Ortho Clinical Diagnostics Holdings plc

Welcome to the Ortho Clinical Diagnostic Second Quarter 2021 Earnings Conference Call and Webcast. At this time, all participant lines are in a listen-only mode. For those of you participating on the conference call, there will be an opportunity for your questions at the end of today's prepared remarks. Please note this conference is being recorded. An audio replay of this conference call will be available on the company's website within a few hours after this call. I would now like to turn the call over to Brian Brockmeyer, Vice President of Investor Relations. Brian?

Good afternoon, everyone, and welcome to the Ortho Clinical Diagnostics Second Quarter Earnings Conference Call. With me today to discuss our financial results are Chris Smith, Ortho's Chairman and CEO, and Joe Buske, Ortho's Chief Financial Officer. Mike Iskra, our EVP of Commercial Excellence and Strategy, will join us on the Q&A portion of the call. This conference call is simultaneously webcast on the investor section of our website, and a version of today's presentation can be downloaded there. We'll start with a safe harbor statement and then proceed with the call. Some of the statements we will make during this call which represent our expectations or beliefs concerning future events are forward looking statements within the meaning of section 21E of the Securities Exchange Act of 1934 which provides a safe harbor for such statements. Our use of forward looking statements is subject to a number of risks, uncertainties and other factors that could cause actual results to differ materially from our current expectations. These risks and uncertainties include, but are not limited to, those factors identified on slide two of today's presentation and our other filings with the SEC. Please 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 forward-looking statements we will be making... we make will be realized. We undertake no obligation to update any forward-looking statement to reflect future events, developments, or change circumstances or any other reason except as required by law. During today's call, we will also be a discussion of some items that do not conform to U.S. generally accepted accounting principles or GAAP. Please see slide three for a list of these non-GAAP measures including but not limited to core revenue. constant currency, EBITDA, adjusted EBITDA, adjusted free cash flow, and adjusted diluted earnings per share. Reconciliations of these non-GAAP measures to their most directly comparable GAAP measures are included in the appendix to the investor presentation and press release issued this afternoon, both of which are available in the investor section of the Ortho website. In addition, on today's call, we will refer to our core and our non-core business, our clinical laboratories known as clinical labs, and transfusion medicine businesses represent our core business. Our non-core business is comprised of our contract manufacturing and licensing revenue. Now, I'd like to turn the call over to Chris Smith, Orthos Chairman and CEO. Chris? Good afternoon.

