QuidelOrtho Corporation (NASDAQ:QDEL) Q4 2022 Earnings Call Transcript

QuidelOrtho Corporation (NASDAQ:QDEL) Q4 2022 Earnings Call Transcript February 15, 2023

Operator: Welcome to the QuidelOrtho Fourth Quarter and Full Year 2022 Financial Results Conference Call and Webcast. At this time, all participant lines are in listen-only mode. For those of you participating on the conference call, there will be an opportunity for your questions at the end of today’s prepared remarks. Please note, this conference call is being recorded. An audio replay of the conference call will be available on the company’s website shortly after this call. I would now like to turn the call over to Bryan Brokmeier, Vice President of Investor Relations. Bryan?

Bryan Brokmeier: Thank you, Operator. Good afternoon, everyone. And welcome to the QuidelOrtho fourth quarter and full year financial results conference call. With me today to discuss our financial results are Doug Bryant, QuidelOrtho’s President and CEO; and Joe Busky, QuidelOrtho’s Chief Financial Officer. This conference call is being simultaneously webcast on the Investor Relations page of our website and a version of today’s presentation can be downloaded there. Before we begin, I will cover our Safe Harbor statement. The statements we will make during today’s — during this call about the company’s future expectations, plans and prospects include forward-looking statements within the meaning of the Private Securities Litigation Reform Act of 1995, 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 those expressed or implied in these forward-looking statements. These risks and uncertainties include, but are not limited to, those factors identified under Risk Factors in our quarterly report on Form 10-Q filed with the SEC on August 5, 2022, and subsequent reports filed 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. We cannot assure you that the forward-looking statements we make or are implied by our statements will be realized. Furthermore, such forward-looking statements represent management’s judgment and expectations as of today.

Except as required by law, we undertake no obligation to update any forward-looking statements or any time-sensitive information to reflect future events, developments or changed circumstances or for any other reason. Also, during today’s call, to facilitate a comparison of the company’s operating performance from the fourth quarter of 2021 to the fourth quarter of 2022 and from the full year 2021 to the full year 2022, we will be discussing supplemental revenue and other supplemental adjusted operating results as of Quidel and Ortho have been combined for the applicable periods. We will refer to this information as our supplemental combined information. This supplemental combined information, as well as certain other items we will discuss do not conform to U.S. Generally Accepted Accounting Principles or GAAP.

Please see slide three for a list of non-GAAP measures. Reconciliations of these non-GAAP measures to their most directly comparable GAAP measures are included in the appendix to the investor presentation and press release issued this afternoon, both of which are available on the Investor Relations page of the QuidelOrtho website. Lastly, unless stated otherwise, all year-over-year revenue growth rates, including revenue growth ranges given on today’s call, are given on a comparable constant currency basis. Now, I’d like to turn the call over to Doug Bryant, QuidelOrtho’s President and CEO. Doug?

Doug Bryant: Thanks, Bryan. Good afternoon, everybody, and thanks for joining the call today. I am pleased with QuidelOrtho’s financial performance in the fourth quarter and for 2022 overall. Equally, I am pleased with the many productive things we got done in the quarter. Our accomplishments that I believe will set us up for continued productivity gains in 2023 and for meaningful revenue and margin growth for years to come. Today, I will highlight our financial performance briefly and I will talk about our key growth drivers, the programs that will create accelerated revenue growth and that will be instrumental in getting EBITDA back to over 30% of revenue. As reported, Fourth quarter revenue of $866.5 million increased by 36% over the prior year quarter.

Supplemental combined revenue for the full year was $4.1 billion. In the quarter and for the full year on a supplemental combined basis, revenue excluding COVID revenue grew 19% and 11%, respectively, versus the prior year periods, driven by strength in our Point-of-Care and Molecular Diagnostics businesses. In an early and pronounced respiratory season was marked by higher than typical influenza and respiratory syncytial virus prevalence rates. This was offset partially by weakness in clinical chemistry and immunoassay revenue in China due to the lockdowns there. Joe will talk more about China later, as well as our path to double-digit growth there for this year. By business unit, fourth quarter ex-COVID revenue in the Labs unit declined 10% versus the prior year.

