Ortho Clinical Diagnostics Holdings PLC (OCDX) 2020 Q4 法說會逐字稿

Ladies and gentlemen, thank you for standing by, and welcome to the Ortho Clinical Diagnostics Fourth Quarter 2020 Earnings Call. (Operator Instructions)

I would now like to hand the conference over to your speaker for today, John Sanders, Treasurer and Head of Investor Relations. You may begin.

Thank you, operator, and good afternoon, everyone.

With me today to discuss our financial results are Chris Smith, Ortho Clinical Diagnostics Chairman and CEO; Joe Busky, Ortho's Chief Financial Officer. And joining us for Q&A will be Mike Iskra, our EVP of Commercial Excellence and Strategy.

This conference call is being simultaneously webcast on the Investors section of our website, and a version of today's presentation can be downloaded there.

Let me remind you that the presentation and remarks made today include forward-looking statements as defined in Section 21E of the Securities Exchange Act. Except for historical information, all of the statements, expectations and assumptions discussed in today's call are forward-looking statements that involve a number of risks and uncertainties. Actual results might differ materially from the results discussed in the forward-looking statements. These risks and uncertainties include, but are not limited to, those factors identified on Slide 2 of today's presentation, in our Form 10-K for the year ended January 3, 2021, and other filings with the Securities and Exchange Commission. Except as expressly required by the securities laws, the company undertakes no obligation to update those factors or any forward-looking statements to reflect future events, developments or changed circumstances or for any other reason.

During today's call, there will also be a discussion of some items that do not conform to U.S. generally accepted accounting principles or GAAP. Please see Slide 3. These include, but are not limited to, core revenue, constant currency, EBITDA, adjusted EBITDA, adjusted free cash flow, and adjusted diluted earnings per share. Reconciliations of these non-GAAP measures to their most directly comparable GAAP measures are included in the appendix to the investor presentation and also in the press release issued this afternoon, both of which are available in the Investors section of the Ortho website.

On today's call, we will also refer to our core and our noncore business, our clinical labs and transfusion medicine businesses represent our core business. Our noncore business is comprised of our contract manufacturing and licensing revenue.

Now I will turn the call over to Chris Smith, Chairman and CEO of Ortho. Chris?

Thanks, John.

Good afternoon, everyone, and welcome to Ortho's first earnings call as a publicly traded company. It's an honor to be with you today to share all of ortho's fourth quarter updates. You should have received the deck and have the ability to go through it with us. So rather than us steering, we will call out slides today as we address each one.

I'm going to start on Slide 4. We always love to start all our presentations, whether it's with a customer or a field organization or with investors, around our mission and especially our tagline, Because Every Test is a Life. It's what we do and why we do it every single day. It truly is the credo that drives the company, and we always love to be able to share that as we move into it. To give you an example, today we'll help about 800,000 patients around the world. I'd also like to take a moment and thank and recognize the many Ortho teammates who make it a priority to take exceptional care of our customers and our patients they serve, which was the utmost important during this challenging year with that we experienced in 2020.

2020 was also a year of opportunity for Ortho. When our customers need urgent, reliable solutions to tackle the challenges caused by the pandemic, we answered the call. For example, in just 19 days we launched the first high throughput COVID antibody test, followed by high-volume antigen test in Q4. It's this kind of innovation and dedication to our customers and patients over the last few years that has helped us transform Ortho into the market leader it is today.

I'd like us to move on to Slide 5 now to talk and remind you about the markets in which we compete. As you know, the IVD market is a very large industry with about $76 billion. And when you break down the segments that we compete in, that's about $26 billion of that market opportunity, and we see that growing about 5% to $32 billion over the next 4 to 5 years.

We compete in 2 key markets. The first market in which we play is the clinical labs market. I'm going to move to Slide 6 here, which will give you a highlight of these 2 businesses. The clinical Labs market is about a $24 billion market and growing about 5% a year. We're the only company to have dry slide technology which does not require access to water and is designed to make quality critical chemistry testing accessible. When you think about emerging markets where there's -- many have limited water supplies, our technology is available to make a significant difference. We also saw this important during the initial phases of COVID with pop-up hospitals.

The second area where we compete is in transfusion medicine. This is about a $2 billion business and is projected to grow 3%. This business is comprised of 2 categories. The first is immunohematology, which is when someone needs a unit of blood in the hospital, their blood must be tested and typed prior to receiving a transfusion to confirm compatibility. And we're the #1 provider in this market around the world.

The second piece is the donor screening business, where we have a top leadership position. And in 2021, we'll be closing that competitive gap even more with the recent win of the Creative Testing Solution (sic) [Solutions] agreement. We won this agreement at the end of Q3, beginning of Q4 of last year and have began to place instruments in January, and revenue will be reported in the Q1 results later in May. CTS represents about 70% of the U.S. blood supply, and we're excited about that partnership and we're able to continue to move.

If you move on to Slide 7, it will give you a highlight of our Q1 results. I want to share that over the past 12 months has been foundational for Ortho. We strengthened our leadership team, expanded our position as an innovator in infectious disease and donor screening. We completed our IPO in early February. We strengthened our balance sheet. And we established our position as one of the largest pure-play, publicly traded companies in the IVD market.

Q4 was our first results that we are reporting, and we're very proud of these results. We grew our core revenue to $501 million, an increase of 9.1%. And Joe is going to talk a little bit more about this, but that was split pretty evenly between our base business and the addition of COVID testing. We also increased our operating income by 33%. And we ended the year with adjusted EBITDA of $133.6 million. It was an increase of 3.5%.

Just as importantly, we significantly improved our cash position. In February as you know, we completed our IPO. And we raised $1.4 billion, which we used to pay down debt and increase our cash position. This significant deleveraging of our balance sheet allows Ortho opportunities to continue to grow the business not only organically but also in partnerships and potential M&A opportunities.

I would now like you to move to Slide 8. Slide 8 really is a slide that talks about our economic engine, and this is what drives Ortho going forward. We talked about this during our road show that we really focus on the lifetime customer value of our customers, and it really is about building these long-term relationships with customers.

Historically, in the diagnostic business, a contract may initially be for only 5 to 7 years. But what we find because of our great differentiation in service and the excellent products that we provide, that we historically will extend the life of these contracts for 10, 20, 30 years.

