QuidelOrtho Corporation (QDEL) Earnings Call Transcript & Summary

All right. Good morning, everyone. Thanks for joining us. I'm Tom Peterson, I'm an associate on our Life Science Tools and Diagnostics team here at Baird. We're excited to have QuidelOrtho presenting today and representing the company, we have CEO, Brian Blaser; and CFO, Joe Busky. Thank you both for joining us.

Good morning. Thanks for having us.

Yes. So before we begin, just a reminder to everyone to refer to Baird's website for important disclosures about what we're discussing. And as far as the agenda today, I think we're just going to hop right into Q&A. If anyone has questions from the audience. Please feel free to submit them through the web portal.

Brian, I wanted to start with you, you're relatively new to the CEO role here at QuidelOrtho. So I wanted to get your thoughts as to what kind of drew you to the opportunity set for the company and how do you think about the market opportunity and future growth drivers as you get into the CEO role?

Yes. So I've been with the company now for, I think, a little over four months. And I was happily retired prior to this, but when this particular opportunity came along, literally, when I was called, I said, when can I start? Because I find the combination of Quidel and Ortho to be a very compelling combination where we have now a company that can touch every stage of the health care value stream, participate fully in both centralized and decentralized testing. And as I've come into the business, I appreciate this a little bit when I was doing my due diligence. But as I've come into the business, I think the one thing I'd like to leave with all of you is that despite the fact that there was maybe some misalignment with COVID revenues last year and a disappointment with the launch of the respiratory assay for Savanna. The underlying business here is stable and growing. The labs business is a very solid durable growth business. It's got long contracts, five to seven years. You've got maybe 10% to 15% of those contracts come up every year. We have very high renewal rates. We have a positive win loss ratio on new business. And so the underlying core of the business is quite stable. What we have found, obviously, though, is that the cost structure is misaligned. And so we have a lot of work underway at this point to address that. And fortunately, even before I got to the business, the office of the CEO had leaned into that work, identified a lot of the savings that we needed to generate and has made good progress on the execution of that. So I think it's a very compelling opportunity. Still a lot of work to do. And as I've said before, there's no stone being left unturned here as we go through the process.

Yes, fantastic. I think we'll get into some of your priorities and cost realignments here as we get into the presentation. But I wanted to start up front with the lab business. It's been flattish in the first half of 2024. How is that compared to expectations? And how should we think about the growth outlook in the back half of the year?

Yes. I think it's flattish. If you look at it in total, but there's a kind of a year-over-year comp there with our instrument situation where we had a significant backlog of instruments that resolve. When you strip that away, it's really a solid mid-single-digit growing business. And again, kind of supported by those -- the underlying business model there with long contracts high retention rates, et cetera. And kind of along with that, the immunohematology business a little less higher in terms of growth rate, but again, a very stable business durable growth business.

Maybe talk about the mix between clinical chemistry and immunoassay pieces of those -- of the lab business specifically and on the immunoassay growth opportunity, just how are you evaluating the growth factors here? And how do you think about penetration of that from a mix perspective?

It's actually an advantage from my point of view. Our mix in terms of clinical chemistry only instruments versus integrated clinical chemistry and IAA has kind of shifted 180 degrees from the industry norm, which would have maybe 70% integrated instruments versus 30% stand-alone clinical chemistry, we're exactly the opposite of that. And we're driving now an approach to place more integrated instruments, which will give us access to a higher-growing immunoassay market. That market tends to grow in the mid- to high single-digit range versus clinical chemistry, which is low single. So that gives us a benefit in terms of our ability to grow, but also profitability as the profitability of the immunoassay tests are much higher than the clinical chemistry test.

Do you think long term that, that mix kind of normalizes more to market -- where the market is and...

I think it does, but I think it's going to take a long time. I mean, if you look at us five years ago, our mix of integrated instruments versus stand-alone instruments was maybe 20%. Today, five years later, it's 30%. So we have plenty of runway there to continue that trajectory.

Sure. Maybe touching on China specifically. This has been an area where growth has been more solid here. I think high single-digit growth for 2024 is kind of the expectation. So -- why have you been more successful here? Do you think this growth profile can continue? And do you think there's any impact or potential impact on the business from BPP.

Yes. So China is roughly 10% of our business today. It's a nice market for us. I think we're solidly high single digits with that business today. If you look at our latest results, we're right in that range when you strip out some one-timers. Part of our ability there is we are under-penetrated relative to other competitors. So there's room for us to grow and keep that growth rate high. And then our clinical chemistry dry slide technology has not been subject to BBP. At this point the focus of the government has been on wet chemistry and more immunoassay. And at this point, we don't see that being impacted anytime soon, although we monitor that very carefully, obviously.