Thanks, Brian, and welcome to Orthos Q2 2021 Earnings Call. Before diving in, I would like to welcome Brian Brockmeyer as our new VP of Investor Relations and especially thank John Sanders, our treasurer, who's been leading our investor relations program during the IPO process and our first two quarters of a public trade company. With that, let's dive into the second quarter results. If you look at slide four, I always love to begin with our mission statement. And it briefly states, because every test is a life. This is why we do what we do. We embrace this credo and this critical role that we play in the global healthcare system every single day. And I want to thank all our global teammates around the world for all they do every single day to deliver on that promise. Today, we'll help over 800,000 patients through this promise. And thanks to those teammates. Shifting to Q2 21 highlights on slide five, the company has continued to perform extremely well with our three quarters in a row of strong growth. During the second quarter of 2021, as compared to last year's second quarter, we grew our core revenue 23% in constant currency to $488 million. Our base business, excluding COVID, was up 27%, further demonstrating the strength of this core business. We generated adjusted EBIT of $128 million, an increase of 27% as compared to the second quarter of last year. And very importantly, our adjusted cash flow in the quarter was $144 million, up $191 million year on year, which benefited from a $75 million of receivable serialization in the quarter. Overall, we had very strong first half of 2021 performance, which is largely reflected in our team's dedication to growing and improving our business with innovation and commercial expansion. As you know, we shifted our strategy in 2019 to diligently manage this business for growth as opposed to value, and this is a clear testament to those efforts. Slide six illustrates this growth trajectory seen in our core business over the recent years, and in particular, the strength in the last three quarters. We also delivered solid growth in our install base, which is a great leading indicator of future revenue growth, and this includes the consistent double-digit growth of the all-important integrated systems shown here. We'll discuss this in more detail in a few slides. We see a significant opportunity to carry this strength forward as we continue into the second half of this year and well into the future. Lastly, I'm pleased to report that given our strong first half performance and sustained momentum, we are raising our full year guidance across all key metrics. Our outlook for the full fiscal year is now 10% to 12% core revenue growth, up from 9% to 11%, which we shared last quarter. Please note that we expect the contribution of COVID-19 testing sales in the back half of last year to impact our year-on-year growth rates in the remaining quarters for the year, given our expectations for declining COVID assay sales in the second half of the year, which is fully embedded in our guidance. For adjusted EBITDA, we are now forecasting growth of 15% to 17%, up from 14% to 16.5%. Joe will touch on these changes on the remaining metrics shortly. Moving on to slide seven, which really outlines our three strategic priorities to drive profitable, sustainable growth and shareholder value. These priorities are product innovation, commercial excellence, and operational efficiency, and they're integral to our long-term sustainable growth. and we will continue to invest and devote energy into each. I do want to touch a couple highlights on each one. If you look under product innovation, we launched the first high-throughput quantitative test, an all-important test as we continue to understand the COVID pandemic and what it's doing to immunity. While this is early days, we're excited about the opportunity to partner with clinicians and leading researchers to understand immunity levels, and we think this test will be key. If you shift over to global commercial excellence, We were again ranked number one by service track for service. This is the sixth year in the award year that we've been earned that award. And to give you an example, this year was the best performance we've ever had. Service tracks all the manufacturers in 37 categories, and we were first in 35 of the 37 categories. In particular, one that we think is all important to talk about service levels, which is MPS, we were over 20% higher than our next closest competitor, a true testament to our team and how important service is to our customers. And finally, if you look at operational efficiency, many highlights, but I do want to call out that the leverage we've got down now to 4.0, and we're well ahead of what we forecasted at the beginning of the year. And again, Joe will spend a little more time on that later on. Moving on to slide seven, which outlines our strategic priorities for driving, oh, excuse me, On slide 8, we highlight the opportunity for organic growth that MU-Assay market represents. Ortho has historically been a leader in the clinical lab business, and we have strong market share with many different products. The ClinLab business has an addressable market of approximately $26 billion, and we compete in the largest IVD markets here with our clinical chemistry and our MU-Assay solutions. As we discussed in the past, moving customers from a standalone analyzer to an integrated analyzer is fundamental to our growth strategy. In 2020, our clinical labs revenue mix was weighted heavily towards clinical chemistry with a 62 to 38 split, while the broader market was reversed with 68% of revenues coming from the IA business. We believe this mismatch between our revenue mix and the proportion of the broader market represents a significant growth opportunity for us to expand our IA market share. and to grow our revenue. This gap can fill through our increasing focus on lifetime customer value and expanding our menu and our install base of integrated analyzers. We are already seeing greater integration penetration with each passing year and believe automated placements will continue to gain momentum. And to give you an example, for the quarter, we registered an impressive 17% growth in our IA business. IA testing for infectious disease and advanced diagnostics is typically the highest revenue and highest margin business in the in the clinical lab side of the business, which will help us continue to drive our revenue going forward and improve our margins. If you shift to slide nine, I'd like to talk about the regions and the result activities in each of these groups. In the Americas, which represents Canada, the US and Latin America, it is now 60% of our total business and it grew 21% for the quarter, 30% without COVID. Driving this continued double-digit growth is placements, especially of our integrated systems, our menu expansion, which is all important because of the pull-through that we can see in the labs, as well as CTS, which was a new agreement that we entered into in the first quarter. In EMEA, which represents 14% of our total business, the team is gaining traction, and we saw growth of 24% in Q2, with Western Europe leading the way with 28% growth in the quarter. And as you know, when we went public, we talked a lot about the importance of growing Western Europe, and that continues to deliver. It's rebounded nicely as a result of the leadership changes that we put in place over the last couple of years and our continued focus on expanding commercial focus. While Greater China represents 12%, we had nice growth of 23% in Q2, but we continue to see a slower recovery from the pandemic than other markets. This recovery has been slower in our slide and chemistry business due to slow recovery in routine patient business and testing, which is weighted really towards chemistry. A highlight is the growth of 7% install base and 15% in our integrated systems, which will be a good indicator for future growth. And to give you an example of how we shifted this integrated system, we actually saw 40% growth on the IA side of the business in China in Q2. Other, which includes Japan, India, and other Asia-Pac countries, grew 24%. In addition, we're incredibly pleased with the rebound in most of our emerging markets, which combined grew 48% led by Latin America and India. I will now turn the call over to Joe to further discuss our Q2 financial results and our outlook through the rest of the year.

