QuidelOrtho Corp (QDEL) Q3 2023 Earnings Call Transcript

Welcome to the QuidelOrtho Third Quarter 2023 Financial Results Conference Call and Webcast. At this time, all participant lines are in a listen-only mode. For those of you participating on the conference call, there will be an opportunity for your questions at the end of today's prepared remarks. Please note, this conference call is being recorded. An audio replay of the conference call will be available on the company's website shortly after this call. I would now like to turn the call over to Juliet Cunningham, Vice President of Investor Relations. Please go ahead.

Thank you and welcome to the QuidelOrtho third quarter financial results conference call. With me today to discuss our financial results are Doug Bryant, QuidelOrtho's President and CEO; and Joe Busky, QuidelOrtho's Chief Financial Officer. This conference call is being simultaneously webcast on the Investor Relations' page of our website and a version of today's presentation can be downloaded there. Before we begin, I will cover our Safe Harbor statements. The statements we will make during this call that are not strictly historical including the company's expectations, plans, future performance, and prospects are forward-looking statements within the meaning of the Private Securities Litigation Reform Act of 1995, which provides a Safe Harbor for such statements. Forward-looking statements are subject to a number of risks, uncertainties and other factors that could cause actual results to differ materially from those expressed or implied in these forward-looking statements. These risks and uncertainties include, but are not limited to, those factors identified under Risk Factors in our annual report on Form 10-K for the fiscal year ended January 1st, 2023, and subsequent reports filed with the SEC. Please refer to our SEC filings for more detailed discussion of forward-looking statements and the risks and uncertainties of such statements. We cannot assure you that the forward-looking statements we make or are implied by our statements will be realized. Furthermore, such forward-looking statements represent management's judgment and expectations as of today. Except as required by law, we undertake no obligation to update any forward-looking statements or any time-sensitive information to reflect future events, developments, or changed circumstances or any other reason. Also, during today's call, we will discuss certain items that do not conform to US Generally Accepted Accounting Principles or GAAP. Please see Slide 3 for a list of non-GAAP measures. Reconciliations of these non-GAAP measures to their most directly comparable GAAP measures are included in the appendix to the investor presentation and press release issued this afternoon, both of which are available on the Investor Relations page of the QuidelOrtho website. Lastly, unless stated otherwise, all year-over-year revenue growth rates, including revenue growth ranges given on today's call, are given on a comparable constant currency basis. With that, I'd like to turn the call over to Doug Bryant.