If you were to normalize the Labs business unit for China and the lockdowns, Labs would be up mid-single digits. Transfusion Medicine was flat at 1% and Point-of-Care increased 138% and Molecular was up 45% from the prior year. From a regional perspective, all the regions were up or flat except China which was down again due to the lockdowns. Overall, the newly combined organization performed well. It was a solid quarter and a good back half of the year, which bodes well for an increasing revenue growth trajectory over the next few years. I think it’s important for investors and the broader market to recognize that I view QuidelOrtho as a growth company and we will continue to manage our business as such. We are a customer-driven company that is executing on over 100 active R&D and clinical and regulatory projects, with an expectation that we will be just as prolific in product development as we have been in the past.

The three key near-term growth drivers that we are acutely focused on in 2023 are our Sofia, Savanna and VITROS systems and product lines, with over 85,000 Sofia instruments installed worldwide. The Sofia franchise is a solid, durable and growing business. A review of our placements in the United States is informative and should be helpful to investors in understanding the longevity of the Sofia platform, as well as our longer term strategy to address an increasingly decentralized segment of the IVD market. In the U.S., over 77,000 Sofia instruments are on multiyear contracts, most of which include urgent care, excuse me, most of which include multiple products. Roughly 50% of Sofia’s are in the POL, 23% are in hospitals, 17% are in urgent care and 10% are in corporate accounts.

On average, POL sites have 2.7 Sofia instruments, hospitals have 7.5 and urgent care sites at 3.4. The number of U.S. Sofia customers is up 6% year-over-year to around 21,400. The number of POL customers is up 8%, hospital customers are up 2% and urgent care customers are up 9%, offset by long-term care customers, which were down 20%, understandably given the end to the Government’s COVID-19 Nursing Home Program. As a quick aside, the total number of customers purchasing our respiratory disease rapid antigen tests, including our QuickVue, is over 72,000 on a year and 12 — a trailing 12-month basis. Saying that we have a meaningful presence in the U.S. outpatient settings is an understatement. Importantly, 82% of 77,000 Sofia instruments run influenza and 70% run COVID, which explains the market share gain we have experienced over the last couple of years in the respiratory disease category.

And interestingly, only 8% of Sofia instruments run COVID only. Non-COVID ALK sales per instrument increased 57% at year-end on a trailing 12-month basis. The Sofia franchise with its huge installed base is clearly a valuable asset, one that can and should be leveraged by us to the greatest extent possible, which is why the R&D team is so focused on developing additional menu for our Sofia customers. The number of companies pursuing Point-of-Care molecular solutions that would potentially address the need for smaller syndromic panels is increasing, which further validates our efforts and strategy to bring Savanna to decentralized access points to healthcare. I am pleased to say that we are nearly there, nearly ready for an expanded global launch ahead of the next respiratory season.

Supply chain and instrument manufacturing issues that were a challenge for us are largely resolved and we now have the capacity to begin to ship the analyzers that we had anticipated all along. For cartridge manufacturer — manufacturing, we are in the process of increasing manual manufacturing lines, hiring additional staff and installing high volume automated lines that will produce millions of cartridges that will be required. The first two panels that we will launch our RVP4 in the HSV/VZV lesion panel. Beyond that, we expect to begin clinical trials for RVP11, STI, 2GI panels, bacterial, viral and the parasite panel, pharyngitis and vaginitis. We have purposely focused our initial menu on these areas to take advantage of Savanna’s unique features, faster turnaround time, test flexibility and lower total cost of ownership.

The largest of our franchises in terms of revenue representing close to 50% of our revenue is the Labs business unit and our VITRO’s clinical chemistry and immunoassay systems and slides, driven by increasing global demand for our integrated chemistry and immunoassay platforms and good commercial execution, we are experiencing a back order of around 650 instruments. While most of this is due to strong demand, there is also a supply chain component which we are addressing with our suppliers. Just as we did with Savanna, I am confident that we will collaborate with our suppliers to improve forecast visibility and to resolve supply chain challenges in 2023 and I expect that we will make significant progress as we move through the year. In other words, we expect to reduce the back order in 2023 by applying the same principles we have employed with Savanna to our VITROS platform.

