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

Hey, everyone. My name is Tejas Savant, and I'm the life science tools and diagnostics analyst here at Morgan Stanley. It's my pleasure to host Hologic this afternoon, and we have Karleen Oberton, CFO; and Ryan Simon from Investor Relations, representing the company. Before we get started, just need to rattle off the disclosure statement here. Please see the Morgan Stanley disclosure website at morganstanley.com/researchdisclosures. If you have any questions, please reach out to your sales rep.

So with that, guys, thanks for doing this. Maybe Karleen, just to set the stage, can you talk about sort of some of your key accomplishments over the last 12 months? And what are you looking forward to as you head into fiscal '23?

Sure. Well, thank you, Tejas, and thanks for having us. We're excited to be here. Hologic, over the last really 2 years, has really transformed throughout the pandemic. But certainly, over the last 12 months, we really amped up our capital deployment in acquisitions and share repurchase. I would say -- let me frame it, in the last 2 years, deploying almost $3 billion, half about on acquisitions and the other half on share repurchase. I think -- we're really excited about what we've done there and kind of the growth drivers from those acquisitions, but also over the past few years, what we've done through the pandemic in our Panther placements and driving the molecular diagnostics content on those Panthers and really emerging as a much stronger organization.

Got it. So just get into each segment in turn. So last quarter, you pointed to some encouraging trends in chip allocation, including, I think, you said stabilized lead times. With the fiscal fourth quarter serving as the low-water mark, how are you thinking about the cadence of the recovery through next year? And is there a chance that some of these issues could impact for the first part of fiscal '24 as well in your mind?

Sure. So at this point, based on the information that we have now, we would tend to think that there is sequential improvement in the Breast Health revenue, meaning improvement in the chip supply through -- into '23 with probably a bigger improvement in the back half of '23. It's a little hard because our suppliers only give us 2 quarters really of visibility. But we do think that's the improvement that we'll see. I don't know that it's going to continue into '24, again, with a limited visibility, but feel good about continued improvement, and more importantly, that this being the low-water mark right here in the fourth quarter.

Got it. And recently, consumer demand has come in fairly meaningfully here. Does that sort of benefit you or accelerate the slope of that recovery on the chip side?

Unfortunately, they're not the same chip. So the chips that serve the consumer side are probably more of a leading-edge technology than what we need on the image capturing side for our business. So it's not a light switch that the allocation can go directly to us. So that's why we still think about an improving recovery into '23.

Got it. And last we spoke, you had pointed to your efforts to allocate inventory for competitive customer situations. How has that strategy fared for you?

Yes. I think we've been doing well. We haven't had any orders canceled or any meaningful shift. Our sales folks still execute on the quarters that were established prior to the chip supply shortage. So that backlog is continuing to grow. And we haven't had to lay off folks because of the revenue shortfall. So we have our production folks building what we call build to short. So if we do get chips in better than what we're planning for, we can deploy those units.

I see. Now one of the things Steve has talked about is gantry is being a lot cheaper than robust and other expensive capital purchases. How resilient do you expect the amount to be in light of some of the worsening macro headwinds here particularly OUS?

Yes. We haven't seen any pressure on the breast business OUS at this point in time. I think it's still a conversation of moving from analog to digital, sometimes outside the U.S. are moving from 2D to 3D. And really detecting those cancers earlier, actually is better outcomes for the women, but it's also cost savings for the health system. So I think those conversations are meaningful and lightful to drive that business.

Got it. What about trends on the service revenue component within breast, I mean, what is the attach rate to systems look like today? And how do you see that sort of trending over the next couple of years here?

Yes. So that's part of our secret sauce in that breast business is that, that field service engineer that service group. We actually have pretty high attach rates already over 80%. So I don't think we'll see that grow meaningfully given so how high it is already. But again, I think our field service engineers are out there, really they are the face to the customer for Hologic and love the work that they do.

Got it. On interventional, you've mentioned the Brevera relaunch and contributions from Somatex as well that have offset some of the imaging disruption. Could you just provide color on what you're seeing there and the longer-term opportunity?

Yes. So we relaunched Brevera a couple of years ago. I think this is really a technology that improves workflow for the physician. And I think what we'll see is more of a pull-through on the disposable element moving forward on that versus continued growth in the capital, which we saw early on, on the relaunch. So now it's about the pull-through and the utilization of the units.

Got it. And how do you think about sort of key gaps in the portfolio on a go-forward basis? I mean you've got SuperSonic Imagine, Focal, Faxitron, et cetera, all embedded in there. Are there any sort of missing pieces that you could add?

Yes. We've done so much work on really diversifying that business and really diversification across the patient continuum of care. I think the only spot we probably haven't addressed as treat is if the market moves to same day see and treat, that might be an area that we expand to in the breast business.

