Becton Dickinson and Co

NYSE:BDX

Earnings Call Transcript 2022-Q1

[Operator]

Hello, and welcome to BD's Earnings Call for the First Quarter of Fiscal 2022. At the request of BD, today's call is being recorded and will be made available for replay through February 10, 2022, on BD's Investor Relations website at bd.com or by phone at 800-839-2461 for domestic calls and Area Code 1-402-220-7219 for international calls. The replay bridges are now dedicated so you no longer need a conference ID to hear the replay. [Operator Instructions].

I will now turn the call over to BD.

[Francesca DeMartino, SVP, IR]

Good morning, and welcome to BD's earnings call. I'm Francesca DeMartino, Senior Vice President and Head of Investor Relations. On behalf of the BD team, thank you for joining us. This call is being made available via audio webcast at bd.com.

Earlier this morning, BD released its results for the first quarter of fiscal 2022. We also posted an earnings presentation that provides additional details on our performance. The press release and presentation can be accessed on the Investor Relations website at investors.bd.com.

Leading today's call are Tom Polen, BD's Chairman, Chief Executive Officer and President; and Chris DelOrefice, Executive Vice President and Chief Financial Officer. Tom will provide highlights of our performance and the continued progress we have made against our BD2025 strategy. He will then turn the call over to Chris for the financial review and our updated outlook for fiscal 2022. Following the prepared remarks, Tom and Chris will be joined for a Q&A session by our segment presidents, Alberto Mas, President of the Medical segment; Simon Campion, President of the Interventional segment; and Dave Hickey, President of the Life Sciences segment.

Before we get started, I want to remind you that we will be making forward-looking statements today. I encourage you to read the disclaimers in today's presentation slides and the disclosures in our SEC filings, which are both available on the Investor Relations website.

Unless otherwise specified, all comparisons will be on a year-over-year basis versus the relevant period. Revenue percentage changes are on an FX-neutral basis unless otherwise noted. When we refer to any given period, we are referring to the fiscal period unless we specifically note it as a calendar period.

I would also call your attention to the basis of presentation slide, which defines term you'll hear today, such as base revenues and base margins, which refer to our results excluding COVID-only testing.

With that, I am very pleased to turn it over to Tom.

[Thomas Polen, President, CEO & Chairman]

Thanks, Francesca. Welcome aboard. We're very happy to have you on the team. Good morning, everyone, and thank you for joining us. We are very pleased with our strong performance in Q1. It reflects the continued execution of our BD2025 strategy and another quarter of consistent strong growth in our base business. We made meaningful progress and delivered on our revenue, margin, earnings and cash flow goals while advancing our innovation pipeline and our tuck-in M&A strategy. Our performance, along with the progress we are making delivering across our key priorities, gives us the confidence to increase our full year revenue and earnings guidance for both our base business and COVID testing.

We were able to deliver these results in an uncertain market environment, demonstrating demand across our broad portfolio of products essential to patient care, along with BD's unique ability to deliver strong performance in the face of an ongoing global pandemic. The market impacts from COVID-19 dynamics continue to be in focus, particularly in the health care sector. However, we've witnessed a global health care system that's more agile and better prepared as each new variant has emerged.

In Q1, health care utilization levels continued at rates similar to what we saw in the fourth quarter of fiscal '21, remaining slightly below pre-pandemic levels until mid-December, then only declining modestly as a result of Omicron.

While we saw some slowdowns in deferrable procedures in the back half of December in certain regions due to hospital-imposed restrictions and staffing constraints, overall, our customers were able to continue to provide care to support patients and sustain a solid base of deferrable procedures. These challenges to procedure levels had minimal impact on our business in the first quarter. In addition, we saw routine lab testing returned to normal levels in Q1 and research lab activity remains strong.

With that said, as we look ahead, there are some pressures today related to staffing constraints that are impacting the delivery of some deferrable procedures, coupled with supply chain dynamics. We continue to watch these market dynamics closely.

Despite the continued recovery, uncertainty and inflationary pressures, I'm pleased with our team's focus on execution. Our segments are delivering strong profitable growth and our strategic initiatives to enhance margins are progressing well. As seen in our results, we're off to a strong start, being very active and intentional in executing our inflation-mitigation initiatives across procurement, shipping and continuous improvements in our plants as well as appropriate pricing-related actions.

Further, we intend to be best-in-class in navigating the current inflationary environment. We see signs of continued pressure on shipping, labor, raw materials and electronic components over the remainder of the year since our last guidance update. However, we believe we have a clear path to accelerating margin recovery, and we expect to offset any inflationary impacts through various cost-containment and pricing-related initiatives already realized in Q1 that will enable us to deliver on our full year objectives.

I'll now give a high-level summary of our financial performance. Q1 revenues of $5 billion reflect continued strong momentum in our base business. And through our focused execution, we grew base business revenues 8.3% in the first quarter. We also saw increased demand for our professional and at-home COVID tests relative to our previously communicated guidance, which was fueled by the Omicron variant.

As expected, in comparison to the prior year, COVID-only testing revenues declined, driven by lower antigen test pricing and volumes and a number of new entrants to the market with over 40 EUAs now granted in the U.S.

We have also continued to execute our cash flow initiatives, and we delivered strong operating cash flow of approximately $700 million. Our strong cash flow continues to enable investments in R&D and tuck-in M&A, which are fueling our BD2025 strategy.

In Q1, we closed 3 acquisitions, Scanwell, Tissuemed and Venclose. And just this week, we announced the acquisition of Cytognos, whose differentiated flow cytometry assays for the detection of minimal residual disease in cancer, bring an important addition to our biosciences business. These acquisitions advance our strategy to expand in higher-growth spaces that complement our durable portfolio and bring new transformative solutions across smart connected care, new care settings and improving chronic disease outcomes.

Our disciplined capital allocation framework gives us the flexibility to deploy capital towards value-creating opportunities in both R&D and M&A for future growth as well as return capital to shareholders through a competitive dividend and share repurchases when appropriate.

As we look across the balance of FY '22, our Q1 momentum and focus on execution are driving our strong FY '22 outlook. As we have communicated, we see our growth profile as derisked as we're leaders in areas of health care that remain in high demand and are driving base revenues. We have strengthened our growth profile through new product launches and acquired assets in the higher-growth spaces that are adding to our performance. And we continue to support increased testing demand. While we expect the recent demand surge to be temporary, in the event that COVID-19 cases persist longer than anticipated, our testing portfolio provides a natural hedge against deferrable procedure softness and other COVID-related headwinds.

