Hologic, Inc. (HOLX) Earnings Call Transcript & Summary

All right. Good morning, everybody. It's great to be here with an old friend, Mike Watts, from Hologic. Hologic has been doing a great job over the past year taking steps to optimize the portfolio while meeting financial targets. The company is seemingly heading back to its roots and positioning itself once again as a women's health-focused company, which is a topic we want to get back to in a second. So thanks for being here, Mike.

Thanks for having us.

We have a pretty ambitious agenda, so I'm happy to just jump into questions.

Yes. Fire away. Fire away.

Okay. So before we get into talking about the return to women's health, as I just framed it, I want to spend a couple of minutes talking about what we've all been talking about, both at this conference and more broadly, and that's COVID-19.

Sure.

So just to set this up, again, we've started most of our discussions at the conference with a question on COVID-19. For you guys, China represents only about 3% of sales. But I am curious, what were you expecting for revenue growth in China?

Yes. Our international business, as you know, Doug, has been growing kind of at a high single-digit, low-double-digit rate. And China has been in that ballpark, depending upon the quarter. So pretty consistent with the rest of international. I mean clearly, that will be affected by what's happening over there now, but we haven't yet quantified that. And at 3% of revenue, hopefully, it's pretty manageable.

Okay. Is there any China supply chain, either direct or indirect, that we need to be thinking of?

Yes. I would say, minimal. I think we're -- certainly, no direct impact we did in recent days and cover a little bit of indirect impact on some of our smaller products, mainly our bone density products and ultrasound products. But it should be okay in the near term. If things continue to stay challenging there for longer term, it would be something to keep an eye on in the second half, but pretty minimal.

Yes. It's been interesting over the course of this week and checking in with folks over the last couple of weeks that that indirect supply chain is a little harder for a company...

It does. It takes a little bit longer to uncover those things. But again, in our case, we think it's pretty small.

Okay. So beyond China, because unfortunately this is clearly moving globally, what's the opportunity and pathway for Hologic to actually provide a solution, a diagnostic for COVID-19?

Yes. I think we -- we're in a pretty good position to help with the public health threat as we did with Zika a few years ago.

Yes. You've done this before.

I mean we've done this before, as you say. I think there's 2 primary paths for us, Doug. One is, we are developing a test for the U.S. market under the EUA procedure, so Emergency Use Authorization, if you're not familiar. Moving as fast as we can on that in consultation with the FDA and hopefully to -- hopefully expect to make that filing within the next few weeks. Secondly, one of the things that may not be immediately apparent is on Panther Fusion. Remember, Panther Fusion has an open-channel capability. So labs will be able to develop their own tests on Panther Fusion in an automated, high-throughput fashion if they so choose. So probably 2 ways that we can help.

Can you help provide guidance for folks to develop an RUO-based, PCR-based tests to run on COVID-19?

Yes. I believe there have been protocols that have been published.

Okay.

So that will be up to the labs obviously to take a look at those protocols, adopt as they see fit, but that can be done under the CLIA regulations.

Okay. And then -- so that's a pretty unfortunate but exciting way that you can help and hopefully drive some volume. On the flip side, yes, I haven't thought about this as much with you guys as some of the other diagnostic companies we cover. But in previous years, yes, there are companies where they will actually see a decrease in volume forecast because people just aren't going to hospitals or even their PCPs as much if they don't have to. Is that something we should be thinking about right now?

Yes. I think that's certainly a possibility. We have seen that in the past with some really difficult flu seasons, for example. And given that some of our business is basic screening and well-woman checks, I mean that's certainly a possibility. And we would not expect obviously a significant upside from our own test development efforts on this at all. It all depends on the severity of disease, how long it lasts, how much testing is done. But there certainly is that potential for visits to be hit on the negative.

Okay. Anything else do you think we should cover on that front?

No. No. It is good.

Okay. All right. So subsequent to the sale of Cynosure, one of the company's messages to the investment community has been really the effort to reintroduce Hologic as a unique asset in women's health. Can you elaborate on the significance of the statement?

