QuidelOrtho Corp (QDEL) 2023 Q3 法說會逐字稿

Welcome to QuidelOrtho Third Quarter 2023 Financial Results Conference Call and Webcast.

(Operator Instructions) Please note that 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 statement. 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 and 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 1, 2023, and subsequent reports filed with the SEC.

Please refer to our SEC filings for a more detailed discussion of forward-looking statements and the risks and uncertainties of such statements. We cannot assure you that the forward-looking statements we make, or are implied by our statements, will be realized. Furthermore, such forward-looking statements represent management's judgments 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 U.S. generally accepted accounting principles, or GAAP.

Please see Slide 3 for a list of non-GAAP measures. Reconciliations to (sic) [of] these non-GAAP measures to their most directly comparable GAAP measures are included in the appendix to the investor presentation and the press release issued this afternoon, both of which are available on the Investor Relations page of the QuidelOrtho website.

Lastly, unless stated otherwise, all year-over-year revenue growth rates, including revenue growth rates 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. And for those of you that have known me a long time, you recognize that I don't sound normal.

Let me just say that having suffered through this over the weekend, we are definitely in a respiratory season and it didn't start in my house. And I note 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 preannouncement, 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 third quarter revenue of $744 million, with adjusted EBITDA of $169.2 million and 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 health care 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 in future demand for diagnostic testing. In our view, there's nothing further from the truth. In fact, patients deciding to forgo 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 U.S. Department of Health and Human Services reports that only 7 million Americans have opted to get the bivalent 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 very 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. And for many patients on fixed incomes, 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. Prior to prescribing any metabolic-based medication, doctors may order our laboratory tests to establish a baseline and would continue to do this in 6-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 to 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 health care CEOs during their recent earnings calls. Frankly, all companies in health care 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 dry slide 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 health care that is not as affected by the economy. Further, because of our dry slide technology, we have 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 [an wi] VBP tender, only the infectious disease panel, hormones and HCG are related to our business. There will be 23 provinces participating that represent [anwi's] 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 risks. Anticorruption 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 4 business units. Our labs business unit delivered 3% year-over-year growth in nonrespiratory 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 increase 19% versus 2022, which is the leading indicator of our labs business growth and durability.

I'm also pleased to note that with increased manufacturing output, we have now 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 a 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-XT7600 integrated system, a trend that also portends well for our recurring labs revenue in the future.

Finally, we reached a significant milestone with the 300 automation track system going live, further expanding our footprint and experience base 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. And as I reflect on the COVID-19 pandemic, we played a critical role in the public response to containing the spread of this deadly virus.

With the initial launch of the COVID-19 vaccine and subsequent booster shots over the last 2 years, there has been a shift away from asymptomatic testing and the necessity to produce a negative PCR test. However, the public has taken a greater responsibility for their individual health in understanding how viruses spread. We are seeing considerable volume from patients and 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 U.S. for our new Sofia 2 SARS Antigen+ 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 U.S. 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 [to] over 18 months and was not included in our 2023 financial guidance. And while the award will not make a material impact on our financial results, we feel privileged to continue providing our COVID-19 test to the U.S. government.

We believe by doing so, we're doing what we can to help 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 both quickly and accurately. Our transfusion medicine business met our expectations for the quarter and our immuno and hematology portfolio, which represents approximately 75% of the transfusion medicine business, grew 4%.

And 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, and in correctly 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 time frame that can affect treatment. I am confident we will receive Savanna instrument clearance by the end of this year, and launch commercially in the U.S. 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 those assays and panels that address unmet clinical needs. As an 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. And 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 because of this. Again, 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 in driving our next phase of integration, to create a highly efficient, agile organization rooted in operational experience. With nearly 18 months into becoming Quidel Ortho, we know more today than we did previously and 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 3 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 health care is what sets us apart. With that, let's turn the call over to Joe to review our financial performance and guidance to close out 2023. Joe?

