Becton Dickinson & Co (BDX) Q3 2021 Earnings Call Transcript

Hello, and welcome to BD's Third Fiscal Quarter 2021 Earnings Call. At the request of BD, today's call is being recorded. It will be available for replay through August 12, 2021 on the Investors' page of bd.com website, or by phone at 855-859-2056 for domestic calls and (404) 537-3406 for international calls using the confirmation number 9447085. I would like to inform all parties that your lines have been placed in a listen-only mode until the question and answer segment. Beginning today's call is Ms. Kristen Stewart, Senior Vice President of Strategy and Investor Relations. Ms. Stewart, you may begin.

Hi. Good morning, everybody. And thank you for joining us. This call is being made available via webcast at bd.com. This morning, BD released its results for the third quarter of Fiscal 2021. You can find the press release along with the accompanying presentation on the Investor Relations website at investors.bd.com. Leading this morning's call is Tom Polen, BD's Chairman, Chief Executive Officer, and President, as well as Chris Reidy, Executive Vice President, Chief Financial Officer, and Chief Administrative Officer. Following the prepared remarks, Tom and Chris will be joined for Q&A by our three segment presidents: Alberto Mas, President of the Medical Segment; Simon Campion, President of Interventional Segment; and Dave Hickey, President of the Life Sciences Segment. During the call, we will be making forward-looking statements, and it is possible actual results could differ from our expectations. Risks, uncertainties, and other factors that could cause such differences can be found in our earnings release and in our SEC filings, including our 2020 Form 10-K and subsequent Form 10-Q. We will also discuss non-GAAP financial measures regarding our performance. Reconciliations to GAAP measures that include the details of purchase accounting, and other adjustments, can be found in our earnings release and its related financial schedules. They are also in the appendix of the Investor Relations presentation slides available on the BD.com website. Unless otherwise specified, all comparisons will be on a year-over-year basis versus the relevant period. Revenue percent changes are on an FX-neutral basis, unless otherwise noted. When we refer to the base revenues, we're referring to our total revenues less our COVID diagnostic testing revenues, which include COVID-related revenues from Veritor, BD MAX, and swabs. When we refer to base margins, we are adjusting for estimated COVID diagnostic testing profitability and the related profit we have reinvested back into our business. When we refer to any given peer group, we are referring to the fiscal period, unless we note it as a calendar period. Finally, when we refer to NewCo during today's call we're referring to the planned spin-out of our Diabetes Care business into an independently publicly traded Company following the effective trade date of the spin, which we announced on the second-quarter earnings call. RemainCo refers to BD post-separation. As a reminder, this transaction is subject to market, regulatory, and other conditions, including final approval by BD's Board of Directors and the effectiveness of the Form 10 registration statement that will be filed with the SEC. With that, I'm very pleased to turn it over to Tom. Tom?