Yes. Sure. So maybe focusing on the reintroducing part, I think there has been so much focus justifiably on Cynosure over the last couple of years, obviously, an acquisition that did not go well. I think that that focus has obscured what's been a strengthening of each of our businesses. In Breast Health, the portfolio has really broadened from a U.S. capital business to one that really spans the whole continuum of Breast Health care globally. Diagnostics, we've added a tremendous amount of menu to Panther. And even in Surgical, I think Surgical has accelerated sequential growth in I think 7 out of the last 8 quarters. So I think some of those things were obscured by the focus on Cynosure, and it's been nice to kind of get back to the basics and share with investors what is really a strengthening business across the board.

Do you think there's a -- I mean you're -- I appreciate you articulating an understanding of why Wall Street focused as much as it did on Cynosure. I get it. At times, though, I would argue. And I was probably part of the problem where it seems disproportionate at points. That being said, within -- as investors pivot back to looking at core Hologic, is there a similar thing going on within Hologic? To some extent, inevitably to something like Cynosure distract people? And now that you've moved past that, does it lead to enhanced focus on what Hologic has already been doing well and potentially lead to you doing even better?

Yes. I hope so. I mean I think the announcement of divesting Cynosure created value right away, which was nice to see. The multiple bounced back a little bit. And certainly, it was a good example of addition by subtraction. And I think we're building -- and I'm sure we'll get into this, a good track record with some of our smaller tuck-in M&A, which is really where we focus going forward. If you look at Faxitron, Focal, SSI, those are off to good starts, and I'm sure we'll get into that. So we recognize we need to kind of build our track record back there in a positive way and think we're doing that -- starting to do that.

Good. All right. So let's talk about the organic revenue growth outlook. So Hologic's organic revenue growth remains really what we spend a lot of time talking to investors about in terms of what is Hologic built to grow in the long term. Do you think Hologic, as it's currently built with the portfolio that's in place, do you think that this is a mid-single digit, around 5% organic grower with the portfolio that you have?

Yes. And I think it's important to kind of remember the history here a little bit and where we've come from. If you think back to the first part of our fiscal 2018, I mean you'll recall, the business was probably growing in the 2% range.

Yes. Yes.

Back half of '18 into 2019, I think 2019 fiscal, we grew a little bit more than 4% organically for the year. And we just increased our guidance to 4% to 5% for 2020. So growth rate is clearly getting better as a function of better commercial execution in the U.S., internationally, R&D pipeline, business development. But not quite at that 5% yet, right? At least for 2019, that's certainly where we want to be. And that's certainly what we aspire to. But I think to continue increasing that growth rate a little bit further, it's going to be those same factors: continue to see productivity out of our R&D pipeline; continue to grow internationally, which has been a nice driver for us; and really importantly, hopefully finding some tuck-in acquisitions that are growing faster than the core is, so that we can inch our growth rate up over time rather than try to do it all in one fell swoop like we did with Cynosure.

Right. '20 -- fiscal '20 guidance assumes that organic revenue growth approximates about 4% to 5%.

Right.

What are the key puts and takes that are embedded into the high end and low end of guidance? Yes, essentially, what takes you higher and what takes you to the low end?

Yes. I think one of the things that's always a little bit more challenging to model is the uptake of new products that you've recently introduced. I think the good news is, we have a lot of new products. The challenge can be getting those ramp assumptions exactly right. So I think that would be one variable. Certainly, that could go either way. And international as well, over time, has been a great grower. I think it's been up double digits -- low double digits each of the last 3 years. But on an individual quarter basis, that can be a little bit lumpy just based on the size of the franchise.

Maybe we can talk about Diagnostics for a few minutes. So Molecular Diagnostic revenue growth accelerated last year.

Right.

Hologic delivered around -- I think it was around 9% growth last quarter, and that was against the tough comp.

Right.

So pretty impressive. What's driven -- what are then the key components of what's driven accelerating growth in this franchise?

