Q3 2021 Ortho Clinical Diagnostics Holdings PLC Earnings Call

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 Brockmeyer, Vice President of Investor Relations.

Brian you may begin.

Thank you operator, good afternoon, everyone and welcome to the Ortho clinical diagnostics third quarter earnings Conference call with me today to discuss our financial results are Chris Smith.

Those chairman and CEO and Joe Buskey, Ortho as Chief Financial Officer, Mike <unk>.

Commercial excellence and strategy will join us on the Q&A portion of the call.

This conference call is being simultaneously webcast on the investors section of our website and a version that.

It can be downloaded there.

Before we begin I will cover our safe Harbor statement.

Some of the statements we will make during this call about the company's future expectations plans and prospects constitute forward looking statements within the meaning of section 21 E of the Securities Exchange Act of $19 34, which provides a safe harbor for such statements. Our use of forward looking statements as a subject.

And 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 two of today's presentation and our other filings with the SEC. Please.

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 today will be realized we undertake no obligation to update any forward looking statements to reflect future events developments or changed circumstances or for any other reason, except as required by law.

Also during today's call there'll be a discussion of some items that do not conform to U S. Generally accepted accounting principles or GAAP. Please see slide three 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 investor in the investors section of ortho the ortho website.

In addition on today's call, we will refer to our core and our noncore business. Our clinical laboratories also known as clinical labs in 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 are given on a comparable constant currency basis.

Now I'd like to turn the call over to Chris Smith, Ortho as chairman and CEO, Chris <unk>.

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 talks about the mission and the credo as a company because every test is a life and this is why we do what we do on a daily basis, we embraces and it's a critical role in the role that we play in the health care system. Every single day to give you. An example today will help about 800000 patients around the world I just wanted to thank.

Our teammates around the world for everything they do everyday to make a difference in those patients and those clinicians lives with that let's get into the third quarter results. We'll start with slide five core revenue grew 13% in constant currency to $509 million with the strength of both our clinical labs and are transfusion mens business or <unk>.

<unk> business was up 16%, excluding three percentage points of headwind from Covid test, reflecting underlying strength in our base business.

Therefore, we have raised our full year revenue growth guidance to 14% to 15% from the prior 10% to 12% for the full year revenue.

In addition to strong revenue growth adjusted EBITDA grew 17% to $140 million, representing a margin expansion of 25 basis points to 26, 7% and adjusted earnings per share is up 50% year over year to 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 continued momentum in our business is a clear result of our dedication to customers and the patients that they serve we.

We talked about the importance of lifetime customer value in 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 I will get into more of that later on in the call.

Continue with our third quarter performance.

Let's look closely at our geographies on slide six 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 S commercial growth, excluding Covid assays was up 13% driven by strong instrument placements, especially of our integrated system, our menu expansion and our revenue reoccurring pull through as well as our Cts partnership and are transfusion medicine business in EMEA growth, excluding Covid assays was up 14.

<unk> driven by strength across our <unk> business. This is the fourth consecutive quarter of growth in Western Europe. Following five 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.

China grew double digits for the third quarter in a row with particular strength in our assay business.

Our EMEA SA business was up 20%, we have not seen full recovery in the routine clinical chemistry testing are.

Our installed base grew 6% in 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% and 19% respectively and growth was particularly strong in India and Latin America.

In summary, our team around the world continue to successfully execute on our growth strategy that we launched in 2019.

Next on slide seven we remain steadfastly focused on executing against our three 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 third quarter and let me cover just a couple of the highlights bill.

Beginning with product innovation as we discussed last quarter, we received emergency use authorization in the U S for our quantitative COVID-19 spike antibody assay.

We're the only company at this point that has that EUA mulch.

Multiple studies are underway to advance our understanding of COVID-19 immunity at individual levels not just at populations and segments and we believe these studies will support further recommendation from regulatory bodies around the world.