Thank you, Kristen. Good morning, everyone, and thank you for joining us. On today's call, I will provide highlights of the quarter and discuss the continued strong progress we have made on our BD 2025 strategy. I'll then turn it over to Chris for the financial review and outlook. After our prepared remarks, Chris and I will then open the call up for Q&A. But first, I want to comment on the other announcement we made this morning regarding Chris' intention to retire from BD, and join the Board of our Diabetes spin-off. On behalf of the Board of Directors, the leadership team, and the Company, I want to express my gratitude to Chris for his leadership and service to BD. I'm confident the CFO transition ahead will be seamless, and his leadership and experience will make him an excellent Director for NewCo's board. Now let's jump into our results. We were very pleased with our third-quarter performance, powered by strong growth and momentum in our base business across all three segments. Revenues totaled $4.9 billion and our adjusted EPS was $2.74, both ahead of our expectations. Total revenues were up 26.9% on a reported basis, and up 22% on a currency-neutral basis. Results included COVID diagnostic testing revenues of $300 million, which contributed 4.8% to growth. Excluding COVID testing revenues, our base business revenues were up 17.6%, better than we expected across most business units. The strong growth reflected the anniversary of the initial COVID wave and the temporary halting of elective procedures and its impact on the medical device utilization in the year-ago quarter. But Q3's result also reflects the continuing momentum driven by the successful execution of our BD 2025 strategy. Excluding COVID diagnostic revenues, base business revenues in Q3 Fiscal '21 increased 3.9% relative to our pre-pandemic third quarter Fiscal 2019 on a currency-neutral basis, which includes the impact of the Alaris ship hold. If you exclude the U.S. infusion systems business, our total revenues would have increased 6.6% relative to our pre-pandemic third-quarter Fiscal 2019. Our Pharmaceutical Systems and Urology/Critical Care franchises continue to be standout performers, where revenues are up 17% and 11%, respectively, over 2019 levels. Bioscience revenues were up 9%, surgery and peripheral intervention revenues were both up 8%. Elsewhere, we see opportunities for improvement ahead in fiscal '22 and beyond. For example, our MDS revenues are up about 2% versus 2019 levels, reflecting the continued impact of COVID as well as the impact of China volume-based purchasing. As hospital utilization improves, we should see further improvements here. Also, as I mentioned, Medication Management Solutions revenues were impacted by the Alaris ship-hold, and we expect our revenues to improve once we receive our 510(k) clearance for our BD Alaris system. While I am pleased with how we are accelerating our revenue performance and profile, I'm equally pleased with the progress we're making in improving our working capital and cash flows. Cash flow performance has been a key focus for us since I became CEO, and that is evident in our working capital metrics. Year-to-date cash flows from operations totaled $3.7 billion, an increase of 80% from the prior-year period. This improvement in our cash flows allowed us to advance a more balanced capital allocation strategy this quarter, which included the repurchase of $1 billion in BD stock at an average price of approximately $242. This marks the first time we have repurchased shares since 2017, and the largest amount we have repurchased since 2012. Even with this repurchase activity, we ended the third quarter with nearly $3.2 billion in cash and an adjusted net leverage ratio of 2.4 times. Overall, I'm really pleased with our performance in the quarter, particularly with the continued positive momentum in our base business. This gives us the confidence to raise our base revenue assumption. We now expect our base business to grow approximately 7.5% to 8% on an FX-neutral basis. This is higher than our previous expectation of mid-single-digit growth. We continue to expect COVID diagnostic testing revenues of $1.8 billion to $1.9 billion, with more revenues coming from international markets than we previously anticipated. We now expect currency-neutral revenue growth overall of approximately 14%. Our positive base business momentum and a lower tax rate allows us to raise our adjusted EPS guidance by $0.10 while continuing to reinvest in our business and overcome lower COVID testing profits, including a provision for excess and obsolete COVID testing inventory. We now expect our full-year adjusted EPS range to be $12.85 to $12.95. Chris will provide you further details on our financial outlook later in the call. Next, I want to provide an update on our BD Alaris pump remediation, which remains my number one priority. Last week, we announced to our customers a positive step in our remediation efforts. Working with the FDA, we are now initiating remediation of existing Alaris system devices in the field by updating the software to version 12.1.2, following submission of the 510(k), which includes this software version. This new software version is intended to remediate the issues identified in the February 4, 2020 recall notice, and provide programming, operational, and cybersecurity updates to affected devices. However, this software update has not been reviewed or cleared by the FDA. To address the question on Alaris clearance timing, we remain confident in our submission and the process we are undertaking, including working closely with the FDA. As Chris will later discuss, we believe it is responsible to not definitively predict the FDA clearance in our FY '22 outlook. We believe this is a prudent approach given the inherent difficulty in predicting FDA clearance timelines. Next, I want to update you on our BD 2025 strategy of grow, simplify, and empower. First, I'd like to focus on our growth pillar. We continue to strengthen our market leadership positions in our durable core business, while purposefully investing in new innovations that help accelerate and shape irreversible trends that we see transforming global health now and in the decade ahead. I've spoken about these three innovations and growth focuses before, and we've been purposely shifting more of our R&D and tuck-in M&A investments into these spaces, which are growing over 6%. Through this, we aim to lift our weighted average market growth rate and performance over time. And this year, we've launched several innovative products and solutions across the continuum of care, across our business units, and across the globe. And after completing our strategic portfolio review last month, I can share with you that our pipeline is very deep and wide across our businesses. It's been further enhanced by our acquisitions over the past 18 months. And you'll hear much more about our innovation pipeline at our Investor Day on November 12. But let me highlight a few of our organic innovations that we're advancing in the near term. In our Life Sciences business, I'm pleased that we will start shipping our BD MAX and BD Veritor combination flu-COVID assays this month, in time for the upcoming respiratory season. Our BD Veritor combination test can detect and distinguish between COVID, flu A, and flu B in a single rapid test with a digital readout. We see the combination test becoming the standard of care moving forward, in advancing our strategy to enable better outcomes in non-acute settings. Another innovation area I'd like to highlight is our Biosciences business. Biosciences has been a strong performer this year, and we expect the unit to deliver high-single-digit growth for the full year. In June, we launched our new eCommerce site, bdbiosciences.com, which is an entirely new and innovative digital marketplace designed to provide a best-in-class online purchasing experience for our flow cytometry customers. Early feedback has been outstanding, and we're already seeing excellent traction and early adoption. We also have an exciting wave of