Thank you, Juliet. Good afternoon everybody and thank you for joining us today for our third quarter earnings call. Let me first take a moment to welcome Juliet to our QuidelOrtho team as we continue to execute on our strategy to increase shareholder value. Juliet's expertise in the medical technology sector and her 25 years of experience managing investment community relations for publicly-traded companies makes her an ideal choice to lead our Investor Relations function. We're committed to transparently communicating our progress to the street and excited to have her on our team. For those of you who have known me a long time, you recognize that I don't sound normal. Having suffered through this over the weekend, we are definitely in a respiratory season, and it didn't start in my house. I know that recently, the CDC published that ILI is now over 2.5%. So, technically, I guess we are in a respiratory season or at least at the beginning of it. I'll press forward though and hope I can be heard and understood well. Turning now to our third quarter financial performance, and as noted in our pre-announcement, we delivered ahead of our guidance and street expectations. We're forging a path to durable growth, and there are many proof points on our progress in these results, including our ability to meet the earlier-than-expected respiratory season demand and the continued strength of our core businesses across all geographies. I'm pleased to report through quarter revenue of $744 million with adjusted EBITDA of $169.2 million and an adjusted EBITDA margin of 23%, which was up sequentially from Q2. During the third quarter, we generated $53 million in adjusted free cash flow, which is another testament to the strength of our business. This quarter, we paid down another $52 million of our total company debt, and year-to-date, we have paid down $175 million in debt. We believe that these efforts will fortify our balance sheet and give us greater flexibility to invest in our long-term growth. We are confident in our ability to deliver on our revenue growth targets over the coming quarters as we execute with speed across our businesses. There's no question that we're operating in interesting times. If you look at trends in the healthcare industry, they point to a greater need for diagnostic testing. Near patient care settings and rapid results are more important now than ever before. Recent news around the adoption trends of new COVID-19 vaccines and the use of GLP-1 drugs has fueled speculation about the reduction of future demand for diagnostic testing. In our view, there's nothing further from the truth. In fact, patients deciding to forego getting the latest vaccines could result in a higher number of COVID-19 cases and thus likely higher levels of testing. Nearly 82% of eligible Americans received at least one COVID-19 shot since the vaccine became available in late 2020. The US Department of Health and Human Services reports that only 7 million Americans have opted to get the booster since mid-September. While we hope for greater adoption among all eligible people, we also recognize that only 51% of eligible Americans received a flu shot in 2022. These statistics are a stark reminder that while the medical technology to severely slow the spread and severity of these diseases exists, COVID-19, along with the flu and other respiratory viruses we test for, will remain present in the general population for decades to come. Turning to the case of GLP-1 drugs and their use in diabetes and obesity, while our A1C and renal testing business is small, and we do not expect any material impact, it is important to remember that first, these drugs are only approved for a select portion of the population and come with serious long-term side effects that are only beginning to be understood. Second, these medications are presently not covered by private insurance or Medicare. With nearly 65 million Americans under Medicare coverage today, these patients must pay out of pocket for these medications. On fixed income, these medications are simply out of financial reach. However, for those patients where a GLP-1 is being administered, we could continue to play an important role in their care journey. Priority prescribing any metabolic-based medication, doctors may order our laboratory test to establish a baseline and would continue to do this in six-month intervals for the duration the patient remains on the drug, which could be several decades. Further, heart disease remains the leading cause of death in America and unfortunately, it's growing internationally as well. While we'd welcome the idea that fewer patients would be affected by heart disease, we do not see a significant change in the need for testing in the near or longer term. Let's shift now to take a closer look at our third quarter performance. First, the strong and early respiratory demand in Q3 was mainly driven by high COVID-19 prevalence throughout the United States. This will potentially be the first real flu season we see where COVID-19 rates immediately precede it, contributing to higher prioritization of our combo assay as