Turning to our second priority global commercial excellence, our commercial excellence program continues to improve our execution in the third quarter, we delivered 16% growth in integrated installed base. This is driving strong growth in our immunoassay business, which was up 14% excluding COVID-19 related revenue.

We continue to lead with service is a key differentiator and as an example in the recently published service track Awards and service track as you May recall is a third 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 third priority operational efficiency 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 in emerging market expansion, while also bringing efficiency scale and cost savings to our organization establishing <unk>.

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. It is designed to guide our.

<unk> to be more agile and adaptive company and also enable continuous reinvestment in our growth.

Yes.

Returning to the Big picture on slide eight 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.

<unk> is our integrated systems penetrated the market and pulled through reoccurring revenues and our commercial excellence progress began their execution.

The key driver is very clear noted in our integrated install base growth shown in the bottom chart, our integrated install base growth accelerated with the launch of our <unk> hundred 7600, and this and the concurrent sale of refurbished 56 hundreds in emerging markets.

This sustained double digit growth in our integrated installed base drove the overall growth of our clinical lab installed base, we see a significant opportunity carried as straightforward as we continue into the fourth quarter and into 2022.

That integrated install base growth is important because our lifetime customer value, which is illustrated on slide nine lie.

Our lifetime customer value is all about building long term relationships with our customers through the strong clinical performance of our assays are 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.

It is this focus 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 install base of Standalone systems with integrated systems and Thats, a key source of growth for the company.

The penetration of the market with our integrated analyzers is fundamental to our growth strategy.

And thats, because our integrated systems pull through 65% more revenue than our Standalone systems.

Right.

Our integrated installed base continues to grow double digits given that our integrated installed base is still just 26% of our total <unk> 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 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 EMEA.

Assay, we believe this mismatch between our revenue mix and the proportion of the broader market represents represents a significant growth opportunity for us as we continue to expand our market share within IAA and as we penetrate the market with our integrated instruments. This allows us to leverage our recently expanded test menu and execute on our <unk>.

<unk> Excellence program globally.

In the third quarter, our <unk> assay revenue was up 14%, excluding COVID-19 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 Joe.

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 third quarter, we have total revenue of $523 million, 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 in collaboration revenue increased 13% on a constant currency basis to $509 million note that the COVID-19 pandemic has impacted our quarterly seasonality and therefore third quarter core revenue was up 5% sequentially from this.

Second quarter.

The substantial revenue growth in the third quarter was primarily driven by the strong recurring revenue pull through on the instruments replaced over the last couple of years across our geographies in both Glenn Labs, and transfusion medicine are calling lab business generated $12 million and Covid assay related revenue, which was down from $21 million in Q3 of <unk>.

Last year, representing approximately 200 basis point headwind on total company core growth.

And Covid assay revenue was actually down 5 million sequentially from Q2 of this year.

Turning to our Q3 performance by line of business Colin Labs revenue grew 10% in the quarter largely driven by double digit growth across all major regions, excluding COVID-19 assay revenue.

In transfusion medicine, we grew 21% driven by strong growth in the Americas, China and other Asia Pacific countries and as a reminder, the third quarter benefited from our new partnership with Cts, which went live in Q1.

This year.

Non core revenue in the third quarter grew to $13 6 million from $7 8 million.

This non core revenue in the quarter includes the benefit of an $8 5 million 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 S. EMEA.

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 claim chemistry and immunoassay is excluding cope COVID-19 assay revenue as well as donor screening.

Instrument revenue grew 15% in the quarter driven by placement of our integrated Clinton lab instruments, and our immuno hematology instruments.

Now turning to slide 13, I'd like to comment briefly on our third quarter financial performance versus the prior year, 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% and this was a 360 basis point increase versus Q3 'twenty.

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 costs, partially offset by negative impact from mix, primarily from the lower high margin Covid COVID-19 related revenue.

Additionally, within both cost of sales and operating expenses, we have seen higher spot air Freights as we've previously previously discussed this trend continues but we are actively managing and monitoring the situation and we've included these higher costs in our guidance.