new product introductions this summer. With the launch of our FACSymphony A5 SE, which is our first BD spectral analyzer and provides an even higher cellular parameter analysis. We've launched our FACSymphony A1 as well, which offers high-end technology and a cost-effective benchtop design. In addition to these launches, we have a healthy innovation pipeline of modular, scalable new instruments, and next-generation dyes that will allow our customers to fully leverage our complete and integrated solution suite of instruments, reagents, informatics, single-cell multi-omics, and scientific support services. Our products and solutions are being used to uncover new insights on the immune system and develop treatments for many related chronic diseases. You can hear more about our Life Sciences strategy from Dave Hickey, our Executive Vice President of BD Life Sciences, and Puneet Sarin, our Worldwide President of BD Biosciences at the upcoming UBS Genomics 2.0 and Medtech Innovation Summit on Wednesday, August 11th. Next, let's turn to our inorganic innovations that we've added to our portfolio. As you know, we continue to be focused on tuck-in M&A as a means of adding innovative products and solutions that leverage our core market leadership position and advance us into higher growth adjacencies. Year-to-date, we've completed seven tuck-in acquisitions. While at the time of the acquisitions these individual deals were not meaningful from a revenue perspective. As we integrate these transactions into our portfolio, we expect them to strengthen our growth profile. Our three most recent transactions, Velano Vascular, Tepha Inc., and ZebraSci are good examples of our M&A strategy. Let me begin with Velano Vascular, which is being added to our MDS business. Velano has an innovative needle-free technology that enables high-quality blood draws from existing peripheral IV catheter lines, eliminating the need for multiple needle sticks. This technology will help customers transform the patient experience through the vision of a one-stick hospital stay. Velano's PIVO device will be integrated into our sales teams' bag of broader catheter solutions initially in the U.S. This is a great example of how we're expanding and strengthening our base business. The second transaction is Tepha Inc., a leading manufacturer of a proprietary resorbable biopolymer technology. Over the past several years through our long-standing relationship, we've been commercializing this platform VRT Phasix resorbable hernia mesh platform. The acquisition benefits are two-fold. First, it provides us with a vertical integration strategy for our current Phasix platform. But more importantly, it provides us with exciting new opportunities to expand our horizon into new high-growth areas of tissue repair, reconstruction, and regeneration. Lastly, we acquired ZebraSci, a pharmaceutical services Company. This acquisition provides the opportunity to expand our Pharmaceutical Systems business beyond injectable device design and manufacturing to include best-in-class testing for drug-device combination products. ZebraSci allows us to further engage and collaborate with biopharmaceutical companies, and particularly smaller companies, where a large amount of the pipeline is, to support the transition of their molecules into pre-filled combination devices. Next, I want to update you on our simplify initiatives, which are advancing well. Through Project Recode we are optimizing our portfolio, optimizing our plant network, and simplifying our business processes. Project Recode remains on track to achieve $300 million of cumulative savings by the end of FY '24. We are also continuing the rollout of our BD Production System, which is a standardized BD approach to driving a next level of lean processes and continuous improvements across our plants. The BD Production System is already helping to drive improvements in quality and reductions in our inventory days. We also continue to advance Inspire Quality, our quality, regulatory, and risk mitigation program. The last pillar of our BD 2025 strategy is empower, which represents the changes in our culture and capabilities that we're driving to empower our strategy. In Q3, we completed our Voice of Associates survey with over 86% participation. And what stood out was that our associates said we're making strong progress, with improvements in 95% of the metrics since our last survey in 2018. And most notable were improvements in our focus areas of growth mindset, strong teams, quality, and excitement about the future of BD. We're also advancing our 2030 sustainability strategy, which addresses a range of challenges in our industry while helping to make a difference on relevant issues that affect society and the planet. Our strategy will ensure we remain focused on shared value creation. Meaning, how we address unmet societal needs through business models and initiatives that also contribute to the commercial success of BD. Next, I want to provide a brief update on the progress of our proposed diabetes spinoff, which remains on track for the first half of calendar 2022. We're making steady progress with our separation activities. We recently announced that two directors from BD's board will be appointed as future directors of the Diabetes NewCo. Retired Lieutenant General David Melcher will serve as a Non-Executive Chairman of the Board. And Dr. Claire Pomeroy will serve as a Director. Their appointments will be effective upon the completion of the spin, at which point they will transition from the BD board to the board of NewCo. Lieutenant General Melcher brings extensive experience in spinoffs, having served as the CEO of Exelixis, following its spinoff from ITT, and under his leadership, Exelixis spun off its Mission Systems business as a separate public Company. Dr. Pomeroy brings broad experience in healthcare delivery, administration, medical research, and public health. I am confident their combined experience along with future planned board members will help to set NewCo well on its path to becoming a successful, independent, publicly-traded Company focused on growth. While continuing to evaluate additional board members, we are also continuing to build a new Diabetes Care leadership team through a combination of current BD leaders and new hires, including Dev Kurdikar, who will be NewCo CEO; Jake AlgaWise, who will be CFO; and most recently, Jeff Mann. Jeff Mann joined our Diabetes Care organization and will be General Counsel and Head of Corporate Development for NewCo. Jeff brings more than two decades of experience in M&A and transactions, securities law, and corporate governance. Most recently, he served as general counsel and secretary of Cantel Medical Group. We are also progressing with the Form 10, which will have the carve-out financials, and we expect it to be publicly available around the end of the calendar year. Before turning it over to Chris, I will leave you with some key thoughts. First, our base business momentum and our recovery from COVID continues. And it is broad-based. We expect that momentum to carry into fiscal '22 and beyond. As Chris will share with you, today's results underscore our confidence in strong mid-single-digit top-line growth for our base business next year. Second, we are executing well against our innovation-driven growth strategy, which includes our internal R&D, as well as advancing our tuck-in M&A strategy. And third, I'm proud of the substantial progress in advancing our BD 2025 strategy and how that will unleash our growth potential in the years to come. We will deliver innovations for our customers, empower our associates, and create value for you, our shareholders. I've been with BD for 20 years, and I've never been more excited. We just completed our annual strategic review process, as I said, and the road ahead is looking more exciting than it did a year ago. We look forward to sharing our BD 2025 strategy in greater detail at our November 12th Investor Day. We hope you can join us. With that, let me turn it over to Chris to review our financials and our outlook.