In addition to our derisked growth profile, we're also confident in our ability to improve our gross margins given the strong progress we've made to date through focused execution against our detailed plans to offset inflationary pressures and deliver cost improvements. All of this gives us the confidence to increase our full year revenue and earnings guidance while remaining appropriately prudent given the current uncertain environment.

So turning to innovation. We remain focused on enhancing our R&D productivity, and it's having an impact. During the quarter, we progressed our innovation pipeline, launching several new products. Examples include BD COR, where we recently launched our molecular MX module, which fully completes the CE Mark system. The MX is built off of our BD MAX assay technology, which will allow us to leverage the BD MAX menu of infectious disease tests into the high throughput lab segment.

We also launched BD Kiestra IdentifA, which received the 510(k) clearance this quarter and is designed to fully automate and integrate the preparation of microbiology bacterial identification testing using smart connected robotics.

Beyond these achievements, we also hit several milestones across our pipeline. We submitted the 510(k) to the FDA for our TREK bone biopsy device. The TREK biopsy system will provide interventional radiologists with an easier and faster way to perform bone biopsies without the need to use multiple devices, thus reduces the cost per procedure, inventory needs and reduces procedure time.

Our Pyxis ES version 1.7 software is now live in limited commercial release at 4 sites in anticipation of full commercial launch. This software adds new capabilities like enhanced automation and controlled substance management via improved connectivity with our C2 Safe offering and enables deeper integration of pharmacy and nursing areas.

We're also very proud of our new BD FACS Discover S8 CellSorter, which is currently profiled as a cover story of the January issue of Science Magazine. The S8 is a landmark advancement in flow cytometry that has the potential to transform a wide range of disciplines from immunology and genomics research to cell-based therapeutics. For the first time, we can sort cells at high speeds while separating cells not only based on which antibodies or other markers we see, but also based on new imaging parameters. To put this leapfrog technology in perspective, the most advanced flow cytometers today can analyze and sort cells based on 3 non-fluorescent parameters and have processing speeds of up to 15 megabytes per second. The S8 analyze and sorts on 11 nonfluorescent parameters and has processing speeds of up to 2,000 megabytes per second. We encourage you to visit bdbiosciences.com/celvieu to learn more about this exciting new innovation.

I'm excited by the significant progress we continue to make advancing our BD2025 innovation-driven growth strategy. To that end, I am pleased to report that our Board of Directors recently approved the spin-off of embecta, which is scheduled to occur on April 1. We remain on track for a successful embecta spin. We continue to believe the spin is a significant value-creating opportunity for our shareholders as both BD and embecta are well positioned for success.

embecta will be one of the largest pure-play diabetes companies in existence today with an ability to focus on its strategic goals, drive strong cash flow and allocate its capital more efficiently and effectively to drive higher revenue growth.

Further, we expect the spin-off will not have an impact on the long-term growth targets we laid out at Investor Day. And instead, we expect it to enhance both our sales and earnings growth profile and create an opportunity for additional shareholder value.

Finally, regarding our progress on advancing our ESG strategy, which serves as a framework through which we address the most relevant ESG issues for our company and our stakeholders. We continue to make strong progress against our goals. We launched our inaugural 2021 Global Inclusion Diversity and Equity report, in which we shared our ID&E foundation, strategy and actions towards the healthy workforce and communities pillar of our 2030 ESG goals. BD's commitment to ID&E sets a new standard for how the company will work together to innovate new products and solutions, and we firmly believe that the more diverse people and perspectives there are at the table, the better outcomes we can produce to deliver what's next in health care.

We also published our second Annual Cybersecurity Report to update stakeholders on the state of health care cybersecurity, BD's impacts on advancing cybersecurity maturity and anticipated trends for 2022. We're very proud to be the first and only med tech company to publish a cybersecurity report. Through our leadership position in health care cybersecurity in our annual report, we're working to address cybersecurity challenges specific to our industry.

We also continue to receive external recognition of our ESG efforts, including just recently being named one of America's Most Just Companies in the Annual JUST 100 Ranking and ranking in the top 3 within our industry.

I'm proud of the progress we're making advancing both our BD 2025 and ESG strategies. The actions we're taking are driving excellent momentum. We believe we are well positioned to deliver and create value for all of our stakeholders.

With that, let me turn it over to Chris to review our financials and outlook.

[Christopher DelOrefice, EVP & CFO]

Thanks, Tom. Echoing Tom's comments, our Q1 results demonstrate the strength of our business and the momentum of our strategy. We are enhancing our growth profile through the portfolio and investment actions we are taking, while also executing on margin improvement and inflationary-mitigation programs to deliver our long-term margin expansion targets and double-digit earnings growth profile. To that end, I'd like to recognize our associates across supply chain for their contributions. We have an incredible team around the world that is not only addressing the challenges that all companies are facing in today's environment, but they are excelling and driving performance.

Turning to our revenue performance. We delivered $5 billion in revenue in the first quarter comprised of $4.8 billion in base business revenues, which had strong growth of 8.3%, and 7.8% organic, which excludes the impact of acquisitions. COVID-only testing revenues were $185 million, which, as expected, declined from $866 million last year, as this was our highest revenue quarter for COVID testing last year given higher pricing and volumes. The year-over-year decline in total company revenues of 5.9% is entirely attributable to the decline in testing revenues.

BD is uniquely positioned to deliver strong performance during these uncertain times. The breadth and diversification of the total BD portfolio, including COVID diagnostic testing, provides insulation against COVID-driven procedure fluctuations, as demonstrated by the revenue performance across our segments, with BD Medical growing 6%, Life Sciences based revenues growing over 17% and Interventional growing 3.8%.

Total company base business growth was also strong regionally, with double-digit growth in the U.S., China and Latin America.

Let me now provide some further insight into each segment's performance. Our Medical segment delivered $2.4 billion in revenues in the first quarter, growing 6%, led by our Medication Delivery Solutions and Pharmaceutical Systems businesses.