Joe. All right. Thank you, Chris. As Chris just noted, Q2 builds on our momentum since we became a public company. Compared to the pandemic-impacted Q2 of 2020, we saw a meaningful recovery in our base business that fueled robust revenue growth across all of our geographies and segments. Now let me provide a little bit more detail on our operating results for the quarter and full year, starting with a breakdown of our revenues on slide 11. Please note that all comparisons are versus the prior year period unless otherwise mentioned. We posted total revenue of $492.5 million. This is up 26.1%. on a reported basis and up 22.4% on a constant currency basis. Core revenue, which excludes contract manufacturing and other licensing revenue, grew 22.5% on a constant currency basis to $487.5 million. The substantial revenue growth in the second quarter was primarily driven by the continued recovery across our geographies in both ClinLabs and Transfusion Medicine. Our business generated $17 million in COVID-related revenue, which was down from $27 million in Q2 of 2020, representing approximately a 450 basis point headwind on total company core revenue. In our guidance, no COVID-related revenue is in the second half of 21, representing an approximately 570 basis point headwind on total company core revenue growth. As a trusted partner of hospitals, hospital networks, blood banks, and labs around the world, our core business bounced back fairly well from the pandemic-induced low points we saw in the second quarter of 2020. Pleased to say our base business has continued its trajectory of year-over-year growth. ClinLabs revenue grew to $325 million from $260 million, a 21.1% increase on a constant currency basis, largely driven by all geographies showing double-digit growth on a constant currency basis. In our TM business, we saw 25.3% growth on a constant currency basis, or $162.4 million in revenue for the quarter, compared to $126 million in the prior year period. Within transfusion medicine, we experienced growth in the Americas, EMEA, and other aspects, primarily Japan. Q2 benefited from our new partnership with CTF, which again went live in Q1 of this year. Non-core revenue grew to $4.9 million from $4.3 million for the second quarter, primarily as a result of timing. Now onto slide 12, which outlines our geographic region results for Q2. The Americas revenue in the second quarter grew to $296.3 million from $241 million in the prior year quarter, or 21.3% growth on a constant currency basis. due to pronounced growth in ClinLabs and transfusion medicine within the region. A median revenue of $67.8 million was up 24.3% on a constant currency basis from $51 million in the prior year quarter. Our greater China segment revenues of $58.5 million increased from $43.3 million or 23.2% on a constant currency basis. And finally, our other segment, which includes Japan, and Asia Pacific markets had revenue of $69.9 million up from $55.2 million, which was up 24.7% on a constant currency basis. Now turning to slide 13, we delivered another solid quarter of performance below the top line with improvements in gross margin and free cash flow in the quarter. Gross margin for the quarter was 49.6%, which is 160 basis points increased primarily due to lower manufacturing costs. Within both cost of sales and operating expenses, we've seen higher spot air freight rates, as we've previously discussed. This trend continues, but we are actively managing and monitoring the situation, and we've included these higher costs in our outlook. Our Q2 SG&A expense is higher year over year versus Q2 20 by $29 million due to higher stock and compensation expense, distribution freight expense, public company operating costs, and finally foreign exchange impacts. Adjusted EBITDA for the second quarter was $128 million, up 27% compared to $100.9 million in the second quarter of 2020, primarily driven by the strong gross profit as well as improving operating leverage. Our adjusted earnings per fully diluted share for the second quarter increased to 16 cents in comparison to just 2 cents last year, driven by our solid operating performance as well as lower interest expense as a result of our debt pay down in the IPO. Interest expense for the period was $33 million compared to $47.5 million in the year-ago period. Our provision for taxes was $15.1 million compared to $3.8 million in the year-ago period. On a gap basis, net loss for the second quarter was $20 million, or $0.09 per share, compared with a net loss of $41.3 million, or $0.28 per share in Q2 2020. Now, let's turn to slide 14 to discuss our free cash flow, capital deployment, and balance sheet. In the second quarter, we generated $144.1 million in adjusted free cash flow, after funding $5 million for CapEx. This number includes the securitization of 75 million of our U.S. accounts receivable in an off-balance sheet transaction. Our global DSO at the end of Q2 stood at 42 days or 22 days favorable to the prior year. Now, without the benefit of the off-balance sheet financing transaction, our DSO would have been 56 days or still eight days operationally better than the prior year. The receivables financing transaction created a shift between operating cash flow and financing cash flow and did not result in additional cash on the balance sheet. We expect cash generation in the second half to be in excess of $100 million, with Q4 making up about 80% of our free cash flow and Q3 contributing to about 20% due primarily to working capital seasonality. Our strong cash flow generation and the accounts receivable securitization enabled us to continue to deleverage our balance sheet and reduce our net debt to EBITDA ratio down to four times down from 4.4 times levered at the end of Q1, which again is ahead of our leverage improvement target for the year. Given the strength of our business performance, we remain confident in our ability to reduce this leverage ratio by at least a half a turn a year going forward as we move towards a more normalized leverage ratio of 2.5 to 3.5 times, providing additional capacity for M&A opportunities. We ended the quarter with cash-in-cash equivalents of $200.9 million and total debt of $2.3 billion. Turning to slide 15, now let me remind you that continued debt reduction is just one facet of our balanced capital deployment strategy. We are actively evaluating organic and inorganic growth opportunities that would complement our core business, further increase operating leverage and give us new or additional exposure to high growth markets. To date, we have established a successful track record of partnerships with industry leaders, including Griffles, IDAX, Thermo, and many others, which truly sets us apart from the competition. While we are guided by our focus on the continued development of industry-leading innovative solutions for patients around the world, we believe that our expertise gained through these highly collaborative partnerships, coupled with our market-leading position in the attractive IVD space and healthy balance sheet following our January IPO, provide us with an excellent platform to pursue bolt-on acquisitions to accelerate profitable growth. Our targets are high-growth, high-margin products that we can sell through our existing global call points and distributors, including molecular, specialty IA, and point-of-care diagnostic systems. We also see an increasing opportunity to bring more value to our customers and patients over time through digital and informatics solutions. We see this playing across both our clean labs and our TM businesses. In terms of financial criteria, our focus remains primarily on bolt-on and niche opportunities where we can see revenue growth, accretive earnings, and deliver an increase in return on invested capital. Our balance sheet has considerably improved since our IPO, and as we continue to reduce debt and generate cash, our capacity for these types of acquisitions will expand. Now turning to our 2021 outlook on slide 16. With the very strong momentum across our portfolio during the first half of the year and continued strength through the early part of Q3, we are raising our guidance as follows. Full year 2021 core revenue within a range of $1.950 billion to $1.980 billion, and core revenue to grow between 10% and 12% on a constant currency basis. That's up a full percentage point of growth from our prior guidance. Second, 2021 adjusted EBITDAs also increased to between 526 million and 534 million, or 15 to 17% growth on a reported basis. And then finally, adjusted diluted EPS will now be in the range of 67 to 72 cents per share for the full year 21, based on full year diluted weighted average share count of 244 million. Note that in the back half of the year, We expect our diluted weighted average share count to increase approximately 500,000 shares per quarter. We're confident in our ability to model our business as the 93% recurring nature of our revenue gives us substantial visibility into the future. We expect to continue to grow the top line across our core businesses in all of our various segments, and at the same time, drive margin expansion and operating leverage through our value capture program and increased placement of integrative analyzers. Given this, we continue to believe that for every percentage point of revenue growth, we expect our non-GAAP adjusted EBITDA margin to grow between 1.2 to 2 times that, depending on our investments back into the business for that period. I couldn't be more pleased with Ortho's performance in the second quarter of 21, and I'm confident that we're building a platform for continued growth. Thanks to all of our teammates worldwide who've delivered on these results. And with that, I'll turn it back over to you, Chris.