Sure. Let's maybe flip over to Savanna and the developments there. I think you characterized this as getting it across the finish line. It's a real focus initiative for you. But can you just kind of walk us through the Savanna instrument profile kind of your thoughts on the current status of that development? And how are you assessing the competitive dynamics of this market aside from sort of menu expansion? What are the key areas of differentiation that you see for the system?

Yes. There's really three things that you have to have with a point-of-care instrument like Savanna. You've got to have a very easy-to-use system. So in the case of Savanna, it is truly sample in answer out as compared to some of the other platforms out there that require some level of either cartridge assembly or sample prep or something upfront, the other thing you have to solve is turnaround time. So under 30 minutes is really kind of the benchmark and our rapid thermal cycling in that instrument allows us to achieve that. And then cost obviously is hugely important. And we think just based on the way the cartridges and the assays are designed there, we're going to have a significant price advantage to our customers which ultimately allows them to create a nice business. And so then the question becomes, well, there's a lot of platforms that have already been placed on the market today, and we have extensively surveyed our customers, and they're telling us, yes, we'll switch for the right value proposition here. Really, the switching costs here are quite low. These are relatively low-cost units that will be on a reagent rental type model. So there's no real capital outlay for the customers. And the training burden for this system is very low just based on the ease of use profile. So by and large, our customers have told us that even though they may have invested in one or two or maybe three platforms, they're willing to look at Savanna as an alternative. And I think the other thing that helps supports us here in the launch is the fact that a lot of the platforms that were placed on contract during COVID. Those contracts are starting to expire now. So it's kind of a nice time for us to enter with Savanna.

And if I could, two other points on the Savanna U.S. launch, I would like to get across, one is that we already have the box and one panel approved in the U.S., that's HSV/VZV, which is essentially the Herpes Simplex Virus test panel. So that box is approved. We are placing boxes. We also have the box and the respiratory panel approved CE marked in Europe. So we're placing boxes. So I don't expect there to be a lot of hiccups with the U.S. launch in terms of bugs, if you will, in the system or in the box itself because we already have the box approved. The other important point I want to make is that the legacy ortho commercial team is going to be the team that's going to sell this product. So it's not like we have to bring in a [ whole ] team and incur a lot of sales and marketing expenses that introduce this product. We already have the team in place and they're ready to sell it.

Yes, that's really helpful color. And I wonder if you have any thoughts on one initial feedback that you've gotten as you place some of these early instruments, both in Europe and here in the U.S. And then I wonder at a higher level as a management team, how you're tracking and evaluating what success means and how you're defining that in the early year of launch?

Well, I think our customers, by and large, are supporting the value proposition in terms of their feedback. And as we go forward with the launch here, first, we have a ways to go. We've got to get through our clinical trials with the respiratory panel and then follow that on with STI. We'll be looking at a number of different factors. Obviously, the adoption by customers and the placement of instruments, but also the revenue ramp, that's supported by the menu expansion. And so we'll be monitoring that very carefully like we would with any other product launch.

Yes. Any updates to the RVP4 assay? And just how important do you think that is over the medium term?

Yes. Well, I think over the medium term, I mean it's a table stakes type of assay, right? We really need that assay in order to start to support broad placement. We'll be entering clinical trials here starting later this fall with the respiratory season going into next year, and we expect to have that assay on the market in '25.

Any other key areas of menu expansion for Savanna that we should be thinking about over the next year?

Yes. So we also have an STI panel under development that we will have on the market -- we want to have on the market in 2025. And then we're following that up with a GI panel that will have both the bacterial, viral and a parasitic vector combination of tests.

Got it. Maybe let's shift over to Sofia. I wanted to touch on a point that you made at the beginning, which is -- or the shift from central lab testing to more point-of-care applications. And I wonder as you think about the market overall, how much of a growth driver do you see as this dynamic? Is it more of a mix shift? Or do you think it's really something that's driving growth over time?

Well, I think the health system kind of moves in two directions. It moves toward the patient and tries to meet the patient where they are and in which case, we have a great offering like Sofia and we'll have Savanna to support that. And then to drive efficiency, central lab testing is very important. So I don't know that it's necessarily a migration of testing that is occurring from the central laboratory to point of care. I think it's meeting the patient where the patient is and where they'll benefit most from the different mode of testing. .

That's really helpful. Maybe getting into flu. I think the combo product was over 50% of 2Q flu revenue. So how are you thinking about this mix over time and what we would consider a typical flu or respiratory season?

Yes. I think and I'd ask Joe, he's got maybe more history than I do here. But I think we continue to see that mix shift continue to more the combo testing. And so far, we're seeing a continued very strong durable results with the test.

Yes. We will likely continue to quote that on every earnings call because it's been pretty consistent for the past several quarters where that percentage has been over 50%. And the point is that you made, Tom, is that it shows that the test is very durable. We don't think it's going away. The docs are still using it quite a bit with their patients.