Thanks, Tom. I'm also very pleased with our overall performance in the quarter, particularly with the base business, which showed continued strong momentum. Third-quarter revenues of $4.9 billion increased 26.9% on a reported basis and 22% on a currency-neutral basis, and we're ahead of our expectations. Our current quarter results also include $300 million in COVID diagnostic testing revenues compared to $98 million in the prior-year period. Excluding COVID diagnostic revenues in both periods our base business revenues increased 17.6%. Our base business reflects continued strong performance as the market continues to recover from the COVID pandemic, the impact from which was most acute in Q3 of last year. The BD Medical segment revenues totaled $2.4 billion and were up 7.7% versus the prior year. MDS revenues increased 24%, reflecting a strong recovery in the U.S., led by strong growth in catheters and vascular care devices. Additionally, worldwide revenues included $18 million from COVID vaccination devices. In MMS, the double-digit increase in our dispensing revenues was more than offset by the expected declines in our Infusion Solutions. As you may recall, when the pandemic started, we saw a higher level of demand for infusion pumps and sets globally. Diabetes Care benefited from an easy comparison to the prior year, the timing of sales, and slightly better than expected market demand. Pharm Systems continued to deliver strong growth with revenues up 12% driven by demand for our prefilled devices. BD Life Sciences revenues totaled $1.4 billion and were up 43%. This included the $300 million in COVID diagnostic testing revenues, $212 related to our BD Veritor system, with the remaining $88 million from BD MAX collection, transport, and swabs. Year-to-date COVID diagnostic testing revenues were over $1.6 billion. Despite lower average selling prices driven in part by geographic mix, we are still on track to deliver on our target of total worldwide revenues of $1.8 billion to $1.9 billion for the fiscal year. Excluding COVID diagnostic testing revenues, our Life Sciences segment grew revenues 27% driven by strong performances in both Integrated Diagnostic Solutions and Biosciences. IDS revenues increased 49%. Excluding COVID diagnostic testing, IDS revenues increased 27%, driven by strong double-digit performance across Specimen Management and Microbiology. Biosciences increased 27% driven by both research and clinical solutions. We continue to see strong demand for research reagents and instruments as lab activity is returning to normal levels. We also continue to see steady demand for research reagents globally, fueled by COVID research activities related to vaccines and variants, especially from academic research and biopharma companies. BD Interventional sales totaled nearly $1.1 billion and were up nearly 35% reflecting the COVID anniversary impact on elective procedures. Surgery revenues increased 68% and peripheral intervention increased 32%. Both businesses saw the greatest recovery in the U.S. and Western Europe, which experienced the greatest impact on elective procedure volumes in the prior year quarter. We saw sequential improvement in both surgery and peripheral intervention. However, in the last several weeks, we are seeing some impact from the COVID Delta variant on elective surgeries in certain U.S. states. Urology and Critical Care revenues were up approximately 14%, driven by continued growth in our PureWick and targeted temperature management franchises. Now, turning to our P&L, as we expected and as communicated, our gross margins this year are being negatively impacted by COVID-related expenses, manufacturing variances, and FX headwinds, which are more acute in the second half of the year. Also as expected, our gross margin declined sequentially. Our gross margin was 51.5%. However, this included a net negative 90 basis point impact from COVID testing and reinvestments. The 90 basis point impact includes a negative 140 basis point impact from an inventory provision related to COVID testing. Adjusting for the net impact of COVID testing and reinvestments, our underlying base business gross margin was 52.4%. On a sequential basis, our base business gross margin declined from our second-quarter rate of 53.7% due to three factors: 70 basis points of incremental FX headwinds, 40 basis points from inflationary pressures, including higher raw material costs and inbound freight, as these costs rolled through our inventory, and 20 basis points of other expenses, including Alaris quality remediation. Now, turning to SSG&A. Our total SSG&A spending increased 21% on a currency-neutral basis to $1.2 billion or 25.2% of revenues. As a reminder, in the third quarter of fiscal 2020, we implemented several cost-containment measures in response to the COVID pandemic. In addition, we are continuing to see higher shipping costs. This quarter also included higher expenses related to our COVID profit reinvestment initiatives. As a reminder, the COVID testing reinvestments we made in FY '21 will not re-occur. Our R&D spending totaled $321 million, an increase of 31.1% on a currency-neutral basis. The higher R&D reflects the timing of project spending, including higher spending related to the BD innovation and growth fund. Our R&D spending was 6.6% of revenues, which is higher than our long-term target of 6%. On a currency-neutral basis, our operating income increased 26.5% as compared to our revenue growth of 22%. Our operating margin of 19.8% was slightly below our guidance of below 20%. The inventory provision related to COVID testing I referenced