If you look at this slide, it will give you a snapshot of how we see this business moving. Today, about 75% of our install base is still a stand-alone analyzer, and it's usually a chemistry analyzer. Then what we find is we continue to bring new technology out, we launched our first integrated analyzer about 10 years ago and our second one a couple of years ago, the 7600, and since then, we've actually moved about 24% of our installed base to an integrated instrument.

But when we move one of our existing customers from a stand-alone instrument to an integrator, we increase our annual revenue by 65% because we expand our menu offering from just not only chemistry but to immunoassay. Then what we'll see is that customer will grow 3% to 7% with us for the next several years. And you can see down at the bottom here, it highlights that when we do add this agreement, we historically will add 13 years to the life of the agreement with our customer.

Now more and more hospitals in our sweet spot, which is anywhere from a 250-bed to 500-bed hospital, are moving to automation. In the early days, automation was very focused on large reference labs or big university settings, but even the community hospitals today are moving to automation because it improves the efficiency of the lab. And what we find is when we move a customer to automation, not only do we increase our revenue by 300%, we add another 15 years to the life of that agreement. And you start to see how this builds value over time through our relationships with our customers.

Now when we think about how do we enact this on a daily basis, I'll have you turn to Slide 9. And this really focuses on our 3 strategic priorities that drive our profitable growth. Now again, we've talked about these before as a company, but in each earnings cycle, we'll spend time talking about what the company has done in these 3 key areas over the prior quarter.

The first one is around product innovation and really is focused in 2 key areas. One is around menu expansion. You can see the highlights here are some significant impacts that we had as a company with the introduction of new menus, not only in the United States, but China, Latin America and EMEA at the end of last year, but it's also about introducing disruptive platforms. And I'm really excited that we began our feasibility work on our dry-dry technology, which will take our dry slide technology and not only enhance multiplexing, it will also allow us to move into dry immunoassay.

The second one -- area that we focus on is really around global commercial excellence, and think about this as our global field organization. Today we have about 2,200 people around the world in the field, and we do business in about 130 countries. And we believe for us to continue to win, we have to excel here. And it really is around kind of the customer experience and our go-to-market strategies. You can see that we again continue to have double-digit growth in our integrated install base, and this is an important indicator of future opportunities from a revenue perspective. And seeing this grow double digit is fantastic.

In addition, we continue to be ranked #1 in service as our fifth year in a row. And when you think about this business, you can go get a blood result from any analyzer, but it really becomes about the one or 2 things you can do different as a company. More and more companies are focused on the leading service provider to be their partner, and that's really done well. And it's one of the reasons you'll see this 9% growth in Q4, and we're also excited about where the growth is in the future.

The other one is about taking what's worked incredibly well in the Americas around our E3, our commercial excellence program, and expanding it to other programs, which we got underway in Q4. And finally, it was adding an additional 61 people into the field organization. Because we believe that in our position from a market share perspective and what the market opportunity is, this will be a key driver of growth.

Finally, our third strategic priority is really around operational efficiency, how do we get better every single day at the things that we do to free up cash to invest in the first two. And you can see an excellent quarter there. The manufacturing improvements in our favorable mix resulted in 40 basis points of gross margin improvement. We expanded our operating flexibility with $101 million of adjusted free cash flow. And also, we actually delivered all the instruments and all the reagents into the CTS accounts in late Q4 and began recognizing revenue in Q1.

And finally, it's about initiating the China localization strategy. One of the things that we've talked a lot about is that China is our second largest market. And for us, as we look out 3, 5, 10 years from now, it's important that we have a footprint in China and that we continue to expand that footprint. One of the ways to do that is to develop both instruments as well as reagents locally in China.

If you think about this business and where we're going as a company, we really think 2021 has started incredibly strong, driven by our continued focus on these 3 strategic priorities to drive growth and shareholder value. As we move forward, I want us to go to Slide 10 as I wrap up, and then I'll hand it over to Joe. But we believe these results in the fourth quarter are indicative of the considerable momentum we're seeing as we head into the year. Joe will go to it in more detail momentarily, but we see ample opportunity to carry this forward for the years to come.

Lastly, I'm pleased to report that we anticipate exceeding our original expectations for the full year 2021's financial performance. Where we initially went out and talked about 7% growth, we are now talking to 7 -- or guiding to 7% to 9% core revenue growth or approximately 10% without the impact of COVID.

As we've mentioned in the past, we believe COVID is a headwind. In the current guidance, we see COVID sales slowing in the second half of '21. However, we are working on initiatives that may accelerate antibody test sales as the vaccine starts to roll out, depending on countries' logistics and priorities as far as testing people post-vaccine.

I will now turn it over to Joe for him to give you more detailed color into the Q4 financial results for 20 -- in Q4 and also 2021. Joe?

All right. Thanks, Chris.

As Chris noted, 2020 was certainly a foundational year for Ortho. We grew our core revenue over and above our expectations. We prepared for life as a public company, and most importantly, we played a vital role in the health care continuum as we all collectively battled through the global pandemic. I'm excited about the opportunity we have here at Ortho to drive long-term shareholder value, and I look forward to sharing our progress with you over the coming quarters.

So let's go a little bit deeper into the operating results for the quarter and the full year now, starting with the breakdown of the fourth quarter revenues on Slide 11. Now please note that all the comparisons are versus the prior year period, unless otherwise mentioned.

We delivered strong results for the fourth quarter ahead of our initial expectations and have considerable momentum heading into 2021. Fourth quarter total revenue was $516.7 million compared to $473.7 million in the fourth quarter of '19, which represents that 9.1% increase, or 8.2% growth on a constant currency basis. Core revenue of $501 million, which excludes manufacturing -- or contract manufacturing, I should say, and other licensing revenue increased 9.1% on a constant currency basis.

The substantial revenue growth in the fourth quarter was primarily driven by higher volumes within clin labs including $26 million in COVID-related revenue, and transfusion medicine as well as continued recovery in the Americas. Now excluding that COVID-related revenue, reported core revenue growth would have been 4.4%.

So as a trusted partner of hospitals, hospital networks and blood banks and labs around the world, our base business bounced back fairly well from the pandemic-induced low points we saw in the second quarter of 2020. I'm pleased to say our base business has resumed its trajectory of year-over-year growth. Clin lab revenue grew to $334.8 million from $296.8 million, a 12.4% increase on a constant currency basis, largely driven by healthy growth in our Americas and Western Europe geographies as well as COVID-19 antibody and antigen assay sales.