MDS revenues increased 7.3%, reflecting strong demand for our durable core products, particularly in the U.S., driven by competitive gains in catheters and vascular care devices. Our leadership position in these markets allow us to provide a strong value proposition to our customers in terms of the breadth of our portfolio as well as the cost and quality of our products. Importantly, as input costs such as resins have increased, we've been able to take appropriate price actions and accelerate cost mitigation programs while continuing to invest in innovation to support our strong value proposition.

In MMS, revenues were down slightly due to the difficult prior-year comparison given the high number of infusion pump placements last year in the U.S. and Europe to support COVID-related hospital needs. Excluding this impact, our MMS business reflects continued execution of our medication management strategy, which drove strong demand worldwide for our dispensing solutions. This was particularly evident in the U.S., where we saw another strong quarter of customer signings. The traction we are getting reflects the value our Pyxis platform provides our customers.

Revenue growth of 1.6% in Diabetes Care reflects our category leadership position. Growth was aided by the timing of certain orders.

Pharm Systems revenue grew nearly 18%, driven by continued strong demand for pre-fillable devices. Growth was also enabled by our focused execution on capacity expansion that allowed us to fulfill certain orders earlier than originally anticipated. Demand for pre-filled devices continues to be aided by the fast-paced vial to pre-filled device conversion for biologics, vaccines and other injectable drugs.

BD Life Sciences revenue totaled $1.5 billion in the first quarter. The decline of 24.8% year-over-year is solely due to lower COVID-only testing revenues previously discussed. Excluding COVID-only testing, Life Sciences base revenues grew 17.2%, with licensing revenue in IDS contributing about 400 basis points to the segment's base growth and about 100 basis points to the total company based revenue growth.

In IDS, base business revenues had strong growth of 20.3%, including about 600 basis points from licensing revenue. Performance was driven by our specimen management, microbiology and molecular platforms as routine lab testing returned to pre-pandemic levels.

Growth in BD MAX IVD assays was also strong, reflecting the leverage we are getting on the larger installed base. Performance in our base business includes sales of our combination flu COVID assay that were in line with our expectations. Indications are the respiratory season will be a normal to low flu season.

Biosciences revenues increased 9%, driven by strong demand for research solutions as a result of lab utilization returning to normal levels and continued research on COVID variants. Contributing to Life Sciences Q1 growth were the 2 new FACSSymphony instruments that we launched in FY '21. As the evolution of flow cytometry continues to move from large labs to more midsized independent labs, we now provide a complete suite of analyzers for researchers from the benchtop A1 to the A5 SE, our first spectral analyzer that enables researchers to do even high-parameter cellular analysis to gain broader insights into pioneering new discoveries and treatments for cancer and other immune-related conditions.

Our new e-commerce site also contributed to growth in Q1. BD Interventional revenues totaled $1.1 billion in the first quarter, growing 3.8%. BDI's performance reflects strong growth in Surgery and UCC. Q1 performance was impacted by temporary supply chain disruptions, and consistent with our ReCoDe initiative, product line discontinuations of lower-margin products in our PI and UCC businesses. While these strategic discontinuations create a temporary headwind to revenue growth, it demonstrates our commitment to simplifying our portfolio and enhancing margins.

We had a strong start to the year in our Surgery business, with revenue growth of nearly 9% despite some modest slowdowns towards the end of December due to Omicron. Strength in the quarter was driven by double-digit growth in advanced reconstruction and repair, with strength in hernia as deferrable procedures recovered, and the recent acquisition of Tepha.

Tepha provides us with a vertical integration strategy for our current Phasix platform, but more importantly, it provides us with exciting new opportunities to expand our horizon into new high-growth areas of tissue repair, reconstruction and regeneration.

Double-digit growth in biosurgery and high single-digit growth in infection prevention was also driven by the recovery of deferrable procedures and continued market adoption of Sterile BD ChloraPrep.

Revenues in Peripheral Intervention declined 3.1% as a result of a product recall from fiscal '21 and the previously mentioned supply disruptions and product line discontinuations that support our margin enhancement goals. However, we saw continued acceleration in our atherectomy platform in China as we have leveraged the capabilities of our sales force. We are also experiencing positive momentum from our recent acquisition of Venclose.

Urology & Critical Care revenues grew 7.7%, driven by continued strong demand for PureWick in our acute urology portfolio. We're also seeing continued adoption of our PureWick solutions in the home as we advance our strategy to expand our addressable market and deliver transformative solutions for alternate care settings. Also contributing to growth was remediation of Q4's temporary supply disruption within acute urology.

Now moving to our P&L. We delivered adjusted net income and EPS above our expectations in Q1, with adjusted net income of $1.1 billion and adjusted diluted EPS of $3.64. We had strong execution of our margin enhancement initiatives in Q1 and delivered base business gross margin of 55.4% and operating margin of 24.3%. We remain on track to deliver our full year base margin goals, with our base margin performance in Q1 ahead of our expectations for the quarter and also above our full year base margin expectations, due to our ability to realize some of our inflation mitigation and pricing initiatives sooner than we previously anticipated.

In addition, our Q1 base business operating margin also included a benefit of about 40 basis points from licensing revenues in Life Sciences that was included in our full year plan. Excluding the licensing revenue, base gross and operating margin would have been nearly 55% and 24%, respectively.

Other key drivers of gross margin in Q1 include a benefit from increased volume utilization given our strong base revenue growth and, as expected, favorable FX we experienced in 2021 but was recorded in inventory and benefited our GP this quarter when sold. We did realize a negative impact from inflation in the quarter, which was broadly in line with our expectations and was partially offset by our cost improvement and inflation mitigation actions, which are occurring as planned. We are making very good progress with strong sequential improvement and our full year base gross margin improvement goal remains on track despite continued inflationary pressures.

SSG&A was in line with expectations and increased year-over-year, driven by variable expenses, including selling and commissions, and inflationary impacts, primarily in shipping, that we have previously shared. The increase in SSG&A as a percent of sales is a function of lower testing sales. However, we did leverage SSG&A versus our base revenue, which is contributing to our base operating margin improvement.

R&D increased year-over-year, consistent with our strategy to invest more to support our long-term growth outlook. As anticipated and communicated on our prior earnings call, our tax rate benefited from the timing of discrete items, resulting in a lower effective tax rate in the quarter.

Regarding our cash and capital allocation. Cash flows from operations totaled approximately $700 million in the first quarter. We ended Q1 with a strong cash balance of $1.9 billion and an adjusted net leverage ratio of 2.8x. Our cash balance reflects our strategic investments in M&A during the quarter.

