I think that we now know pretty reliably that, that will be pushed out. In fact, on a call earlier today, our Head of Clin/Reg suggested it would be more than likely May, June that sort of thing. So I don't think we're any -- we're concerned about 510(k) for initial launch, but the additional menu, we have 3 other syndromic panels that we plan on launching in the year. And I think that they will certainly make it through their clinical trials on time, and we will submit to the FDA on time. And I think the FDA is doing a really good job of recovering from all the workload they had relative to COVID. But for our forecasting, we've gone to the upper end of the range in terms of what we think it will take for them to get through these packages. At the end of the day, if we present a clean package, the data look good. We'll be super confident that it will make it through. And certainly, that makes the conversations with the reviewers simpler than going back and forth and having to answer ongoing questions. So that -- we'll take responsibility for that. But I'm pretty comfortable with what we've planned for 2023 so far.

But I would just add quickly that we did submit for EUA for RVP4 in May. We expect to have clearance by the end of this year. So we'll have that product ready for the flu season as we move to the end of this year into early next year.

Yes. Thanks, Joe. That makes what I said just more clear.

Right. Makes sense. How are you thinking about sort of risk to your COVID business outlook? I mean, obviously, there's a few moving pieces here. The government is no longer going to be sort of funding the purchase of vaccines and diagnostics, and then you have the shift towards retail and at-home testing. But you're doing certain things in as well. So just curious as to how you view the moving pieces there.

Let me be clear on a couple of topics. One is the ramping of our manufacturing that we're doing now is in advance of the retail segment. And we expect to be on the shelves, wherever you all present yourselves to go buy a test. So that's -- we're in good shape. So that, we put into our model. We did not model anything on the federal or state government side. That's true. But that doesn't mean the federal government won't, from time to time, periodically, opportunistically purchased product. So we're just not forecasting it, to be clear. Okay.

Got it. Got it. Makes sense. And then as you think about sort of the Sofia franchise more broadly, you've obviously placed a lot of instruments over the last couple of years. You're -- how are you doing in terms of pulling through non-COVID revenue on that large installed base? And has that -- the non-COVID Sofia revenue base essentially plateaued? Or is there much more upside? And what do you view as the key drivers for that?

Tejas, tell me the last part of that question.

Yes. So basically, non-COVID sort of Sofia revenue base, do you think it is now essentially plateaued? And -- or is there even more upside to come there?

There is. First of all, we nearly doubled the number of placements in the last couple of years. And I think your comment, Joe, during the earnings call was that we were up on a trailing 12 basis year-over-year. We were up 25%. The thing's [ non-COVID ]. It's non-COVID. That's non-COVID. So the thing that's driving that is during the period of time where we were first to market with the Sofia product line, we preferentially shipped customers who want to sign up for all of the products. They were customers -- some customers who didn't like that approach, but it seems like the right approach from our perspective. So we have a large number of customers that would have signed up for 3-year agreements to purchase all of the products. So we -- and in the old days, we would have said on a typical year that we would do between $100 million and $140 million in influenza. But what happened was we were the only ones in the market for some period of time, and we closed a large number of customers. I think the number of customers that we increased by was about 6,000. So we picked up at 6,000 customers. Those customers had to come from somebody else, right? And so we took share. So 76% of our customer base are on longer-term agreements that include other things other than flu and COVID. Okay. So there's that factor. And then there's the other products that we will introduce over time. And I think we're running around 20 R&D projects right now that are tied to Sofia assays, so...

Got it. On the Ortho side of the house, Doug, I mean, how are you thinking about recent trends in terms of integrated and automated placement growth? Have you seen any sort of moderation there given sort of the macro conditions, given perhaps sort of FX headwinds as well?

No. I would tell you that the commercial strategy was developed by our Head of Commercial -- the Chief Commercial Officer, Mike Iskra, formerly from Ortho. The strategy he put in place to target the right customers that would be -- that would have a higher propensity to purchase our clin labs products was extremely successful, and they improved the growth rate from about 1% annually to about 3%. Another factor in addition to targeting was this move to, I would call it, a more integrated approach. So looking at the customers that were only clin lab and trying to put them together so that from that same sample, I could also test on in vitro system. The immunoassay has been extremely successful. What I would say is, ex U.S., I think there's more of an opportunity, particularly in places like China to do the same. China is a market where a lot of the products are in for both companies, not one company, of course, but are in stat labs. And we would see that changing over the time with the introduction of this integrated platform strategy. And so I know, I don't think we've plateaued. I think there's still room to grow there.

Yes, Tejas, only 25% of the clin labs installed base is integrated, so we have years and years of [ runaway ] there.

And you mentioned Mike, so I'll ask you on the dry tech and bringing that to immunoassay. I remember the last time I spoke to him, he talked about sort of the 3- to 4-year time line there. Do you mind, Doug, I mean how high a priority is that for you? And would you consider sort of doing anything to pull that forward?

Well, I think it's a very high priority given what needs to be done in order to service the donor screening market. I think that's our principal driver to the program. I would say that we are doing everything we can to get to understand the performance of the product on what's called revision 9 of the slide. Once we understand that, I'll have a lot more to say about where we're at. And so far in a very limited set of data that I recently previewed in Rochester, I would say it looks reasonably promising. But running it to ground, making sure that across all the assays necessary for donor screening can be accomplished on these slides and manufactured at high volumes. These are the things -- these are the questions that we still have. So I really, Tejas, can't fully answer the question. We are going to have an Analyst Day, December 13. We will have our R&D folks there. They can talk a little bit more about the detail regarding where we're at. I don't know that we have the ability to accelerate it, though, because until I see the data, I'm hesitating to comment but it's very much a priority.