In transfusion medicine, we saw 2.9% growth on a constant currency basis, or $166.2 million in revenue for the quarter compared to $158.3 million in the year-ago period. Within TM, we experienced growth in our Americas, Japan and ASPAC regions. We also spent time in the fourth quarter preparing for our new partnership with CTS that went live in the first quarter of '21.

Noncore revenue fell approximately 15% to $15.6 million for the fourth quarter as compared to $18.4 million due to a decrease in contract manufacturing revenue, which was partially offset by growth in license revenue.

Now if you move to Slide 12, which outlines our geographic regional results for Q4, our business in emerging markets slightly lagged the robust recovery seen in more developed countries, but we are seeing growth in those areas return. With that said, Americas revenue in the fourth quarter grew to $311.6 million from $273.4 million in the prior year quarter. This is 15.6% on a constant currency basis due to growth in clin labs and transfusion medicine within the region, and it was partially offset by a decline in noncore revenue.

The EMEA segment revenue of $72.3 million was down 5% on a constant currency basis compared to the prior year quarter, as a result of the pandemic's impact on sales in the region and the timing of shipments in distributor markets.

Our Greater China segment revenues of $67.2 million increased 1% on a constant currency basis, with growth slightly inhibited by the impact of the pandemic and distributor decisions to reduce their inventory in response to the pandemic.

Our Other segment, which includes the Japan and Asia Pacific regions, had revenue of $65.5 million, which was relatively flat on a constant currency basis and was impacted by lower sales of elective procedures in ASPAC and Japan as a result of the pandemic. However, we are seeing good signs of recovery in many countries in this segment, including India, which exceeded our expectations for the quarter.

If you move to Page -- or Slide 13, which shows our annual performance by segment. Americas revenue totaled $1.07 billion versus $1.04 billion in 2019, representing 4.1% growth on a constant currency basis. The Americas region benefited from substantial growth in clin labs, specifically COVID assay sales, which more than offset the negative impact of the pandemic on other testing and the decline in noncore revenue.

EMEA sales of $240.6 million declined by 5.2% on a constant currency basis, primarily due to the pandemic. It also impacted Greater China and the Other segment also. Greater China sales of $229.6 million and the Other segment sales of $228.7 million fell by 6% and 13.9% on a constant currency basis respectively.

Now turning to Slide 14. We are pleased with the acceleration we experienced throughout numerous areas of our income statement during the quarter as we continued to make progress against our growth plan. This is seen to a lesser extent in our full year '20 numbers, which were more severely impacted by the pandemic, in particular in the second quarter of 2020.

For fiscal '20, revenue was down 2% to $1.77 billion compared to $1.8 billion in fiscal '19. On a constant currency basis, total 2020 revenue decreased 1.3%, and core revenue for 2020 was up 0.4% to $1.74 billion.

Now moving back to Q4 and sort of working down the income statement from gross margin to earnings. Fourth quarter gross margin of 50.1% increased 40 basis points due to favorable product and segment mix as well as lower manufacturing costs. Full year gross margin fell 20 bps to 48.6%, largely due to the negative pandemic impacts, partially offset by $74 million in full year COVID testing revenue.

Operating income for the fourth quarter increased 33% to $40.4 million, primarily driven by higher gross profit, but was partially offset by higher SG&A and R&D spend, while full year operating income increased 3.3% to $88.3 million. Non-GAAP adjusted EBITDA for the fourth quarter was $133.6 million, increasing 3.5% compared to $129 million in the comparable period.

Net loss for the fourth quarter was $40.9 million or $0.28 per share compared with net income of $1.6 million or $0.01 per share. Adjusted net income increased 44.8% during the quarter to $29.1 million. The variance between actual and adjusted fourth quarter net income is driven primarily by intangible amortization, unrealized FX and other onetime costs.

We generated $101.5 million of non-GAAP adjusted free cash flow during the fourth quarter. It's a 185% increase compared to the prior year quarter.

All right, let's turn to Slide 15 to discuss the balance sheet and liquidity. As of the end of fiscal '20, our total cash and cash equivalents was $132.8 million, up from $72 million at year-end 2019. Total debt stood at just over $3.7 billion. And the net proceeds, as Chris said, of $1.4 billion from the IPO, which included the exercise of the full over-allotment, would have reduced net debt to $2.3 billion on a pro forma basis.

We used the $1.4 billion in net proceeds entirely to reduce our outstanding debt, thereby reducing our net debt-to-EBITDA ratio to 4.5x and giving us significantly enhanced financial flexibility. Please note that this forward-looking ratio is based on the midpoint of our '21 projected EBITDA, which I'll talk you through in a minute. From our continued cash flow generation, we plan to reduce this leverage ratio about an additional 0.5 turn per year over the next several years to achieve a target leverage ratio of 3 to 3.5x.

Another good news, as expected, both Moody's and S&P upgraded our credit ratings subsequent to the receipt of our IPO proceeds. And we recently upsized our revolving credit facility by $150 million, resulting in total borrowing capacity of $500 million under this facility. This is supporting the strongest liquidity position that Ortho has seen in years. Our healthy cash position, reduced interest burden and overall flexibility enabled by the IPO will allow us to have a much more balanced capital allocation strategy over the coming years that will be focused not only on deleveraging, but also in supporting both organic and inorganic growth opportunities for investments in the development of the industry-leading and innovative solutions.

With that in mind, I'd now like to turn to Slide 16 for the outlook for 2021. We are already seeing real strong momentum across our portfolio during the first quarter. And for the full year '21, we expect the following:

Full year 2021 core revenue within a range of $1.86 billion to $1.9 billion, and core revenue to grow between 7% and 9% on a constant currency basis. '21 full year adjusted EBITDA between $504 million and $517 million, or 10% to 13% growth on a reported basis. And adjusted diluted EPS in the range of $0.57 to $0.63 per share, based on a full year average share count of 234 million shares. For '21, we also expect annual interest expense of between $140 million and $150 million. And our effective tax rate in 2021 is expected to be a negative 15% on a net loss. Our cash taxes are approximately $20 million for the year.