Moving down the P&L sales marketing and administrative expenses as a percentage of revenue was flat year over year at 27% of revenue.

Adjusted EBITDA grew 17% to $140 million and adjusted EBITDA margin expanded 25 bps year over year to 26, 7%, primarily driven by positive mix and our placement of integrated systems efficiency improvements and the successful execution of our value capture program now if you exclude the arbitrage.

<unk> Award I mentioned, a minute ago, which was recognized in noncore 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 million a decrease of $13 million is isn't as anticipated due to lower average outstanding debt balance and lower interest rates.

Our provision for income taxes was $6 million compared to a benefit of $10 million in the year ago period, we continue to expect cash taxes for the year to be approximately $20 million.

Our adjusted earnings per fully diluted share for the third quarter increased 50% year over year of 'twenty one.

Driven by our solid operating performance as well as lower interest expense and on a GAAP basis, we reported EPS of six cents per share compared to a net loss per share of <unk> 20 in Q3 of last year.

And positively this was our first quarterly GAAP profit since 2019.

Now turning to free cash flow capital deployment and balance sheet on slide 14 in the third quarter, we generated $56 million and adjusted free cash flow after funding $8 million and capital expenditures. Our days sales outstanding came in at 41 days, an improvement of 20 days compared to the third quarter of last year.

Now this includes a securitization of $75 million in the U S that we talked about last quarter and without the benefit of this financing transaction, our DSO still would've improved by seven days compared to the third quarter of last year.

And as I said on our second quarter call, we expect cash generation in the second half of the year to be greater than $100 million.

Our strong cash generation enabled us to continue to deleverage our balance sheet and reduce our net debt to EBITDA ratio to three seven times down from four times at the end of Q2.

Given the strength of our business performance, we continue to expect to reduce this leverage ratio by at least a half turn per year going forward as we move towards a more normalized leverage range of two five to three five times.

While maintaining flexibility for strategic M&A opportunities, we ended the quarter with cash and cash equivalents of 256 million and total debt of $2 3 billion.

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 increased operating leverage and give us new or additional exposure to high growth markets. While we are guided by our focus on the <unk>.

<unk> deployment are industry, leading and innovative solutions for patients around the world. We believe that our expertise gained through our highly collaborative partnerships, coupled with our market leading position and attractive the IBD space and a healthy balance sheet. Following our January IPO provide us with an excellent platform to pursue mostly bolt on.

<unk> to accelerate profitable growth going forward.

Now turning to our outlook for the remainder of the year on slide 16, first I want to provide some broader context on our fourth quarter and the full year 'twenty one guidance.

We saw very strong demand through the first three quarters of this year.

And given positive utilization trends as well as leading indicators, including forecasted inpatient admissions. We expect continued strength in the fourth quarter of this year, we expect minimal COVID-19 assay revenue in the fourth quarter of 'twenty, one compared to $26 million in the fourth quarter of last year, representing up to a 500 basis point headwind on our total.

Company growth core growth in Q4, the fourth quarter 2020 included an extra week under our fiscal period, which we estimate positively impacted sales growth by approximately two percentage points.

Now Consequently, we are raising our 'twenty one guidance as follows core revenue is expected to grow 14% to 15% on a constant currency basis to $2 billion to $2 billion 20 <unk>.

Compared to our prior guidance of 10% to 12% constant currency growth to $1 $95 billion to $1 billion 98.

At current rates current currency translation is expected to increase our full year sales growth by approximately two percentage points.

Adjusted EBITDA is expected to grow 19% to 20% on a reported basis to $542 million to $547 million, an increase from our prior range of $526 million and 534.

Diluted.

Adjusted diluted EPS is now expected to be 76 to 78 per share an increase from our prior guidance of 67 to 72.

Based on our full year diluted weighted average share count of $235 million.

Now before turning it back over to Chris I'd like to discuss supply chain disruptions.

Global supply chain challenges combined with the strength of our business over the last several quarters is putting increased demand on our supply chain our.

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.