Yes. As you know, the biggest tests in that market are our women's health assets. So this would be for chlamydia, gonorrhea, HPV, trichomonas, those kind of things. And the business as a whole could not post the growth rates that it has unless those products were growing nicely, which they have been. And that I think speaks to the importance of our physician-based sales force and the partnerships that they have with some of our lab customers to drive underlying testing demand in compliance with testing guidelines. So those certainly in dollar terms have been the biggest drivers of that growth. And then obviously the new products. We now have 16 I think different tests approved on Panther. Many of those have been approved in the last couple of years. So the uptake of those -- particularly the viral load assays, which are growing nicely, so these are quantitative tests for HIV, hep C and hep B seeing good uptake, particularly OUS, we're starting to see some uptake in Africa. And then some of our newer women's health tests like our vaginosis panel are contributing as well. But ultimately, the recipe in Diagnostics or Molecular Diagnostics is putting more Panthers in more countries and putting more menu on those. So it's a classic -- if you're not familiar, the classic razor-razorblade business model where we want to load up those Panthers, that automated instrument, with as many tests as possible.

You mentioned the 16 Panther assays cleared in the U.S. We've -- in our checks and our discussions, there's been enthusiasm for mycoplasma genitalium as well as some of the virology assays. Are there assays do you think that we should be paying more attention to in terms of just trying to assess the growth, the sustainable growth outlook for the franchise?

Yes. Well, I know you guys pay attention to a lot of things in Diagnostics. But certainly, viral loads were a little bit less than $40 million of revenue. Last year, in our fiscal 2019, that almost doubled over the prior year period. So those will be important. Amgen, which you've mentioned, has been identified by the CDC as an infection of interest. So keep an eye on that one. And again, our BV/CV/TV panel, or the vaginosis test, which is really the primary reason that women go see their OB/GYN, certainly a need for market development there and for Amgen. But it wouldn't surprise me that if over a number of years, one or the other of those products could be a $50 million, $60 million, $70 million product kind of like tricky as today. That's a similar example of where there was a need for testing out there. We developed that market. Now it's a very nice product for us.

In a recent industry article, a Panther customer noted that Hologic has been more aggressive, more competitive with pricing in order to convert from a competitor.

Right.

Could you talk about how pricing has trended across this portfolio? Is there a change in strategy? Or is this just a...

Yes. Yes. I saw that as well. I mean I certainly can't speak to an individual customer, but I mean I would tell you that for our existing assays, the mature assays, pricing is generally flat to down very slightly.

Which is normal.

Which is normal in this market, as you know. So certainly, that's not how we try to compete. We compete -- again, on Panther, the automation that Panther provides and trying to provide the lab a full complement of assays, so they can knock out competitors. And so we haven't seen anything that we can offset with productivity gains and such. And I'd also point out that some of the newer tests, whether it's viral load or some of the new women's health assays, are higher priced than the legacy tests. So we get a little bit of mix benefit there.

Panther Scalable Solutions, this is something you recently launched. These solutions are targeted at bringing efficiency and platform consolidation benefits to customers.

Right.

To us, it seems like these solutions should help get some of those lingering TIGRIS customers to move over to Panther and better position you guys to win -- get some competitive wins, competitive transitions. Is that a good way of thinking about this initiative?

Yes. I think it is. The neat thing about Panther is that it can play in a relatively small lab based on the expanding menu, but also because of its throughput can play in the larger labs as well. And clearly, these solutions, there are actually 3 different configurable, if that's a word, options: Panther Plus, which adds reagent capacity and walkaway time; and then Panther Trax is the high-end system which actually physically link systems together; and then in the middle is Panther Link. So you can run multiple Panthers from 1 software interface. So all those things are really geared toward the bigger labs. So the neat thing about Panther is regardless of the size of the lab, we can provide a solution for them. And as their business grows, and hopefully we help them with that, they can expand their throughput with some of these solutions.