earlier negatively impacted operating margins by approximately 150 basis points. Interest and other expenses were essentially flat year-over-year at $98 million. The adjusted tax rate was 5.8%, lower than we previously expected, due to discrete tax items that occurred this quarter. The lower tax rate essentially offsets the impact from COVID diagnostic inventory provision in the quarter. The average diluted share count used to calculate our EPS in the quarter was 291.9 million shares. We repurchased a total of 4.1 million shares for a total of $1 billion at an average price of approximately $242. Our adjusted EPS increased 24.5% over the prior year to $2.74 on a reported basis, and were up 25.9% on a currency-neutral basis. Now, I would like to turn to guidance for the balance of the fiscal year. Our guidance continues to assume no major widespread hospital restrictions on elective procedures related to the COVID pandemic. However, we did start to see some impact on elective procedures from the COVID Delta variant in the last one to two weeks in certain U.S. states, and have assumed some continuation of this in our guidance. That said, given the continued positive momentum of the base business, we are pleased to be able to cover this and still raise our currency-neutral revenue growth to about 14% up from our previous range of 10% to 12%. Our revised revenue range would incorporate a base business currency-neutral growth assumption of 7.5% to 8%. Further, we have reaffirmed our previously communicated COVID diagnostic test revenue range of $1.8 billion to $1.9 billion. We now expect a favorable 250 to 300 basis point impact from currency. This brings our total reported revenue growth to approximately 16.5% to 17.5%. For the full year, we now expect our fiscal 2021 adjusted EPS to be in the range of $12.85 to $12.95. This higher guidance reflects the positive base business momentum and a lower tax rate. These benefits allow us to continue to invest while offsetting the COVID testing inventory provision and lower COVID selling prices. Next, I want to share with you our expectations for gross and operating margins for full-year fiscal '21 and provide you with an estimate of the net impact of COVID testing and the related reinvestments of profits on our margins. We expect our full-year adjusted gross margins to be in the range of 53.5% to 54%. And this range includes a net neutral to slight positive impact from COVID testing and reinvestments. We expect our full-year adjusted operating margin to be in the range of 23.5% to 24%. This range includes a 200 basis point contribution from the net impact of COVID testing and reinvestments. Finally, I'd like to address FY '22. We plan to provide our specific fiscal 2022 guidance on our November earnings call. But we wanted to provide some directional color today. To give you a sense as to what a floor could look like in fiscal '22, we have taken the following approach. As you know, there is a great deal of uncertainty around the level of COVID testing. Therefore, we have not modeled any testing revenue beyond the typical flu season. With the continued momentum we are seeing, we have increased confidence in our ability to deliver strong mid-single-digit revenue growth in fiscal '22 over our fiscal '21 base revenues, which as a reminder, adjust for COVID diagnostic testing revenues. With respect to Alaris, our filing is comprehensive and more complex than most submissions. As we have previously stated, it is possible that the review could be in line with typical timelines. However, as we have also mentioned, it is more likely to take longer for the FDA to review and ultimately grant clearance. It is inherently difficult to predict clearance timing. We are not assuming Alaris 510(k) clearance. It is difficult to predict how things will play out as shipments are only being made under the medical necessity process. At this time, we have incorporated the assumption that revenues associated with Alaris will be approximately similar to FY '21. We believe it is prudent and responsible not to definitively predict FDA clearance timelines. That said, we remain confident in our submission, and the process we are undertaking, including working closely with the FDA to obtain comprehensive 510(k) clearance. We expect to drive base business gross and operating margin expansion. We expect the operating margin for our base business to expand more than our traditional annual target of at least 50 basis points and translate into double-digit operating income growth. For reference, we expect our base business operating margins to be between 21.5% to 22% in fiscal 2021. With these assumptions, we expect an adjusted EPS floor of at least $12. This represents approximately low-teens growth over our expected base business earnings in fiscal 2021. Now before opening it up to Q&A, I want to take a moment to comment on today's announcement of my upcoming retirement. With our strong base business momentum, our strengthened balance sheet and improved cash flows, which is evident by the increased number of tuck-in acquisitions that we've been doing and the restart of our share buyback program for the first time since 2017, I feel that now is the right time for the transition as the Company is well-positioned to continue to drive shareholder value and impact the lives of patients around the world. I look forward to helping to ensure a seamless transition to the new CFO. And I'm very excited about the value creating opportunities ahead for NewCo and helping to ensure the success as a member of their board. With that, let me turn it back to Tom.