And with that I'll turn the call back over to Chris to make a few summary comments. Thanks, Joe Great update on the quarter and look I. We've shown this slide before but it really is the investment thesis. We continue to believe that ortho is a fantastic investment number one because we are a pure play IBD and it is a highly attractive and growing market obviously the <unk>.

Second thing, we think we have a very unique and 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&A.

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

Thank you.

Our first question comes from Tycho Peterson of Jpmorgan.

Your line is open.

Hey, Thanks, guys.

Hey, Chris I wanted to start with China last quarter, you talked about being slower to return I know you were still up 10% in greater China, but obviously theres 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 are trying to capture some of the high value low volume tests similar to what they did with pharma and $4. Seven so maybe can you touch on those dynamics are you viewed as a competitor in China at this point and then how do you think about the tender process.

We're still not tyco viewed as a local and I think that's one of the reasons. We've created our two partnership agreements our localization strategies, one around instrument and one around assay development. We're now about.

I don't know 96 to nine months into those partnership agreements, which we think will help us as far as the tender youre exactly right. I mean that is starting to occur as you probably know we did participate.

And really kind of the first tender that was out there.

Kristin <unk> Tyco everything has been tender always I mean, any hospitals in United States or tender Europe standard Middle East, but China. This was relatively new.

Two as you probably know two major <unk>.

Multinationals chose not to participate 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 will pick up share there and so we do think that will continue but we feel like we're we're learning a lot as we went through that process and we believe it or our ability that so much of our business is outside the United States and has been.

Part of tenders across the world that we feel pretty well positioned there, but as you know it grew double digits again, we base a lot of where we think the business is going on.

Installed base growth and integrated installed base growth of both of those were really robust for the quarter and I think the other thing Thats 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.

We are at or below our 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.

Don't know if I answered all your questions that you had a couple so I hope I got them all of that that's great and then I want to follow up with Joe and the supply chain comments.

It's about your ability to pass on higher freight costs and things to customers. If they are under multi year contracts can you maybe just touch on that and then any kind of input shortages or things you're going to have to deal with on the other hand.

Yes Tycho.

We are passing on price increases to our customers where possible.

And Youre right that 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, it's no different than what others have said on calls microchips resins.

<unk>.

And so we've got a lot of initiatives in play that I mentioned in the prepared remarks.

Strengthening our relationships with.

Our history of kind of a contract manufacturing partners were taking over portions of the distribution network.

Bringing in additional key supply suppliers for key components.

So there is a lot of activity going there and.

We feel that there really wasn't a significant impact on our Q3 results.

Okay I appreciate it thanks.

Thanks Tycho.

Yeah.

Thank you.

Our next question comes from Vijay Kumar of Evercore ISI.

Your line is open.

Maybe Vijay Hey, guys Hi, Chris.

Congrats on a good print here.

Just on the Q itself grew at 16% core growth that's about eight points about feet models I'm curious.

Are there any one offs in the quarter I mean, this is really really strong it doesn't seem like COVID-19 had a big big.

In April here.

Talk about the underlying trends are on what drove the 16%.

Joe do you want to take that and maybe talk about what happened in the quarter, Yes, Vijay I think.

As I noted in the comments.

Included in noncore revenue.

Obviously rolls up in the total revenue, we had an arbitration award, which was $8 $5 million.

Clearly thats.

Something that wouldn't have been planned or forecasted and then yes. The COVID-19 assay related revenue in the quarter was $12 million, so probably maybe a little bit stronger than maybe some had expected yeah and you know Vijay we had originally put in the second half and so obviously, we're getting some depending on where your model was built.

But COVID-19 coming around 12, Joe mentioned, the the one off but really that's just.

I go I always talk about this and this being a portfolio business, but right now, we're just really performing well everywhere.

Across the world and so I think what Youre seeing is that that strong execution being pulled through all of the all regions at the same time, but Vijay just to be clear I mean, but.

Excluding that non core collaboration revenue that I spoke about in the Covid. The core revenue is up it's up 16%. So it's a strong quarter.