In addition, we are installing two more automated slide manufacturing lines in Rochester to meet increasing slide demand. Another step we undertook in the fourth quarter was entering into a joint venture with Shanghai Runda Medical to develop and manufacture VITROs assays in China, which longer term we believe will translate into a faster time to market and more compelling menu for VITROS assays in support of our growth strategy in China. We also continue to progress our China instrument localization initiative. Internally, I speak often about excellent execution being a function of things done well at speed. Achieving speed requires focus, picking the two or three things that are going to matter and giving yourself permission not to focus too acutely on things that don’t matter as much, at least not currently.

In other words, first things first. In my mind, these three franchises matter. Our success with these three programs will create the greatest shareholder return in the next couple of years. It doesn’t mean that Transfusion Medicine isn’t important and that our development of a next-gen donor screening platform will be important in the longer term, because it is and it will. It doesn’t mean that leapfrog and quantitative assays at the Point-of-Care are important in the longer term, because they are. And it doesn’t mean that deploying our capital wisely isn’t important, because it is. But for me in 2023, these three businesses matter most and that’s where I am focused. Of course, I am also following our progress with integration very closely and it’s going well.

As we transition from our interim state to our future state over 70% of interim state milestones have been completed to-date, a remarkable achievement in such a short amount of time. Following a disciplined and thoughtful approach, our integration team is ahead of expectations in both identifying and realizing cost synergies. Last year, we realized approximately $15 million in cost synergies. We have also identified the full $90 million in cost synergies over the next three years and believe that there could be even more upside. Given where we are today, we are confident that we will exceed our 2023 target of $30 million and commercial cross-training related training through revenue synergies is well underway. In summary, we had a fantastic quarter and a terrific year.

We are ahead of schedule on our integration plans and have multiple growth drivers at work. We have a plan in place and everything we need to hit our financial targets going forward. Our path to meaningful growth as we move from 2023 onward is well understood and largely derisked. The headwinds that we were rightly concerned about not be the obstacles we were expecting and may not be as significant as we had originally thought. Objectively, our fourth quarter was truly an outstanding performance and sets us up for a strong 2023 and beyond. With that, I’d like to turn the call over to Joe to further discuss our Q4 financial results and 2023 guidance. Joe?

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Joe Busky: Thanks, Doug, and good afternoon, everyone. I will begin with a bit more detail on our operating results for the quarter and the full year. As mentioned previously, to facilitate a comparison of the company’s operating performance from the fourth quarter of 2021 to the fourth quarter of 2022 and from the full year 2021 to the full year of 2022, all growth rates that I referenced are presented on a supplemental combined basis, as if Quidel and Ortho have been combined for the applicable periods and may be referred to as supplemental combined information. So let me start by saying that; one, we finished the year strong with a great Q4 that exceeded our expectations; and two, we are today providing 2023 guidance that is in line with our three-year outlook that was provided at the Investor Day in December.

I will now provide more detail on both those areas. Starting with the breakdown of Q4 revenue on slide seven. In the fourth quarter, we recorded revenue above the guidance we provided in November. Revenue excluding COVID-related revenue came in at $734 million, which is up 18.6% in constant currency driven by Point-of-Care and Molecular Diagnostics. COVID-related revenue totaled $132 million in the quarter. So in total, we recorded revenue of $867 million, a year-over-year decrease of 23% in constant currency. The currency translation decreased sales growth by about 180 basis points resulting in total sales decline of 25%. For the full year, however, total revenue was up 10% in constant currency to $4.1 billion. Excluding COVID-related revenue, full year revenue increased 11% in constant currency.

Note that as we and others in the diagnostics space have been saying for several quarters now, we believe COVID-19 is transitioning to an endemic state and we now see it as just another respiratory disease, and appropriately, we will begin to bucket COVID-19 revenue with our other respiratory revenue in 2023 and forward. Turning to our Q4 performance by business unit on a constant currency basis and excluding COVID-related revenue, Point-of-Care revenue grew 138% largely driven by pull-through of our broad respiratory menu. These results reinforce our view that our Sofia system has been and will continue to be the beneficiary of tailwinds associated with increased respiratory testing, especially among the 85,000 cumulative instrument placements.