Our current cash and leverage position and continued focus on strong cash flows provide us the flexibility to advance our balanced capital allocation framework and support our BD2025 growth strategy through investments in R&D, capital and M&A.

During Q1, we invested in R&D at over 6% of sales to advance our innovation pipeline. We also invested over $400 million in 3 additional tuck-in acquisitions across our businesses that will support our strong growth profile in 2022 and beyond.

Turning to our fiscal '22 guidance assumptions. First, the macro considerations that support our guidance. While we still expect some global COVID-driven variability, our guidance assumes the continued easing of COVID-19 restrictions, the stabilization of deferrable procedures and no significant disruptions to deferrable procedure volumes. Additionally, we see signs of continued inflationary and supply chain pressure over the balance of the year, with some stabilization by the end of the year. However, we believe we have a clear path to margin recovery, and we expect to offset any incremental inflation impact through various cost containment and pricing-related initiatives already realized in Q1. Our guidance doesn't contemplate a more significant step increase in market-driven supply chain and inflationary disruption.

A few comments on testing-specific assumptions. Our base business revenue assumptions include sales of our combination flu COVID assays. We anticipate a normal to light flu season based on what we've seen so far from the CDC surveillance reports.

Moving to our updated guidance for fiscal '22. We are well positioned for strong growth across our 3 segments, which are delivering at or above our initial expectations and, thus, we are increasing our base revenue guidance.

While we aren't providing segment-specific items, relative to our revised total company base growth outlook, we expect our Medical segment growth to be slightly below and our Life Sciences and Interventional segment growth to be slightly above total company growth.

We now expect base revenues to grow 5.75% to 6.75% on an FX-neutral basis from $18.3 billion in fiscal '21. This is an increase from our previous guidance of 5% to 6% growth and is driven by our Q1 revenue outperformance and confidence in the strength and resilience of our base portfolio, and our Q1 acquisitions, which account for about 25 basis points of the increase.

For COVID-only testing, we are now assuming $450 million in revenue, which is a little more than double our original expectation of $200 million. As we communicated last quarter, higher testing revenues position us well to manage through this period of uncertainty and also provide the potential to create value through reinvestment in our business. Given our increased testing revenue expectations, we currently plan to reinvest a portion of the testing profits over the balance of the year, but we'll ensure they are value-creating opportunities and would not invest at a level that would result in our full year testing margins dropping below our base margins. Should those investment opportunities not materialize as anticipated, we would allow the incremental profits to flow through.

Based on current spot rates, for illustrative purposes, currency is now estimated to be a headwind of approximately 125 basis points or about $250 million to total company revenues. This is an incremental 75 basis point headwind compared to our prior view.

All in with our base revenue, COVID-only testing revenue and the illustrative currency impact, we now expect reported revenues in the range of $19.55 billion to $19.75 billion in fiscal '22, compared to $19.3 billion to $19.5 billion previously announced.

We still expect operating margins in our base business to improve by approximately 200 basis points over our fiscal '21 base operating margin of 21.7%.

Given the planned reinvestment, we also still expect operating margin on COVID-only testing to be modestly above our base business margins. A few additional items for your models. We now expect $50 million to $75 million in year-over-year improvement in interest other or an incremental $25 million benefit. We still expect an effective tax rate of 12.5% to 13.5% for the full year. Our guidance still assumes share repurchases that, at a minimum, offset any dilution from share-based compensation.

All in, we are raising our adjusted EPS guidance to be between $12.80 and $13, which is an increase of $0.50 at the midpoint from our prior guidance of $12.30 to $12.50. This includes absorbing the negative impact of currency, which we estimate to be about $0.10. The increase reflects our strong Q1 base business performance and our expectations for increased COVID testing net of reinvestment.

As a reminder, our fiscal '22 guidance continues to include our Diabetes business. As Tom mentioned, the embecta spin has now been approved by the Board of Directors. As we proceed towards the spin date, I want to provide a few reminders Restated financials for RemainCo will not be made public until the completion of the spinoff. Given the higher but declining margin profile of embecta, one should expect BD margins to be lower after they're restated. However, off the restated FY '21 financials, we are still targeting about 400 basis points of base operating margin expansion through FY '25. BD is expected to receive a distribution of approximately $1.44 billion, equivalent to multiple years of cash generated by the Diabetes Care unit. We remain excited for what's ahead for embecta and making this a successful and value-creating opportunity for everyone.

As you think about phasing for the balance of the year, the following are a few key considerations as you think of our base revenue and earnings. Regarding sales, we remain confident in the durable nature of our portfolio and the strength of our underlying sales.

In Q2, we expect some impact from Omicron on hospital staffing and procedures. But recall, Q2 is a relatively easy compare due to the significant COVID resurgence we experienced in Q2 of fiscal '21. As a result, we anticipate base revenue growth in Q2 to be above our full year guidance range, with the remaining quarters being equally balanced.

Regarding our margins and P&L, as I noted, Q1 had the benefit from licensing, which added about 40 basis points to operating margin, which will not repeat in Q2. While we expect improvement versus the prior year, we also previously shared that Q2 would be the quarter with the largest inflationary impact.

So given those 2 dynamics, you would expect a sequential step down in margin, and we expect Q2 to represent the low watermark for base operating margin for the year.

We remain well on track to achieve our base operating margin guidance of approximately 200 basis points improvement. As we progress through the second half of the fiscal year, in Q3, we expect the impact of inflation on our business to stabilize and see a modest pickup of cost improvement and price-related benefits flowing through, with Q4 being the highest benefit. As a reminder, we see our SSG&A and R&D costs relatively evenly spread through the year.

As expected, our tax rate in Q1 benefited from the timing of discrete items. At the midpoint of our full year guidance range, that would imply we expect our average tax rate for the balance of the year to be about 13.7%, which is best to apply for the subsequent quarters.

Regarding COVID-only testing sales, we expect the vast majority of testing revenues to occur in fiscal Q2 and then trend down as Omicron subsides. In future years, we would not expect this level of COVID-only testing to repeat.