I see. On the core diagnostics, I mean, you've seen fairly strong growth here. I think in the third quarter, you did over 20%. Are you seeing any sort of shift in trend? I mean, particularly OUS, deteriorating FX, obviously, and perhaps even some concerns around energy spending and costs.

Yes. So that's core molecular diagnostics grew 22% in the third quarter, really about continuing to drive content on the Panther and that's playing out both in the U.S. and OUS. In fact, OUS has been growing at a faster rate and particularly with our HIV product, is driving a lot of that growth. So really haven't seen energy come into play in regards to that business at this point.

I see. And then in light of the limited pricing power in diagnostics, Karleen, how are you thinking about operating margin improvement, particularly on the OUS side of things?

Yes. So we think about molecular diagnostics, the majority of our -- all of our molecular products are produced in our San Diego facility. So -- and that manufacturing capacity is fungible between COVID and all the other assays that we manufacture. So just the more volume drives margins for that business. And in particular, OUS, over the past several years, we've really invested significantly in our commercial capabilities. And I think that now we're at a point of leverage moving forward as we deal with things like FX.

Got it. Obviously, you've talked about that transition and pull-through from COVID to non-COVID work. You've expanded the Panther installed base. I think it's about 3,200 units, if not more. How should we think about the cadence of placements first on a go-forward basis particularly given that there is probably existing capacity that's still relatively underutilized as COVID testing normalizes?

Yes. So Tejas, as you know, it's not really the Panther placement that drives revenue, it's putting the content on the Panther. So given what the number of placements we've accelerated over the past 2 years, I wouldn't be surprised if the Panther placements came down over a few quarters below that pre-pandemic level, again, just given the acceleration and pull-forward that we've had. But again, that doesn't impact revenue. It's more about how do we get the content on the 32 Panthers that are out there.

Got it. And in terms of annualized pull through, do you think we're at a low-water mark or close to that at this point? I mean, as you transition from COVID to non-COVID work.

Yes. I mean that utilization metric is going to have some ups and downs. Certainly, with the -- if we looked at all of the COVID in the base revenue, it's at all times high, right? As COVID comes down, obviously, the utilization will come down. But then we also have the dynamic of -- we've recapitalized some of our largest customers from TIGRIS to Panther. And as that revenue ports over, that utilization will spike again, but it won't be an increase in revenue. So to me, it's more about, as I said before, driving the content on the Panther that's going to drive that revenue top line as we've seen the 22% in the third quarter.

Got it. And can you just talk to us about your efforts with your sales teams in terms of driving many utilization, improving same-store sales? I know in the past, you talked about tests of record. But are there any other key metrics that you can talk to today just about that transition in pull-through?

Yes. So certainly, early in the pandemic, we incentivized our sales force kind of twice their typical compensation to drive non-COVID revenue. And I think we've seen that in the test of records that we talked about in that over the past several years, our test of records have been higher than the prepandemic levels. The other thing that we also utilize is our physician sales force. So we have -- I'd say that's our secret sauce and our Molecular Diagnostics business. So the physician sales force are the ones that go out and call on the docs and teach them about guidelines and adherence to guidelines. And we actually partner with our labs to get data to drive those conversations. And so in particular, about a year ago, the CDC changed the guidelines on screening for sexually transmitted diseases to opt out. So we are the ones that will go out and educate physicians around that and grow that market.

Got it. So that's actually a perfect segue to my next question. I mean, is it starting to move the needle on FTI revenue for you? And if not, I mean, over what time frame do you expect to see that play through?

Yes. I think it's still early days on that. Think about still really, since the guideline changed, dealing in the pandemic, less access to physicians. So I think this is something that's going to play out over several years.

Got it. And on Mobidiag, how are you thinking about sort of the revenue opportunity in fiscal '23? And are there any opportunities to drive margin leverage as well in the business?

Yes. So Mobidiag approved in the EU has been available in the EU this past year. We've probably had more of a limited launch because of supply chain challenges. We've addressed those and looking forward to a hard launch beginning of our fiscal '23 and some nice revenue contribution there, I think. Still small from an overall business perspective. I think from a margin perspective, really spend is focused on getting the U.S. approval, which we expect in '25. So less focus on margin improvement for that business in the near term, that will be more when it's available in the U.S.

And are there any sort of potential levers you can pull to perhaps accelerate the U.S. time line?

We're trying. We're trying, but I think I'm going to rely on my experts when they tell me that time line. But certainly, if there's an opportunity, we would do that.

Got it. And then on Diagenode, in terms of how many high-throughput PCR tests you expect to have available on the Fusion by the end of this year?