Thanks, Joe. Before opening the line for Q&A, I'd like to spend a few minutes on slide 17, outlining the core tenets of our investment thesis that we talked about during the IPO that allows us to create long-term shareholder value. The first tenet here is that we are now one of the only publicly traded pure plate IBD companies. This is important because while a number of our peers have a presence in IVD market, many of them are part of large conglomerates and have several areas of focus outside diagnostics. Next, we have clear differentiation that creates this lifetime customer value, which is really driven by our reoccurring revenue stream. Our strong reoccurring and predictable revenue allows us to consistently invest in our R&D and innovation efforts and support our strong operating model. And finally, we have built strong momentum over the last two years, which Joe has just outlined, and it's carried us forward into the first half with strong top-line growth and profitability. We believe our core growth is sustainable, and we have numerous opportunities to expand our business and drive long-term shareholder value. Now I'll throw the call back to Brian, and we'll begin the Q&A process.

Operator, we'll take the first question.

Thank you. We will now begin the question and answer session. If you have a question, please press star then 1 on your touch tone phone. If you wish to be removed from the queue, please press the pound sign or the hash key. If you're using a speaker phone, you may need to pick up the handset first before pressing the numbers. Once again, for any questions on the line, that's star then 1 on your touch tone phone. Standing by for questions. And our first question on the line comes from Mr. Vijay Kumar from ISI. Please go ahead.

Hey guys, thanks for taking my question and congrats on the print and guide race here. Chris, maybe on, hi Chris, maybe on Americas here, the sequential declines, maybe I'm not looking at this the right way. It seemed a little light. Was this just the timing of CTS contract here when I'm looking at the sequential trends or perhaps could you talk about the underlying, you know, immunoscientific clinical chemistry markets, if there are anything that's going on on an underlying basis? given the Delta variant spread.

Vijay, you're talking about from Q1?

Correct.

Yeah, so look, I think when you look at sequentially, so as you know, the base business is really important to us, which is really that day-to-day business. And so when you back out things like COVID, which is going now, it's really becoming a headwind every quarter. We actually had sequential total growth as a company of around 3% to 4%. And so what we call our base business, which is really that reoccurring things when you back out stuff like COVID or contract manufacturing. But, Joe, do you have anything else to add on this, particularly the Americans? It's the same theme, Vijay, on Americans.

If you were to back out the COVID revenue, the base business is actually up sequentially a quarter of a quarter.

Thanks for clarifying that, Joe. Maybe one on the guidance here, Chris. If I look at the back half, correct me if I'm wrong, but ex-COVID headwinds, the base business implied as high singles. And when I look back at your comments around integrated and start-based growing mid-teens, that's 25% of your mix. I mean, the business is growing 4% just based on your integrated and start-based growth. With your remaining rest of the portfolio growing in a load of mid-singles, I think Now, I'm getting to, you know, something 6-7 for the outlook, maybe peg it back by a little bit of pricing. But why shouldn't, you know, this business be a solid 5-plus? I expect some of the comp issues on Cohen. Is that, you know, when I look at these insult-based numbers, is that the right math, Chris?

Yeah, well, look, we definitely think this is a 5-plus growth business. And, look, I think, Vijay, so you have to remember – COVID is a huge headwind as we move into the second half of the year. So while we're guiding to 10% to 12% revenue growth, it's higher when you back out COVID for the year. When we think about our year from a COVID perspective, it was significant. So I think that maybe when we catch up one-on-one, but Joe, do you want to throw more? Because look, at the end of the day, the business is pretty robust and that integration is driving it, especially around the IA side of the business. I think one of the challenges you have, for example, in comps is you didn't have, COVID's going backwards. And I think that's an important component of that. And then I think from a positive perspective, as we move into the second half, we'll have CTS, where we didn't have CTS in the second half of last year.

Yeah, hey, Vijay, just to add on to that, remember that the COVID revenue is going to be almost a 600 basis point headwind on our revenue in the second half. And so it is fairly significant. So, you know, if you exclude that, I think you're going to see the core business growing, you know, in the area that you're expecting.

Operator, our next question.

Thank you. Our next question on the line comes from Mr. Tejas Savant from Morgan Stanley. Please go ahead.

Hey guys, good evening. So just one more on the COVID situation here. Chris and Joe, can you perhaps elaborate a little bit on trends in July? I mean, are you starting to see any cracks appear in terms of the situation on COVID reversing? And on that note, I know you've excluded everything on a contribution basis in the back half of the year. Is that starting to change here, I mean, given the Delta variant and your launch of the quantitative antibody test?