Labs revenue declined 10% in the quarter, primarily due to the continued lockdown challenges in China. Transfusion Medicine revenue grew 1% with high single-digit growth in donor screening driven by plasma demand, partially offset by immunohematology due to lower procedure volumes in China. And finally, Molecular Diagnostics revenue grew 45% in the quarter, though this is on a relatively low base. Now looking at our quarterly performance by geography on a constant currency basis and excluding COVID-related revenue, North America revenue grew 38%, EMEA declined 3%, China declined 27% and other regions, which includes Latin America, Japan and other Asia Pacific markets grew 7%. North America, our largest geography by revenue delivered strong growth excluding COVID-related revenue driven by Point-of-Care and though it didn’t meaningfully impact the quarter, we recently received two government contracts.

One, a one-year $108 million U.S. Government contract for QuickVue at-home COVID-19 tests. The contract provides for an expected value of $54 million and a maximum order value of $108 million. We did ship only a few million tests of this order in Q4 and we expect to shift the remaining tests in the initial 54 million order primarily in Q1. And then more recently we received a second U.S. Government contract for up to 37 million COVID tests for a total of approximately $97 million. We shipped a very small amount in late Q4, but most of this non-guaranteed contract is also expected to ship in Q1. In EMEA, revenue growth, excluding COVID-related revenue slowed as Lab volumes were negatively affected by the timing of tenders. Positively, Point-of-Care grew strong double digits, driven by strength in both Sofia and Triage.

In China, which makes up about 10% of our total company revenue new COVID-19 lockdowns caused a double-digit decline in hospital visits, which had a severe impact on our recurring revenues. Positively, though, late in the fourth quarter and into Q1 we saw increased testing and an acceleration of orders. The end of China’s zero COVID policy is expected to support accelerating demand as we moved through 2023. Looking at our Q4 revenue by category. Recurring revenue, which includes reagents, service and other consumables grew 5% and was up 24% excluding COVID-related revenue. QuickVue revenue was down 72% but up 371%, excluding COVID-related revenue. Instrument revenue grew 9%, driven by strong cash instrument sales in our TM business, including a few nice large wins in North America.

Global supply chain challenges continue to limit our ability to deliver instruments in our Labs business. Given Q4 seasonality and instrument demand, Open Labs instrument orders were up modestly from the third quarter. That said, customer demand continues to be strong and we are prioritizing new instrument placements and integrated instruments in order to maximize our recurring revenue pull-through. Now turning to slide eight. I’d like to comment on our fourth quarter financial performance below revenue versus the prior year again on a supplemental combined basis. Although year-over-year growth rates were negatively impacted by the decline in COVID-related revenues, we delivered a strong quarter of performance below the topline. Gross profit margin for the quarter was 54.6%, in line with our expectations and down from prior year, largely due to the decline in COVID-related revenue as we transition from a pandemic state to an endemic state, as well as FX headwinds, partially offset by favorable base business mix.

Adjusted EBITDA also declined year-over-year, again due to the transition from a COVID-19 pandemic state to an endemic state, resulting in adjusted EBITDA of $245.1 million, ahead of our expectations due to the strong revenue. Adjusted EBITDA margin contracted year-over-year to 28.3%, again better than our expectations. Net interest expense for the period was $34.1 million, a decrease of $2 million as anticipated due to lower interest rates, partially offset by the increase in the average outstanding debt balances related to the combination. Our provision for income taxes was $39 million, compared to $92 million for the prior year period. This represents a fourth quarter adjusted tax rate of 25.4%, bringing our full year adjusted tax rate to 22.5%.