disease stages converge. While the high COVID-19 rates were less pronounced than the 2022-2023 season, there is potential for a longer drop-off in overall season duration. If the timing in Australia translates to this hemisphere, the most aggressive growth in flu prevalence could occur early November with peak prevalence sometime in early January. Both the overall market for respiratory testing and our respiratory business became significantly larger due to more testing in general and significant share gains from competitors for us specifically. We have a strong position in this market, and our respiratory diagnostic capabilities play an important role in combating both early and seasonal upticks of COVID-19, RSV, and influenza among others. We're also well-positioned to manage any seasonal fluctuations given our operations team's agility to respond to meet customer demand. We had strong solid performance across all geographies in Q3, including China. This may be a surprise to some investors, but it isn't us. And we remain bullish on our business there today and into the future. Joe will discuss geographic performance in detail, but I wanted to speak specifically about China given the numerous recent comments by healthcare CEOs during their recent earnings calls. Frankly, all companies in healthcare in China are not the same, and neither are all diagnostic companies with businesses in China. QuidelOrtho has challenges, of course, but our challenges are not the same as all others. Here are a few differences. Our business in China is largely clinical chemistry and uses DriveSlide Technology. Our instruments are in medium volume stat labs. And when the Shanghai and Beijing lockdowns ended, the volumes returned quickly to normal levels, driven by people who are ill and in need of immediate care. This is a part of healthcare that is not as affected by the economy. Further, because of our DriveSlide technology, we've often not been subject to VBP tenders, and our pricing has been reasonably stable. Our immunoassay business in China is still small, relatively speaking. With respect to the often-discussed VBT tender, only the infectious disease, hormones, and HCG are related to our business. There will be 23 provinces participating that represent in these immunoassay categories about 2% of our overall business in China. Assuming we participate in the tender and lower our prices at the rate that we saw in the 2021 VBP tender, the impact would be a loss of 0.72%, that's less than 1% of our business in China. Our opportunities far outweigh our risk. Corruption has also been an often-discussed topic. As I've said before, we are not seeing any impact thus far and we continue to monitor the situation closely. For example, we are watching installation rates on instruments purchased to understand that this will create a few weeks lag in reagent ordering, but that's the extent of what we are expecting. In summary, our China business is fine and is expected to be a growth driver for us moving forward. As I said, we're bullish. For Q4, we expect to be up 25% over the prior year quarter and we expect continued growth in 2024. Shifting now to our four business units, our Labs business unit delivered 3% year-over-year growth in non-respiratory revenue with growth across all major geographic regions, including Asia-Pacific, China, Europe, Middle East and Africa, and North America, where we saw year-to-date placements increased 19% versus 2022, which is the leading indicator of our Labs business growth potential and durability. I'm also pleased to note that we've increased manufacturing output. We have not worked through the majority of our Labs instrument backlog returning to normalized levels and are primed to meet customer demand moving forward. The notable strength in clinical chemistry continues to be driven by return to pre-pandemic utilization levels and the strong integrated instrument placements over the last few years. Additionally, our integrated installed base grew 12% and automation increased 14% year-over-year, continuing the positive trend that we've seen since implementing our Commercial Excellence Program and launching our VITROS XT 7600 Integrated System, a trend that also pertains well for our recurring Labs revenue in the future. Finally, we reached a significant milestone with 300 automation track systems going live, further expanding our footprint and experience space through laboratory automation. Turning to our Point of Care business. In addition to its role in acute care settings, our Point of Care portfolio remains a cornerstone for managing a range of respiratory infections such as flu, RSV, COVID-19 and Strep A. As I reflect on the COVID-19 pandemic, we played a critical role in the public response to contain the spread of this deadly virus. With the initial launch of the COVID-19 vaccine and subsequent booster shots over the last two years, there has been a shift away from asymptomatic testing and the necessity to produce a negative PCR test. However, the public has taken greater responsibility for their individual health and understanding how viruses spread. We are