Yes, maybe to have a point on that line of question, I mean, what's the right way to think about endemic COVID or respiratory testing. Are we close to that point here in 2024? And how are you thinking about that over the next couple of years as the market sort of normalizes?

Yes. I don't think anyone really knows. We've as you know, kind of scaled back our expectations for COVID testing. I think we are approaching kind of this endemic level, and we're kind of seeing patterns recur where we have a summer spike, and then we have the spike in the respiratory season. But we're just going to have to continue to monitor that and do our best in terms of calling COVID, that's going to be the biggest challenge in terms of calling our results.

Yes, sure. I don't think you're unique there. And maybe some challenges and forecasting COVID and COVID testing. But any potential near-term impacts from recent government programs, initiatives around free COVID testing. Is that affecting your view on COVID revenue for '24?

Yes. So we were awarded a significant contract in 2023 for, I think, close to a 11 million tests. We're continuing to supply those tests. I think we ship close to 110,000 tests a week to the government for that. I don't think what the government has announced is going to result in any additional material supply from us for those needs, but we are participating in that. I think that contract expires for us in 2025.

Okay. That's helpful. Any comments on current flu season insights from Southern Hemisphere and how you think this is shaping up relative to a typical season?

Yes, I would say it's shaping up to be a very typical respiratory season. When you look at what's happened in the Southern Hemisphere thus far, the peak of the respiratory season already hit, and that peak was above the 5-year average. So it does seem like the season in the Southern Hemisphere is tracking to be at least an average to slightly above-average season. The big wildcard now is the duration. How long does it go out? That's the piece we just don't know yet. So I would say that based on that information and based on what we've seen, based on what we're hearing from our distributors in the U.S., it does feel like things are shaping up to be a typical or fairly average respiratory season. And I would just add with the -- coming back to the COVID revenue, again, at the beginning of the year, we put out a a stake in the ground of $150 million of annual COVID and pandemic revenue this year. And I would say through the first half of the year, we're about halfway there. So we're tracking well towards that $150 million. So it does feel like we've got a pretty good estimate there for the full year.

Got it. Maybe let's take a step back. You recently decided to unwind the U.S. donor screening business as part of some portfolio rationalization. Do you see other areas of potential portfolio rationalization across the business? And how are you evaluating that as you look at sort of the mix of the portfolio.

Yes. I think -- first, I'd say I think exiting the donor screening business was the right move coming out of COVID and just given the competitive situation with that business, and we'll fully exit that business by the end of 2025. I've looked at the portfolio and at this point, and there are some small -- very small things that we might take action on. But by and large, I like the portfolio. I like the immunohematology business in transfusion medicine as a complement to the labs business. There's a lot of overlap there with commercial synergies. And so I think our focus is going to be on improving the profitability of all of our businesses and then doing some menu refresh or menu expansion and platform refreshes to improve the competitiveness and see if we can elevate the growth of each of these businesses.

Got it. That's helpful. I mentioned at the beginning, some of the initial cost actions that you've taken as CEO about $100 million of full year cost savings in 2024. Can you give us just kind of an overview of where those actions occurred and how they're informing your future areas of strategic investment in the core business?

Yes. So yes, we've identified $100 million of annualized savings. I would say most of the initial savings was from staffing. So we took roughly a 7% reduction in our staffing, which kind of monetizes out to around 12%, just given the fact that we targeted probably more senior level positions, higher level roles in the organization. We're continuing -- we'll continue to have some additional staffing adjustments as we go through the end of this year and into next year, but we'd like to get those behind us as quickly as we can. Our next phase of targeted savings really is in the nonstaffing areas where we're looking at everything from everything that goes into our products to all of our OpEx costs, travel, entertainment, services, supply chain logistics, you name it really across the P&L. And we're being a little bit cautious in terms of how we communicate where we're at on that because we want to make sure that we had -- we've got it defined and actionable plans identified before we commit to those numbers.

Yes, no stone unturned, as we said, Joe, you talked about progressing back to kind of the mid- to high 20s from an adjusted EBITDA perspective. So give us a sense for how you see progression towards that target. How are you thinking about revenue growth and sort of reinvestment in the business? And where in the P&L do you see opportunities to increase margins?

Sure. So as we've said, we believe the path to the mid- to high 20s adjusted EBITDA margin will take two to three years and we will make progress in 2025. So I do expect that the margins will improve as we move from '24 to '25, exactly how much improvement we get we'll probably hit more of that as we move to the latter part of this year, early next year, and we give we give '25 guidance. I think that the improvement will be across all areas of the P&L. We should see improvement in the gross margin. We should see improvement in the OpEx as a percentage of revenue. As Brian said, we're hitting all the areas, whether it's direct costs or whether it's indirect cost. So it's really us as the leadership team trying to instill a continuous improvement culture within the company. This isn't just a onetime thing. We're going to take some costs out now. We've already started to. We'll continue. We'll talk more about it as we move through and execute it. But we really want it to be a continuous improvement culture, and we continue to find efficiencies and keep those margins up where they should be for a company in the space that we're in.