Yes. We haven't really disclosed that kind of our goals on assays on the Panther Fusion. But like the work that we've done, I think we recently announced the approval of our transplant assays, which really complements the portfolio, meaning that in some markets, you need those assets -- assays as the ticket to entry to really drive the rest of our portfolio.

Got it. And then on breast cancer index, clearly, you have the NCCN and ASCO guidelines in place. Are you making a bigger commercial push here? And how could that sort of impact growth in fiscal '23?

Yes. So really pleased with that asset and the performance in this past quarter. We did just under $20 million in revenue. That compares to $30 million in the 12 months prior to acquisition. So we're already seeing great commercial performance there. We have actually been in the process of moving the CLIA lab into our San Diego facility to fully integrate physically. We're also making investments in lab automation, information systems, and that's what will really improve the customer experience and accelerate performance.

Got it. Cytology and perinatal, I mean, obviously, it's a smaller business. Any sort of updates on the pandemic recovery there? And as you think about longer term, I mean, you've got the longer testing intervals and the vaccines rolling out and the revised ACS guidelines as well. What gives you confidence that, that business can still land in that 5% to 7% ZIP code that you've laid out?

Yes. So if I think about the cytology business, it probably isn't in the 5% to 7%, right? Overall, diagnostics is, but cytology is probably in the U.S. is more flat, a little bit of growth in the U.S.

Got it. That makes sense. On COVID, I mean, obviously, pockets of case counts going up and especially in Europe and China. Any indications over the past few weeks that could point to upside relative to the $100 million or so you've baked into your guide here in the near term?

Yes. So let me just clarify, the $100 million was about $70 million on the assay and $30 million on the COVID-related revenue. But certainly, I think what we've seen in the U.S. is consistent testing about over 3.5 million tests a week, which probably wasn't what we considered when we initially guided. But as we said, we're managing COVID as upside to the business.

Got it. And how are you thinking about the 4-in-1 test versus stand-alone? I mean obviously, I mean, at least in the southern hemisphere, it's a pretty strong flu season. How does that sort of shape your expectations heading into winter in the U.S.

Yes. So far, I mean, the demand has really been for COVID only. There really has been minimal demand for the multiplex assay, but we do have it available on our Panther Fusion. And so if demand is there, we'll be able to supply.

I see. And what would be the margin implications of that mix shift? Were we to see a, I don't know, 50-50 or something like that heading into the...

Yes. I think it's certainly a multiplex assay comes at a meaningfully higher ASP. So it would be accretive.

Got it. On GYN Surg, I mean, any high-level color you can share in just month-over-month procedure trends? And how are hospital staffing shortages looking at the moment?

So I won't give an inter-quarter update, but certainly, as we looked at Q2 when we had more of a surge in the pandemic, the growth rate was only 3.5%. Q3, jumped up to 9 -- just under 10% growth in the quarter. So I think what we're seeing is a quicker recovery when we have these surges from the pandemic that people are getting back faster than we did a year ago. So overall, that business is performing well and expect another strong quarter here in the fourth.

Got it. And talk to us about the MyoSure runway, Karleen. I mean that's the question which probably doesn't get as much attention given all the other sort of moving pieces in the portfolio? And how big is NovaSure for you today? I mean, does it really even move the needle anymore?

Yes. NovaSure has been declining. It's still a significant piece of revenue, and it's still a pretty profitable piece of revenue. So we'd like to get that more off to a stabilization, but that market has been under pressure. MyoSure, we think that will continue to grow probably more in the low to mid-single digit versus -- I mean, we had so many quarters at 30% growth. But those days are behind us, larger base, but it's also -- what we'll see the growth is complementary Fluent Fluid Management unit, which complements the MyoSure procedure. And that also has a disposable element to it. And that really is an eloquent solution to what was a pretty pedestrian challenge in that procedure.

And on that note, is there anything else that you can add to your sales reps portfolio?

We're trying. We're trying. Yes, I mean, we have -- that's our largest sales force, our OB/GYN sales force. Like what we've done with the Acessa and the Bolder acquisitions, adding more to that bag. But certainly, that's part of the business development strategy, how can we leverage that sales force more.

Got it. And you just mentioned Bolder as well. What remains to be done here on the final integration? And how are you thinking about the penetration ramp on the OB/GYN front?

Yes. It's still early days for sure. I think ramping up demo activity with our sales force had some supply chain challenges and actually getting some of the product this year, have addressed those. From an integration standpoint, it's probably more on the systems, putting them on our one instance of Oracle, but certainly fully integrated with the sales team. And I think it's early days as far as penetration on the OB/GYN.

Got it. And what is -- talk to us about the OUS component of GYN Surg and the growth you're seeing there. Have there been any sort of shifts in demand in Europe, I mean, given some of the recent headwinds?