Our adjusted earnings per fully diluted share for the fourth quarter was $1.76, above our guidance and compared to $5.12 in the fourth quarter of 2021 on a supplemental combined basis. The higher EPS in the fourth quarter of 2021 was driven by the greater COVID-related revenue than in the fourth quarter of this year. And for the full year, our adjusted earnings per fully diluted share was $13.80, compared to $13.60 in 2021 on a supplemental combined basis. Turning to cash flow and balance sheet on slide nine. In the fourth quarter on a GAAP basis, we generated operating cash flow of $169 million and after funding $59 million in CapEx and adding back $25 million in integration and other costs we estimate recurring free cash flow to be $135 million or 55% of our Q4 adjusted EBITDA.

In terms of capital deployment, in the fourth quarter, we did not buy back any shares as we focus on bringing down our net leverage through a combination of paying down debt and building cash on the balance sheet. We paid down $52 million of debt in Q4 for a total of $104 million in the second half of 2022. We intend to maintain a flexible and balanced approach to share repurchases and debt paydown going forward, which will include debt paydown of at least the required $206 million in 2023. We ended the quarter with cash, cash equivalents and marketable securities of $366 million and total debt of $2.6 billion. We ended the quarter with 1.5 times net debt-to-EBITDA on a supplemental combined basis and consistent with what we said at our December Investment — Investor Day, as COVID-related revenue declines to an endemic level over the coming year, we plan to maintain prudent levels of leverage and expect leverage to increase up to approximately 2.5 times by the end of 2023 and we believe that we are in a good position to continue to invest in the business.

Deleveraging is a top priority for us and we have a goal to be at or below 2 times net leverage by the end of 2024, while maintaining flexibility for strategic smaller M&A opportunities. Okay, now turning to our fiscal year 2023 guidance on slide 10. First, I’d like to provide some broader context on this outlook. Going forward, although there may be spikes and no one really knows for sure, we assume COVID-19 transitions to an endemic state. Similar to other seasonal respiratory viruses and we plan to bucket it with those other respiratory viruses in 2023 and forward. And while 2022 included a record-setting respiratory season, including flu and COVID-19, we expect 2023 to return to a more normal respiratory season. We expect to continue to capture and grow our share of the respiratory market underpinned by our large and growing Sofia placements.

Outside our respiratory, the Point-of-Care market is healthy and is expected to deliver strong revenue growth in 2023. Our Transfusion Medicine business is expected to be about flat with solid growth within our core IH business and softness in donor screening. Labs instrument supply issues are expected to modestly alleviate as we move through, which along with an anticipated recovery in China are expected to drive solid growth, it is a little more back half loaded. Savanna sales in Europe are expected to drive strong growth within our Molecular Diagnostics business, which along with the expected ramp in the U.S. volumes after receipt of regulatory clearance are expected to drive meaningful revenue in the back half of the year. Given the volume strength we are seeing in stat Labs through to the end of the lockdowns in China, our recent launch of the vitros-XT3400 and our localization plans, we are expecting strong double-digit growth in China, excluding COVID-related revenue.

And then finally, inflation and global supply chain disruptions continue to be a challenge. However, we are seeing greater access to semiconductor chips and expect challenges to further ease as we move through the year. So in light of these dynamics, we are introducing the following fiscal year 2023 guidance, which is in line with our three-year model as presented at our Investor Day in December. Total revenue of $2.8 billion to $3.1 billion. Breaking this down further, revenue growth, excluding respiratory sales, is expected to grow 4% to 6% on a constant currency basis to $2.21 billion to $2.25 billion. Respiratory revenue of $610 million to $875 million, which includes COVID revenue of $300 million to $500 million, rapid flu revenue of $230 million to $270 million and other respiratory revenue of $80 million to $105 million, and this includes some benefit of recently awarded government contracts and as compared to 2022 supplemental combined total company respiratory revenue of $1.8 billion.

Adjusted EBITDA is expected to be in the range of $800 million to $850 million, representing a margin of 27.4% to 28.6%. Adjusted diluted EPS is expected to be in the range of $5 to $5.60, which includes the increase in the interest rate environment over the last year. In addition, I’d like to provide assumptions that may be helpful for modeling purposes. At current rates, we expect currency translation to be about neutral to full year sales and adjusted EBITDA. There are no differences in the number of billing days in 2023 compared to 2022. Net interest expense is expected to be in the range of $145 million to $150 million. We are expecting a full year adjusted tax rate of about 23.5%. And consistent with what we have said at our Investor Day, we expect recurring free cash flow to be at the lower end of the 50% to 65% of adjusted EBITDA.

