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

Welcome to TD Cowen's second day of our Annual Healthcare Conference. I'm Max Masucci, one of a Cowen's Life Sciences and Diagnostic Tools Analyst. I've had the pleasure of covering Hologic since 2017 with a short stint between. But it's great to see you, thanks for being here.

Thanks for having us.

All right. So we've got CFO, Karleen Oberton; and VP of IR, Ryan Simon.

Yes. Yes.

All right. Great. Wanted to make sure I have the titles right. So let's just jump into questions. So if we compare the pre-pandemic Hologic to today, it's very different. In fiscal '19, the company generated adjusted operating margins of just under 29%. And you've directionally guided to fiscal '23 adjusted operating margins of roughly 30%. So we've received questions from investors around whether the roughly 30% operating margin guide is simply a conservative managing of expectations. But I know there's a lot of moving parts. So to kick off, maybe can you just briefly highlight the major core assumptions included in the 30% operating margin guide? And then what's excluded?

Sure. So Max, let me start where you started, where is -- Hologic is a very different company from prior to the pandemic. We're more global, we're more diversified, and you have more growth drivers that are both organic and inorganic. And so feel really good about where the company is and certainly an exceptional balance sheet, exceptional capital structure, which enables us to go after those growth drivers -- continue to go after those growth drivers here in the future. From an operating margin perspective, maybe I'll do a baseline. As you said, there's a lot of moving parts. If you go to a baseline of Q2 fiscal '20, this is the first quarter without Cynosure. We had divested Cynosure. And it's really the first quarter without any COVID impact. And in that quarter, we did operating margins about 31.5%. So that's the baseline. So then maximum -- you look to the 30% here in 2023, there are certainly moving parts. So when we see COVID revenue, which is coming down significantly, which has been accretive to operating margins coming down. You have recovery of the Breast Health business. So that's recovering from the chip supply issue. And that recovery is pretty much on the gantries, which are margins are accretive to the corporate average. So that's kind of an upside coming through. Then you have lower operating expenses over the course of the year. So primarily related to marketing and our partnership with the WTA. Highest margins were in the first quarter -- highest operating expense in the first quarter that will come down over the course of '23. What's persistent throughout '23 is inflationary costs. So we've estimated that at 200 to 250 basis points over the course of '23. At this point, that looks pretty sticky. That might come down in '24, but just don't know yet. So those are the puts and takes that gets us to that 30% over the course of the year.

And so the next question, we'll move a little bit further down in the P&L and talk about net profit margin because if you do compare the pre-pandemic net profit margin, it was around 19.6%. And our fiscal '23 EPS estimate puts you around 23.4%. So you're certainly seeing some leverage there. So if we take into account the six M&A deals that you did between 2020 and 2021, and then you did take a bit -- you've taken a bit of a pause as the net leverage ratio has declined. If we think about evolving regional exposure and then also just an evolving mix of recurring revenues, how should we think about Hologic in terms of a long-term profitability generator and what that ceiling has risen to compared to prepandemic stats?

So banks are picking up on net margins. Our net margins have improved a few hundred basis points from prior to the pandemic. And that's really a result of looking at the P&L up and down. So it's the higher revenue growth, operating margins, which are already rich compared to the industry, and then even working below the line on things like tax rate, are all contributing to improvement in that net margin. And when we talk about our long-term revenue growth rate of 5% to 7%, we look at growing earnings. faster than that 5% to 7%. We really should get to high single, low double-digit EPS growth each year with that revenue. So -- but as we look over the long term, some of the puts and takes are certainly -- as our molecular business continues to be a bigger part of our revenue, that is accretive to the margin profile. But also our international business is growing faster, and that's a little dilutive to the margin profile. The acquisitions are a little dilutive right now, but will -- that will be an improvement over the course of time. And certainly, the rest of that breast and surgical business, still nice operating margins on both of those. But I don't think I'd view it as focusing on operating margin ceilings, but focusing on that 5% to 7% and low double-digit EPS growth is how we look at the business long term.

Yes. And it doesn't seem like there's been any change to the guidance philosophy at Hologic. I mean, it's -- you've been -- I don't know. I don't know what the right word to say is, but maybe punished for the success that you've had in COVID?