And again as Chris said it was across all regions.

The I guess.

And then that segue.

Segue into my next question, because I mean, <unk> clearly execution was above.

<unk>.

That trend.

Q4 guidance.

Understand.

Some of the comp issues.

Was there any timing element because.

Adding a sequential step down of almost 14%.

I think the implied is close to $470 million revenues in Q4.

Was there any pull forward of revenues from Q4 into Q3 or like why shouldn't we see.

Assistance at these strong trends because the comps don't team at hard it seemed to be about five six points harder in Q4 sequentially.

I should Q4 be.

High single double digit core growth core.

Turner.

For Q4.

Yeah, Vijay if you if you take the we gave the full year guidance and obviously just sort of imply that Q4 numbers out of that youre going to youre going to get in the range of 2% to 6%.

Total, but excluding COVID-19, it's going to be 6% to 9%.

The range so the midpoint of that range in your 7% to 8%.

Growth on the top line, excluding COVID-19. So it is very much in that in the high single digit range in Q4. So we do feel like that growth is continuing.

Yes, I think Vijay we also remember we have a pretty significant headwind in Q4 I mean, we're look we're this COVID-19 is always a moving we had a very strong COVID-19 quarter of Q4 last year.

Theres not a lot in the Q4 forecast for US right now it's minimal.

So I think that 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 four ish plus.

Total and ex Covid eight ish, yes high single digit.

That's helpful. Thank you.

Okay.

Thank you.

Our next question comes from Derik Debruin of Bank of America. Your line is open.

Hey, good afternoon, Hi.

So.

Really impressive.

14% to 15% constant currency revenue growth, obviously for this year I mean, it's obviously begs the question on things.

Thinking about trends as we go into 2022.

And.

You're tracking well above.

We had you in the deal model and.

Certainly the outlook seems to be very good I mean can.

Can you give any initial thoughts on how dose or are you thinking of the puts and takes on due 2020 to.

Mid single digits sort of like core growth still in the cards.

Through like do all the puts and takes just any high level thoughts would be appreciated.

Yes, obviously, we won't do guidance for a bit but kennedy to give it to you high level. Derek I mean look I will tell you 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 done before 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 our standalone and moving to an integrated it's a net zero. So when you see four 5% on the stand alone 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 IAA side.

Pull through a lot more revenue when we convert a standalone to an integrated that's why you hear in my statements in 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. So I think when you take that combined with winning market share. That's why you're I think you're seeing the wins that youre seeing across the globe and part of this has been this.

Pivoting 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 IH 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.

Got it yes.

Yes that was high level. Thanks.

Yes.

Yes.

Alex you man hours.

I've gone on for Bose.

Soon in giving you guidance.

Yeah.

Yes.

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 dry side technology, which is technologically differentiated from the other.

Technology.

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 or other technologies I'm sort of curious is like is that a competitive advantage and sort of going into some of these arguments somebody's debating Andre I think it is I'm going to let Mike take this one and second who runs our global commercial.

So, but I definitely think it is an advantage because we get differentiation historically, we'd gotten better reimbursement, obviously don't have the water issues. So I do think that that having that differentiation helps us I'll also say that our leadership team there.

Particularly with the woman who runs China for US is very astute and I will say deep into the understanding of the market dynamics in 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 was around the dry chemistry, and then also how they're handling the tender situation there.

Yes.

Derrick It is a differentiator for hey, Chris hit on the main reasons why the other thing when you think about the China market we have.

So a little bit different for us in that market as we have a very large presence in the stat lab market in China, and a big part of that is <unk>, the reliability to slides and actually on Chemistries, it's pretty fast turnaround time compared to our competitors. So all those things combined are what helps with the differentiation Chris did mention.

<unk>.

There is reimbursement benefits that.

We do not see in China, but again globally customers, particularly customers that have used dry slide and see the benefits.

Those attributes and the benefits they get can.

Can be written sometimes into tenders, which makes it very difficult for wet system to compete.