seeing considerable volume from patients with influenza-like illness symptoms, turning to their medicine cabinet to self-administer our QuickVue at-home over-the-counter COVID-19 test or asking their doctor for a test in the clinic. Further strengthening our position as the leader in COVID-19 testing capabilities, I'm delighted to report that we received CLIA waiver in the US for our new Sofia 2 SARS antigen plus FIA in September. This is the first rapid antigen test that detects COVID-19 to be awarded FDA market clearance through the agency's de novo process. This is also now the first rapid antigen test to receive a CLIA waiver. In addition to our CLIA waiver, we were honored to receive an award from the US government to provide the government with at-home COVID-19 tests that will be provided for free to American households. The top-line impact from this $29 million award commences in the fourth quarter and is expected to continue for over 18 months and was not included in our 2023 financial guidance. While the award will not make a material impact on our financial results, we feel privileged to continue providing our COVID-19 tests to the US government. We believe by doing so, we're helping the government be prepared for another pandemic-level threat. COVID-19 has clearly moved into an endemic state. However, we expect it to remain a persistent respiratory pathogen for many years to come. Our testing capabilities allow patients and providers to be informed quickly and accurately. Our Transfusion Medicine business met our expectations for the quarter, and our immunohematology portfolio, which represents approximately 75% of the transfusion medicine business grew 4%. Lastly, our Molecular Diagnostics business, I consider our R&D team diagnostic pioneers as they recognized the potential early on and the important role that syndromic panels can play in accurately detecting pathogens responsible for infections in the bloodstream, central nervous system, GI tract, and respiratory system. With public awareness of syndromic panels increasing and the rise of multiple circulating viruses, the need for fast, accurate multiplex syndromic testing solutions like Savanna is critical. Unique to Savanna are its rapid turnaround time, simple workflow, and test flexibility, allowing more clinically relevant information to be generated closer to the patient, in a timeframe that can affect treatment. I am confident we will receive Savanna instrument clearance by the end of this year and launch commercially in the US very quickly thereafter. We have instrument inventory, and I expect that we will launch at pace. As we continue to innovate and significantly differentiate ourselves in the market, we are focused on developing assays and panels that address unmet clinical needs. For example, we have added syphilis to our STI panel. Syphilis is one of the fastest-growing STIs with a 74% increase in cases since 2017. Among those cases, newborns have surged with a 203% increase. The lack of sufficient diagnostic test methods for primary syphilis compounds this problem, and those numbers are likely underestimated. This is just one example of how diagnostic testing can provide unique solutions to help combat devastating but easily treatable bacterial infections. We expect several planned panels to be de novo and to be differentiated as well. While we continue to expand our suite of products and capabilities, we are steadfast on driving our next phase of integration to create a highly efficient, agile organization rooted in operational excellence. With nearly 18 months into becoming QuidelOrtho, we know more today than we did previously, and we are aggressively focused on reducing complexity in the business, enhancing our culture, improving capital allocation and portfolio management, and upgrading our global manufacturing operations and supply chain capabilities. These cost reductions also create room on our P&L so that we can increase our business development efforts and other growth investments. As I mentioned on our second-quarter call, our work to capture the $130 million in cost synergies over three years is well underway, and it's worth repeating, is being done in lockstep with creating a long-term growth mindset and prioritizing initiatives that can help drive incremental growth, increase efficiency, and improve profitability. While other companies are concerned about inflation and FX headwinds, we believe our cost synergy efforts can more than offset these effects and ultimately result in EPS growth. Before I turn the call over to Joe, let me take a moment to thank our many stakeholders from my brilliant colleagues who bring innovation to solving complex issues to the patients and providers who put their trust in our products when accuracy matters most to our investors who believe in our vision to advance diagnostics to power a healthier future for patients around the world. QuidelOrtho's proven ability to quickly meet the ever-changing needs of healthcare is what sets us apart. With that, let's turn the call over to Joe to review our financial performance and guidance to close 2023. Joe?