Got it. I wanted to shift over to capital allocation and the balance sheet. You had to draw on the revolver in 2Q. You've talked about the overall leverage profile. Can you just walk through your level of confidence for ending 2024 at flattish leverage? I think about 3.4x on a pro forma basis right now. So how are you thinking about that and your capital allocation priorities as it comes to debt paydown?

Yes. So the first half of the year was not a great cash flow half of the year for us. It was as expected and really driven by two things: one, seasonally lower revenue in the first half of the year, particularly Q2 is a low revenue quarter for us seasonally and then the cost improvement actions really weren't executed until the very end of Q2. And so we really didn't get the benefit of any of those cost improvements in the first half. We'll get them more in the second half. So we did draw on the line. For the second half of the year, we do expect revenue to be seasonally higher as we move through the respiratory season. And we do expect, again, those cost improvements to have an impact in the second half of the year. So we expect cash flow, recurring free cash flow to be positive in the second half of the year. And in fact, we expect recurring free cash flow for the year to be positive, which will allow us to pay down a good chunk of that revolver that we borrowed in the first half of the year. So as far as the leverage ratio, yes, on a pro forma basis, we do expect it to be right around where it was at the end of the first half, which is, like you said, about 3.5x levered. On the base of the balance sheet, though, the leverage ratio is a little bit above 4. Now that's not a place where we want to be with the leverage ratio. We want to bring that down. And so as you think about capital allocation strategies and priorities, we're going to be a little more focused on debt pay down for that reason. We want to get that leverage ratio down below 4 well into the 3s and be able to bring it down at least a 0.5 turn as you move through 2025. So we will look at things like share repurchase or M&A. But I would say those things are a little bit of a lower priority right now in the near term as opposed to debt pay down.

Got it. That's really helpful. Do you have any high-level thoughts about where for that recurring free cash flow number tracks into 2025 and how you're thinking about that over the medium term .

Where we should be as a company is that the recurring free cash flow should be between 50% and 60% of adjusted EBITDA or greater than 100% of our net income. We were there the last couple of years. We fell backwards this year. And again, we're -- in the second half, I think we'll start to approach those numbers, and we hope to get back to those targets in 2025 and 2026 as we execute on the margin improvement initiatives.

Got it. That's really helpful color. With a couple of minutes left, I wanted to get your thoughts on potentially restoring financial guidance was suspended as part of the 1Q update. So any incremental thoughts on sort of the guidance timing? And Brian, what are your overall kind of guidance philosophy and guiding principles as you think about maybe restoring that potentially into 2025 .

Yes, we'll be looking to restore guidance in Q3 results here. And my philosophy is to provide guidance that is achievable, realistic where we're in a situation where we will perform to the guidance that we provide. We need to be reliable, more reliable in that regard, and that's definitely a focus of mine.

Got it. Without giving a formal guide for 2025, can you just walk us through some of your prior comments that going into 2025, that this is a mid-single-digit plus growth business, if you kind of back out COVID and U.S. donor screening, and are there specific areas of the business where you feel confident you can grow at mid-single digits or better? .

Wel, I think you just, again, you look at the underlying business model of our labs business, which, again, is supported by all the things in the business model. I mentioned long contracts, high renewal rates, a positive win loss ratio, it has been a little noisy here with some onetime items that have been working its way out. But that is clearly mid-single-digit business. The IH business is a low single-digit business. And then you layer on the respiratory element to that. And I think you've got a business that is kind of in that mid-single range. But we'll be providing more color on that with the Q3 guidance.

Sure. Yes. How dependent do you think the medium-term growth outlook is on the Savanna success and the menu expansion and hitting those time frames? .

Well, Savanna is critical for us in terms of elevating our current growth profile, and it's the biggest single thing that we can do in the short term to elevate our growth profile beyond the mid-single digits. And that's why along with the value proposition that I talked about that we're committed to getting that across the finish line and making that a successful product.

Got it. While we're under a minute left, so I'll end with one final question, which is just what do you think are the most underrated aspects of QuidelOrtho's business and how you see the opportunity set

I think, again, it goes back to the power of the combination of the businesses and the ability to -- for us to touch every aspect of patient care along a patient's journey, that ability to participate in both centralized and decentralized testing and just the underlying strength of the business model here that that supports the business. We have work to do clearly on the cost structure, but the underlying business is stable and growing. And I think as we improve the cost position we are going to be well prepared for the future.

Fantastic. Well, I think that brings us right to time. So we'll leave it there. But Brian, Joe, thank you so much for joining us here today. .

Thank you. Appreciate it.