Thanks. Good afternoon, everyone. Our top line performance in the third quarter was [markedly] impacted by strong and 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. And to assist with prior year comparisons, we've added [4 nearly] quarterly nonrespiratory and respiratory record charts for 2022 and the first 3 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 nonrespiratory and labs growth rates than quarterly results, which smoothes 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 nonrespiratory revenue growth within our communicated full year guidance [margin]. And note that there is some timing of instrument revenue between Q3 and Q4 that explains this varying growth rates for Labs business. But 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 lab business is well positioned to provide durable growth in both the near and longer term. Respiratory revenue came in strong at $185 million, which reflects 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 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 the regions, with instruments and lab showing strength in [Clinical Chemistry] (technical difficulty) 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, as I said, 1% compared to the prior year period. However, if you exclude COVID-19 revenue only, North America actually grew 10% and delivered solid revenue in the Labs business. In EMEA, nonrespiratory revenue increased 3% with strong performance in Transfusion Medicine. And as Doug said earlier, our China region achieved strong third quarter results of 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% gross margin, a 490 basis point improvement sequentially. Gross margin was driven by Sofia in North America, primarily 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. And 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. And during the third quarter, adjusted EBITDA was $169 million or 23% adjusted EBITDA margin to 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 $15 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 was 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 were 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 2x net debt leverage by the end of 2024. Towards 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 3x, and we continue to expect our net debt to be approximately 2.5x by year-end. And while we did not buy back any shares in the third quarter, we continue to maintain a balanced approach here. That is, 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 3 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 Q4. And 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 nonrespiratory business. And 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 end, moving to Slide 10, we are reiterating our full year financial guidance as follows. We expect full year '23 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 million to $775 million. And 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 [when we] 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.

Now 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 and adjusted EBITDA, with some higher FX impact on nonrespiratory revenue. Net interest expense continues to be expected to be in the range of $145 million to $150 million. And 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. And by the way, this translates into more than 100% of adjusted net income. Full year diluted weighted average share count is 67.3 million.

And 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 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 stand-alone basis.

Contrary to some recent opinions, we believe, as evidenced by our results, the market, the diagnostics market is positioned for continued durable growth for many years to come. And with that, I'll ask the operator to open the line for questions.

(Operator Instructions)

Our first question is from Andrew Brackmann with William Blair.

This is Dustin on the line for Andrew. As we look forward to 2024, just wondering if you can touch on some of the building blocks for revenue and 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.

Yes. 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 Savanna. So I would look as an investor to those 3 milestones. Joe, what would you add?

Yes. I was just going to add that we still expect the growth in the margins will be aligned with the LRP that we communicated about a year ago at Investor Day. So there's really no change there. And as Doug said, we have a lot of confidence in our labs business. And as I said in the prepared remarks, we have good visibility into that nonrespiratory business. Now as you think about sort of the more variable pieces and sort of more of the building blocks that we still have to work through between now and early next year when we provide '24 guidance.

It's the timing of the respiratory season Q4, Q1, it's the launch of Savanna. It's the endemic COVID levels and where that finally ends up at the end of this year. It's the synergy achievement, and then of course, there's inflation and FX to think about also. So those are all the big moving pieces.

Another question on Savanna. Good update on the approval time line 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 Savanna is a successful launch? .

We're in good shape from a menu development perspective, and the clinical trials will drive our success. So we will do several clinical trials throughout 2024, with an expectation that once the instrument has already been cleared that 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 market with at least 4 or 5 different panels before the end of 2024. And that would be our major objective.

We have instruments in inventory. We've recently completed the software update. We are fully manufacturing cartridges. And so I don't see any other constraint other than U.S. FDA clearance. And obviously, we will work with the regions to launch the Savanna product internationally as well. But obviously, we have pretty high expectations for here in the U.S.

Our next question is from Patrick Donnelly with Citi.

Maybe the first one is for Joe. I've 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. So first of all, again, we -- as I said on the call, probably a couple of times, we've got good visibility into the nonrespiratory business, and we expect a pretty solid Q4 for the Labs business. Of course, the growth, as you think sequentially, is going to be driven predominantly by the respiratory business.