Thanks Doug and good afternoon, everyone. Our top-line performance in the third quarter was positively impacted by strong earlier-than-expected demand for our respiratory products in our key markets. So, let's begin with details on our third quarter revenue on Slide 7 of the earnings presentation. To assist with prior year comparisons, we added quarterly non-respiratory and respiratory records for 2022 and the first three quarters of 2023 on Slide 18 of that deck. Non-respiratory revenue was up 2% in constant currency to $559 million in the third quarter, driven by continued strength in our Labs business, which grew 3%. We are focused more on full-year non-respiratory and Labs growth rates and quarterly results, which smooths out quarterly variability tied to instrument placements. We have good visibility in this part of our business and are confident of high-single-digit Labs growth in Q4, which will translate to non-respiratory revenue growth within our communicated full-year guidance range. And note that there is some timing of instrument revenue between Q3 and Q4 that explains the varying growth rates for the Labs business. Importantly, we are back to normalized instrument backlog levels in Q4. We have a strong order book and are actively winning contracts, and we believe our Labs business is well-positioned to provide durable growth in both the near and longer term. Respiratory revenue came in strong at $185 million, reflecting earlier-than-expected demand for COVID-19, flu, strep, and RSV tests. In addition to normal pre-respiratory season distributor stocking orders, we saw greater demand and sell-through in Q3. Compared to the prior year period, respiratory revenue was down 21%, primarily due to the anticipated decline in COVID-19 revenue. Now, looking at our quarterly performance by geography on a constant currency basis and excluding respiratory revenue, we saw solid performance across most regions, with Instrument and Labs showing strength in most areas. North America revenue declined 1%, EMEA grew 3%, China grew 6%, and our other region, which includes Latin America, Japan, and other Asia-Pac markets, grew 7%. North America, which is our largest geography by revenue, declined 1% compared to the prior year period. However, if you exclude COVID-19 revenue, North America actually grew 10% and delivered solid revenue in the Labs business. In EMEA, non-respiratory revenue increased 3% with strong performance in transfusion medicine. As Doug said earlier, our China region achieved strong third quarter results with 6% growth. We, of course, will continue to monitor the situation closely, and we expect that our China business, excluding respiratory, will grow in the high teens for the full year 2023. Now, turning to our third quarter financial performance below the revenue line compared to the prior year period and turning to Slide 8 in the deck. Adjusted gross profit was $376 million or 50.5% on gross margin, a 490 basis point improvement sequentially. Gross margin was driven by Sofia in North America, Primero COVID-19 flu combo test strep and RSV. Moving down the P&L, SG&A expenses were $194 million, a decrease of $10 million compared to the prior year period as we continue to execute on cost synergies. On a sequential basis, SG&A expense increased by $15 million due to variable expense accruals related to higher sales and remuneration costs. We expect SG&A expense in Q4 to be more in line with what we saw in our Q2. R&D expense was $62 million, a decrease of $3 million year-over-year, reflecting our continued disciplined investment in our product pipeline. Net interest expense for the period was $38 million, an increase of $8 million versus the prior year period as expected. During the third quarter, adjusted EBITDA was $169 million or 23% adjusted EBITDA margin, 600 basis points higher than Q2, driven by higher North American sales and expense management. Compared to the prior year period, adjusted EBITDA declined by $58 million due to the previously referenced anticipated decline in COVID-19 revenue. Our adjusted earnings per fully diluted share for the third quarter was $0.90 compared to $1.85 in the third quarter of 2022. The year-over-year decrease was driven by the exceptionally strong COVID-19 revenue in the prior year. Adjusted diluted EPS increased by $0.64 sequentially, which is stronger than expected due to higher total revenue. Now, moving to the balance sheet on Slide 9, we ended the third quarter with cash, cash equivalents, and marketable securities of $205 million and total debt of $2.5 billion. CapEx during the quarter was $33 million and adjusted free cash flow was $53 million, which was positive and reinforces our view on the full year 2023 adjusted free cash flow guidance. In terms of capital allocation, deleveraging remains a top priority, with our goal to be at or below two times net debt leverage by the end of 2024. Toward that end, we have paid down $175 million year-to-date with $52 million paid down during the third quarter. Our current net debt ratio is three times and we continue to expect our net debt to be approximately two and a half times by year-end. While we did not buy back any shares in the third quarter, we continue to maintain a balanced approach here, and given the recent stock movement, we look to be opportunistic in share repurchases while also continuing to prioritize our debt reduction. Now, turning to our fiscal year 2023 guidance on Slide 10. First, I would like to provide some broader context on our outlook. As part of our business combination, we have identified cost synergies of $130 million that we expect to realize over three years. We are making steady progress across the organization, improving the efficiency of our business, paying down debt, generating cash while maintaining flexibility for smaller tuck-in M&A opportunities. We're laying the necessary groundwork for our transformation to an organization that's focused on long-term topline and bottom-line growth. Our Q3 financial performance, which exceeded our plan significantly, de-risks in Q4. While we can't precisely predict the timing of the respiratory season in advance, we believe it's prudent to plan for a normal or typical season. In addition, we have excellent visibility into our non-respiratory business. Again, we expect our Labs business to grow high single digits in Q4. All-in-all, we are very confident that we can end the year strong. Toward that and moving to Slide 10, we are reiterating our full-year financial guidance as follows. We expect full-year 2023 total revenue of $2.88 billion to $3.08 billion, with non-respiratory revenue growth of 5% to 6.5% on a constant currency basis to $2.27 billion to $2.31 billion. We expect respiratory revenue to be at the upper end of our range of $610 to $775 million. For Q4 and going forward, we will be including COVID-19 revenue as part of our overall respiratory business now that it's in an endemic state. Gross margins to be in the low 50s based on product mix, including higher instrument revenues and the open Labs instrument orders as we satisfy back orders. Adjusted EBITDA of $800 million to $830 million or 27% to 28% adjusted EBITDA margin and adjusted diluted EPS in the range of $4.85 to $5.30. As a reminder, our 2023 financial guidance includes the following key assumptions. At current rates, currency translation is expected to be about neutral to full-year sales in adjusted EBITDA with some higher FX impact on non-respiratory revenue. Net interest expense continues to be expected to be in the range of $145 million to $150 million. As discussed last quarter, we expect adjusted free cash flow to be at the low end of the 50% to 65% range of adjusted EBITDA as we appropriately invest in our manufacturing capacity to meet customer demand. By the way, this translates into more than 100% of adjusted net income. Full-year diluted weighted average share count is $67.3 million. Now, with that, I will now turn the call back over to Doug for his closing comments.