In summary, we are continuing to advance our BD2025 strategic objectives with focused execution against our key priorities. As we look forward, and as reflected in our FY '22 guidance, we are well positioned for growth with excellent momentum in our base business, increased investments in our innovation pipeline, tuck-in M&A momentum, strong progress executing our balance sheet and cash flow initiatives and clear visibility to meaningful margin improvement.

Thanks for your time. Operator, we can now open the line for Q&A.

[Operator]

[Operator Instructions]. And our first question comes from Vijay Kumar with Evercore ISI.

[Vijay Kumar, Evercore ISI]

Maybe my first question, some clarification on the Q1 numbers here. Can you quantify what the contribution from combo test. There's some confusion on whether it was an abnormal contribution. I think in the past you've said it's about $75 million to $100 million. So was it in line with expectations? Has anything changed on combo test? And this licensing fee, it looks like maybe it was $40 million or $50 million contribution from a dollar perspective. Is that the right way to think about it?

[Thomas Polen, President, CEO & Chairman]

Vijay, this is Tom. Thanks for the good question. So on flu COVID combo, testing is very much in line with our expectations. The -- as you said, it was $70 million to $80 million or so is what we expected for the full year, and you would expect a portion of that to be in Q1, and it played out as such. Essentially, it's relatively immaterial to overall BD, as you can imagine, if you take the 75 80 and you spread it over a couple of quarters. So that's what was in our numbers. We have not seen any -- it's a normal to light flu season this year. It's certainly higher than it was last year when there was essentially no flu. But if you look at the CDC data, it is on track for a light to normal flu season. but nothing above our expectations at this point in time.

I'll turn it over to Chris for the other question.

[Christopher DelOrefice, EVP & CFO]

Yes. And just to confirm, on the licensing revenue, yes, so it was worth 40 basis points. You can do the math. It's roughly $50 million. We also had -- you heard me reference, we're actively driving our ReCoDe initiative and SKU productivity and have been very intentional about making choices there to enhance our profitability. Given the strong growth profile, this affords us the luxury of being able to absorb some headwinds as we simplify our portfolio. And primarily in the BDI business, there was some impact there as well, and that actually had a negative impact in the quarter of about 30 basis points.

[Vijay Kumar, Evercore ISI]

That's extremely helpful, Chris. And maybe my follow-up on the guidance here. You guys [indiscernible] Q1 by about $250 million on the revenues versus street models, $0.60 on EPS. The guide raise was of a similar magnitude. When I look at your gross margin execution, ex licensing, it's well over 55%. It feels like perhaps the guidance is conservative, maybe talk about the assumptions that went into the 2Q to 4Q implied guide?

[Christopher DelOrefice, EVP & CFO]

Yes, thanks for the question. Let me approach this 2 ways. So let me first talk about the quarter and how we delivered in the quarter maybe relative to what folks are seeing from kind of an external expectation standpoint. So obviously, we're very pleased with our Q1 results, clearly reflected strong base revenue growth which exceeded our expectations. As you noted, there was also a strong execution against our margin enhancement objectives, actually realizing benefit earlier in some areas, which will help us going forward because certainly we're seeing continued market-driven supply and inflation pressure as you look out into the back end of the year. Finally, we -- as you noted, we did realize incremental revenue from COVID-only testing. You can see that in our results. That actually had a strong margin as well in the first quarter.

The good thing here is the strength is nicely balanced between our base and the increment from testing. There were a couple of timing items as we think comparing to, again, kind of more what I would frame as external expectations. First, we had signaled there was -- we had expected a discrete tax item in Q1, which did play out as expected. So we had a lower effective tax rate in the quarter. We're still confident in our full year expected tax rate. So thus, you would expect a slight increase over our full year average through the balance to go there.

You had highlighted the licensing impact, which I don't think was contemplated in the external view. That was planned on our side.

Those 2 items alone explain what I would call the delta you're seeing between our total results relative to the external view.

I think the other 2 new considerations to think about that don't really show up in the quarter, one is we talked about reinvestment of the testing upside, which will obviously happen through the course of the year as we find those value-creating opportunities. And then we talked about the negative FX, which was worth about $0.10, which, again, that will also play out through the back of the year.

So actually, when you think of that, that implies that we actually have a stronger balance to go on the back end to account for absorbing those items.

So similar to what you said, bigger picture, I think the simple way to think of this is we increased sales by $250 million. That included a base increase of $150 million, testing of $250 million to $400 million. We did offset currency headwinds of $150 million. So that nets to the $250 million.

I think also importantly, if you take our Q1 actual results against our new base guide and look at our implied guide for Q2 to Q4, it's actually in line with our previous guide, which means we did not take our revenue projections down in the future.

And I think everyone is acknowledging there's actually more uncertainty given Omicron. We mentioned how we exited December heading into January. So that's actually signaling strength in how we feel about the back half.

And then our EPS, we increased $0.50, absorbing $0.10 of currency. And if you do the drop-through on EPS to sales, it's an extremely high conversion of sales to earnings, implying strong margin on that, fully leveraging our base and gives us confidence actually that we're on track to deliver our margin commitment.

So I think in light of all that, we see this as actually especially strong in light of continued market uncertainty and is reflective of our strong base business growth and our focus on execution.

[Operator]

And our next question comes from Robbie Marcus with JPMorgan.

[Robert Marcus, JPMorgan Chase & Co.]

Yes. And congrats on a good quarter. Chris, maybe I could just follow up on that a little bit and get a little more from you. You raised EPS by less than the beat. Should we think of that as any changes to the inflationary environment? Or maybe what went into the view to not raise it as much? Was the licensing, did it come earlier than expected? Or just anything we can get and help us phase through the rest of the year versus where we were before.

[Christopher DelOrefice, EVP & CFO]

Yes. Thanks, Robbie, for the question. I guess I'll reiterate some of the things that I just shared. To your point, extremely strong quarter. You saw the results relative to external expectations. There were 2 timing items. We had signaled tax in Q1, that was not contemplated in the external view. The licensing also wasn't contemplated in that external view. Those were both items that we had planned and we had communicated the tax. So when you think of those 2 items alone, we're actually giving more than, call it, an adjusted external view.

And then I think the last piece that isn't being considered is, there are new items in the back half of the year. Again, FX, right, which is going to play out, there's $0.10 there that will play out post Q1. And in addition to that, we had highlighted the fact that we are going to do some reinvestment on some of the margin drop-through on the incremental testing that happened in Q1.

