GE HealthCare Technologies Inc. (GEHC) Earnings Call Transcript & Summary

Welcome to the 2024 Wells Fargo Healthcare Conference. I'm Larry Biegelsen, the medtech analyst. And it's my pleasure to host this next session with the management team from GE HealthCare. With us, we have Jay Saccaro, the CFO; Carolynne Borders, the Head of Investor Relations. The format is fireside chat. If anybody has a question, please raise your hand, we'll come around with the mic. Jay and Carolynne, thanks so much for being here.

Thank you.

Larry, thank you for the invitation to the conference. We, as always, really appreciate it. And then thanks to folks in the room for joining us and those dialing in. We appreciate the interest in our company.

So it's our pleasure to have you here.

Jay, so you've been at GE HealthCare for a little over a year now. So what's gone well? What could have gone better? And what are you excited about?

Sure. I'm absolutely thrilled to be at the company. I think, for me, it is so exciting to be at a company where we are truly trying to create a world where health care has no limits. And that means investing in innovation, transforming the way things work and helping patients achieve better outcomes. So so thrilled and honored to be there with the leadership team and so incredibly exciting. As I think about over the last year, we've made tremendous progress on a number of different fronts. First, you see the significant investment that we've made in innovation over the last 1.5 years. And we're advancing the pipeline in a very positive and productive way. We've built a series of innovation processes, most notably our worldwide product planning process, which is designed to lead to productive R&D. So so happy with the investment and the supporting processes on innovation. From a commercial standpoint, we have outstanding commercial teams. We've reorganized many of them over the last couple of years, and it's starting to pay dividends. You saw some outstanding growth in the second quarter in a number of different areas. We talked about our U.S. region, led by [ Katrine ], who does a wonderful job there. We talked about our PDx business, another business that has done extremely well. So really nice growth from a commercial standpoint. And I think each of our areas are setting themselves up for real continued success going forward. You see that evidence in the backlog. And then the final thing I'd point out that's doing really well is this whole lean focus. We talk about cost transformation. We talk about a lean transformation, lean mindset, and very pleased with our ability to drive gross margin improvements to continue to invest in R&D and drive an EBIT transformation. I think it serves us really well. I've been incredibly impressed with the initiatives. Now by the way, lean is more than just cost, safety, quality, delivery, cost and innovation, it's how we think about it. But cost is an important element, and it's one metric that we look at as evidence of the progress that we're making on our lean journey and really pleased with what we're able to do there. So those are 3 things that have gone really well. Listen, we had to lower guidance from a sales standpoint at the second quarter at the halfway turn of the year. And a lot of that comes down to the China market and volatility there. And so if I were to say, we're always disappointed when we have to adjust guidance. So that would be probably the most prominent disappointment. Having said that, I'm so proud of the team in China and the work that they're doing to navigate a complex environment, but that was a tough dynamic that we had to address.

And what are you excited about?

So as I look forward, for me, continued progress along those 3 dimensions. I think what you're going to see in the coming years is those investments and innovations start to pay off in a very meaningful way, the investment in commercial that we're making, that reorganization, continued success on that front. You would have heard us talk about a lot of partnerships, creative partnerships that we're pursuing with our customers. We're so excited about the work that we're undertaking there. And then finally, this continued transformation from a cost standpoint, from a free cash flow standpoint and most prominently, from a lean standpoint, those are 3 things that are incredibly exciting to me.

Perfect. So Jay, let's talk about 2024 and how you see the rest of the year playing out. The guidance, I think you gave guidance for Q3. I think it implies about 1% growth, slightly below what you did in Q2. And then a decent step-up in Q4. What -- how are you thinking about the rest of the year playing out?