Yeah, look, I think it's a great question. Look, I would say every part of the world right now is a little bit different. And I think it's been interesting. So we are being conservative on the revenue. As Joe said, we're guiding to zero revenue revenue. of COVID in the second half of the year. However, we did spend money and R&D dollars in the first half developing a couple of products that we just brought out. So the nucleic acid and the quant are huge for us. And that was really around if COVID does start to take off. So the quant is still too early. We just rolled that out. The United States just got approval, the only one out there right now that has approval. I think our challenge is right now the World Health Organization and CDC is struggling to find out what does your number mean. And so I think what you're probably seeing early days with us on that test is working with clinicians and researchers around clinical trials to be able to create studies that shows what that number actually means. So we can give you what the number means. But the market and the clinicians have not yet said. So I think that we're going to see in the second half how important that becomes. I think as research starts to come to market and people understand the importance of that test, I do think that test will take off. But I think it's more around us, just it's an unknown. It's kind of like we talked about last year. We want to be available to provide it to our customers. But at the same time, we think we're building it from a conservative revenue perspective.

Got it. And then, Chris, one quick follow-up for me on 22. I know you probably don't want a guide just yet, but as we think about the comp here, I mean, you've taken up your guide for the core constant currency growth number by about 100 bps or so at the midpoint. And so for next year, I mean, how comfortable are you getting to sort of mid-single-digit-plus growth on a year-over-year basis?

Yeah, so a couple things. So I love your first comment that we're probably too early to guide into next year. But a couple things that I think you can refer back to, and we kind of talked about what we thought this business looked like on the IPO. So we believe that we should be growing at or above market. So I think that kind of helps guide you. I'd say the other thing, a couple things have happened. I think one is Western Europe in particular is performing really well. And you have to remember, we had five years of backwards growth there. And that's really been a shift for us. And I think it's It's been an incredible positive. I'd say the second one is that our key emerging markets, so Mexico, Brazil, India, are performing significantly better than they had in the past, as is the U.S. So if you look at all our markets, they're actually all performing better than we had projected. I would say the one caveat is China. And while China is growing in the mid-20%, our business there had primarily been chemistry, dry-slide chemistry. And we are seeing a slower rebound there because that's mainly around routine testing. Now, I'm really pleased I announced this to China that the IA business grew 40%, so that's important because we're placing those, and our integrated analyzers in China grew 15%. But other than China, which is still growing nicely, we're seeing great things from all the other areas. So I think we feel pretty confident that we can grow at or above market.

Thank you.

Next question.

Thank you. Our next question line comes from Tycho Peterson from JP Morgan. Please go ahead.

Hey, Tycho.

Hey, I'm actually going to pick up where you left off on China because, you know, you were up 23 percent, but then you did comment, you know, slower to return. So can you maybe touch on those dynamics and what you're thinking for the back half of the year?

Yeah, so look, I would say that China was impacted very, much more than anywhere else in the world for us last year. And I think a lot of that, as you start to get to know this COVID and you understand what's flowing through the hospitals, we really started to understand that this has been a lot around this routine testing and folks that would go to the hospital on regular things. And you're just not seeing that bounce back yet in China like you're seeing it, for example, in the United States or in some other markets. And so, look, we still feel really good about the outlook, double-digit growth in China for the year. I think they were on our internal projections, but it's just taking slower to bounce back on that chemistry side of the business than I think that we probably thought.

Okay. On the transfusion side, you highlighted the optics reader in the presentation. Can you just talk about how meaningful that is in terms of the overall portfolio there?

Yeah, look, it's incredible meaning because it rounded out our portfolio. We've got Mike on the call. Mike, who runs kind of the product group. Mike, you want to comment a little bit more on the optics reader?

Yeah, will do, Chris. Thanks, and hi, Tycho. The optics for us really does round out the portfolio. It gives us a little more automation at the low end of the market, which should help us in some of the smaller markets, lower volume sites. but it also helps us where we have a high degree of presence in the larger hospitals when they need a backup solution, the optics will help us there. And again, all that's rounded out. We did not just launch the optics, but we launched the Vision Swift product line, which is going pretty much in line with expectations. So a complete offering now with the immunohematology platforms and one that we think makes us even more competitive than we were already in our market-leading position.

Okay, last one for me. I appreciate the commentary on COVID as it relates to guidance and the headwinds there. You do have the BARDA contract, $54 million. Is that baked into the back half of the year, or how should we think about that flowing through?

Yeah, Joe, you want to take that? Yeah, hey, Tycho, it's Joe. So just to be clear, that $53 million BARDA contract that we did our press release on, that's for CapEx. It's not revenue. And so we're going to be building a manufacturing line in Rochester to help with future, hopefully not future, but a pandemic if there ever was one in the future. So it's not revenue, that's CapEx, where we get reimbursed for CapEx spent over the next 12 months.

Thank you. Our next question on the line comes from Derek DeBruin from Bank of America.

Hey, Derek.

Hi, good afternoon.

So, you know, your slide eight where you've got the 30% spread between email assays in which you sell currently and the market, what do you have to do to close that gap anymore, right? Are you still building menu? Do you have to wait for existing contracts to roll off so people move their platform there? Can you just give a little bit more about what you need to sort of shift that?