Thanks, Joe. I'd like to leave you with one key takeaway, and that's, you know, we are the same successful respiratory company that we were prior to the global pandemic and the acquisition of Ortho Clinical Diagnostics. The key difference is that the overall respiratory market, including COVID-19, now in its current endemic state, is significantly larger than it was pre-pandemic. And QuidelOrtho's position in the overall diagnostics market, including respiratory, is much stronger as a combined company than either company was on a standalone basis. Contrary to some recent opinions, we believe, as evidenced by our results, the diagnostics market is positioned for continued durable growth for many years to come. With that, I'll ask the operator to open the line for questions.

Thank you. We will now begin the Q&A session. Our first question is from Andrew Brackman with William Blair. Your line is now open.

Yes. Hi, this is Dustin on the line for Andrew. Thanks for taking our questions. As we look forward to 2024, just wondering if you can touch on some of the building blocks for margins. Understanding it's a bit early here, but a lot of investors are asking about the moving parts. So, any color there would be greatly appreciated.

Yeah. I'll let Joe go through some more detail. But clearly, the fact that we've stabilized the Labs business is very helpful to growth. We expect it to continue to do well in respiratory, and of course, we'll be launching Savannah. So I would look, as an investor, to those three milestones. Joe, what would you add?

Yes. I was just going to add that we still expect the growth in the margins to be aligned with how we communicated about a year ago at Investor Day. So there's really no change there. As Doug said, we have a lot of confidence in the Labs business. As I said in the prepared remarks, visibility into the non-respiratory as you think about sort of the more variable and sort of more of the building blocks that we still have to work through between now and early next year when we provide 2024 guidance. It's the timing of the respiratory season Q4, Q1, it's the launch of Savannah. It's the endemic COVID levels where that finally ends up at the end of this year. It's the synergy achievement, then of course, there's inflation and FX to think about also. So those are all the big moving pieces.

Understood. Thanks for the insight there. Another question on Savannah. Good update on the approval timeline there. Just maybe if you could talk about your confidence in the rapid menu expansion and then placement install expectations? And then maybe to ask it another way, what are kind of the KPIs that you're going to be looking at to determine if Savannah is a successful launch? Thank you.

We're in good shape from a menu development perspective, and the clinical trials will drive our success. We will do several clinical trials throughout 2024 with an expectation that once the instrument has already been cleared, the packages should be somewhat straightforward on each of the panels that we'll do. So we've said before that we will attempt to be in the market with at least four or five different panels before the end of 2024. That would be our major objective. We have instruments in inventory. We've recently completed the software update. We are fully manufacturing cartridges. I don't see any other constraints other than U.S. FDA clearance, and obviously, we will work with the regions to launch the Savannah product internationally as well. But we have pretty high expectations here in the US.

Okay. Great. Thanks for taking our questions.

Next question is from Patrick Donnelly with Citi. Your line is now open.

Hey, guys. Thanks for taking the question. Maybe the first one is for Joe. I've got a few questions, how are you? I got a few questions just on the 4Q ramp. The revenue, I think, sequentially is about flat. I think EBITDA is about double 3Q. So can you just talk about what the moving parts are there? Obviously, the respiratory piece is I assume a big piece. But can you just talk about that ramp and the confidence level in the EBITDA margin, EBITDA dollar ramp there in 4Q?

Yes, Patrick. First, as I mentioned earlier, we have good visibility into the non-respiratory business, and we expect a strong fourth quarter for the Labs business. Sequential growth will mainly come from the respiratory business. In Q3, we reported $185 million in respiratory revenue, and our target aims for what we've identified as a typical flu season. To reach the high end of the respiratory revenue range mentioned earlier, we're looking to increase by about $50 million from Q3 to Q4. Based on our understanding of the respiratory season, that seems achievable. However, if this occurs, we would still see a decrease of approximately $115 million or 33% compared to last year's Q4 respiratory revenue. Therefore, we are not anticipating a record respiratory season like last year, but rather a return to a normal season.

Yeah. And maybe, Joe, I could add just a little bit more color. Typically, what has happened over the last years, and I've been watching this now for 14 years, particularly driven by U.S., the distributors will order product in Q3. Historically, it's actually been close to when kids go back to school. So they've ordered, and you can see right now in our own inventories at distribution, which we have very good visibility to. You see fairly high inventory levels. What would normally happen is as we see a respiratory season, clearly high surplus emerge, the tests are going to come out of that inventory. Depending on how quickly that inventory bleeds down, we'll determine when the major distributors will order before the end of Q4. Sometimes, we've been holding our breath until the last week of the year, but typically, it happens in the last three weeks. So that's what happens pretty much every year. Obviously, COVID changed that dynamic a little bit, but that's typically the trend. Right now, looking at the ILI rates and the fact that I'm hearing that a lot of physicians are actually ordering the combo products, I think it's reasonable to expect that we have a bleed off that mimics what we've seen in prior years. We won't see a lot of ordering in October, but we will be expecting that distribution inventory levels get down below a certain point to trigger additional orders.

Okay. That's helpful. And just, Joe, on the margin/EBITDA dollar ramp, is that almost all tied to respiratory? That's a pretty big step-up as well. I just want to make sure we're thinking about the margin profile correctly from Q3 to Q4.

Yes. It's driven by two things, Patrick. It is the respiratory revenue step up, which, as you know, the respiratory products carry the highest standard gross margins of all of our products, as well as just continued expense management synergy achievement. Those two things are going to drive the increase in gross and EBITDA margin.

Okay. Understood. Thank you. And then maybe just on the non-respiratory piece. The Lab business, Doug, can you maybe just talk about the trends you saw in the quarter, the visibility here going forward in terms of the growth, just trying to balance expectations into 4Q and as we work our way into 2024. Just what you're seeing there and expectations would be helpful.