Sure. So from a sales cadence standpoint, you're right. We did say approximately 1% in the third quarter. And then you can -- that implies a step-up in the fourth quarter. It's important to note that we build our revenue forecast using a couple of different methods. There's a statistical method. There's a bottoms-up method. And then one of the important things that we look at is how much of the sales that you're counting on in the third and fourth quarter is coming from the backlog that you have today with dates attached to it. And in a given quarter, what we like to see is around 75% secured. That's what we call the secured rate. And then the residual is what you have to sell and install in the quarter. And so as we looked at the second half of the year, what we were able to see is because of all of that good work that we were doing in the second quarter outside of China in terms of orders, 6% orders growth is ex China in the second quarter, a lot of those had dates attached in the fourth quarter. It allowed us to put together this third and fourth quarter forecast, where we had this fourth quarter step up. Now what I'm talking about relates to capital. That's about 55% of our sales. And so when you have the 55%, about 75% of that is secured. The residual part of the business, the 45% is a bit even more bankable than that in the sense that it's more linear flow in the case of PDx or it's attach the contracts in the case of service. So I think that really gave us the confidence as we looked at the second half of the year, that we could count on a solid Q3, but then this acceleration into the fourth quarter. Now the other thing I will say is, of course, the comps get easier. We had very challenging comps in the first half of the year, third quarter, and then the fourth quarter is the easiest comp of the year.

All right. That's helpful. You lowered the guidance that you touched on earlier by about $500 million by my math. Was the reduction all China, Jay?

Yes. So we lowered the guidance, 4% goes to 1% to 2%. That's somewhere between $400 million and $600 million at the midpoint exactly as you say, $500 million. For us, we were -- we saw a lot of uncertainty in China. We think the stimulus is a positive for the market. We think there are a lot of positive attributes with the market long term. Certainly, it's been a great market for us over the last 100 years, the last 30 years manufacturing there. So it's a good market, but there's just been a lot of volatility. So we really wanted to reduce the risk of our forecast related to China. So it was exclusively a China move.

Got it. And the margins were actually a bright spot in Q2. How do you see the margins playing out the rest of this year? And I think the guidance does imply a pretty big step up there, too, in Q4. Is that tied to the sales acceleration?

Yes. So we were really happy with the margin in the first half of the year. If you think about it, what we were able to do is about 110 basis points of gross margin expansion in the first half. We then grew R&D well into double digits, leading to a 50 to 60 basis point expansion on EBIT. So really nice performance from a margin standpoint. We did it in the face of essentially flat sales. So no sales volume contributing to this really good gross margin story. So the question is, what was going on there? And I think as we looked at it, we saw extremely good performance in terms of these variable cost productivity initiatives, which more than offset inflation. And then when you add to that the pricing initiatives that we had in place, it led to this dramatically positive impact on gross margin. We'll see that continue in the third and fourth quarter, but we will also have the benefit of incremental volume, we'll have the benefit year-over-year of incremental price. And then there were some one-timers in the fourth quarter of last year, some R&D spending that occurred that will not repeat. It was more kind of onetime in nature R&D. So that's a little bit of a tailwind as well into the fourth quarter. So there are a number of things that collide in the fourth quarter that support this expanded accelerated margin transformation. And I think we feel good about the forecast that we put together.

That's helpful. So before we get to China, which is on a lot of people's minds, just outside of China, any color on the hospital capital equipment environment?

We feel good about the hospital capital environment. I mean, notwithstanding China, we feel good about the hospital capital environment. I think we do a fairly rigorous survey each quarter and then we also look at all of the work done externally, and there's a lot of rich work done by a number of sell-side analysts, along with others who follow hospitals. And what we see is hospital profitability is looking pretty good, staffing shortages have eased to some extent, you see continued procedure volume strength, you see that in all of the med tech companies that are deeply procedure tied and our PDx business. So all of those things lead to a fairly attractive capital environment. No, I don't really have any further changes since what we said last time, but I think it's a decent environment right now. And you saw it in the orders in the second quarter, really strong order performance in a number of markets outside of China.

So Jay, turning to China. My question is not for an intra-quarter update there, but is there anything public that you can speak to in terms of developments with the China -- with the stimulus? I mean, we don't -- I don't read Chinese. I don't read the news. Are there any public developments that you can speak to on how things are? Hospital activity with the anticorruption or stimulus? Any updates there?