And so if you think about where we are in Q3 with $185 million of respiratory revenue in Q3. The remaining guide, again, is to get us to what we've been calling this "normal" or typical flu season. And so to get to the high end of the range that -- for respiratory revenue that I talked about in the prepared remarks, you're looking to increase roughly $50 million from Q3 to Q4. And given what we know about the respiratory season, that doesn't sound super insurmountable.

And by the way, if that happens, we would be down about $115 million or 33% from the prior year Q4 respiratory revenue. So clearly, we're not planning for a record respiratory season like last year. We're planning towards this normal or typical season.

Yes. 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. And what would normally happen is, as we see a respiratory season emerge, the tests are going to come out of that inventory. And depending on how quickly that inventory bleeds down will determine what the distributors, the major distributors will order before the end of Q4. Sometimes, we've been holding our breath to the last week of the year, sometimes, but typically, it happens in the last 3 weeks. So that's what happens pretty much every year. Obviously, COVID changed that dynamic a little bit, but that's typically what happens. And right now, looking at what the ILI rates are, and the fact that I'm hearing that a lot of physicians are actually ordering the combo product, I think it's reasonable to expect that we'd have a bleed off that mimics what we've seen in prior years.

And so we won't see a lot of ordering, for example in October, we didn't. But we will be expecting that once distribution inventory levels sort of get down below a certain point, they will trigger them to order. And the speed with which they got there sometimes affects how much they order as well.

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, 3Q to 4Q.

Yes. Yes. It's driven by 2 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 2 things are going to drive the increase in gross and EBITDA margin.

Okay. Understood. And then maybe just on the nonrespiratory 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 '24. 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 up to our test of record. But we do expect a tick up in Q4 on the Labs business. And frankly, this is maybe a little bit too much detail, but every Friday, I see exactly what we closed. And I have seen a ramp up in terms of the order rates. So that's my visibility to it.

Our next question is from Alex Nowak with Craig-Hallum.

That actually, just 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 thoughts.

Yes. As I mentioned, we will be up around 25% in China alone. And for the year, I think we're high teens, aren't we, in terms of growth 2023. So China clearly is back on track. It is a growth driver for us. And of course, the other major driver is the U.S. What happens in the U.S. because of the size is particularly important. So what we're seeing and expecting to see in Q4 is driven by China and by the U.S.

Alex, I'm sorry, I was just going to add that most of the regions are going to be up sequentially, Q3 and Q4. But the year-over-year growth, as Doug said, there's -- a lot of it has to do with China and the lockdowns we saw last year, obviously lifted.

Okay. Got it. And then so on Savanna, what has been the feedback so far at the FDA? And I'm sure they've had questions around the submission. And 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 super confident that we'll have approval for the box. And it will be approved by 510(k). We'll pursue CLIA waiver at our earliest opportunity. But it's not going to be in the EUA.

And that's 510 (k) 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.

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

Our next question is from Jack Meehan with Nephron Research.

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 -- and I think I heard SG&A was going to be 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 must be a disconnect somewhere because it should be more like mid-30s. It would not be -- and that's pretty much -- I think last Q4, we were at 32%, 33%. So it shouldn't be as high as 40.

Okay. I'll have to play with the model. But even getting to a mid-30s EBITDA margin, still pretty healthy kind of relative to the pro forma that -- if you put together the 2 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 the -- we expect the 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 2 shots on goal with cost synergies, projects that we called Synergy 1.0 and 2.0. And 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 in order 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. And I think you're seeing the beginning of it in the fourth quarter, and I would expect us to be able to report to you our expectations for the efficiencies that we will gain moving forward. But I can't emphasize this enough. We know what needs to be done.

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 2 sides to this, you've had other VBPs that have included clinical chemistry, and some of those have excluded our products because they're dry slide chemistry. And one, a couple of years ago, I don't have all the details in front of me, but we chose to participate. We did reduce price 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 so easily.