Thank you. Chris and Kristen, I think we should now open up the line to Q&A.

Great. The floor is now open for questions. Please follow the instructions provided to you when you entered the queue. Your first question comes from the line of Bob Hopkins with Bank of America.

Great, thank you and good morning. Can you hear me okay?

We can, Bob. Good morning.

Great. Great. Good morning. And Chris, congratulations on your decision. So I guess the first question I would have, and thank you for all the detail today in the early thoughts on 2022. It looks like you're suggesting operating margins in 2022 will might be in the 22% to 23% kind of range. That's still multiple hundreds of basis points below where you were in fiscal '19. So can you just help us understand the difference between 2019 and this new guidance for 2022 and why you're those couple hundred basis points below that level? Just to make sure I'm hearing it, the primary difference between those two is you guys see it as, really, those three things: Alaris, the China price cut, and then inflation? Just want to make sure we have a sense for all the moving pieces. And in terms of the timeline to get back to those levels, is that something that's a multiyear process or do you think that that can happen within a year or two? Thank you.

I'll let Chris respond.

Sure, Bob. As we think about margins, we do see the opportunity to get back to those 2019 margins over time, and we'll see that as Alaris comes back into the market, and as Project Recode and our normal continuous improvement occur, and we'll see that improvement also as we grow mid-single-digits and we provide leverage that drops to the bottom line and that will also increase. There's a number of things that have pushed those margins down. We've talked about those in the past. You have Alaris and the ship-hold; obviously, there's an impact, but that will come back. We also have the drop in the China volume-based procurement, which is an impact, and obviously we're seeing some pressure from inflation, et cetera, that have run through. So, they have come down, but the model is intact, and we're very confident that we can drive those margins back to the '19 levels in the next couple of years as Alaris comes back and as we get the continuous improvement from Recode.

Okay. Just to make sure I'm hearing it. So, the primary difference between those two is you guys see it as, really, those three things: Alaris, the China price cut, and then inflation? Just want to make sure we have a sense for all the moving pieces. Okay. That's it. And then in terms of the timeline to get back to those levels, is that something that's a multiyear process or do you think that that can happen within a year or two? And then I'll get back in queue. Thank you.

Yes. So, a couple of things will help us improve. And the other thing that I should mention is there is some FX drag on margins as well, and that's been flowing through our inventory, so you'll see that abate going forward. As we think about improvements going forward, we'll see improvements from utilization as utilization comes back. And so that will also help — comparatively to the margins that we have this year. We'll see continuous improvement, Recode kicking in. We'll see less one-time items. We took in a number of one-time items this year, the spending in the Veritor proceeds, et cetera, so those come back. So you would expect to see us getting back to those kind of margins as Alaris kicks in in '23, and we see that impact and as we make continuous improvement in '22 and '23.

Okay. Thank you.

Your next question comes from the line of Vijay Kumar with Evercore ISI.

Morning, Tom. Thanks for taking my question. Chris, all the best to you. I hope you enjoy a good rest. Tom, maybe starting with the margins back on Bob's question. It's one way of looking at it is your pre-pandemic gross margins were 56%. I think your base for fiscal '21 is 53.5 to 54. Walk through the delta about 70 basis points seems to be inflationary costs, 70 basis points FX. You do have these inventory charges related to COVID diagnostics and Alaris for moving parts. I guess my question is, when do inflationary costs abate? Do we have to annualize? Is that mid next year? Should FX still be a drag next year, and when you think about COVID inventory charges, are we done with that in Q4 or is that going to be a drag in fiscal '22?

Vijay, let me take a little bit of that question and I'll let Chris comment further on the margin details. When it comes to the inflationary question that you had, certainly I think we felt the most significant impact of inflation already, and we have a good view of where that's going to be in '22 as we've rolled up our costs. As you know, it's been an unprecedented period of time there as you look at everything from the cost of resins to electronic components and shipping. And shipping is up roughly four times to move products from Asia or Europe to the U.S. or vice versa. We are also being very proactive — we're not looking to absorb all of those increases in raw material costs over time. We are beginning to pass on some of those. We've raised our shipping rates for customers, and we are passing on price increases. Of course, as you know, we do have long-term contracts and tenders around the world, and so that's not something that we can pass through with those price increases immediately, but we do have a very active program to share those increases. We have to share those increases with customers and that will not happen overnight. I’d just share that it will also be something that will have an impact as we look forward. We're not going to absorb all of those raw material costs just within BD. Chris, other comments on margin?

Sure. I think it would be helpful to look at the flow from third quarter to the fourth quarter. We do expect margins to improve. I think we said that our full-year gross margins would be 53.5 to 54, which is up a full point from the Q3 margins, and that's coming from improved utilization combined with some of our continuous improvement efforts. We'll also have less one-time airfreight that we saw in the back half of '21, and we will have some pricing actions as well. We do expect it to improve operating margins more than the normal 50 basis points relative to '21 to '22, and that again comes from utilization. As utilization improves next year, there's less impact from FX. We have seen FX flowing through our inventory, and so you'll see that abate going forward. And then, we see our continuous improvement items offsetting any continued flow-through of inflationary pricing. When we look at the impact on our raw materials, resins as you know, is a big piece of that. Resins is a combination of some inflationary pressure, but it's also a function of other things; supply and demand in the oil market. And we took a big hit on that in '21, and we would expect that to abate somewhat, and that's something that we're watching very closely as we think about giving guidance in '22.

Got you. And maybe Tom, can you say more on the Q4 revenue guidance and some of the comments you made on reinvestments. The Q4, it looks like Q3 your base grew 3.9% relative to 2019 levels. Q4, I'm not sure if I'm doing the math correctly, but I'm getting to a slight decline versus Q3. Is that just conservatism, and related to that — the reinvestments that we are making should we expect any new products to flow through in fiscal '22?

Yes. As we've said in the past, and we'll share a lot more about this on our Investor Day in November, which we hope you can attend, we expect the impact of our investments of the COVID profit reinvestments to begin having an impact in the back half of next year. And we'll talk about what those specific programs are. Some are for short-term R&D lifecycle management programs that we'll be hitting, but also include non-R&D initiatives such as reinvestments we made to establish a new telesales organization in Europe that's helping us access smaller hospitals that we weren't calling before and we're getting new growth from, or expanding our non-acute sales channel in the U.S. We used some of those investments to accelerate investments there, tapping into a high growth market as the non-acute space is now growing much faster than the acute care market where we've had our traditional sales strength. Those commercial investments have near-term payoff. We expect actually the investments that we're making on the commercial side this year to be self-funding next year. So they're quick paybacks and we'll see those benefits as we've said, supporting the strong mid-single-digit profile in our base business next year.