And while we plan to stick to an annual model with our guidance program in the future, I did want to give you a few observations to help better model 2021. We now anticipate core revenue growth to be stronger in the first half of the year versus the second half. This is being driven by a very strong start to the year in our core business. And in expectation of a declining overall COVID market, we are also assuming that our COVID-19 antibody assay will decline in the second half of the year.

Since we're so far into the first quarter, we're going to share some quarterly top line expectations this one time. We believe that Q1 core revenue growth will be 15% to 18% versus prior year Q1. We feel confident in these projections as the recurring nature of 73% of our revenue gives us substantial visibility into the future of the business.

We expect to grow the top line across our core business in all of the various segments. We also expect to see continued margin expansion and operating leverage growth as a result of our value capture program and ongoing shifts to the increased placement of integrated analyzers. To quantify this a bit more for you, for every percentage point of revenue growth, we expect our non-GAAP adjusted EBITDA margin to grow by 1.2 to 2x that, depending on our investments for that particular period.

I'm very encouraged by what the future holds for Ortho. This is an exciting time for us. And I'd like to end by offering my personal thanks to all of our teammates around the world, and welcome to all of our new shareholders.

With that, I'm going to turn the call back over to Chris.

Thanks, Joe.

Listen, to close off, two quick points. One is, Joe mentioned that 73% is reoccurring revenue. It's actually 93%. So I just wanted to make that quick correction before we go to the investment thesis, which is the next slide.

And look, we continue to believe the things that we've talked about -- really, over the last 6 months about Ortho and why it's a great investment continue to hold true. Number one is we really are the only pure-play IVD company. If you think about Roche, Abbott, Siemens, these are diagnostic divisions in large conglomerates, and that industry continues to be a highly attractive and growing market.

The second is, is that we're seeing more and more of the clear differentiation of our products and services makes a significant difference, as we focus on this lifetime customer value and this 93% reoccurring revenue base. And we're really seeing that indicative, not only in the results of Q4, but what we're seeing as we move into Q1, and as Joe gave this guidance of 7% to 9% of growth for this year, and really 10% when you back out COVID, which will be a headwind.

And finally, it's about the momentum that we have in this business. And as we continue to expand our field organization, expand our menu, and place integrated analyzers at double digits, we think that we see strong momentum moving through the year and as we continue to focus on profitable, sustainable growth.

So why don't we pause there. I mean, we're sure that a lot of folks have some questions to go through. And we'll turn it back to John, and we'll take some Q&A for the next 30 to 40 minutes.

Very good.

Thanks, John.

Thank you, Chris. Thank you, Joe. Ladies and gentlemen, we now have time for Q&A. (Operator Instructions)

Operator, at this time, Twanda, if you would give instructions for how to join the queue and open the line to our first questioner?

(Operator Instructions) Our first question comes from the line of Tycho Peterson with JPMorgan.

I'll start with a couple of quick ones -- just a couple of quick ones on guidance. Wondering if you could provide any segment color, clinical labs versus transfusion. And then I think previously, you talked about CTS adding about 5% to 7% growth to transfusion this year. Is that still the assumption?

And then the 1Q guidance is obviously coming in quite a bit above The Street. Can you just talk about how much of that is driven by recovery in the base business versus the COVID business?

Yes. So a couple on that, so Tycho, so we don't break out the clin labs and transfusion. But remember, we mentioned that CTS would be a few points of growth, 2% to 3% of growth in that -- in our total business. So that kind of gives you a highlight.

As far as recovery, I would say a couple of things have happened. We've seen nice recovery in Western Europe. To give you an example, Western Europe grew about 4% in Q4, which was above where we would have thought. And I think a lot of that's being driven by that leadership change that we made over the last 18 months, both in our cluster leaders as well as the head.

The other thing is really nice recovery in India. We grew through 13% in Q4 in India, and is particular the south cone of Latin America. So I think what we saw is while we didn't see the recovery in Q3 in some of these countries -- or markets, we really saw a nice recovery.

But leading the way, Tycho, continues to be really North America where we're growing double digits. You heard Joe mention 15-plus percent. And while some of that is related to the COVID tests, it really has only been about half of that growth. We're seeing high single digits growth in our base business. And we think a lot of that's been driven by this placement in the install base especially around these integrated analyzers.

I think that got to all your questions. You got three in there really quick, so I hope I got them all.

No, that's great. And then one follow-up on China, if I think back to kind of the original discussions around the IPO, I think China was positioned to be one of the potential sources of upside this year. I know you talked about timing of distributor shipments, so maybe just talk through that. And then I think you announced the localization strategy to produce instruments in the agents. Can you maybe just touch on that, too?

Yes. Look, China obviously is one of our key markets. It's where we've invested heavily over the last 18 months. Joe did mention kind of the slowing with some of our distributors because of the pandemic.

I would say that we think kind of the silver lining there though, Tycho, is that we actually grew the install base 9% last year -- I mean in Q4 in China. And we actually grew the integrated 17%. So really about placing these instruments, so we feel really good about this year.

We're guiding -- we're not giving individual guidance. We're seeing China growing at the low double digits this year, and it has started the year very strong. So we feel really good that China will have a nice bounce back year, but candidly the recovery there had taken longer than I think we thought. And it was really driven by doctor and hospital visits being semi-restricted, so really people only going in the case of emergency as compared to the large elective procedures, which so much of our business is driven by.

Okay. And the localization strategy?

Yes, the localization strategy. So one of the things I think we mentioned this on the road show is that we want a bigger presence. We have over 300 people now in China. And we think -- I think one of our challenges, we are developing a majority of our products in the United States, so whether analyzers or assays. And what we decided to do is kind of "developed in China for China" and the emerging markets.

And we have now signed 2 localization agreements, one for an analyzer and one for reagents, where we're working with 2 partner companies in China, where we'll develop those products first for China, but then we'll take those products to emerging markets.

All of those were signed in Q4. Both of those agreements, Tycho, were signed in Q4.

Our next question comes from the line of Derik De Bruin with Bank of America.

I guess first question, can we talk a little bit about the pace of reinvestment? And basically sort of thinking about the R&D targets and sort of margin pacing through the quarter for the year?