Got it. Two questions on China. I mean, obviously, I think you had called out sort of significant COVID benefit in the second quarter there, thanks to a government contract. COVID case counts remain elevated in the region. So are you seeing sort of the potential for upside there in the back half of the year? And then on the flip side of that, given some of the shutdowns in Chengdu, Shenzhen, et cetera, any sort of challenges to your operations, particularly on the clin lab side of things that we should be thinking about?

Two-part question, wasn't it? So on the COVID side, I would say that the forecast that we provided generally as part of -- for the year as part of the Q2 earnings call is solidly intact. So the back half of what we had thought we would do in terms of COVID, I would say I'm super confident. We're going to be fine with that particular aspect. You're asking about probably on the instrument builds specifically on the clin lab piece. Yes, what I would say is we are accelerating our manufacturing on those instruments. But because the demand is generally higher in the fourth quarter, I don't think we'll bleed off a lot of the back order. The good news is we're not really under any threat necessarily in those customers that have signed it for a box. I don't think we're going to lose customers with a little bit of a delay in getting them what they ask for. But if fourth quarter weren't expected to grow like it typically does for us, we probably would be able to work on that backward. But I think what we can expect is that level of back order won't get worse as we exit 2022.

Got it. Makes sense. One on the supply chain, Doug. I mean as you think about semiconductor sourcing, has there been any sort of shift in month-over-month trends at all? Any improving allocation or access?

No, nothing to do with the things that most people had experienced. For example, the chips, we saw for all that. It's not really a parts issue at this stage on any of the instrument systems as far as I'm aware. But I would say, to be maybe more transparent on the Savanna side, we weren't happy with the sonicator that was in as part of the instrument. And we had solved that. So that created a little bit of a delay. We're probably going to lose about a week in manufacturing. But I mean it's not horrible. So all the things that you would have expected me to say, we had a problem with, and we saw, so we did. But then along the way, we found another thing and [ just means all ] that. So these are normal. These are typical, and I'm not concerned at this stage.

Got it. Just turning to the financials. How are you thinking about -- you talked about sort of your base business growth profile of high single- to low double-digit growth. What's the growth algorithm underlying that across the different sort of segments?

Well, we have it done by business unit. And earlier today, we saw this question, Tejas, and we said he was going to answer it, so...

Yes, I can take it. So I'll try to lay it out as simply as I can. So if you think about the combined company business in an endemic state world, so that's where -- again, we've said COVID revenues in an endemic state will be $150 million to $200 million. I would describe our -- about half of our revenues as being in the clin lab space, and the growth there will be mid-single digit to high single digit. And the next business unit would be transfusion medicine. That's about a quarter of our business, and I would describe that as being low single-digit to mid-single-digit growth going forward. And then you've got point of care, which is about 20% of the combined company business. And that's certainly a double-digit growth business. And then finally, molecular, small right now. Just a few percent of the total combined company revenues, but that's where a lot of growth is going to come. It's really high double-digit growth there as we roll out Savanna over the next couple of years.

Got it. And then given your second half EBITDA margin outlook, Joe, I think it's roughly around 30%. How should we think about that as a jumping off point for next year?

Yes. So we gave guidance on the Q2 call for the full year, and that was an implied second half guide in that call. But if you think about the seasonality of the business, Q3 is a seasonally weak quarter for us as you get less people going in for procedures, it's a very low flu season -- typically, it's a low flu season. So the margins will be a little bit lower in Q3. Q4, you have higher revenue, but it's a high instrument revenue quarter. So you have slightly lower margins in the fourth quarter as well. However, if you combine that with the first half and normalize the first half for an endemic state of revenue, call it $30 million to $50 million of COVID revenue per quarter, you'll get about $450 million of revenue, with the midpoint of our second half guide of $350 million. Later on some synergies, later on the growth, and you're pretty quickly up into the $850 million to $900 million of EBITDA as you move into 2023.

Got it. That's helpful. And any sort of like thoughts on just free cash flow conversion?

Yes. There's really no change there from what we've been saying for months about the combined company, and that is that the free cash flow conversion will be about 65% of that adjusted EBITDA number.

Got it. And then last one, in the 0.5 minute or so we have, just capital allocation priorities. Interest rates are rising. You've also announced a repo authorization, and you're in the process of integrating the Ortho transaction. How are you thinking about the different priorities there?

Well, we're going to pay down debt. We do have a 10b-5 in place. We've got capital that we need to spend, ramping up instrument and cartridge manufacturing, I should say, slide manufacturing in Rochester. That's -- those are the principal uses of cash at this stage. People have asked us, "Are you looking at other companies?" I would say, if something presented itself that was extremely good in terms of a fit, we would probably look at it. But right now, I think that we can create more value by making sure that we get this integration done really well. And so I don't -- I want to make sure we don't distract the management team from what we have ahead of us.

Got it. This was great, guys. Thank you. Thank you so much for spending the time with me this afternoon.

Thanks, Tejas.

Thank you. Good to see you.