Well, just generally, as I say, the orders are up. So really, what drives the growth rate after that is the speed with which we get the installs done and the customer tests of record. We do expect a tick up in Q4 on the Labs business. This is maybe a little too much detail, but every Friday, I see exactly what we closed. I have seen a ramp-up in terms of the order rates. So that's my visibility to it.

Okay. That's helpful. Appreciate it.

Thank you, Patrick. Our next question is from Alex Nowak with Craig-Hallum.

Yeah. Staying on that last topic there, the Labs business ramp in Q4. Is there any geography in particular that's driving the outsized growth? Is it China perhaps? Obviously, a lot of focus there. Just what's the thought?

Yes. As I mentioned, we will be up around 25% in China alone. For the year, I think we're in the high teens for growth in 2023. So China is clearly back on track. It is a growth driver for us. The other major driver is the U.S., what happens in the US, because of the size is particularly important. What we're expecting to see is driven by China and by the US.

Most of the regions are going to be up sequentially, Q3 and Q4. But as Doug said, a lot of it has to do with China and the lockdowns we saw last year obviously being lifted.

Okay. Got it. That's all my side.

Go ahead.

On Savannah, what has been the feedback so far at the FDA? I'm sure they've had questions around the submission. I've honestly forgotten, is this going to be a 510(k) or an EUA that we should get the approval at the end of this year?

Thanks for the question, Alex. We're confident we will have approval for the box, and it will be approved 510(k). We'll pursue CLIA waiver at our earliest opportunity, but it's not going to be in EUA.

And that's 500 for the RVP 4 as well, just to confirm.

That's correct. So RVP 4 would be cleared. HSV obviously is under active review as well.

Okay, perfect. And then just an update on the high-volume cartridge manufacturing line. Thank you.

I don't have a further update. We're still targeting everything on track for mid-year next year.

Excellent. Good to hear. Thank you.

Thanks, Josh.

Our next question is from Jack Meehan with Nephron Research. Your line is now open.

Thank you. Good afternoon. First, I hope you feel better soon. I wanted to follow up on some of the fourth quarter guidance questions. Maybe just looking at the margin profile in the fourth quarter. I think the guide implies something like a 40% EBITDA margin. If I just look at the history of the company, it's somewhat unprecedented outside of the COVID period. So I think I heard SG&A within more like 2Q. Are there other factors you can call out?

I'm super happy that you asked that question, Jack, because no, we're not going to do 40% EBITDA in the fourth quarter.

Yes, Jack, there seems to be a misunderstanding because it should be closer to the mid-30s. Last Q4, we were at 32% or 33%, so it definitely shouldn’t be 40%.

Okay. I'll play with the model. But even getting to a mid-30s EBITDA margin is still pretty healthy kind of relative to the pro forma that if you put together the two companies, historically, just talk about going from 23% in the third quarter to that level, what drives the step up?

As I said before, it's the increase in respiratory revenue, which carries high margins and then expense management. I said in the prepared remarks that we expect SG&A in Q4 to come down to closer to where it was at Q2 levels. So we're expecting a drop in expense.

Yes. And maybe this would be a good time to comment on this. We've talked before with everybody on the phone about the idea that we started with Harmonization. We went to integration we had two shots on goal with cost synergies, projects that we called Synergy 1.0 and 2.0. Some of those things are finally showing up in the fourth quarter. So that's a factor. But Jack, after only 18 months as a combined company, we know what needs to be done. We understand the levers we need to pull, and we're in the process of identifying the initiatives that we will need to execute moving forward. At the end of the day, we can run this business better, and we expect to run this business better, which will result in EPS growth over time.

Okay. And then I appreciate all the comments on the China VBP. I was just curious if you could clarify, do you plan to participate in this program at all? And do you think in future test categories? How important is it for you to maybe get exempt from the program?

Yes. So there's two sides to this, you've had other VBPs that have included clinical chemistry, and some of those excluded our products because they're DriveSlide chemistry. A couple of years ago, I don't have all the details in front of me, but we chose to participate. We did reduce prices, and we actually increased volume pretty dramatically. I think my colleagues in the diagnostic industry look at it the same, while it is a threat to price, sometimes it gives you greater access to the volume that's out there that we might not ordinarily have had access to so easily. In that case, two years ago, Ortho actually was the winner and did pick up the volume. We will try to participate in this tender, but it really is only hormones, infectious disease tests and HCG, which are pretty low volumes for us. If we do choose to participate, we will more than likely reduce our pricing as was done in 2021 about that same level, which could be pretty draconian, but it could be valuable to us to retain our volume. You heard me in my prepared remarks say that that's 0.72% impact if we were to reduce pricing at that level. That would be the worst-case scenario because you have to remember that we're going through distribution and distribution will pick up part of that price. So yes, we are going to participate if we can. Of course, we would. That would be the impact if we didn't pick up any volume, but simply retained what we had.