Yes. Outside the U.S., surgical is pretty small. It's still early days. We've seen some really accelerated growth rates, but off a pretty small base. But we think that, that will continue to grow as we move forward.

Got it. Margins, I'm sure you spent a lot of time with investors talking about this in the last few weeks. Clearly, you're anticipating a recovery here towards the low 30%-ish range by the end of fiscal '23. Just walk us through the moving pieces there. You've got this 400 to 450 bps sort of gantry headwind, 200, 250 bps on input cost headwinds. And then you've also got the WTA expense coming out by the end of December. So how -- what does that mean for you, particularly as you layer on sort of your typical seasonality, which also drives the margin dynamic?

Yes. So I think as we talked about on the revenue headwind, we expect that to -- as the revenue improves throughout the year, we expect that margin impact to lessen throughout the year, certainly, and hopefully, as we exit Q4, we're more at a normalized state. As you said, the WTA expense will end here in the Q1 or actually -- the most significant piece of it is in Q1. It's lessens throughout the year. But I think the higher input costs are probably a little more sticky and they'll be here through '23 and likely more of a tailwind as we get into '24.

I see. And then how does the seasonality play into it, Karleen?

Yes. So Q1 is usually seasonally stronger as most health plans reset at the beginning of the calendar year. So if people go in to get their procedures while they're not -- well, they don't have to pay the deductible. So I don't think it's -- if we look at Q1, it's going to be an anomaly where they will have higher revenue, but we still have the WTA putting pressure and more of an impact on the breast health. So it's not.

Are those full offsets? Or is it...

No, I wouldn't say -- they are not full offsets now.

I see. Got it. Makes sense. Capital allocation, you've got a pretty large free cash flow base, a pretty healthy balance sheet, close to $2.5 billion in cash. What is your appetite for larger deals beyond sort of the tuck-ins that you've pursued here?

Yes. I mean, obviously, we have the dry powder to do something larger. But I still think it's a focus on tuck-in or maybe we call it a bolt-on, but it's still where we have a point of leverage? Where do we have an expertise? What are those assets that would perform better as part of Hologic versus not part of Hologic. So the strategy really hasn't changed. I think we just have -- the aperture is a little bigger given our free cash flow.

Got it. And as you evaluate your deal pipeline, walk us through what are the key metrics you look at? And to what extent is profitability and accretion important to you versus assays that might be growing a lot faster?

Yes. I think the capital that we've deployed over the past few years has been more on the higher revenue growth. And as we know, some dilution that we've absorbed. So I think certainly we're a little more sensitive to level of dilution as we move forward and look at deals. But I think, first and foremost, it starts with the revenue growth, with our confidence in the revenue growth and how accretive is that revenue growth to the overall company. And then certainly, it's dilution versus accretion, and how quickly can that asset be accretive to the corporate profile. And then finally, certainly, we're looking at returns. And certainly, ROIC is part of long-term compensation for the executive leadership team, so we're making sure that we have a reasonable ROIC on the deal as well.

Got it. I just got one here over e-mail. You've called out sort of 90% of users utilizing more than one assay today. I think you talked about also, I think a majority of them are actually between two and four. Does that sort of defer by either customer type or region?

Well, given it's 90% globally, I think there's probably more in the U.S. that have higher number of assays on the Panther than OUS, given just the penetration that we've had in the U.S. has been stronger.

I see. And going back to capital deployment. I mean, obviously, share repos have been a key part of the equation for you. How are you thinking about sort of repos going forward? And then I have a quick follow-up.

Yes. So certainly, at a minimum, we want to cover our dilution from our equity plans. But I like what we've done. We've bought over 5 million shares year-to-date this year, which is in excess of that dilution. And we'll still continue -- it will be ongoing, Tejas, as part of our capital allocation, and we'll jump in when we see opportunities.

Got it. And do you sort of foresee any issues with the Inflation Reduction Act and sort of this buyback tax that's embedded in there or not really?

No, not really. And I think the tax is the cost of equity, so it doesn't hit the P&L. So probably a little less sensitive to it.

Got it. I mean, just in closing, Karleen, how do you think about sort of the most underappreciated aspect of the Hologic story? What is your vision for the company over the longer time frame?

Yes. I think what's underappreciated how much stronger we are post the pandemic. And when we talked about the long-term growth rate of 5% to 7%, what really gives us excitement about that is that's across all of our divisions, right? So it's not just one play. It's not just the Panther that's driving that growth, although that is one of the accelerators is across all our businesses, coupled with the capital that we have, the cash flow that we have, we feel like we can continue to execute on our capital allocation strategy and continue to make this company stronger.

Got it. This was a great overview. So thank you so much for the time this afternoon. We appreciate it.

Thank you for having us. Take care.

Yes.