There's a little bit of a toggle with this approach, right? I mean right now, pull-through per Panther is I think just under $250,000 annualized. So on one hand, if you're more successful in converting some of the high-end customers, the pull-through goes up. If you're more successful driving some of the smaller customers, I could see a scenario where pull-through actually goes down a little bit on a per box basis. I mean at this point, do you kind of care one way or the other?

Well, ultimately, revenue is the pull-through times the number of boxes, right? It's not half of the equation. So I think there is a natural limit on that pull-through number simply because as a lab loads up more menu on their system, once they get to 2/3 or 3/4 or whatever it is capacity, they're probably just going to get a new Panther, which is like totally fine with us and totally good for the lab as well. And they might use one system to do some of their testing, the other system to do the rest. So in that scenario, average pull-through goes down, but Panthers go up. So in the end, it's the revenue that matters. And as you said, that's been a pretty consistent kind of high single-digit grower, which has been nice.

Maybe to pivot to Breast Health. So it seems like you've broken out of the historical norm of I guess what could be characterized as a boom-bust cycle where you launch a new platform, goes up hockey stick rank, then it drops off. Would you agree with that? Even when -- and as we look ahead to when all the 2D systems in the U.S. are converted to 3D, do you still think you're in a position where it's not going to drop off the way it has in the past?

Yes. I mean certainly, overcoming that boom-bust cycle has been a major strategic focus of Pete Valenti, who runs that business and his team, and they've done a great job of that. One of the slides we show is that I think a lot of investors still look at breast as mainly a U.S. capital business, but the reality is that U.S. capital is only about 21% of breast revenue today. So what we've tried to do is rather than just selling capital, we've tried to play across that full continuum of Breast Health care with service revenue, which is actually bigger than our capital revenue today. We've got biopsy products that we're adding to the acquisitions of Focal and Faxitron Health and obviously ultrasound deals as well. So I think we have really diversified that revenue stream out. A few years down the road, there is a next-gen system on its way. It's not here yet, and we don't need it to be because there's still 2D to 3D conversion to go. So I think we will have a product cycle at some point. As you alluded to, that's unlikely to be as steep as it was in the past because we are pulling some of those features forward today, new software upgrades, even some hardware upgrades that give us more consistent revenue as opposed to that up and down.

With -- I think gantries, mammography gantries represent about -- that's a 21%.

Yes. Yes.

In recognizing the trend there, which has been stable to slightly down. But for the overall business, recognizing that's a relatively small part of it now, I mean can -- are you now positioned based on what you just described to actually -- I was going to use the word inflection, that seems a little traumatic. But I mean are you positioned for growth in this business based on the mix?

Yes. We think we're -- we feel great about where Breast Health is. We feel great that it can be a consistent grower over time. Gantries are still at the core of that. And that's really where we start the patient journey. And as you point out, that's probably -- gantries themselves are probably not a growth market at least in the U.S. going forward. But with all these other things going on, we do think that can be a very consistent grower, and we feel really good about where that business is today.

You mentioned the opportunity for international growth. In fiscal Q1, revenues actually declined in Breast Health, excluding SSI.

Right.

Was that largely just a function of a tough comp?

Yes. It was just the comp. I wouldn't read too much into that. We would fully expect that international breast number to rebound over the balance of the year.

Okay. Maybe just to pivot to Surgical for a few minutes. So what's the go-to-market strategy for some of the new products like Fluent and Omni in the Surgical division?

Yes. I mean it's pretty simple, really. I mean I think in all of our businesses, we're trying to leverage strengths that we already have, right? So getting back to breast for a second, it's really that 3D mammography installed base; in Diagnostics, it's the Panther instrument; and in Surgical, it's our sales force, right? I mean this is our largest sales force. It's a sales force that's largely been upgraded and turned over, over the last couple of years. It's -- those reps are now 100% commissioned. So if they want to eat, they have to go hunt, right? So that I think has made a big difference on performance. And we really just want to -- in leveraging those relationships with the GYN surgeon, what else are they using that they're buying from someone else that they could be buying from us? And you mentioned Fluent. That's our fluid management system that's used with MyoSure in that procedure. So that's a nice combination there. But also we've introduced a new hysteroscope that obviously helps with the visualization and insertion of the -- in doing the procedures, a new cervical dilator, those kind of things. So really trying to leverage that call point as much as we can with products that that kind surgeon needs.