We really don't have an update in terms of China. And it's kind of progressing as we kind of anticipated. There's increased interest in putting orders in, what we call this pre-tender bucket. So we're seeing that progress kind of as we would expect. But all of this has to pay out from pre-tender to tender to approval to order to sale. And so it's a fairly extended process. The biggest thing is this is a longer process than the last stimulus. The last stimulus was, it felt like more centrally coordinated. So it was a fairly rapid rollout. This is just taking longer. And that's okay. Like from my standpoint, I think we have taken a prudent approach to our guidance in terms of really reducing it. And I'm hopeful that this becomes a tailwind at some point. We're watching it very carefully, but we're not counting on it in any specific month because, to your point, it's a volatile and hard to understand dynamic. Like I say, we think it's a good market long term. The dynamic is solid. And if you look at the 10 years of growth for us, it was outstanding. And as we forecast forward for the next 10 years, we really do see positive growth dynamics there. It's just that in any given year, there's volatility around that line.

There's a debate on how big the stimulus could be. Some people -- I mean there's people who think it's relatively small. There are some people who think it's relatively large. How do you think about how significant the stimulus could be?

I think we have a point of view, but we feel -- we'll wait and see until it comes out. I mean, it's great to talk about it. It has shown up in our orders. And there's been a lot of like, over the last several months, there's been a lot of speculation around size, how much geared to health care, who's going to win in health care, what types of products within imaging and ultrasound are going to be targeted with this. There's a lot of variables that people are speculating around. We made the guidance decision that we did because we wanted to stop speculating. And so we'll see. I think our team is working very closely with customers, governments, so that I'm optimistic that this will be a good thing for us and for the market. But as far as size and how much is geared to CT machines versus others, it's just premature to speculate.

Larry, maybe just to add, one of the things we try to focus investors on is the fact that the China government is committed to expanding access to care for the people. And so you saw that evidenced in the 2022 stimulus and again this time. And so it may be taking longer, but there's a clear commitment to building out that infrastructure.

That's helpful. Jay, given the $500 million in kind of reduced sales for this year, do you think you can get some of that back next year? I mean you did $2.8 billion in China in '23. The guidance applies like $2.3 billion this year. Can you get back some of that back next year?

I'm certainly hopeful that we will. It's too early to give guidance for 2025, I think. But first of all, we'll have easy comps in China next year. That's clear. And then second, hopefully, some of this pent-up demand is paid off next year because, by the way, it's not only this idea of stimulus, it's the fact that there are orders being postponed as a result of lack of clarity. So it's not like it's an incremental order per se, it's an order that you might otherwise have seen this year. So we're hopeful that we get orders back, but I think it's premature to comment on 2025.

And outside of China, are there any other potential puts and takes we should consider for '25? I know you're not giving guidance, but anything that we should just be cognizant of?

So we'll give guidance in February. I think importantly, on the second quarter call, we said we feel good about the trajectory of the business and where we're going. That's not a '25 comment, but that's saying, "Hey, how is the health of the business looking over the midterm?" We feel good, and it comes down to those 3 things that I said at the beginning: innovation plus commercial execution plus transformation yields great outcomes. So we feel very good about the progress that we're making, the work that we're putting in. And so we'll have more to say when we see you in February.

Sounds good. One other question, more of a long-term question actually before we get to the margins, which are obviously very important to people. The tax rate. I've talked to a lot of people about GE HealthCare since I initiated coverage, and I rarely have ever been missed about the tax rate. You're the proud CFO of one of the highest tax rates in medtech. So there's got to be an opportunity to reduce it. I'm joking, obviously. It predated you. But there's an opportunity. By my math, if you get it down to 18%, it could add 1% to 2% of EPS growth over the next, call it, 5 years. How are you thinking about the tax rate?

So first of all, I will definitely share that with our tax team, that specific comment in terms of the impact that the tax rate can have. It's not loss on us. First of all, we have a tremendous tax team, really wonderful individuals and really talented group of folks. And in fact, we just recently hired a new tax leader for the function. So I'm thrilled to welcome this individual. So we'll be doing that shortly here in the coming weeks. But your point is a good one. Is there opportunity to optimize the GE HealthCare tax rate, work from where it is to '23 to '25? There are gating factors. The structure of how you set up your manufacturing network is a very important gating factor. There are some companies that you say, "Hey, how do they have such a low tax rate?" Well, you look at the locations of the 4 plants, then it kind of explains everything. But in our case, we have certain high tax cost jurisdictions, but I'm not going to say there's no opportunity there. And it's something that we're carefully looking at, consider the [ gauntlet thrown ] down, and we will -- I will share this clip from this discussion with the entire tax team because we're working hard to drive this opportunity for our company. So I appreciate that.