Okay, got it. And just last question, the accounts receivable stepped up, I think, $85 million sequentially. What drove that?

The higher respiratory revenue in the quarter. By the way, our global DSO is 33 days, and it's, I believe, 20 or less from the U.S. So all that respiratory revenue overachievement was in the U.S. We've already collected all that cash. So yes, that's what drove up, and we've got a very solid DSO.

Thank you.

Yes, thank you.

Our next question is from Andrew Cooper with Raymond James. Your line is now open.

Hey, guys, thanks for the questions. Maybe just sticking with the Labs business a little bit. Can you give us a little bit more color just on sort of what the typical seasonality is here and how we should be thinking about one, what that meant for 3Q, but also when we think about that 4Q, I look at it and see a relatively easy comp. We have the backlog of instruments back to normal, which should be a tailwind here. So is there a scenario where this could be faster than the high single digits you pointed to in 4Q? If not, maybe what might be limiting that relative to some of the tailwinds that we think about in the space?

And Andrew, you're specifically talking about the Labs business?

Correct.

Yes. I do think there, again, we've got great visibility into this business.

So, coming out of Q3, which is typically the lower in terms of instrument orders. Q4 not only is higher decisions made before May before year-end. If they're selling instruments, we would see them higher in the fourth quarter. So I'll start with that. What drives the growth rate after that is the speed with which we get the installs done and the customer tests of record. We do expect a tick-up in Q4 on the Labs business. This is maybe a little too much detail, but every Friday, I see exactly what we closed. I've seen a ramp-up in terms of the order rates. So that's my visibility to it.

Okay. Helpful. And then you mentioned capital deployment and not necessarily doing any buybacks as of yet. As we continue to see the stock price sort of come down, rates remain kind of steady. How do we think about that decision-making process and where that threshold is to get a little bit more aggressive on the buyback as opposed to prioritizing debt paydown as you have so far?

We've said before in terms of capital allocation that we look both at debt repayment as well as share repurchase. When we do the math right now, obviously, the math would tell you that it's probably better to be buying shares than paying down debt, but it's not dramatically so. We will continue to be opportunistic for sure.

Okay, I will stop there then. Thanks for the question.

Thanks, Andrew.

Our next question is from John Sourbeer with UBS. Your line is now open.

Hi. Thanks for taking the questions. I was wondering if there's any additional color to provide on the Savannah backlog and then maybe more broadly on molecular diagnostics. Just any updates on the shift you're seeing there from centralized labs to decentralized solutions, and then how should we think about Savannah offsetting this in 2024?

You are right that the play there for Savannah is to meet the need of bringing molecular testing closer to the patients. We would see that as an unmet need that has existed for some time and has been addressed in part by other companies. We happen to think our solution, given its speed and ease of use and the comments that we're getting from potential customers, that we will be successful. I will say that if we weren't successful, if you're looking for what the trend is, the trend is going to be that it's going to be decentralized for sure. A need for molecular testing has been in there for a while. We're simply trying to do it and address it in a better way.

Got it. Appreciate that. And then maybe just a follow-up on the VITROS platform. And I just want to make sure I understand here, but have you seen any extension or change in the actual sales cycle there throughout the year?

No, I'd say not. I don't see any significant macro changes in terms of capital availability or decisions being delayed. So it's been fairly steady for a couple of years now.

Globally, we still average broadly 50-50 between cash yields and pre-age arrivals. That hasn't changed.

Right. The speed with which orders are coming, I don't see customers behaving differently in terms of making decisions. We do seem to be winning a few more than we normally would at this stage. But I don't see anything macro, John, that would impact clinical chemistry or immunoassay sales.

Got it. Thanks for taking the question.

Thank you, John.

There are no further questions at this time. So I'll pass the call back to the management team for any closing remarks.

I'll just say, on behalf of the team, thanks for your interest. Thanks for joining the call. We'll talk soon.

That concludes today's conference call. Thank you for your participation. You may now disconnect your lines.