Okay by the way Derrick 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.

Great. Thank you very much.

Thanks.

Thank you.

Our next question comes from.

Goldman Sachs. Your line is open.

Hi, everybody. Thanks, Hey, Thanks for taking my questions I, just want to focus on the commentary in the slide you have on the integrated installed base growth. Its obviously continues to be impressive and it's great to see the teams. It's also gone from 14 to 15 to 16 over the last three quarters is that a trend that we should expect or you're seeing accelerating growth and a great installed base.

I mean, I think being mid teens is great, but I'm just wondering if theres any additional trends that you could highlight that maybe is resulting in accelerated growth of the integrate install base.

Yes, Matt I think that's been an interesting phenomenon. If you look back at 17 and 18 I think a lot of that would have been a conversion from a standalone to an integrated I think the difference you are 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 three weeks ago four.

Weeks ago, a big system Youre talking a system, that's due in two and a half.

Plus a year and we won that from a competitor, but we only did integrated so they've never had a standalone of our of our analyzer and so when you look at that that would be not only increasing our install base, but it also increased our integrated installed base and so I think some of that is that tip of the spear and why youre 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.

The business has been good so I think it's a little bit of both Mike again do you want to comment any more than maybe you see.

No of course I think.

I think you're on it right one of the things.

When you listen to the narrative you hear we keep saying some of the shape things over and over.

But it's really the playbook and I think when.

What do you see this we're now executing that globally. So what was happening in the U S and a few other markets now you see globally.

As both using integrated to move Standalone instruments up but to win new business and so it's not just one market either I think thats whats, helping some of the patients.

That you see broad applications.

Great. Thanks, that's helpful color and then just.

You continue to take down the net debt.

<unk>.

And you put yourself in a position for M&A, you've talked about exploring the market in the past just anything evolved in your thinking.

How does the landscape pipeline look how are you thinking about valuations here just any thoughts on M&A at this point.

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.

A molecular and point of care and we're still primarily looking into the areas of bolt on or niche acquisitions nothing transformational here.

We are getting pretty darn close to our.

Our desired leverage range of two five to three and a half were $3 seven now we're going to probably ticked down a more as we move through 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.

I don't think theres been a whole lot of change in philosophy there great.

Great. Thanks, very much appreciate it.

Sure.

Thank you.

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

Hey, Patrick.

Hey, guys. Thanks for taking the questions.

Joe maybe one for you on the margin side, you continue to put up pretty good performance. There guidance suggests we continue.

Obviously, we keep hearing about inflationary pressures supply chain logistics issues et cetera can you just talk about the moving pieces there dynamics as we go through <unk> and into 'twenty. Two I mean, it feels like expansion should continue but just want to talk through the different pieces there.

Yes, it's actually a very good question we.

We did have a good quarter in Q3 from a gross profit margin expansion perspective.

Laid out.

Factors I talked about in the prepared remarks.

Want to remind you that 80 bps of that was driven by that arbitration award of $8 5 million that we've put in noncore revenue, but the rest of it was a combination of some some FX tailwind and mostly operational.

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.

<unk> mix of instrument revenue, which is typically lower margin than the recurring.

Reagent revenue so.

Built into the guidance as expected declining in gross profit margin for the fourth quarter and Thats again, we've seen that every quarter for several years now.

Do you 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've put out of the.

The increase in gross profit margin of at least 30% to 60 basis points annually.

Okay. That's helpful color.

And then Chris maybe just on Europe, EMEA I mean, Western Europe has done a really good story for you guys can you just talk about what youre seeing there expectations going forward just general trends there would be helpful.

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 five years. So our first view is we'll get it to flat to one 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 and I and I would say in our countries, where we did have strong leadership like in Italy, where we didn't make changes they continue to perform a little bit above the market and I think again I come back to I think we're just winning more and part of this goes back to this philosophy that we've kind of had that this will to win and I think under R. J <unk>.