All right. The margins, Jay, are a big part of the story, obviously. You guys have done a nice job this year. You talked about the margin expansion despite sales being flattish. You talked about getting to high teens to 20% adjusted EBIT margin over the near term. How do you see the ramp, Jay? And what's your kind of conviction now that you've been at GE HealthCare for a year?

I feel good about the margin plans that we have. And really, it's a combination of things that's going to drive us forward. Obviously, to your point, volume growth and pricing are important contributors. But in addition to that, these productivity initiatives that we have in place, every single plant has a list of initiatives. We centrally coordinate with the Center of Excellence that helps those plans develop ideas. We track those on a monthly basis, and it drives a very significant impact. In addition to that, you heard us talk about some of the tactics that new spinoffs tend to undertake on our earnings call. One of the things we highlighted is that we moved many of our servers from hosted by GE to into the cloud, be it Oracle or others, and that generated significant savings in 2024 and will add incremental benefit in '25. You heard us talk about consolidation of application service providers that was going to save us, I think, $20 million, along with some PC moves that we made. And so I share -- we share those deliberately because it's part of the playbook of a transformation of a cost structure for a newly independent company. And so a lot of the work around thinking creatively and efficiently around simplification on the back office is areas where we have right opportunity. We had -- in finance, we had 8 different business intelligence tools that we were using, creating thousands of different reports. Many of those reports were designed to answer the same question done in a different way. So for us, we said, okay, let's get down to one tool. That in and of itself will save money from an IT standpoint. But then when we can consolidate on one set of reports, then it allows us more efficiencies and more effectiveness as a function. So that's the journey that we're on from a G&A standpoint. So as I think about the margin, it really comes down to a number of different things: commercial execution, innovation, driving higher margin on new products, this variable cost lean initiatives and then the G&A. You put all of those things together and it's a really exciting story. Taking on the margin of a company from 14% to -- hopefully, we get to the high end of the range in years to come, it's incredibly exciting, it's something that we're all committed to and we're seeing real progress. And it's exhibit a, you grew gross margin 110 basis points, you grew EBIT 60 basis points, despite R&D, 15% growth in a flat sales environment, pretty good. What can you do when you start to see normalized sales growth? Let's see.

That's helpful. Jay, you talked about the capital allocation strategy. And specifically, the comments Pete made on the Q2 call about expanding your horizons to think about what should be part of GE HealthCare. Can you elaborate on that, please?

Sure. I think -- so we regularly evaluate the portfolio. But I think, for us, we have a very interesting situation from a capital allocation standpoint. I think what I'm incredibly compelled by is the organic investments that we can do in the base business. The fact that we're spending so much more on R&D, it's not because we just want to spend more on R&D. It's because we actually have programs that are driving real returns, the last dollar spent is still driving real returns. And because of this innovation process that I described at the beginning of the meeting here, we feel very good about -- it's a good legitimate project with a real return attached to it. So first of all, our capital allocation begins with reinvestment in the business to drive accelerated growth, expand capacity and things like PDx, those are the kinds of investments that we'd love to make. The second thing is, from our standpoint, M&A is an incredibly rich area. And why is that? First of all, we have a lot of balance sheet flexibility, right? We do. The balance sheet, because of the cash flow generation of the company, is in a good spot. And then as you forecast forward, the balance sheet, based on the future cash flow, goes to a great spot. And so this idea of smart M&A to supplement our strategies becomes really, really compelling. Our model ideally becomes more about systematic acquisition where it's strategically accretive. You look at the financial returns, ideally, EPS accretive in the near term, ideally a very attractive ROI versus our weighted average cost of capital in a few years' time, 5 years, call it. And then we are tilting a little bit more towards recurring revenue as another feature. So those are all things that come into play. But what it comes down to is very much about ideally strategic tuck-ins. Now that's not to say we rule out larger acquisitions. But to the extent that we can build this muscle of consistent acquisitions, learn from every single one, bring them into the fold and then accelerate growth that way, I think that's a template that a number of folks have applied that we are really trying to implement at our company. We've had a few successes, right? So for example, Caption Health is basically artificial intelligence that attaches to ultrasound devices, that allows untrained sonographers to quickly get good ultrasound exams complete. Really a cool -- it opens up ultrasound to lots of different folks that would not do it prior. So we've incorporated that into a number of our products with more opportunity. The [ MIMS ] acquisition is another great example of a company that we acquired, and it's interesting because we were lacking an element of our portfolio, which is when you're selling a multi-modality deal, the importance of digital software to support comparisons amongst modalities and enhance workflow, it's really important. And so when we were selling a lot of deals, we would sell MIMS on top of our software. They would sell MIMS on top of our hardware offering. By acquiring MIMS, it was just a great acquisition that tucks directly into what we do, and we can incorporate it more seamlessly and then drive to better outcomes. So those are 2 great examples. The interesting thing is, you heard me talk about our objectives, but the portfolio that we have really lends itself to a lot of near adjacencies. And that becomes a very important part of our capital allocation. We pay a dividend. We'll evaluate things like share buyback as well. But I think we're very compelled by this business development opportunity and the opportunity to drive consistent growth through consistent deployment of capital to that vehicle.