Yeah, look, I think the first big shift of it, Derek, is moving a – a standalone to an integrated. And so when you think about our business reviews with our teams, that is a high, high level of focus. And why we always talk about, we run our overall install base to grow four or 5%. We need that integrated growing double digits. And so the first thing is placing the analyzer. I will say the second thing is continue to bring out menu. And as you know, because of regulators around the world, menu drops at different times in different parts of the world. So I'll use PCT, which is launched in the United States, but hasn't launched yet in China. for example, which we think will be great there. And I talked earlier that we're in a partnership with a Chinese local manufacturer to develop some assays that will start in China and then roll the other way. So without question, menu's important. We have about 25 to 30 menu items that will roll out at different places over the next three years, so pretty significant introduction. We've, I think, brought four or five to market so far this year. So menu, obviously, is a key component. And then I'd say the third one is this commercial excellence. And I think that really gets under-discussed in this industry. But we have made a huge pivot in our field organization of hiring lab specialists, people that were med techs in the hospital, and basically keeping them in the lab to focus on pulling through menu. And there's been a lot of focus on that. And that's where you've seen this big lift in IA. Where China's up 23%, their IA's up over 40%. I would say it's all three of those levers. I think, look, without question, the last part of your question, contracts are key. Unfortunately, when you have them, they're great because they're long-lasting. When you don't, you have to move them. The other pivot we made on commercial was about 18 months ago, starting in the Americas and now moving across the world, is this hunters versus farmers. Our hunters, which are business development people, are now in contracts two years before they're due. And so we are winning a lot more than we've ever won. And I think that's helping us to keep that growth going. And I think it's reflected when you look at, I don't know what it was, but that quarterly growth, you can just see that we're continuing to accelerate. So it's all those things.

Yeah, as a follow-up to that question, I mean, there's a lot of debate in the molecular side of the market about what does the molecular diagnostics industry market look like, share look like, once you sort of get past COVID and because a lot of labs bought incremental systems and, you know, they've got multiple platforms and those are going to be consolidated. I'm just curious, do you think any of sort of the expansion and some companies doing better in the molecular space and doing like that will have any sort of like downstream implications on the IVD side of space?

Yeah, we got asked that a lot when we were just coming out on the IPO about these idle boxes for molecular, and I think Mike's talked a lot about that and how he's viewed his team from a commercial excellence. Mike, do you want to add a little more color about that?

Yeah, sure. Hi, Derek. So I think there's a couple things. One, within molecular today, the tests and the needs that are being served tend to be more specific assays where that level of sensitivity detection is critical. They tend to be higher cost, more complex tests that need to be operated differently, slightly differently in the laboratory. And so I'd say here in the near term, midterm, not much of a threat to the immunoassay part of the business where we are today. But I think this ties back in actually more, I'd say more of an opportunity for us than a threat in that, as Joe shared with you, based on where we are from a balance sheet point of view and what we can now do with capital, this is an area that we're not in, but we believe is coming to our sweet spot, that mid to high volume hospital, and it is a need that exists and one that we think we can serve, wrapped with our commercial organization that Chris talked about, and then of course our number one service capability. So in our minds, I think we see that far more as a near midterm opportunity than a threat.

Thank you. Our next question on the line comes from Mr. Luke Sergut from Barclays.

Great, guys. Thanks for the questions. How are you guys doing? Can you just talk about the step up here in integrated, you know, it's been taking up 14, 15 percent growth. Can you give us a sense of the mix there between the 7600 and 5600 and the implications there from a mix standpoint?

Yeah, great question. Mike, you want to talk about what's been going on with that on the 56 and 76? And kind of the way we're thinking about the refurb program for emerging markets and stuff.

Yeah, Luke, so the 7600 is the XT7600, which is the newer platform, is the driver, right? We are seeing far greater growth, we're seeing far greater absolute number of placements with the 7600 than the 5600. And so that part's not surprising. I think what is surprising that we're benefiting from is really the legs on the 5600. That analyzer's very proven, established, customers love it, and we're placing still a large amount of 5600s new in the market. But to Chris's point, the success we're having with the XT7600 is also giving us, as we replace some of our older 5600s, it's putting into a reefer program that integrated placement that we're now starting to move and use for more adoption in emerging markets. So right now the situation is being led by XT7600 but it's still a lot of strength by the 5600.

And maybe to follow on to that, Luke, real quick, as you think about this, we really talk about this lifetime customer value. You may remember that slide from the IPO. But we keep customers 30, 40 years. And what it allows us to do is upgrade a 5,600 customer to a 7,600. And mainly right now, it may be developed markets. Refurb that 5,600, which already has been depreciated, and take it into the emerging markets. And I will tell you, that's why you're seeing this high growth in places like in Latin America. You know, to give you an example, Latin America grew 70% in the quarter. I mean, and it's really being driven by the ability to place and pull through these refurb 5600s. So for us, I think it's a really nice strategy. As we look to our next platform, it'll be right about when that 7600 hits the timeline that the 5600 hit. And so we'll be able to continue to build on this and keep these customers, you know, really throughout a lifetime.

Okay, that's helpful. And then more on the back half guidance here. Can you give us a sense of how you guys are thinking about the gross margins where you have increased supply and logistics costs, but you've maintained your margin expectations there? Just give us a sense of the puts and takes that you guys have at your hands. Do you want to take that, Joe?