Jay It just wasn't a desire and so we continue to feel really good there I will say that one of the nice things for US for example, we saw in the Middle East, Russia, Eastern Europe, all up double digits in the third quarter that would have been that's a change in our new leaders in the last 12 months and if you look at places like where we have to win in places like the U K.

Spain, where we had not won before again great.

Close to double the double digit growth type of things. So I think we're seeing it not just coming from one place, it's really coming from that whole region.

Under John Martin's leadership.

Hey, Patrick it's Joe again.

Kind of go back to your margin question for a second.

The address the sequential.

Impacts to the gross margin Q3 to Q4, but I, probably should've mentioned also the year over year impacts to Q4 I mentioned this in the prepared remarks, but again, we did $26 million of Covid assay revenue in Q4 of last year and as Chris said a minute ago, we have minimal COVID-19 revenue.

And our guidance for the remainder of the year. So you are going to see.

A headwind on gross margin year over year due to mix dropping that COVID-19 assay revenue, which is which is fairly high margin revenue so that year over year, we will see a headwind.

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

Thank you.

And then.

So lot of Morgan Stanley Your line is open.

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 with inflation and freight costs and the mix of cash versus reagent rentals in the instrument fund in the supply chain issues et cetera.

And then there is the COVID-19 comp as well I mean, you have some COVID-19 revenue this year.

And last year, but presumably as you guide for next year.

Assume sort of zero Covid contributions like you have here in the fourth quarter. So as we look at sort of margins in 2022 is 30% to 40 basis points of margin expansion. Tim is there a way to think about it or should we be considering some incremental downside from some of these dynamics.

Yes to us I think you'll definitely see the tailwind is continuing that we've talked about all year and that is the value capture program the target to $25 million of savings annually, most of which end up in gross margin, you'll still see the tailwind of gross.

<unk> coming through from the strategy of shifting customers to integrated which drives more immunoassay higher margin revenue, but but.

The drop in the Covid assay revenue.

Is going to be likely significant in our view.

<unk> you just said if you assume it's zero, we're going to go from roughly call. It mid <unk> of Covid assay revenue this year two zero.

Three points of topline growth and a lot of.

Headwind on the gross margin. 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-19 for sure given the value capture program and the tailwind we get on the integrated strategy. We can we can get there.

And if not I hope it ends up playing through look I think we talked about it on the quant assay.

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 in there's 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, giving example, I got my booster on Monday, and I didn't know I didn't.

It tested with our own device nowhere my immunity level is and I did but I think we may see some opportunity with that test with Covid next year that we just don't have built in yet.

Got it and then a quick one on emerging markets for you Chris can you share some incremental color on the strength <unk> seen in India, and Brazil, and the Boston I think you've noted at least put in.

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 two go's evolving for you heading into 'twenty two.

Yes look I think when we look at.

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.

In India and again those are all up high double digit growth in Q3, continuing like they were.

And it's not COVID-19, especially in those markets and I think Theres a couple of things happening I would say if you look at Mexico.

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 youre 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. If you look over in India. I think the thing Thats really started to play incredibly well is that we've always been the number one service provider, but I don't think that was as important to hospitals until 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 seven distribution centers in India. It's a high presence market for us and I, just think Thats 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 at <unk>.

Done a really nice job there so I see all three of those markets continuing with very nice growth as we go into 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.

Got it very helpful and congrats on the Prem guys.

Thanks.

Thank you.

And with Jon <unk> of UBS.

Your line is open.

Hey, John.

Alright, Thanks for taking my questions I guess, just maybe digging a little deeper on <unk>.

<unk> I think previously.

The highlight was maybe 100 to 150 bps of pricing pressure there.

The supply constraints and inflation is that still the right way to think about the diagnostic market and then I think.

It also might use more contract manufacturing and then some of your competitors anything to highlight there.

Yes, I'll, let Joe take the first one on kind of around pricing and then I'll take the second one kind of around contract manufacturing John I would say that the typical.

Annual price erosion, we're seeing has not changed it's still in that point.

150 basis point range no change there.