What's the target net debt-to-EBITDA, and where are you?

We don't really have a target. We haven't come out to specify a specific net debt-to-EBITDA target. We'll evaluate that, too. We'll have more to say about capital allocation at our upcoming Investor Day. But what I would say is we really like BBB. And I think that we'll have a lot of capacity against a BBB rating shortly as we continue to -- we paid down debt last year, not clear that we need to pay down more debt. We'll evaluate that as we approach year-end. But really nice free cash flow generating ability of the company, really nice EBITDA growth. So those are 2 wonderful dimensions that support an enhanced balance sheet profile.

Free cash flow conversion, you have a stated goal. This year, I know the guidance implies about 90%, this is high. Do you have a stated annual goal?

Yes, we did say that. What did we say at the Investor Day?

At the last Investor Day, we said 85%-plus free cash flow conversion, but you're right that the current guidance implies higher than that.

Yes. And listen, that's an intense focus for us, too. That comes -- the operational discipline required to deliver 85%, 90-plus percent is really high, and it comes down to how are you managing your inventory turns, how are you managing your collections. Those are the leakage areas where you start to lose relative to this adjusted net income conversion ratio. So I think we're making good progress there. And again, it's an intense focus for us.

That's helpful. Jay, switching gears, there's -- my impression is there's more interest and excitement around the PDx business for a few reasons. Starting with the proposed imaging agent reimbursement changes. I don't think people have a good sense of what that could mean for your business. Could you help frame the opportunity, please?

Yes. We're going to talk much more about this at our Investor Day because to your point, this has been a bright spot for us, the PDx business. I think we grew 13% or 14% in the second quarter, 2/3 of that related to volume, some price and then some contribution from new products. Interestingly, something like Vizamyl, we sold a few million dollars' worth. It tripled versus the prior quarter. And so you don't need to grow at those kinds of rates for an extended period of time to start to get really, really interesting. And it's doing that despite some reimbursement challenges in the hospital setting. Outside of hospitals is one thing, but in the hospital setting, it has a challenging reimbursement profile for Medicare patients. So what the CMS ruling does is it really allows for a decoupling or discrete reimbursement for things like Vizamyl, for things like Flurpiridaz, our breast cancer drug diagnostic, Cerianna. All of those things today, which have sort of a bundled reimbursement will be called out and specifically reimbursed. So this means a lot to things like Vizamyl. Right now, when a hospital prescribes Vizamyl, it's kind of covered by the bundle, meaning the economics of that because we charge a decent amount for that in the thousands, the economics of that to a hospital could be challenging for a Medicare patient. As you decouple, you start to have a discrete reimbursement, allowing people to prescribe more fully this kind of a diagnostic agent. Same is true with Cerianna, where Cerianna may be the best available agent in a given situation. But there is a real tough reimbursement challenge for hospitals that look to prescribe it as you have the CMS ruling come to bear, which should be in January, depending on how things go, then all of a sudden, you create a new opportunity. So I think for our entire PDx business, it starts to create new avenues for growth, which we're quite excited to support. And I think the reason we're so excited is because I go back to where I started. I told you I'm so excited to be at this company because of creating a world where health care has no limits, and this idea of precision medicine, medicine to use specifically. And that's what these imaging agents are doing. They are advanced diagnostic agents that prescribe you -- describe you as a patient very specifically. Now we're getting the reimbursement support to help that. So think, let's -- we'll have more to say about Flurpiridaz and Vizamyl and Cerianna, but I think this reimbursement is important.