Yes, why don't we take that two ways? I'll start, and then I'll throw it to Joe to kind of give you more kind of the margin improvements. But look, we historically had spent around 5% on R&D. We have lifted that number closer to 6, 6-plus percent of revenues in R&D because we believe that that's going to be one of our turbochargers to growth.

I think we had spent a lot of money coming out of the carve-out with Carlyle just to get the menu back to being competitive, but now, it's also about some of these disruptive technologies like dry-dry. So we have lifted that R&D spend, as we start to think about future platforms that will pay dividends 4, 5, 6 years from now, and I would say accelerating menu expansion.

And then -- and we're continuing to invest in the field. You mentioned -- you probably saw on the slides, we added over 60 people in the field in the fourth quarter because we believe that's going to be a driver of growth.

But on margin expansion, let me throw it over to Joe.

Derik, we've talked about this before on the road show, but we're going to see nice margin improvement in '21 as compared to '20, and I'm talking gross margin here now. And that's mainly because of the impacts of the pandemic that we saw in 2020 with idle plant facilities and freight premiums and things like that. So we should expect to see about 125 to 150 basis point improvement year-over-year in the gross margin.

And we'll see stronger margins in the first half of the year, and that's driven by a couple of things. One, like we said in the prepared remarks, we're going to have likely higher COVID revenue in the first half of the year versus the second half, which drives higher margins. And we also -- we're going to see -- as the inventory was building in the first half of the year coming out of the pandemic, you'll see some nice absorption impacts hitting the P&L, and we're going to see some favorable product mix.

I think I would expect to see the gross margins a little stronger in the first half of the year than in the second half of the year. But overall again, full year should be about 125 to 150 basis point margin improvement year-over-year.

Yes. Maybe also, Derik, to follow on to that, as Joe has talked about, I mean if you back COVID out, we're guiding to close to 10% in our core business. And with the formula Joe's built, this 1.2 to 2x operating leverage, you can see that will get us some nice margins for the total year.

Great. And can you talk a little bit -- just to follow up on this, can you talk a little bit more about inflation sensitivity and just labor cost? And sort of are you -- it sounds like you're going to be able to offset what you think is going to be coming in for potential labor -- potential inflationary pressures?

Yes, that's right. We've got the price erosion that this industry has been seeing for years now of about 1 point a year. And then you've got the normal merit increase that you would see with employees, which is fairly low this year. It should be between 1% and 2% on this year's numbers for the full year.

And with the value capture program that we've had in place for several years that's -- just as a reminder, generated over $200 million of cumulative savings, and we're targeting $20 million to $25 million annually. A lot of that value capture savings that we generate offsets and more, that inflation that I just mentioned.

Our next question comes from the line of Erin Wright with Crédit Suisse.

In terms of the first quarter trends andin particular, what are you seeing in terms of like stocking dynamics? Or what are you seeing in terms of the actual pull-through on analyzers year-to-date?

Yes. Look, I think Erin, as you know on the analyzers, we kind of look at the install base in 2 categories. We look at the total number, which we always want to be around that 4% to 5% in that total number, which we would have been at in the fourth quarter as well as we believe in Q1. But we, more importantly, want to see that integrated in double digits. And that's where I think we're seeing a significant difference. And it's not only our existing analyzers upgrading to integrate, but it's winning new business with integrated.

So I think that's one that is driving a lot of this growth. And I think that -- that, and I think a lot of the -- we expanded the field organization starting 12 to 18 months ago. In this industry, it takes a good 12 months to really kind of get time and grade and starting to make an impact. And I think we're seeing that menu pull-through on the analyzers that are out there.

And I think COVID gets a lot of press. And Joe talked about this with our COVID number last year, but we also are introducing other tests. Like PCT was a big test for us to introduce, for example, in the United States in the second half of the year. So we'll continue to add on to that. But we'll probably see similar install base numbers in the first quarter.

Okay. Great. And then in Europe, given there's been some additional lockdown, for instance in Italy, how are you thinking about the recovery across that market in particular?

Yes. Look, I think, Erin, what we've seen is almost similar to the United States and the developed markets where we were locked down so hard in Q2, while you're seeing a lot of protocols put in place from a lockdown perspective, like I said, we saw 4% growth in Western Europe in Q4. And that's probably the first time we've grown in Western Europe, I don't know, in 3 or 4 years. So we're actually seeing nice recovery in Western Europe and winning a lot of business there.

I would say the challenge for us in the EMEA region really had been the Middle East. I think one, it was our comparable. And two, we changed out the leadership team down there at the very end of the year, and I think that's going to make a difference for us. But we feel pretty comfortable with that 4 -- 3% to 4% number that we think we can get in that market.

Our next question comes from the line of Yi Chen with H.C. Wainwright.

You mentioned that the Chinese distributors have reduced their inventory in response to the pandemic. But considering the pandemic is largely under control in the country compared to Americas and Europe, is there anything that has fundamentally changed over there in terms of the IVD space?

Yes. Look, I would say, look again obviously, it's a different market than the United States. The thing that we think we're seeing that's significantly different than the U.S. is these doctor and hospital visits being semi-restricted to people really focused on emergencies. So you're not seeing the lift, at least we're not, in the elective procedures. So what we were really focused on, I would say, is 2 things. Number one, our e-connectivity, which tells us every single day with the analyzers with the tests are being run. And while we've seen tests slow, we have not lost business.

I would say the more important one, as I mentioned the silver lining, is this growth that we're seeing at 17% in the integrated analyzers and 9% in the total analyzers on the installed base. So we think as we move into to '21. At least this is what we've seen in the first couple of months. We've seen back to that double-digit growth, and things are coming back. I think it's just coming back slower than what we saw in some of these developed markets.

(Operator Instructions) Our next question comes from the line of Steve Mitchell (sic) [Steve Milunovich] with Wolfe Research.

One of the things that folks like us spend a lot of time thinking about is of course COVID testing. And I know there's been a lot of focus on antigen testing in the call. But I wonder if you could just -- maybe this might also bring in Mike. But talk about how the market has evolved over the last year, and what COVID has meant for your customers and how you interface with them. And if COVID has had an impact on how you and your core business think about competing with other companies in the market that are growing really fast.

But a lot of moving parts. I'd just be interested to hear how you think about that high level.

Steve, I'm going to let Mike take that one. And remember, we are not doing molecular right now or point of care. So we are a little bit different than some of the Abbotts and the Siemens. But let me have Mike kind of spend more time on how he's seen it evolve because he kind of leads that group.