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 thats a good model.

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 its core competency in the development and manufacturing of that on the instruments decision was made at the carve out too to outsource that but I feel really good about the partnering we chosen on larger.

In the world and deep relationships, giving examples because of the supply chain challenges, they're doing stuff for Tesla and airlines and 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 is our business has grown but.

Look I think it's something like any business you probably I probably spent a lot more time on it now than I, probably would have two years or three years ago, but I think you go to where the opportunities are where the issues may lie and you try to manage those and I think our team has done a fantastic job putting things in place to manage through it but we are but we are spending time doing it.

And there's I think there's a lot of things that we continue to do like taking over our distribution center in Memphis from Cannes, and we had outsourced that to <unk> and <unk>, but we believe that's part of the customer experience shipping of our products. So we wanted 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 we back to Joe's point next year with <unk>.

That will improve margins, but it also improves service levels. 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.

Thanks, David.

Just one follow up.

Yes.

SAP menu expansion is the target there is still 8% to 10 assays per year is that the right way to think about it in any area to discuss on where you may be focused on menu expansion yes.

Mike So I think we've talked about 20 to 30, new or improved assays in the next three years, but Mike do you want to give a little more color.

Around that yes, I think I think that's the right number to think about 30 assays in the next three to four years.

It's a combination of menu expansion new items, some enhancements and improvements I think we're as you see we have some passage that we 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.

Per calcitonin, which we've launched worldwide with the exception of China, we're targeting for next year.

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 paas.

We're working on for instance, hemoglobin AMC on a micro slide we think will be a difference maker, we're pretty excited about for launch early next year things like that.

Got it thanks for taking my questions.

Operator, we have time for one more question.

Thank you.

Our last question comes from Ken of HC Wainwright. Your line is open.

Thank you for taking my question could you comment on whether the supply chain issue is limited to certain geographic area or present.

Worldwide markets, and whether the issues primarily related to manufacturing or shipping logistics.

Yes, listen I think it's a good question I would say I think there is challenges in both.

I would say that the logistic issues are.

Our relatively manageable with price. So as you probably know spot rates have gone up significantly and I think you.

You have the ability to get the products, where you need the products to go based on what you are paying and 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 two primary distribution points, one in Memphis and one in Strasbourg, but then we go closer 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 had carry and I think that's one of the other reasons, we're being able to do that is to make sure that debt.

We do not have logistic issues. So I'd say, that's one but we manage that pretty well. If you look at the manufacturing one look I think it's the same thing I think what youre 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 as 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 is a lot more contracting going on a lot more vendor fares or we go out and see.

Our vendors so I think it's actually impacted both parts candidly of our business, but I think theyre all manageable as long as I think we are out in front of them.

Thank you and just a quick follow up do you believe the COVID-19 related revenue too.

Continued to decline in coming quarters.

Yeah.

I'm trying to think where we did Q2, what do we do in Q2 17, yes. So we did 17 than we did 12 look I think we see it's minimal so we're planning for less.

In Q4, I think a lot depends on what happens with the client 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 and so what we need is 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-19 projections are to be significantly less than they were this year currently.

Okay got it thank you.

Okay.

Hey, listen guys. It kind of brings us to the end of the time in the call, but I did want to let you know one other quick point is that.

We know that you probably are well look we have never had an investor day kind of 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 will send out more information, but we're really excited about that because what we want you to do is one is.

<unk> is here with me.

He is our chief Innovation Officer policy is going to really give you some insight into where our new technology is going 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 four to five years and then we're going to have a couple of regions.

In particular, we're looking to have China, if hopefully China's open and Irish Lin who runs that market for us and warn 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 find kind of focus around the business units and giving you really nice insight in how we're running the business and the transfusion medicine and Glenn Labs, and then finally.

We'll let Joe bring it home and give you more insight on the financials. So we think it's going to be an exciting day, we probably will provide lunch. So youre going to want to definitely get there, but we'll 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.

Okay.

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

Okay.

Okay.

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