Vijay, I would just remind you that, going back in history, if you look at Q4 of FY '19, that's a tough compare. That was the biggest MMS quarter for a number of reasons. And so that's what you're seeing as you're doing your calculation.

That's helpful, guys. Thank you.

Your next question comes from the line of Robbie Marcus with JPMorgan.

Good morning. And congrats, Chris, we'll be sorry to see you go. I don't want to be the dead horse here, but I wanted to focus on the fourth quarter margin guide, and the floor of $12 for next year. It's been, probably, if I go back, a decade-plus since we last had operating margins as low as you're guiding for fourth quarter. And even to get to a floor of $12, versus where you are in that fourth-quarter margin, is pretty tough to do. So I was hoping you could really, as best as you can, walk through the building blocks of why the fourth quarter margin is so low, especially after you said last quarter it'd be in the low twenties for the back half of this year, it looks more like high teens. And then some of the building blocks you used to get to a floor of $12 and on top of that, how you're thinking about what a floor means in relation to where numbers might settle out?

Hey Robbie. This is Tom. On the $12 floor, I think Chris walked through very clearly how we built up the $12 floor there. Essentially that takes out all standalone COVID diagnostic testing. We thought it prudent to focus on projecting our base business. We do have some Veritor flu sales and flu-COVID combination sales, which are next-generation flu tests and align to what you would see in a normal flu season, rather than increased demand from testing for COVID patients. We have not assumed any standalone COVID testing beyond a normal flu season in that floor. We also are not assuming Alaris 510(k) clearance in that floor, given the inherent difficulty in predicting FDA approval timing. We have assumed Alaris revenues approximately similar to FY '21. Those are the main factors. I'll let Chris add more detail on the Q4 specifics.

Robbie, I would remind you that we have pointed to the fact that we are making investments this year and not to really look at the second half margins as indicative for '22. The Q4 margins are pressured by an additional amount of COVID reinvestment. We made that reinvestment announcement earlier — it is back-end loaded — so there's a preponderance of reinvestment in the quarter. We continue to see some drag from FX in the quarter, although less than the third quarter. We also expect to see the impact of inflationary costs running through our inventory in Q4 as well. So when you sum that up, we talked about the baseline of 21.5% to 22% as the jumping-off point for the base business. How much more is then what you have to plug in to get to the $12 number that we gave as a floor. As Tom articulated, the $12 floor doesn't have any testing assumption for standalone COVID in it, although it assumes a normal flu season and flu-COVID combination testing. We'll give more clarity on these assumptions in November. The floor was meant to provide a conservative baseline that excludes unpredictable standalone testing and excludes Alaris clearance timing.

Great. And maybe just one quick follow-up. The tax rate came in a little lower this year. What do you think we should be thinking as we head into next year?

I would flow the lower tax rate through for this year. Historically for next year, we've guided a range of approximately 14% to 16%; you should consider being at the low end of that range for planning purposes.

Operator, next question, please.

Your next question comes from the line of Larry Biegelsen with Wells Fargo.

Good morning. Thanks for taking the question. Chris, congratulations on your decision. Just a couple of questions on the margin. When we look at the Q4 base operating margin of about 20 to 20.5, what's the ramp through fiscal 2022 look like? On the last call, you said it would ramp through the year. And Chris just a multi-part question on the margin. You had guidance to 25% to 26% post-Alaris and post-China VBP. So is the difference here mostly inflation? You talked about the moving parts and the $200 million reinvestment. That alone you said would come off — that's about 100 basis points. So any other headwinds or tailwinds to consider on that margin commentary?

There were multiple parts. On phasing, it's still too early to give specificity for November, but utilization should build throughout next year. The $200 million reinvestment does go away and that will restore roughly that 100 basis points. The difference between those historic margins and where we are today is not purely inflation. It's more around China VBP, Alaris, and some FX impacts — the combination of those brings you down, roughly 150 basis points on a gross margin basis. If you take a step back, we're pulling all the levers to drive margin recovery: base business growth, reinvesting Veritor proceeds wisely, Project Recode continuous improvement, balanced capital allocation including buybacks, and repositioning the portfolio. All of that gives us confidence we can get back to prior margin levels as Alaris comes back and continuous improvement kicks in.

Thanks, I'll drop back in the queue.

Your next question comes from the line of Richard Newitter with SVB Leerink.

Hi. Thanks a lot. Could you just reiterate the headwinds you listed — China VBP, inflation, Alaris, and FX — and quantify roughly how much each contributes so we have a sense of the pluses and minuses? And then, regarding the $12 floor, could you give some framework as to how to think about what testing could look like next year and what a reasonable base case might be?

You captured it well: China VBP, Alaris, inflation, and FX are the primary headwinds. The Alaris headwind should come back in 2023 as it returns to market. Combined impacts are roughly in the area of 150 basis points on gross margin relative to prior levels. As for the $12 floor, it's exactly that: a conservative baseline with no standalone COVID testing assumed beyond a normal flu season and no Alaris clearance assumption. Estimating standalone COVID testing for next year is highly uncertain; we'll give more detail in November.

Okay. Thank you very much and good luck, Chris. Congratulations.

Your next question comes from the line of Travis Steed with Barclays.