Is there an opportunity to bundle new products with MyoSure, NovaSure? Is it really just what you described going out there and not being -- get in front of the dock and being able to sell some of these products?

Yes. I don't know that I'd use that word necessarily, but I think it can make...

You can make that word. So...

Right. But certainly, some of these products are used with the MyoSure procedures. They can go hand-in-hand in that respect. But I think anytime you can give the rep a new product to talk about with the doc, that's really what provides value. And Sean Daugherty, who runs Surgical -- I mean his goal is to deliver a new product every quarter to that sales force, either organically through our own R&D efforts or through acquisitions. So off to a good start with Fluent, the cervical seal, the new dilator, those kind of things.

And they have enough room in the bag to keep that?

Absolutely. Absolutely.

Okay. Okay. Any chance you'd ballpark how big these products are now as...

The new products?

Yes.

Yes. I mean they're not huge, although they are significant contributors to growth. I think in the last quarter, they were less than 10% of Surgical revenue. But I think that the number roughly tripled over the prior year, I think almost. So huge growth. And that's not to diminish what we're doing with MyoSure either, right? I mean I would also point out that MyoSure had an exceptional quarter as well. That was up well into the double digits in the quarter, but new products are certainly important driver of growth.

You mentioned the fact that Surgical sales rep compensation is now 100% commissioned. Is it too early to tell how that's working? Or are you already seeing benefits from that?

Well, I think if you look at the sales by quarter, it's either 6 out of last 7 or 7 out of the last 8 quarters, quarterly growth has accelerated sequentially. So I think the upgrading of the talent in the sales force and those new reps settling in and understanding the business better has certainly been an important driver of that. I think there's a tremendous amount of momentum in the Surgical business. And that new commercial model and new talent and better talent has definitely helped.

You mentioned MyoSure. I mean it's kind of got a little bit overlooked in our discussion here just because of the focus on new products, but growth continues to be impressive. Yes. I think you grew up to mid-teens in the most recent quarter. What's driving this? And how do you think about the sustainability at this level of growth?

Yes. I don't know that it's going to grow mid-teens forever, but I think it can certainly be very accretive to corporate growth rates. And I think there's a couple of things. One is just the maturing in the -- of the sales force that we talked about before, and those folks really settling in. Secondly, it's just a really good product, right? And it's an easy way to remove fibroids and polyps. I mean some of the newer line extensions for MyoSure help reach -- I mean literally, the product is called MyoSure REACH, helps the doctor remove more pathology as well. So that helps expand the available market, and we think there's pretty good runway ahead.

Maybe just to close on capital deployment. Starting on M&A, what -- how would you describe your M&A framework?

Yes. So definitely division-led, right? We don't have -- to give maybe a little bit of color, we don't have a large corporate business development group, but rather small group sit in each of the divisions. So we're looking for smaller tuck-ins that either leverage an existing sales channel or that help us expand into a near adjacency. For example, some of the breast acquisitions, Faxitron and Focal, enabled us to expand from just calling on the radiologists to also calling on the pathologists and the breast surgeons. So near adjacency there. So leverage existing channels, near adjacencies, relatively small. Financially, we're looking for things that are accretive to growth. So we don't just want that onetime step-up in growth, but rather more consistent growth on a go-forward basis. Focal and Faxitron are good examples of that. I think we're up in the teens in their first 9 months or so last year on a pro-forma basis. So that was nice. We're also looking for good ROIC and over time earnings accretion. Although I would say, we would be willing to do a deal that has a little bit of earnings dilution. I mean SSI is a good example of that. We said that would be a few cents dilutive or less than 1% dilutive, I guess, in the first year. But I mean that's what we can -- we think we can compensate for that in other ways, particularly with the buyback program and other things.