And then finally, full year diluted weighted average share count of 67.2 million. So, in summary, the fourth quarter results were exceptional as our positioning in the respiratory market drove strong results even as our largest and generally most resilient business, Labs, faced temporary weakness largely due to the China lockdowns. In 2023, we expect a normal respiratory season, which will cause a difficult comp in 2023 and we expect Labs to bounce back and support our business model as our guidance indicates. This 2023 guidance provides for a two-year CAGR for revenue, excluding COVID, in line with a 6% to 9% long-term outlook we provided at the Investor Day. And beyond 2023, we fully expect to continue delivering on our high single-digit long-term growth profile.

So, with that, Operator, I think, we are now ready to open the call for questions.

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Q&A Session

Operator: The first question comes from the line of Andrew Brackmann of William Blair. Please proceed.

Andrew Brackmann: Hey, guys. Good afternoon. Thanks for taking the questions and appreciate the clear comments on the value drivers in the scripts. I thought that was helpful. Maybe if I could just start on the guide here, a lot of moving pieces, I think, Joe, as you called out, I think, a lot of those were already anticipated. But maybe just as we sort of think about those cross wins impacting the business to get to that 4% to 6% base number, can you just maybe talk about how you are thinking about the progression of those variables through the year and then I guess, how does that also impact your thoughts on pacing here? Thanks.

Doug Bryant: Yeah. Hey, Andrew. Thanks for the question. As in the comments, I do think that, in particular, the Labs growth will be a little more back-end loaded for a couple of reasons. One, the China recovery we expect that we will be a little more back-end loaded. And then also the Labs instrument backorder recovery will certainly be a little more back-end loaded as well. So I think that is going to push a little more of the revenue that growth into the second half of the year, particularly Q4. I would also add that given how the respiratory season played out in 2022, with a very strong flu season in Q4 that sort of ended fairly quickly at the end of Q4. We are not expecting a very heavy respiratory season in Q1, but we are expecting a fairly typical respiratory season in Q4, which again is going to move some more of that revenue into Q4.

Andrew Brackmann: Okay. Thanks for that. And then I guess just a similar question on the profitability front, any thoughts on pacing there? And then it looks like the dollars for both EBITDA and adjusted earnings per share were a little bit higher than feared here. So any comments or any thoughts around specific gross margin sort of trends for the year and sort of how we should be thinking about OpEx? Thanks.

Joe Busky: Yeah. Consistent with what I have said on previous calls, we still expect in 2023 that seasonality is going to have our Q2 and Q3 quarters to be the latest quarters of the year, particularly Q2. And because of that, when you have got those lower revenue quarters with still a level of fixed costs, that’s going to produce lower gross margins and EBITDA margins in Q2 and Q3, and then with slightly stronger revenue quarters in Q1 and Q4, you are going to have a stronger GP and EBITDA margins in Q1 and Q4, and so it’s going to get you for the full year as we have been saying, GP margins sort of in that low to mid-50s range.

Doug Bryant: And if I can just add, Joe, that and I think most of our investors know this, historically, Q2 has been our lowest quarter in terms of revenue.

Andrew Brackmann: Okay. Thanks, guys.

Joe Busky: Thanks.

Doug Bryant: Thanks, Andrew.

Operator: Thank you. The next question comes from the line of Andrew Cooper of Raymond James. Please proceed.

Andrew Cooper: Thanks, guys. I like the back-to-back Andrews here. But just to kind of jump into it, one thing I think investors are certainly going to be teed into is the commentary for 2023 being normal and that $300 million to $500 million of COVID. I think it sounds like it does include those government contracts or at least some contribution from. So can you give us a sense for where you are sort of settling out, of what normal might be for COVID and how that’s going to play out through the course of the year kind of in context of, Joe, what you just said about some of the seasonality in flu and respiratory in general?