Steve, so a couple of things. So -- to step away from the tests and just talk about some of the dynamics that have changed in the market, interfacing with customers, I think one thing that really has changed is just the ability to deliver effective communication and services remotely or virtually. And I think that's a trend that we were on a path to and was accelerated by COVID.

For Ortho, what we feel really good about is we were focused on those things before COVID, and we're able to -- already had some things in motion and were able to turn them on. I think what we now see is clearly those things last longer. But it's created new ways to interact with customers. I think we figured that out to some degree, but I expect that to continue to evolve. And so that's a heavy emphasis for us from a commercial point of view is finding ways to be effective in that manner. And there's some leverage from that, as you can imagine, when you can start to do things from home versus having to travel so much. So I think that dynamic changed. We've taken advantage of it, and we'll continue to take advantage of it.

As far as testing goes, I just would call it the whole scenario one that you just need to read and react. And there have been a lot of predictions on COVID, more wrong than right. And I think we've been careful to kind of play this quarter by quarter. But I think what's clear is that testing has a significant role. And while we see what's happening with testing and it may come off the peak as we're talking about second half of this year, there will be ongoing testing. It's accelerated some of the trends to a decentralized testing environment, whether it's decentralized professional point of care with pickup at universities, even employer health services and pharmacies. But what we see here rapidly in a lot of news this past week from the Biden administration, in particular, about driving it ultimately to the home. We're just seeing -- those were trends that were happening, and it's accelerating.

So when we look at this, it's a matter of seeing where we participate. And our first focus has always been on our hospital customers to help make sure they're taken care of, but clearly, this dovetails with some of the other things we've talked about, whether it's getting into molecular as an adjacency or point of care. So that kind of crosses over into our M&A strategy that post-IPO, we have a little more freedom to execute on.

Mike, maybe -- Steve, maybe one other thing, Mike, just talk about the -- some of the things we're working on in the antibody tests, like quant, semi-quant, like cases depending on what happens with the vaccine.

Yes. So again earlier on, Chris talked about it. We were out early with tests, very high-quality, high-performing tests. But as we monitor these trends, particularly around vaccine, I think it's anticipated that, that market will move to a quantitative need. So we're working on that for our antibody test. We are also working on in evaluating nucleocapsid test for the antibody, as you know, our initial test had spike. But as you move forward, if we want to look for reinfection in patients that have already had a vaccine, it's going to be important that we measure both the spike and the nucleocapsid so we can detect what the antibody reaction is due to. So those things are underway, and we'll be looking to develop the release in the not-too-distant future.

Okay. Much appreciated.

I think Steve had a follow-up.

I'm sorry, Steve. Go ahead.

I have two, one for Joe. I thought the perspective you gave on deleveraging, the 0.5 turn per year, really helpful. I'm wondering if you'd be willing to put any sort of color on the components of that bridge.

One, can you talk about what you think about free cash flow conversion in '21 and beyond, and to what extent should we think about cash taxes over the next few years?

Yes. So I'll take the last couple of questions first.

So the free cash flow conversion for '21 should be around 50% of our EBITDA. And that's going to be achieved through the increased EBITDA and growth we're going to see in the business as well as the increased cash flow from the lower debt levels as a result of the IPO.

The leverage ratio 0.5 turn a year decline, Steve, is really just based on the growing EBITDA in our projections as well as the required debt payments only. And so I also want to remind you that my leverage ratio uses a net debt calculation, so I'm assuming that all excess cash within the business stays in the cash line, won't reduce debt, but it still reduces the leverage ratio. So hopefully that helps.

That is super helpful.

Our next question comes from the line of Patrick Donnelly with Citi.

Maybe just to piggyback on that leverage one, obviously, I know it's early to talk about thinking inorganically. But as you guys get below 4 as we get into '22, Chris, can you just talk about, I guess, priorities? Obviously, point of care seems like a pretty logical extension for you guys in terms of where the portfolio is. Can you talk about what makes sense organically and inorganically for you guys to continue to expand the portfolio here?

Yes. There's a lot to unpack on that one, so let me maybe take it a couple of different ways. So if you think about -- I will start inorganically and then finish with organically.

If you think about inorganic, we're very focused on our call point or where we believe our differentiation makes a difference. So for example, I think the obvious place of our call point are things like molecular. And I -- look, we had a pretty robust business development group already. Because we couldn't do acquisitions, we were doing so many strategic partnerships, things like IDEXX where we are the exclusive provider of IDEXX. And so that group has pivoted. And I will say that we think that molecular is an interesting opportunity for us because it's where our call point is.

I think the other place that is interesting is point of care. We believe that through this COVID that you're going to see a significant rise in things like point-of-care and even home testing. While we want to continue to partner with our hospitals and make sure that we're providing the testing in the hospitals, we do believe, especially around infectious disease and even tighter around respiratory and even maybe COVID, that there's an opportunity from a category killer perspective. So I would say that, that would be a very interesting place for us to look.

Look, and I'd say the other place that we think is interesting is that we're #1 in transfusion medicine or definitely anti-IH. And we think that that's an underserved market where there's opportunities. So that I would say, are all kind of some areas that we're looking at inorganically.

When you think about organically, look, our belief is to continue to do the menu expansion that we have. We think again that, that -- and you probably heard this in many places, we don't think we've seen the first or the last COVID. And we think to be ahead of the curve, we think it was advantageous for us to be on the front end of that as being a world leader in infectious disease. So we'll continue to expand and bring out that menu there.

We think cardiac and acute care is an interesting place where we can continue to expand and utilize it. And then we think it's about continuing from a new platform. And we think -- we'll talk more about dry-dry later in the year when we do kind of an Investor Day, but we think that there's some unique opportunities there.

Mike kind of drives all that. Mike, and I took -- I hope I didn't take too much. But let me let Mike kind of finish off the question on organically, some stuff to you and your team are thinking about. He also runs M&A.

Yes. Look, Chris, I think you covered the main items. The one I would say, and you put it in organic growth, is the IA menu. But that is, for us, as we look at some of our potential MA targets or partnerships, what can we do with some current external companies to accelerate that faster, even get some novel new areas that come back into our base technology. So that's the only in addition -- I think, that plays on both inorganic and organic as a priority focus.