Yeah, sure. Look, I said on the last Q1 call that we would have stronger markets margins in the first half of the year compared to the second half of the year, primarily related to two things, and that is the favorable manufacturing absorption variances we're seeing in the first half because volume started to step up in the back half of last year, and we saw a lot of those variances hit the P&L in the first half of the year. In addition, you've got higher COVID assay revenue in the first half of the year versus the second half. And again, that COVID assay revenue for us, it's an immunoassay. It carries a higher gross margin than some of the more common clinical chemistry assays. So we are going to see a lower gross margin in the second half versus first half by about 100 basis points. And I still think that guidance holds true. What we're seeing now, and this is a comment I made in the prepared remarks, is the spot rates on air freight are remaining stubbornly high. In the guidance that we had provided earlier in the year, we had assumed that some of those air spot rates would come down in the second half of the year, and they're still remaining stubbornly high. As you think about the second half guidance that we just gave, it does include a little more pressure in both the OPEX and the GP margin for those higher spot rates because you've got inbound freight hitting GP and you've got outbound freight hitting SG&A in the distribution line. So, you know, there will be a little more pressure, but it's all built into the guidance. But again, I think it's all very consistent with the guidance that we gave earlier in the year that we're going to have the second half margins be a little lower than the first half margins.

Thank you. Our next question online comes from Mr. Patrick Donnelly from Citi. Please go ahead.

Okay, Patrick. Thanks for taking the questions, guys. Maybe one on the capital deployment side, you know, certainly appreciate all the color and the prepared remarks on the slide deck, for that matter, on the M&A opportunities. Can you just talk about, you know, the pipeline, you know, how it certainly seems quite active, but, you know, how you're thinking about valuations in the market currently and And what, I guess, is the most pressing gaps in the portfolio? Again, you highlight some good ones in the slide deck, but just wondering if any feel more near-term than others and how we should expect the activity given, you know, you guys got down the leverage to four times ahead of schedule here.

Yeah, look, I think that we, you know, we really are looking at it three levers that we're trying to pull. I'd say the first one is organic, and that's really... I would say the R&D pipeline, and I'd say there's two big things going on there. I mean, obviously, you saw that we're investing considerably our spend in R&D because one is we can think we can obviously bring out menu, but we think we can bring a lot of innovation to the marketplace. So that continues to move incredibly well, well into, we talked about this on the IPO, well into dry-dry, which is really the ability to take dry MUSA and combine it with multiplexing. and also on the chemistry side. So that's a big investment and well underway. Look, I'd say the second one, and I think a lot of people move away from it, for us anyways, is partnerships. And we've spent a lot of time creating, I think, pretty innovative partnerships for both products and services, and we'll continue to do that. But finally, the slide you really saw was the acquisitions. Look, I think we come back to, it really comes down to our call point. We now have almost 2,300 people in the field. We believe it's a huge strength in the markets where we compete, kind of in that 250 to 500-bed community hospital or those type of sizes when you get outside. And that's a place where more and more molecular has been moving downstream. And it accelerated really through COVID and the desire for them to have that testing in-house. So I would say that that's an obvious place for us. I think the second place for us is that we really believe that we can expand our menu on IA in places – You know, that we like there are things like neuro. You know, obviously, also on the molecular side would be things around infectious disease and oncology. And then, look, I'd say the third one would be point of care. And while it's not really in our distribution point, we believe it's a nice extension of the technology we're bringing in the future through dry-dry and some of the innovations. And so we think that that would be the next one. Your point around valuation, I know that, you know, look, they've been a little bit crazy, some of them out there. And I think, look, our view is that we work every day, you know, for first our clinicians and our teammates and our investors. And we want to make sure we're prudent in the way that we do deals. And so that's why getting that leverage down as fast as possible is important to us because then it allows us to, you know, do deals and we're looking for things that will be accretive.

That's really helpful. um and then maybe just one on emea obviously strong performance in the quarter can you just talk about the pockets of strength you saw there it seems like western europe obviously is coming back pretty nicely but above just some color there and then you know expectations in the back half as well yeah look i think we did when you go back a couple years ago we were not winning in a lot of places candidly but one of them was the middle east and then i would say as we started to turn

this business. It was an area where, candidly, we were challenged. We changed out that leader. It was the last leader changed in the EMEA region. A new leader went in about nine months ago, kind of right in COVID. It was a person that was working for us, but doing kind of Eastern Europe countries. And I think it's done a fantastic job getting in there and winning some tenders that were really important that I think that our local team really had had built those relationships. So it continues to be a really key market. Sometimes we get sidetracked with the Mexicos and the Brazils and the Indias, but it really is important to us. And the team continues, I think, now to perform well and really proud of that whole EMEA team because it's completely different than it would have been three years ago. But they've come in, they've learned the business, they've changed out the team. So much of this is around people. It's a people business. And I think getting the right people in the right seats of the bus has made a huge difference out there.

Thank you. Our next question online comes from John Sorbier from UBS. Hi.

Congrats on the quarter. Thanks. Digging a little bit more into the compelling upgrade cycle that you had presented earlier, I think automation is pretty small today, around 1%. Can you maybe provide an update on what you think the placement outlook is for those instruments over the next whole month, and when does this become more of a meaningful part of the overall portfolio?