And then the hope is that becomes accretive fairly quickly thereafter.

Absolutely. Yes. Absolutely.

Does -- originating M&A at the divisional levels, does that really change the risk profile of what the company is going after?

Well, I think there's risk in any deal, right, regardless of corporate or division. But what I do think I think you're right in that we're not trying to set up new verticals or expand into new areas. We are really trying to grow what we know well.

Play off your strength.

We play off of our strength, exactly. Grow what we know well. So you think about the leadership change that has occurred at Hologic and Steve joined at the beginning of 2013, I mean all of our division presidents and all -- most of the senior management is new. And I think it's taking those teams a little bit of time to kind of settle into their divisions and really understand the landscape. So as we're looking at deals in Diagnostics now or Surgical or Breast Health in many cases -- in some of the Breast Health deals, we've always been the preferred buyer of those assets. So we started the relationship several years ago, maybe even took a look in the acquisition a few years ago, didn't work at that time but have come back around to us. So really playing where we know the markets well. And I think almost by definition, that's going to be a less risky profile.

And then how do you prioritize at the corporate level between, yes, let's say, if somebody wants to do something in Breast Health and somebody wants to do something in Surgical? I mean does everybody have the same capacity to do deals? Or is there some prioritization from the top?

Yes. I mean we really want each of the divisions to be looking for their own transactions. I think the good news, Doug, is we haven't had to choose, right? And we generate hopefully close to $700 million in free cash this year. So that's plenty of room to do hopefully a couple of small tuck-in deals and buy back some stock. We're only about 2.5x levered at the end of last quarter. So a lot of headroom there with our balance sheet. So I think we're in a good position given our cash flow to have each of the divisions looking for those transactions and be able to execute on them. And so far, we've only completed deals in Breast Health. But definitely, Surgical is looking and Diagnostics is looking as well.

There's activity.

Yes. For sure.

Okay. Maybe just to close on share buybacks and then tax if we have time. So starting on the accelerated share repurchase program that you put in place at the time of the Cynosure divestment -- divestiture, excuse me. So I think around 80% of the buyback was completed in the fiscal first quarter. Is the remainder of that expected to be completed?

Yes. The remainder of that's done now. I mean it's kind of the mechanics of how the buyback program rolls out, but that's done now.

Okay. Okay. And the Board has authorized an additional $500 million share repurchase program beginning in fiscal Q3.

Right.

Is there any way we should be thinking about how that would work because I think the structure is a little -- it's obviously a little different than the ASR. I guess what I'm getting at is, should we tie that to free cash flow or anything like that? Or is it more opportunistic?

Yes. We've -- we haven't given any guidance on that, Doug. I think our buybacks have been opportunistic over time. The ASR was a little bit of a catch-up, if you will, because obviously we had closed our window internally as we were getting late in the Cynosure negotiation. So -- and we weren't able to buy back stock at that time. So the ASR helped us get caught up. So no specific guidance there. I would say, however, that in this notion of leveraging strengths that we've talked about, we do have our product strengths that we've covered, but we also think free cash flow is a strength, right? We definitely want to be more active in deploying that free cash both in these growth accretive tuck-in deals, but also in buybacks.

Closing on tax rate. So it's meaningfully declined for Hologic from the mid-30s 5 years ago to just above 20%, 21% to 22% today. How much more room is there for tax optimization from these levels?

Yes. I think there is some room over time, Doug, probably not in the near term. I think one of the things that's been interesting is with all the changes in the U.S. federal tax law, I mean regulations on some of those things have just been being issued literally fairly recently. So we have now got a better understanding of what the playing field is in the U.S. and can kind of look at that over time. I think in the near term, we probably about are where we are. But as we expand internationally, that still does give us some potential benefit over time that we should be able to realize.

Okay. All right. That's great. Well, why don't we leave it there and then we'll cover anything else in the breakout? But really, appreciate you taking the time today.

Great. Thanks so much.