I think we saw really through COVID and also through PCT, our broad footprint of 2,200-plus people, if we can get the right test, we can move it pretty quickly and keep -- and have growth higher than the market.

That's really helpful. And then maybe one for Joe just on the guidance. I think it was mentioned earlier, 1Q came in well above expectations. 2Q, you faced a really easy comp on the COVID side. So it feels like the first half very much derisks kind of the overall range and almost calls for the second half to be more flattish.

Can you just talk to, I guess given it's your first quarter coming out with guidance, your philosophy around this? How conservative you are in the back half, given obviously a lot of moving parts in the global world at this point?

Yes. I think that's a good point. The second half revenue we did in our original expectations had some COVID antibody test revenue in it that we're going to pull down a bit, because based on what Mike said earlier, the general expectations in the market right now are coming down in the second half across many of the diagnostic companies. So we are pulling down some of the second half revenue due to COVID only.

But the base business is still growing very solidly in that mid-single-digit to even into upper single-digit growth range, so no impact there. But we are -- and I wouldn't say it's being conservative. I'd say it's just resetting with the expectations of COVID now in the second half that most companies are seeing.

Yes. I think the way to think about it, base business running faster than we had seen, and COVID slowing in H2.

Yes.

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

I was thinking of asking a 10-part question, but I'll be cognizant of the time.

Just on the guidance here, what is -- I guess how much were COVID revenues in 2020? I think I heard it $74 million. What are you assuming for Q1 on COVID and for rest of '21?

Yes. So Vijay, you're right. The '20 -- the full year 2020 number was $74 million. The Q4 number was $26 million in the prepared remarks. We didn't say what Q1 is, but Chris did say earlier that the COVID revenue in our projection for '21 is a couple points of the headwind. And so you could put that in the $40 million to $50 million range full year for 2021.

Front end.

And it's nearly going to be all front end, as I've just said, answering the previous question, first half of the year.

I think what we're seeing, Vijay, also, and a good rule of thumb is that whatever our growth is, we're finding it being kind of half and half. And so if you think about that fourth quarter and as we move into Q1, the guidance Joe gave at 15% to 18%, look -- you know that we'll be doing obviously COVID in H1, but it will slow down considerably, we think, in H2.

That's helpful, Chris, and then one follow-up. On -- I guess Siemens Healthineers is -- I think they're looking at close to $400 million of antigen revenues. Any reason why your central lab antigen revenues would look different from Siemens? And in integrated analyzers, up double digits, is that an acceleration or perhaps more in line with what you guys saw in '19 and '20?

Yes, I will let Mike talk a little bit about Siemens.

Yes, Vijay. So the revenue Siemens is seeing a report on is rapid point of care mostly out of Europe. I think they've done well there with their launch. But as you know, our antigen-based test is a high-throughput lab-based test. We do not yet have an offering for a rapid point of care, so kind of a different comp between the two.

Yes. So I think it's -- careful that -- on those comparables. Because we've been looking at core diagnostics and we backed off that a little bit with Q4 because a lot of them had thrown in their point-of-care diagnostics. And that's where all that revenue is coming from, which we don't have.

Yes. I want to come back to Joe, I think, guided that we'll only do $40 million to $50 million in total COVID revenue in '21.

Our next question goes from the line of Tejas Savant with Morgan Stanley.

Chris, I just want to pick your brains a little bit on India and Brazil. I mean you've highlighted those as areas of strength in the fourth quarter. Both have had a sort of very marked recent resurgence here.

How should we think about that? I mean perhaps sort of 1Q isn't too impacted, certainly sounds that way given your strong growth that you're expecting in 1Q. But in 2Q, what exactly should we expect in those two geos? I believe India, you had mentioned in the past as being over half of Asia Pacific outside of China.

Yes. Look, we've seen really nice continuation of that momentum that we saw in India in Q4 into Q1, so we feel -- we continue to feel really good about that kind of double-digit growth in India. And look, in Brazil I would say high single to low double-digit growth. Again, Brazil, we think, is a little bit more of a challenged market for us than India because of the install base, but that business continues to do well.

And so they're obviously contributing to our Q1 guidance that Joe gave, and I would say so is our developed markets. I think we're seeing good -- candidly, we're seeing really nice performance from all markets right now.

Got it. Got it. And then just one follow-up on the pipeline. In terms of sort of key assay launches to look forward to later this year, I mean, are there any that you'd like to highlight that are particularly impactful? I believe in the past, you've talked about troponin. And then the Vision Swift launch, I mean how should we think about sort of progress there?

Yes, let me have Mike take that one.

Yes. So one, I think look, we consider ourselves still in the midst of launching PCT in the Americas, in particular, which was good performance last year, but we expect to be good this year. We'll be expanding that. China is a market we'll be getting into for PCT later this year, and so I'd call that out as probably the main highlight. High-sensitivity troponin again is launched in certain markets. We expect to be submitting that for the FDA and are working towards that for the U.S. market. So that would be beneficial there.

When I come to Swift, Swift is on target for launch first half of this year, and again, we're excited about it as we've talked about it. There's a certain number of enhancements to that platform that helps us with security, speed and ease of use. And we think will be a value enhancer for not just our current customers, but attractive to those customers that did not convert to the original vision. So again, looking to get that launched this year in most markets, and excited about that one.

And just to note to Twanda and to everybody, I know that we are at 6:00 right now, we're willing to run a few minutes over. We have a few people in the queue, still, so we will take those questions. So for anybody who wants to stay on to continue for those questions.

Our next question comes from the line of Rishi Parekh with Barclays.

You went through a lot of the operational questions. You did talk a little bit about direction in terms of acquisition focus. Can you maybe just dive a little bit more into the M&A front? Exactly what areas are you looking to fill in? Are there any particular regions?

And as you think about M&A, can you talk about target leverage? I know you're going to try to delever 0.5 turn a year, but what is the target leverage? And what's your comfort level in terms of leverage if you decide to focus on some of these M&A targets, which arguably could come in at higher multiples?

Yes. Look, I'll talk a little bit, and maybe Joe can move from there. But look, we think there's some innovative ways obviously to structure deals depending on what is going on inside that business. And I think in particular things we've been looking at, what in that business is COVID-related versus base business, and I think -- so kind of you put that there. Look, I think that -- we think that there's the opportunity, because of our footprint, to be able to accelerate growth in a couple of these key areas that I mentioned kind of earlier in places like molecular or -- and point of care.