Yeah, you sound like you were just in our management meeting last week, John. Look, John, I think there's so many levers to pull, and I think automation sometimes gets lost. Look, at the end of the day, the team has done a really nice job in partnering with Thermo on that. We really are the only one with a good modular system, so you don't have to bolt it to the floor. That's up 20%, so it's growing significantly, but it's still 1% to 2% of our total business. What we are finding is that more and more of these hospitals do want to bring in automation, but it is a longer sale process than I think you see in a normal cycle. And so part of our process, especially around things like the 7600, is being able to tie it into automation. We don't guide on the number of systems that we'll put out, but I will tell you that we're up 20% and we see that continue to accelerate as we go through the second half of the year and into next year.

Thank you. Our next question online comes from Matt Sykes from Goldman Sachs. Please go ahead.

Hey, guys. Thanks for taking my questions. My first one, just if we go back to the IPO and you guys were talking about the value capture program, you kind of targeted sort of a 25 to 35 million annual savings per year. And I know we're only a partway through the year, but I'm just wondering in terms of how you look at that and how you measure yourself, are you still sort of on track to be realizing those types of cost savings or has something changed either up or down in your ability to take out costs?

Yeah, it's a good question, Matt. And as a reminder, that program has delivered over $200 million of cumulative savings since we implemented the program back in 2015. And we do target $25 million a year annually in additional savings. And I'm happy to say that we are right on track this year to achieve the $25 million as we're halfway through the year. You know, I will tell you I've got a monthly meeting with a large group of people where we go through in a lot of detail all of the projects that are in flight and as well as projects that are in the funnel that will become part of the Value Capture Program for 22 and beyond. So, yeah, I mean, the project is alive or the program is alive and well, and we're right on track this year. Thanks, Joe.

Great. Thanks for that, Culler. And just a follow-up question, when you guys take a look at the opportunities around the world, there's sort of greenfield and displacement, and EM is a lot of some greenfield, and in the U.S. it's a little bit more competitive perhaps. And when you look at your target market, you guys have had a lot of long relationships where you've been able to increase revenues of your existing customer base. But you've also talked about your win rate, where you're kind of winning in displacement opportunities. Can you talk a little bit about what your win rate has been. And when you go up against a competitor and there's displacement opportunity, how successful have you been over the course of this year?

Yeah. I don't think we give the exact win rate. We haven't kind of disclosed that. But Mike can kind of talk about our strategy and how we're executing that because it really is a very rifle shot strategy than a shotgun. And, Mike, you want to talk about kind of the sweet spot and how we're going about that and what we're using to win when we are winning? Okay.

yeah we'll do and Matt so you're right it does vary and when you do think about emerging markets I think we see both that opportunity for Greenfield and to take wins away from the competition and so that's important so we do we do both there we are seeing in general our competitive win rate increase that's been consistent now for the last couple years And to Chris's point, where we've seen that rate shoot up has been in some of these markets where we've executed on our commercial excellence program that we call Commercial Edge. And that comes back to defining the market, being very focused on where we best fit, where we provide the greatest value proposition, and then therefore have the best competitive offering. And we are deploying that now. And so by nature, we would expect our win rates to go up. I can tell you actually in a few regions and one that comes to mind is LATAM for us that's performing very well. In fact, I think one of the challenges there for us in that region is how do we go out and pick more fights because we're seeing a very good win rate, very good consistent improvement and now that's a market that I think we now have to look at how do we expand our presence and get into more opportunities. We're taking this market by market, team by team. But in general, I think things are tracking in line. And the best evidence of that, obviously, is the install base growth.

Operator, we have time for one more question.

Thank you. And our last question comes from Yi Chen from HC Wainwright. If your line's muted, please unmute.

Hi, thank you for the question. So could you comment on whether the COVID-related products have driven your relationship with customers around the world to purchase your non-COVID products?

Thanks for that. Mike, you want to talk about that? You were pretty instrumental in the rollout of those products.

Yeah, and it's a great question. And I'd say probably the short answer is, No, not tremendously. The truth is it had some impact. There are some competitive accounts that may have brought us in to augment what tests they could offer and that's because we were first with many of the assays that a hospital laboratory would need and so we came in at that point in time and we had some wins but most of our our wins as you look throughout have been due to sort of our core offering. Where I do think it's been highly beneficial is actually protecting our base in that because we have a complete offering of COVID tests, both through the antibodies tests that we offer and the antigen. And in fact, we're first in many of those. Our customers never had to turn to somebody else to fulfill that need because we met it right out of the gates and led the way. And so I think that What it did do for us is really reassure our current customers that when needed, Ortho can be innovative, can be fast to market, and can give them what they need. So a little bit for competitive, but not major impacts, but definitely, I think, very impactful, very valued by our current customers.

And thank you. We have no further questions. I'd like to turn the call over to Mr. Smith for closing remarks.

Thanks, and hey, thanks everybody for joining us. And look, in conclusion, we really do believe we have the right strategy with these clearly differentiated kind of pillars around innovation, commercial excellence, and operating efficiency, and the right team that's allowing us to execute and deliver the results going forward. So we feel really great. And look, on behalf of the management team and all our teammates around the globe, I just want to thank you for your continued support and interest in Ortho, and we'll look forward to sharing our journey with you as we go forward. Take care everybody.

And thank you ladies and gentlemen. This concludes today's conference. Thank you for participating. You may now disconnect.