I wouldn't say punished necessarily...

From a stock perspective.

Yes. I would say that when we think about the stock and the story, I think there's questions out there like COVID. What is the COVID revenue? What's the duration? and I think what we've done beautifully is manage that as just upside. We managed the P&L on the base business because that COVID revenue has come down significantly, and we don't know what it will be, going forward. Especially you have the public health emergency ending here in April, which may have an impact. But I think there's questions on the chip recovery. I think what you'll see is over the course of '23, that breast business will continue to improve, kind of answered that question. And again, I think operating margins on the base business has been a question. But I think I just went through that. We feel really good about where it is and where the business will go from here.

Yes, absolutely. I mean, so many near term, let's call it 3-year dynamics that have changed. It does appear to us, at least someone who's covered the stock since 2017, that it's a different business, right?

Absolutely.

It doesn't seem like the valuation in terms of how you trade versus peers have sort of evolved in a similar way?

Yes. I think if you look at our leadership team, there's a lot of sports analogy, a lot of people who played sports are on our leadership team -- yes, we'll just continue to put some points on the board, right? And we'll continue to do that. And that's a little bit of what guides our structures. Our guidance is we want to make sure we meet our commitments and hopefully beat them. Again, continue to put points on the board and be a stock that people can count on.

Yes. Hopefully, you can put some points on the board at the TD Garden tonight.

I'll leave that to Ryan.

I'll take care of that.

All right, cool. Great. Well, I just want to remind anybody in the crowd, if you have any questions, feel free to e-mail me, [email protected]. So let's move into diagnostics. So you have essentially doubled the Panther global installed base since pre-pandemic times. But before we get into the more important results of that, which would be the recurring revenues. I want to first ask a few questions around placements. So you did place, I believe, several Panthers to new regions where Hologic was previously underrepresented or increased your exposure in areas where you previously were underrepresented. So -- going forward, do you see the majority of the -- you spoke to sort of that run rate to expect. But do you see the majority of Panther placements being competitively displacing? Or is there still a reasonably sized opportunity for what we would call greenfield placements because of those new...

Yes. I would say it's a little bit of both, but I think the Panther placements is not what drives the revenue. It's the utilizations, the pull through, in existing customers -- again, that pull-through as they add more menu, they also add Panther, another Panther to their efficiency in the lab.

One of the reasons -- yes, it was one of the reasons why I wanted to get the placement questions out of the way before we get to big consumables. But -- so you had the core Panther platform which I believe was FDA approved in 2012, then came the Panther Fusion module. And then in 2020, Panther Plus and Panther Link, and then the future Panther Trax. But for new Panther adopters during the pandemic period, which configuration was the most commonly adopted?

Yes. By and large, it's the regular base Panther that was adopted. What you're talking about is what we call our Panther scalable solutions. When you talk about the Links and the Trax, that's about efficiency within the lab and the workflow. But clearly during COVID time, it was about the Panther, and it was even converting in some of our larger customers, the TIGRIS, to the Panther. So think about our largest customers have our legacy instrument TIGRIS, which only 4 assays are approved on -- because COVID was developed on Panther, that was essentially a recapitalization opportunity for those larger customers. And as Panther Fusion really unlocks PCR capabilities in the COVID-19 assays that we have approved, probably only about 20% of that Panther installed base have the Fusion on it.

Okay, 20%? That's good to know. And I did have an opportunity to...

I think you have a question in the audience.

Oh, do we have a question? Yes. Go ahead.

Take a step where you think the evolution of the breast and scalable business [put that on the] on the breast side, where that business is going to in the future. I mean the 3D is pretty much an established technology now. Are things like AI going to be the [mix]? Or where is that [indiscernible] the future [indiscernible]?

Yes. Certainly, 3D in the U.S. is highly penetrated and we're the market share leader. I think there's obviously opportunities outside the U.S. for 3D capabilities and even 2D capabilities is definitely -- even analog devices that are out there. Certainly, I think what we're probably in the U.S., somewhat of a replacement cycle is coming, and we certainly have a next-generation gantry in a secret lab, somewhere in Danbury, Connecticut, that we're working on, that will focus on improved image quality and even patient experience because that is one of the common reasons that a woman doesn't go for a mammogram is that the fear and the pain related to it. But certainly, AI, as you talk about, we already have some AI capabilities, is a keen focus organically and inorganically for us for that business.