I would say the other thing that we would potentially look for, our strength is obviously in North America. I think we're -- we believe that China and Europe, there are some interesting technologies and companies that would also strengthen our positions there. So I think that would be something that would be interesting to us.

But on leverage, Joe, do you want to talk a little bit where you'd get comfortable? And maybe talk about the expansion of the line of credit, and we've got the ability to refinance and stuff?

Yes. So Rishi, we -- I said in the prepared remarks that our target leverage ratio over the next couple of years is 3 to 3.5x. But that could change based on strategic initiatives or growth opportunities or potentially be delayed, if necessary. Our business model, as you can probably tell from our comments, is pretty supportive with a highly recurring revenue stream and strong free cash flow generation for us to be acquisitive.

We've got visibility to the 4x leverage at the end of '21, but we do want to grow the company. And so we're going to continue to look at partnerships in creative ways to structure deals as we've done in the past. There could be earnouts that we could structure in the deal that could limit the amount of debt that we take on. But we do want to grow this company, and so we're going to have to balance that target leverage ratio with the growth. But ultimately, yes, I mean the goal is to get down to 3 to 3.5x at some point.

Yes. And Rishi, we'll be a very disciplined buyer. So I think that's really key. I think when you go public and you start to drop your leverage, everybody thinks you're going on a shopping spree. I don't think that's the case. We think -- I think we're going to be very fundamental where we have where we believe that we have differentiation, and I think we can make a difference.

And we think there's some unique partnerships. We'll talk more in the future about some of these China localizations, but it's giving us significant advantages from a local perspective. And it's going to give us quicker development of some assays that we think we couldn't have done, for example, in the United States. So there are some other ways to go about it versus just through M&A.

Our next question comes from a line of Mike -- Matt Sykes with Goldman Sachs.

Just on -- you guys talked about the growth in the integrated platforms. I'm also curious about, and you guys mentioned in the IPO, you also talked about the growth you've seen in automated. I know it's a much smaller part of your installed base, but just curious any on that growth and what you're seeing there?

Yes. From an automation perspective, Mike, do you want to kind of talk a little bit about what's going on in automation?

Yes. So I think one of the things we talked about is the automation is a focus area, right? It's in that progression for a laboratory. What I think that we benefited from initially as we've refocused on automation over the last several years is the higher end of our own customers, being ready for automation. We've also seen as an opportunity to take business. It's helped us win competitive accounts across the globe, frankly.

And then now our intention is to continue to do both of those things, but add in some automation solutions that are geared towards our more core customer, so helping us with more of the middle tier of our customer group and better penetrate them with automation.

And I've commented before, one of the advantages of our automation is that we don't have to bolt it to the floor. It's very flexible. Customers can start with one configuration. And as they grow and their lab expands, then we can add things in. But in the end, overall it has -- while it's been a small percentage, it's growing. It's 18% install base growth in 2020, and one that again we expect to see ways that we can keep growing that further in 2021.

Yes, just to kind of bring it home, I was in the Pacific Northwest last week with our team. And we just won a deal there that started as a competitive bid for a couple of 7600s. And one of the things that we've done a really nice job of is developing these reference accounts where we can take customers. And they weren't even thinking about automation at the time because of the size, even though their largest was a couple of hospital systems, even their largest hospital. But after going on this site visit and really spending time with customers, they pivoted to not only doing 2 7600s, they added 2 3400s and an automation system. And it was because of the modularity and the flexibility where it could work so well in a hospital that size and to drive the efficiencies.

And I think those are things where we now are, I think, introducing which is unique to us in the past. Rather than us just going and bidding on a couple of analyzers, we went in and gave them a full solution which included automation, showed them how it works, had them talk to customers who have experienced the amazing impact on efficiency. And it allowed us to win the deal where we may not have won it if we hadn't done automation.

Great, and just one quick follow-up. It sounds like we're going to get a lot more details on dry-dry at the Investor Day you guys talked about. But just given you've initiated feasibility work, are you still kind of sticking to that? I believe it was like a 3- to 5-year time frame to roll that out? Or is it going to be accelerated? Or are we going to get more details at the Investor Day later?

Yes. I think look, we'll give you a lot more details later. I mean, obviously, a lot of that will be driven from where we come out of validation and then regulatory approvals. But yes, I think that's probably fair to think of it the way you're thinking it, 3 or 4 to 5 years.

Our last question comes from the line of John Sourbeer, UBS.

Congrats on the quarter, guys. My cell dropped during the all, and I apologize if this was already asked. But the North America growth was pretty solid in 4Q. And given the anticipation in COVID revenue declines in the second half, can you provide any color on how you think this geography grows throughout the year?

Yes, so we're not giving guidance on the individual markets for the year. But I would say that we came out and told you guys a couple of months ago we were thinking about, I think, 7% growth, and we've lifted that to 7% to 9%, and are saying 10% without COVID. And I can tell you that the U.S. is the biggest driver of that growth. So the U.S. for us is performing incredibly well, and we see that continuing. And a lot of it has been driven over the last several quarters as we expanded the install base, but it is also because of menu expansion.

And by the way, John, we're going to have to start a tradition and let you be the last call -- the last question. We want to get off early, we may call you early and let you take the first question, just say it's the last one.

Sure. I'm happy to take the first one. I guess just lastly here, did you break out the difference between antigen and antibody revenues in the COVID revenue guidance of $40 million to $50 million?

No. No.

It's all in there.

You're not going to provide any color between the two?

No. Not at this point.

Not when you think about what the dollar amount is. It's not big when you look at the size of the overall business, it's only $40 million to $50 million.

Right.

So with that -- thank you, John.

With that, we'll turn it back to Chris for a few closing comments.

So we got a few more seconds, obviously.

Everybody, listen, thank you for taking the time. Look, I promise we'll get better at this as we go along from a quarter-to-quarter perspective. But we really appreciate the interest and the questions, and we look forward to hopefully seeing you guys or talking to you soon. Take care.

Thank you, everyone.

Ladies and gentlemen, this concludes today's conference call. Thank you for your participation. You may now disconnect.