Congrats Chris again. On the calculus for the mid-single-digit revenue growth and the double-digit shareholder return: when you think about that, is there a minimum operating margin that you're committed to longer-term with that calculus?

I think it's really an improvement in the margin year-in, year-out, and that's been the model. We're confident we can return to the 2019-level margins over time, and drive margins back up as we make progress.

Do you expect Alaris to be accretive right away to operating margin or will there be a period where it takes a bit longer to get accretive? And on the COVID testing margins, you mentioned a lower price point outside the U.S. Is there a big difference in margins on COVID testing U.S. versus outside the U.S.?

On ex-U.S. testing, one difference is we launched a manual test in some international markets, particularly in Europe, which is at a lower price and competes with manually read lateral flow tests. Product mix and tendering dynamics can reduce average selling prices outside the U.S. Regarding Alaris, when it returns there will be a ramp. We've intentionally kept service and commercial capabilities in place even as volumes were down so that as shipments ramp, the existing expense base will be absorbed and we won't need to rehire to support customers. That dynamic will help margins as revenue returns.

When Alaris comes back, sales will ramp over time, so margin accretion will follow that ramp.

All right. Great. Thank you.

Your next question comes from the line of Matthew Mishan with KeyBanc.

Thanks for taking my questions and good morning. I assume the $12 floor doesn't include the Diabetes carve-out. Do you have a better sense of what dilution is from that and impact to operating margin on a pro forma basis?

The $12 floor does not contemplate the spin. As we complete the spin and get closer to the separation, we'll make adjustments and provide more specifics. Historically we've said the dilution to RemainCo would be primarily stranded costs, and we'll have transition service agreements in place with time to offset potential dilution during the transition period. We'll provide more detail as we approach the spin date.

Okay. And then a quick one on guidance comments for next year. I think everyone assumes there will be some COVID testing, so there will be upside from that, but the flu season is probably a little lower than normal. What is a normal flu season for you as far as revenue goes so we can adjust?

Just to be clear, we did not provide full '22 guidance today; we provided a floor for thinking about '22. We did say that a normal flu season is in the range of $80 million to $100 million. Last year the flu season was essentially nonexistent. We'll give more clarity in November.

Okay. My apologies. It seems like COVID testing upside could be greater than downside from flu, is that fair?

We do have a COVID-flu combination rapid test, which will be part of normal flu testing and could support higher testing volumes if symptomatic testing is common. There will also be some standalone COVID testing. The uncertainty around the amount of standalone COVID testing makes it difficult to predict upside, which is why we provided a conservative floor and will give more detail in November.

Your next question comes from the line of Matt Taylor with UBS.

Good morning. Thanks for taking the question and congrats, Chris, you'll be missed. I wanted to ask about your assumptions for disruption. I know there are some states that are seeing paused procedures now. Would you characterize the build into your guidance as relatively minor? Any framing you can give on how much disruption you think we could see in the coming month?

Appreciate the question. We use several data sources, including our MedMined informatics, which provides real-time admissions and utilization across hundreds of U.S. hospitals. Over Q3, we saw about 91% to 92% utilization versus pre-COVID, exiting June at about 92%, which was a sequential improvement from Q2. Non-acute sector utilization was higher, around 105% in May/June versus pre-COVID, with sequential improvement from Q2. Europe showed similar improvement, exiting the quarter around 93%. Regarding the Delta variant over the last one to two weeks, we've seen concentrated pockets of reduced elective procedures in specific U.S. geographies; as of last week I was tracking about 16 meaningful U.S. health systems that had stopped or significantly reduced elective procedures, many in the South, such as Florida and Louisiana. We're not seeing broad-based global disruption, and our guidance incorporates some continuation of this localized impact. If the disruption does not continue or is less than assumed, that could be upside to our outlook.

Thanks. I had one quick follow-up on the tuck-ins. You did several tuck-in acquisitions; can you quantify the contribution we should expect from those going forward?

Those tuck-ins are included in our outlook assumptions. None of the recent deals were material to revenue in Q3 because many closed at the end of Q3 or in Q4, but they are part of the growth equation going forward. Velano strengthens our base by adding an innovative blood-draw technology that complements catheters and vascular solutions. Tepha provides vertical integration for the Phasix portfolio and opens new tissue repair and regeneration opportunities. ZebraSci expands Pharmaceutical Systems into combination product testing services and helps us engage smaller biopharma customers earlier in development. We expect these tuck-ins to strengthen our growth profile over time.

At this time we have reached our allotted time for questions. I would now like to turn the call back over to Tom Polen for closing remarks.

Thank you. Before we sign off, on behalf of the board and the entire executive team, I want to thank BD's 70,000 associates around the globe. This past quarter, I had a special opportunity to travel to a number of our sites, including our warehouse in Georgia and two of our plants in Nebraska, who've all been working tirelessly to produce essential medical devices, some that are being used for the pandemic response. I'd like to say a special thanks to them and all of our manufacturing associates around the globe. They are the essential part of our frontline team and make me proud to be at BD. For all of you listening, I hope everyone stays safe and healthy. Thank you for joining us. Hope you have a great day.

Thank you. This does conclude today's teleconference. Please disconnect your lines at this time and have a wonderful day.