So in that case, 2 years ago, Ortho actually was the winner and did pick up the volume. So 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, pretty Draconian, but it could be valuable to us in order to retain our volume. And if that's the case, you heard me in my prepared remarks say that, that's 0.72% impact if we were to reduce pricing at that level. But that would be the worst case scenario, actually, 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. And that would be the impact if we didn't pick up any volume, but simply retained what we had.

Okay. Got it. And last question, The account -- maybe for Joe, the accounts receivable stepped up, I think, $85 million sequentially. What drove that?

Higher respiratory revenue in the quarter. And by the way, we -- our global DSO, Jack, is 33 days, and it's -- I believe it's 20 or less from the U.S. So all that respiratory revenue overachievement was in the U.S. So we've already collected all that cash. So yes, that's what [drive it up], and we've got a very, very solid DSO. Yes.

Our next question is from Andrew Cooper with Raymond James.

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? And if not, maybe what might be limiting that relative to some of the tailwinds that we think about in the space?

Andrew, you're specifically talking about the labs business or nonrespiratory, right? I mean I do think there -- again, we've got great visibility into this business. So...

Let's just start with the timing part of the question, if you want. So coming out of Q3, which is typically the lower in terms of instrument orders. Q4 not only is higher, decisions made before year-end. But often, if they're [sale] instruments, we would see them higher in the fourth quarter. So I'll start with that. I mean that's what's driving some of it. And then the question that Andrew, I think, is really trying to get at is, is there potential upside there?

And I would say, yes, but we have to deliver. We have to execute. And we have to get -- we've got to get installs. We've got to make sure that we've got everything covered on the supply chain side, and everything has to go pretty darn well to be a lot better than what we're forecasting, is -- how do you feel about that?

I'll leave it at the [crimina at the wall] side. But I'll comment further on the...

What they're witnessing, it's just the optimism of the CEO and the conservatism of the CFO.

But I will comment further on the seasonality of the last instrument revenue [and when] I think it is probably a good point to hammer on. If you look at the 5-year average of that legacy ortho business, Q1 and Q3 are typically the lowest instrument revenue quarters and the 5-year average is about 22% to 24% of the instrument revenue in those quarters. And then Q2 and Q4 are the highest revenue quarters for lab instruments, 25 to 28% of the annual instrument revenue. So we will see an uptick sequentially from Q3 to Q4 on Labs instrument revenue, yes. That I can say with a lot of confidence.

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?

Well, we've said before in terms of capital allocation that we look both at debt repayment as well as share repurchase. And 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. But we'll continue to be opportunistic for sure.

Our next question is from John Sourbeer with UBS. .

I was wondering if there's any additional color you can provide on the Savanna 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 Savanna offsetting this in 2024?

You are right that the play there for Savanna is to meet the need of bringing molecular testing closer to the patient. And so 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 the ease of use and the comments that we're getting from potential customers, we think that we will be successful. But I will say that if we weren't successful, somebody else in the space would be. Molecular testing needs to be closer to the patient. That need has been in there for a while. We're simply trying to do it and address it in a better way. But if we didn't get it done, if you're looking for what the trend is, the trend is going to be that it's going to be decentralized for sure. And I didn't understand, John, your question on the backlog of Savanna. We do have inventory. We do have inventory that we built in anticipation of a launch in early 2024. Frankly speaking, we would love to have shipped a lot more boxes in Q4, but we're not cleared yet. But again, I'm confident that we will be, and we'll be ready to launch.

Got it. 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. No. I don't think we've seen any significant macro changes in terms of capital availability or decisions delayed. No, it's been a fairly steady -- for a couple of years now.

Globally, we still average roughly 50-50 between cash deals and [by each rentals], that hasn't changed.

Right. And but the speed with which orders are coming -- I don't see the customer behaving differently in terms of making decisions differently. And 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 and/or immunoassay sales.

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 line.