And so we still have a decent chunk of time. I will say that the -- we just celebrated my mom's 19th year, stage (III)B breast cancer survivorship, and she was misdiagnosed for 7 years. And the capabilities of the 3D system which are aimed towards women with firmer breasts were one of the reasons why she was misdiagnosed for so long. And so I do have a number of breast health questions and so I just wanted to carry and introduce that now. But anyway, so let's move to assay utilization. 24.5% year-over-year organic growth in non-COVID molecular diagnostics revenues in fiscal Q1. You've 19 FDA-approved assays. We spoke to it a bit earlier, but pricing in terms of the assays for U.S. versus OUS, Panther users, is that our pricing difference is meaningful enough to influence sort of that long-term margin expansion goal you guys have set?

Yes. So we certainly haven't disclosed the difference in margin between U.S. and OUS. But clearly, the pricing is lower outside the U.S. for our assays. What I would say is that substantially all the assays are manufactured in our San Diego facility. So just as we increase that volume, that's a tailwind to overall margins for the molecular business. So that will impede our focus outside the U.S. in that growth because just, again, increasing that volume improves the margin.

Yes. So essentially, the volume leverage is sufficient enough to overcome the pricing delta.

We'll overcome it all, but it's certainly that growth.

Yes. [indiscernible].

Yes. And we'll create -- and the other thing on OUS, just to put it in perspective, is even though there's some lower margins, we have significantly invested over the past several years in our commercial capabilities. And so that will also be a point of leverage as we move forward for that business.

Yes, absolutely. And then putting some context around -- there was a comment made on a recent call, I believe, by Steve, that for new adopters that have gravitated to other items in your menu there is often -- the contracting process -- and they can often include multiyear contracts and whatnot. So -- we have 55% of new Panther customers, I believe, as of April 2020. New customers being as of April 2020 that are now running at least two other assays in addition to COVID testing. So just -- can you put some context around the sustainability of that menu adoption that you're seeing outside of COVID? And then whatever you can offer on your contracting process I think that would be great.

Yes. I think that metric, which is in our corporate presentation, and I think the other metric was that I think over 85% are running at least one other assay. So I think there was a concern of instrumentation mothballing of the instruments coming back. So we know that metrics do give people a sense of these new customers that took Panther and time of COVID are now contracting and committing to other elements of our menu -- assay menu. And that -- those contracts are multiyear, usually 5 years of commitment, maybe some of its as low as 3. So that gives us a sense of the stickiness of the Panther instrument once it's in there, that people appreciate the workflow, the automation, the hands-off time that, that instrument brings and therefore, are validating other assays. And that process of validating a new assay doesn't happen in a week. It's usually several months. So once an assay is in there, it's usually going to stay. And that's why we contract for close to 5-year periods because that instrument stays on our balance sheet, right? So all of the revenue comes through the assay pull through. The customer doesn't buy the instrument, we kind of rent it to them, so to speak, through the assay.

Makes sense. All right. Well, let's move to breast health. Yes, you did have a slide in your deck that displayed the percentage of breast health revenues represented by the entries and how that's evolved between 2014 and 2022, and it was 17% exiting fiscal '22. So interventional solutions and services have become a larger -- have become larger pieces of the pie. So maybe just given that you do have your product portfolio has expanded in terms of breadth and diversity. What do you -- which interventional products and breast services seem to have the most resilient long-term growth outlook?

Yes. So first, Max, congratulations to your mom on her longterm survivorship. That's great. As it relates to gantry in the percentage of the total revenue, I think the 17% in '22 is probably artificially low given the supply chain headwinds that we talked about. But I would say we've been intentional in diversifying that Breast Health business away from just being a gantry or capital business. It has led to both organic and inorganic in the interventional in the breast conserving surgery businesses that we have. I would say to highlight [indiscernible] is an organic development, which it optimizes the process of pathology of imaging, kind of one in one device kind of real time. As well as the breast conserving surgery has been really more from an acquisition standpoint where we have Trident and other -- and the localized or others that kind of improve that process for the woman through once she have a positive diagnosis then she has biopsy and then extraction of the tumor. So all those are exciting elements. And then as we looked at the Breast Health business, those organic and inorganic are what we call the continuum of care. And so we'll continue with that and maybe get into some form of treatment or things like that. Again, that continued care is where we look at acquisition and organic development opportunities for the business.