Larry, we took a look recently at what the potential net reimbursement change could look like in certain examples. And we estimate there could be an improvement in that net reimbursement in the hospital setting of anywhere from $1,500 to $3,000 per dose. So it would be meaningful as hospitals are considering, where do I have capacity on devices to send patients for these exams, whether it's outpatient or inpatient.

Is there any way to frame how much the exposure of the PDx business is today to this new -- to the new reimbursement?

That is the smallest piece. Today, the radiopharmaceutical products is less than 1/3 of what PDx revenue is today. But obviously, we think that has big room for growth over the coming years, and we will talk about that more at Investor Day.

And you give a global number for PDx. So less than 1/3 is the radiopharmaceuticals. Do we then have to take a [ haircut ] U.S., OUS?

It is fair to say that most of what we sell today in radiopharma is in the U.S. market. If you see where a lot of the drug therapies are being approved first, that tends to happen in the U.S. market first.

With this, this really comes down to market opportunity and unlocking that. And I really think that this reimbursement change makes it incredibly exciting because what we're talking about is our sales today. But you heard Carolynne, the reimbursement could be upside down for hospitals that are trying to prescribe some of these therapies. Let's see what happens. And so we'll talk more about the addressable market when we sit down with you all in November.

Jay, you mentioned Flurpiridaz. Do you still expect approval in 2024? And how are you thinking about the opportunity broadly?

Yes. We think -- listen, we think Flurpiridaz is a great opportunity. It's a great improvement over conventional care, of course. There's going to be an adoption curve that needs to take place. And in the case of Flurpiridaz, we're actually asking for a change in practice. So those are all -- it always takes longer to engender a change in practice versus just prescribing something new. But we're incredibly excited about it. We can't speak on behalf of the FDA, so we're awaiting further information and optimistic about the quality of the filing that we put forth. So stay tuned.

Okay. And Jay, GE HealthCare probably talks about it, the benefits, more than any other company in medtech or one of the most from AI. And I think you mentioned publicly in a webcast that AI today is about $1 billion somehow revenue-wise...

We call it digital revenue. It's $1 billion, over $1 billion.

Where do you -- how do you monetize AI? That's what investors are asking. And where do you see the greatest impact over the next few years?

So AI represents a very significant opportunity for imaging companies, and we are intensely focused on R&D programs that will support that going forward. And by the way, our business today benefits from AI significantly. So if you think about, for example, we sell a product called Air Recon DL, and what this essentially does is for an existing MR machine, it enhances the quality of the image by reducing or improving the signal-to-noise ratio, and it allows the scan to be done in less time. So by the way, hospital MRs are highly constrained depending on the hospital because an MR exam, you could be under the magnet for 45 minutes. Air Recon DL reduces that, improving capacity for hospitals and improving image quality. And so what we're doing today is we're selling this as an add-on to existing products. People are buying it. They love it. And it further differentiates us. It's a great way to differentiate our product offering. But then for new products, they're also attaching it with Air Recon DL. And so it's a great example of a product today that has meaningfully impacted our financials as a company in a very positive way, both sales and operating income. As we go forward, I think that there are more holistic and comprehensive ways that AI can influence things. Things like comparing images, right, across to drive better outcomes. All of those things are kind of a little further into the future, but represent very big opportunities for imaging companies. And so we're going to be talking at our Investor Day about a lot of these investments that we've made, how we're utilizing artificial intelligence to drive better outcomes for the devices, between devices to drive better care for our patients. But it's clear, it's one of the biggest reasons why our R&D has stepped up so much.

All right. Perfect. We're almost out of time, Jay. I want to give you the last word. Any closing remarks or anything we should have covered?

No, I think we hit it all. Really appreciate everybody's interest in our company. We're so excited to be where we're at. And we're 1.5 years old start-up based on a 100-year-old company. And we have tremendous opportunities in terms of innovation, commercial execution, embracing a lean culture. We're so proud of the progress that we face, a lot more to do. And tax, by the way, I hope my tax team listened in to this conversation today. Larry, great to see you. Thank you so much.

Thanks for being here.

Thank you.