So that kind of explains it. Again, I think the easiest way to think about it is, we delivered 8.3% growth in Q1. Our revenue guide has us holding the 8.3% and then actually holding the same guide on the balance to go, which means we're equally confident in our original guide despite the fact that everyone would acknowledge that there are more headwinds as it relates to Omicron, et cetera. It also implies at $0.50 on $250 million of sales an extremely strong drop-through to profit, right? It's highly variable. It's actually at a GP level or plus, which means all that revenue, we're fully leveraging our base and it only implies a strengthening perspective on our margin outlook.

And again, we're extremely excited about the start of the year. I feel good about where we are. Obviously, we did talk about -- we do see continued inflation pressures as the year progresses. We're working really hard. The team is doing an outstanding job mitigating those. But it is certainly a unique environment. But I think a great start to the year. The guide increase signals more confidence than when we entered the year despite what I would argue is actually more complexity.

[Thomas Polen, President, CEO & Chairman]

And Robbie, this is Tom. I think you've heard me used the word prudent pretty nonstop since the COVID pandemic hit. And so I would view our guide today is prudent with -- as the market continues to remain more stable, that there's opportunity for upside as we move through the year.

[Robert Marcus, JPMorgan Chase & Co.]

That's actually very helpful. So it sounds like there's an extra $0.20 or so of reinvestment going back into the business. How should we think about where that's going and when and where we might see that materialize?

[Christopher DelOrefice, EVP & CFO]

Yes. Thanks, Robbie. Yes. Obviously, so one, as the CFO, of course, it's going to be contingent on there'll be strong value-creating opportunities. We've always looked to innovation, I think, first. I think also anything that we can do to accelerate the great programs that we have in place to build capability and execute against our Simplify agenda, which will lead to margin, I think, would be the 2 areas that we would continue to prioritize.

I would likely see that kind of phase more second half. Certainly, with the new guide in our plan, some of that will happen in Q2, but it will probably be more kind of spread throughout the year is the way to think about that.

[Operator]

We'll take our next question from Matthew Mishan with KeyBanc.

[Matthew Mishan, KeyBanc Capital Markets]

Just first, could you go a little bit deeper on the Peripheral Intervention issues around the recall and supplier constraints and how long that's expected to last? And is there any way to quantify the magnitude? And was that originally contemplated in the guidance as well?

[Thomas Polen, President, CEO & Chairman]

Matthew, this is Tom. I'll turn that over to Simon.

[Simon Campion, EVP & President, Interventional Segment]

Matthew, Simon. Yes, I'd be happy to provide that information, but before I do so, I think it's fair to say we're reasonably happy with the performance of BDI in the quarter. And with respect to PI, we're happy with the position of that portfolio. We're happy with our competitiveness. We're happy with our ability to continue to strengthen that portfolio as you've seen the acquisition of Venclose during the quarter.

So the issues we face are -- I would classify them as extremely acute in nature and I feel time-bound. Three issues generally have been the source of the majority of the problem today. But this time last year, we recalled the Venovo venous stent and so we've got a headwind for 4 quarters at this point in time.

We expect 2 things from that. Number one, it's almost annualized. And number two, we do expect it to be back in the market in the second half of this financial year. And just to reiterate, that is not an implant issue. In fact, in September of last year, we published 3-year data from the [indiscernible] study on Venovo, which showed 84% [indiscernible] and 0 fractures and 0 migration. So we are very confident that this is going to have an impact on the market again.

Second issue was the backorder and supplier challenges in the NPI. PI does have the most complex portfolio, the most complex products and the most complex supply chain certainly within BDI. And we've experienced headwinds from raw material capacity to COVID impact in supplier sites to sterilization capacity in the past number of quarters. We do see light at the end of the tunnel on a number of those issues, particularly in relation to sterilization. And we expect to begin to see material improvements in our performance with respect to back order by the end of this quarter.

And then finally, as Chris and Tom have remarked, SKU rationalization has impacted PI more so than any other business this past quarter. And as we discussed in other fora, these product discontinuations are being done strategically with a view to enhancing margins and increasing efficiencies across our entire cycle from manufacturing to sales rep time allocation.

[Thomas Polen, President, CEO & Chairman]

I think just to add, Simon, those strategic product exits that we've been doing in PI, but also in other areas of the company as part of our ReCoDe initiative, across the board, those -- with the strength of our revenue, we've been in a position to accelerate that strategy in a number of ways. And those products that we're discontinuing typically always have growth rates that are far below the company average and margins that are far below the company average. And so it's addition by subtraction as we think about that long term, as we simplify our portfolio and focus in those higher-growth spaces that are going to be driving the future of the company. So thank you, Matthew, for the question.

[Matthew Mishan, KeyBanc Capital Markets]

Okay. And just lastly on Alaris. And I'm sorry if I missed it in the prepared remarks. I know it wasn't previously assumed in guidance, but it says that FDA clearance of Alaris is not expected now in FY '22. Did something change in the conversations with the FDA?

[Thomas Polen, President, CEO & Chairman]

No, Matthew. That's very -- that's exactly what we said when we gave guidance. That's no change at all. We continue to be focused on advancing Alaris and there's no updates.

[Operator]

[Operator Instructions]. We'll take our next question from Larry Biegelsen with Wells Fargo.

[Lawrence Biegelsen, Wells Fargo Securities]

Congrats on the nice start to the fiscal year. I'll ask both my questions upfront. I heard pricing a lot so far on this call. Where do you guys see opportunity to take price? And what's embedded in the guidance for net price change year-over-year?

And second, Chris, the guidance for the base business implies second half growth is below the range, I believe, based on your quarterly phasing, by our math, maybe 4%. Is that conservatism? And what does it imply about your ability to grow 5%, 5.5% plus beyond fiscal 2022?

[Thomas Polen, President, CEO & Chairman]

Okay. Thank you for the question, Larry. Why don't we start with the last question first. I'll turn it to Chris on the growth pretty clear answer.

[Christopher DelOrefice, EVP & CFO]

Yes, Larry, thanks for the question. Yes, the full balance to go is actually equal to our guide. What we did signal though was Q2, we're still navigating through kind of a recovery period, if you remember the resurgence last year. So it's really more I would think of it as kind of outsized on the BDI side of the business, in particular.

There are a couple of small comp dynamics in Q4 as well, right? We had some new product launches. So if you look at the comp from last year, it's very strong. So it's really just more comp dynamics, I think, as it relates to 5 5 plus for the long term, that this more than validates that we're well on track and strong there. As a matter of fact, our continuing to look at growth versus '19 as an example, too, is extremely strong, actually moving to over 5% with -- and that's -- and considering the fact that you have a year of COVID in there, that's a strong signal for the trajectory of the business.

[Thomas Polen, President, CEO & Chairman]

And on pricing, Larry, so as you know, as you know BD very, very well, we've been focused on pricing for many years and had begun the journey with putting in resources in every business that are dedicated to pricing, pricing leadership at the company level as well. And obviously, in an environment where there's record levels of inflation, it's been an area that has been ever more important.

And so we began our journey of working on pricing in an inflationary environment last year and began taking actions. And you're starting to see and will continue to see the impacts of that flow through in the year. We take those actions very serious in discussions with our customers. We understand they work in a reimbursement-constrained environment. And so if you look at where we are implementing price most significantly, it is -- and we're very transparent with our customers, by the way, on where we're raising price and why we're raising price and the impacts of inflation as the driver of that. But where you see it most is in those products that we're selling for a dime, a quarter or low dollars, where BD over decades has invested billions of dollars of capital in creating extremely efficient, fully automated manufacturing facilities that allow us to be one of the only companies on the planet who can sell billions of devices at dimes and quarters and dollars.

And because of the way that we've just continued to refine our manufacturing capabilities over the year in a best-in-class ways, any increases in variable costs like resins, as an example, or chips, et cetera, they tend to flow right through and directly impact product margins and profitability. And so we can share what those impacts are on those raw material increases with our customers, and we have those discussions, and we've been raising price actively, particularly in those product categories.

And so while we're not giving out -- not sharing a specific number on price through the year, we are -- have been very, very active on that. And it's -- we're doing it in every region around the world, it's not a U.S. or Europe thing, it's equal across all geographies and directly related to passing through a portion of the inflationary impacts that we're getting on raw materials.

Of course, at the same time, we're taking a number of actions beyond pricing, passing it all through to our customers, and that includes us taking cost actions within the company, continuing to drive significant continuous improvement in our manufacturing plants and always look at ways to be more efficient and look at prices, that last resort. But we have certainly been doing more price this year than we have seen historically.

[Christopher DelOrefice, EVP & CFO]

Larry, just one other quick thing. I don't know if this helps, I wasn't sure if your comment was operational. But obviously, the FX phasing will be certainly more back-end loaded in terms of the negative currency impact, maybe another consideration.

And then further to just Tom's comment on pricing from a progress standpoint, I think what I can share, we did not split out the dynamic, but it's part of our plan as it relates to -- we talked about an inflation impact and then cost improvement programs and price. Cost improvement is actually a large portion of it, to Tom's point, where we're getting a net 50 basis points improvement for the full year of the 200 basis points. The other 150 is coming from volume and strong growth and some FX benefit that carried over from last year.

And on pricing, we entered the year with plans, with 80%, 90% of firm plans in place and 50% of that action. We now have 100% plans fully identified and 7% of it is already fully executed, with the balance really more timing tied to triggers and other events. So really good progress there.

[Operator]

We'll take our next question from Matt Taylor with UBS.

[Matthew Taylor, UBS]

I just had a follow-up on the thread on all the supply chain inflation issues and your ability to mitigate them. So wanted to understand better the forecast and what you're assuming for the second half of the year in terms of some of those headwinds abating. And Tom, I appreciate your comments on the nickel, dime and quarters, the lower-cost products. I was wondering specifically if you could also raise price on reagents or anywhere else in the portfolio?

[Thomas Polen, President, CEO & Chairman]

Thank you for the question, Matt. So on the supply chain and inflation perspective, we don't have -- there's not assumptions that there's any major material reversal of the cost. There are some areas where we expect continued trending. Resins, for example, have been heading in a moderately to minorly favorable direction, as an example. We expect that to continue. But overall, we don't see major abatements in areas like shipping, as an example, or chips. That's -- we bake that into our outlook as we go forward. We do think those supply chain dynamics will continue certainly longer than most of the world thought at this time last year, and we see them -- many of them continuing through '22. So we have that built into our considerations and outlook.

The other question was.

[Matthew Taylor, UBS]

Just on reagents or any other areas...

[Thomas Polen, President, CEO & Chairman]

Yes. Thanks, Matt. Certainly, we do look at those, and we have raised price in a number of areas as appropriate across the portfolio. There are a few products, of course, in today's environment that aren't impacted by inflation in areas such as shipping or computer chips, et cetera. Instrumentation will be a good example of electromechanical inflation that we see and we raised costs there in areas such as service, where spare parts, certainly, the cost of those go up. And we do share the increases of those as well.

So the answer is yes. But by far and away, the most significant increases would be on those products that we are just extremely efficient at producing and where the percentage of COGS made up of raw materials are disproportionately high.

[Christopher DelOrefice, EVP & CFO]

Just one small add that may help you think about how this sort of could play out through the year. Inflationary impacts kind of started more in the second half of last year, right? So as you go through this year, what you're going to see in the first half is kind of a full impact of continued inflation. As you get to the back half, you'll see some stabilization to some continuous increases, but to a smaller degree. And then think of the opposite as it relates to kind of the offsets that will drive, call it, the net, right? That will ramp a little bit slower, although we were -- we actually exceeded our expectations for Q1, but you have just sort of the natural ramp that happens as you put actions into place throughout the year. So that may help you as you sort of think of the timing dynamics.

We did talk about GP or GP operating margin, Q2 kind of being the low watermark as it relates to the full impact of inflation flowing through. And that is GP and up margin because a lot of the inflation is also in the area of shipping. So you should think of both line items in that regard.

[Thomas Polen, President, CEO & Chairman]

And Matt, just maybe one other item to add is we have been very active and we put this in place last year. We have a formal inflation task force that we've established, with multiple different pillars within that and dedicated groups, working on everything from rethinking our logistics chain, and that includes looking at alternative shipping partners in a number of areas. For example, how can you ship from Asia to the U.S. or from Europe, U.S. to Europe in more efficient ways? What parts of our supply chain have traditionally used airfreight, as an example, that we can move on to rail or boats? We've been taking actions and rethinking that, both how we get products to customers, but also from raw material suppliers into our plants. And of course, looking at the materials themselves, where there's alternative vendors and working with existing vendors on different technologies that could be more cost effective for us to use. All of those are different components within our inflation task force, it's been very active, and we're seeing the impacts of that as well.

[Operator]

We will take our final question from Rick Wise with Stifel.

[Frederick Wise, Stifel, Nicolaus & Company]

Tom, Chris. Tom, just this excellent quarter, just the superb margin performance, et cetera, makes me think back actually to our December -- mid-December 2019 meeting as you were about to step into the CEO role. And I'm curious about 2 aspects of your comments back then. One, you highlighted your growth-focused priorities, particularly inorganically. I'd be curious to hear just maybe update -- your updated thinking on M&A and opportunities for the rest of the year, how aggressive you hope to be or what the opportunities are.

But the second part, and even more particularly, today, we've heard again and again about the clear path to that 400 basis of operating margin improvement. I was hoping you could be a little more granular about the 3 things you highlighted back in December 2019. You said we're going to reduce the manufacturing footprint. You're going to unify the end-to-end operational processes. And we've heard Chris highlighted the SKU rationalization reduction. Where are we on those initiatives? How much more is there to go? Sorry for the long question. Appreciate any color.

[Thomas Polen, President, CEO & Chairman]

Thank you, Rick, for the question. And hopefully, get to see you again soon in person. As the pandemic here, it's been a while since we were able to connect live, which I always enjoy.

So I appreciate it. It's a great, great question. Certainly, as we look back and we laid out the BD2025 strategy, I do see that we're beginning to transition from how we view the first phase of that strategy into the second.

The first phase of that strategy, and I remember our discussion well, we talked about an initial focus on, including strengthening our balance sheet and cash flows to increase flexibility. And you've seen really pleased with the team's work around accounts receivable, payables, inventory. You've seen our free cash flow conversion moved up meaningfully. over that period of time. And that's allowed us to have flexibility to do what you just mentioned, M&A opportunities. And I think we are among, if not the highest, number of acquisitions within med tech this -- over the past 2 years. We clearly demonstrated our interest there.

We've also spent a lot of time accelerating innovation and reshaping our portfolio and driving strong execution in that portfolio. If you recall very early on, we jump-started that with the Growth and Innovation Fund. We gave that strategy a further boost by reinvesting a portion of the COVID testing proceeds last year. And we're beginning to see the results of that work. And the energy across the organization as our mindset is very strongly pivoted to growth.

And I am pleased with the cadence of the company M&A and how we've built those capabilities as a new lever for the organization. Obviously, just this quarter and the first few weeks of Q2, we've done 4 acquisitions. This year, I believe we did 6 or 7. Last year up to 17, over the last 2 years since we've met. And we are going to continue that focus.

We shared at our Analyst Day that 80% of our M&A has been focused in transformative solutions. The 3 areas that we've described repeatedly, smart connected care, enabling new care settings and improving outcomes in chronic disease, focused within higher-growth sectors within those markets. Expect our tuck-in M&A strategy to continue to be focused within those while selectively doing deals that help secure and strengthen our position within our durable core, which is also doing very well as evidenced through our performance this quarter.

On the -- as we think about M&A opportunities, we certainly have -- continue to have a strong pipeline going forward. We've made commentary, we continue to not have any transformational M&A within scope of our strategy at this time. We're focused on tuck-in M&A. We do have the ability to go larger than what we've been doing, more in the up to $2 billion. And we can -- we will flex over $2 billion for the right strategic opportunities and value-creating opportunities. And so we'll continue to evolve the size of those as we go forward.

On the -- as we think about -- and maybe one last thing there, too, when we talk about M&A items coming in, of course, a major milestone here this week with the Board approving the spin of embecta, and that's part of our portfolio strategy as we now have dedicated Diabetes Care business. We will be one of the largest dedicated diabetes companies on the planet, able to have a focused management team, with focused cash flows, driving a focused strategy in that space to create shareholder value, while we focus in the other remaining areas for BD. Focus our talent, our resources, our capabilities in those areas that are most strategic to us. And I think it's a value-creating opportunity very clearly for what will be now 2 stand-alone companies. But a major milestone. And interestingly, a milestone that was achieved, nearly to the day, 100 years. It was January of 1922, end of January 1922, when the first insulin was injected. It was used in therapy on a teenager up in Canada. And it's interesting nearly 100 years later is when we just are spinning out the world's largest insulin injection company now as a stand-alone organization.

So on the Simplify side, we're really pleased with the progress there. And you could hear from whether or not the actions that we've been taking and how we've been exiting certain product lines, that thousands of SKUs that we're getting rid of as we simplify our portfolio to focus on those products that matter and we're going to drive our growth and help simplify our plans. We have dedicated teams working on our network simplification strategy. Those have all been identified and are underway around our manufacturing footprint.

And while SKU rationalization, you've heard it's well underway. We'll continue to execute that. Largely over the next year, that will be completed as that.

At the same time, you can see very clearly, we are hyper focused on our margin strategy. ReCoDe is part of that, but it also includes areas around the supply chain and inflation management that I talked about, includes pricing as part of that as well.

We made a commitment during our Analyst Day around the 400 basis points of improvements in getting back to pre-'19 margin levels by 2024, and we've got that in our sights and are hyper-focused on delivering to that goal.

So we're very pleased with the progress we're making. As we look ahead, we're going to continue to focus on executing that strategy that we outlined as part of BD2025 and shared more details on at our Analyst Day, and we look forward to continue to update you on the progress.

[Operator]

And at this time, I'll turn the call back over to Tom Polen for any closing remarks.

[Thomas Polen, President, CEO & Chairman]

Okay. Thank you, and thanks, everyone, for your questions. Before we sign off, I just want to thank BD's 75,000 associates around the globe who live our purpose every day to advance the world of health, who are working tirelessly to support our customers and frontline health care workers around the world and are committed to executing our strategy. I'm proud of how we've started fiscal '22. I'm looking forward to continuing to deliver on our goals and making meaningful impacts for our customers and their patients around the world. On behalf of the entire executive team, thank you for your efforts and sacrifices.

And operator, with that, we will end today's call.

[Operator]

Thank you. And this does conclude today's audio webcast. Please disconnect your lines at this time, and have a wonderful day.