Yes. It makes sense. In double mastectomy adjuvant chemotherapy, radiation with tamoxifen, you acquired Biotheranostics, which is a company I've known for quite some time, which is a breast health focused -- I guess you'd consider specialty diagnostics -- specialty cancer diagnostics. So it's a little bit outside of your traditional realm, but I'm just going to skip down a little bit. We are hosting a panel tomorrow morning, an MRD monitoring panel. One of our companies, MRD Tests, just earned Medicare coverage to guide treatment decisions in the adjuvant setting for breast cancer patients. So that one might be a little bit more emotional than this discussion, just a heads up. But you do have -- you -- I don't know where you are in terms of the integration of Biotheranostics into San Diego HQ, but are you leaving room for any potential additional acquisitions that are breast focused that could enhance that sort of continuum of care for breast cancer patients over that longer duration?

Yes. Certainly, from a BV perspective, all of our divisions are looking at targets, so there could be other things within breast health, for sure. As it relates to Biotheranostics, we're really pleased with the performance of that acquisition. Strong top line growth, and just about fully integrated into the San Diego facility. I think they might have moved in last week to the state-of-the-art lab and really working on some lab automation and improvement of their infrastructure and their systems, making it easier for customers to order the test, which will help continue growth for that acquisition.

Great. And then just sort of sticking on the topic of breasts, it's sort of pivoting back a little bit, I think the number that was provided initially when the chip supply shortages started impacting breast health was that expected roughly $250 million in fiscal '22. Breast health revenues could be pushed into fiscal '23. Given you've slightly outperformed, I would say, in the quarter since that statement in terms of gantries -- and you have cited that I think you have about 2 quarters of visibility into chip allocation. So it would be great to hear if there -- how should we think about that original $250 million number now? Or how should we frame that chip-related revenue recapture opportunity in '23 today compared to when [indiscernible].

Yes. I would reframe that a little bit in that, yes, we quantify the $250 million in FY '22. I think we fully realized that from our original guidance for that year. I wouldn't say that $250 million just moves into '23. It's more of a continued recovery of the breast business for chip supply over the course of FY '23 such that off of a lower comp, '22, we get double-digit growth for the breast business in FY '23. And again, we believe that will be sequential improvement and likely return to growth here in Q2 where we had declines in Q1. What I would say in regards to chips, feel confident about our '23 guide that we've kind of secured the chip supply that we need to fulfill that. We are still on allocation. But the indication is that allocation will improve, but it really hasn't at this point. But again, the indication is that things are improving. What I would say is that I wouldn't expect any -- if we got all of our full demand of chips for next quarter, we're not going to have a blowout breast health quarter because of the limitation of -- it's our same FE field service engineers that install the gantries that maintain the installed base as well. So we're doing both with the same resources. And while we didn't lay off those resources when we had the headwind, we're certainly not going to ramp up as we recover. I think the other thing, Max, that I'd point out is the backlog is strong. The backlog continues to grow. We haven't seen any increase in cancellation rates and feel good about as the supply recovers, we will recover as well.

That's great. So I'm going to ask one more question, and then I'll open it up to anybody who has a question in the audience. But just -- it hasn't been too long since you reported earnings, but China headlines continue to sort of dominate the news outlets and whatnot. So I would just -- maybe a spot check on your expectations for regional performance. Any puts and takes there? And if you have any change in opinion today compared to when you initiated the guidance?

Yes. No real change. I think to put it in perspective, China is less than 3% of our revenue kind of pre-pandemic to put it in perspective. We have limited direct supply chain exposure to China, so that's not an issue. It is -- we look at our strategic plan, it is an area of opportunity for us, but we'll manage it as we see appropriate, given the changing dynamics. But in any event, it's not -- certainly in the near term not a major concern for us, but certainly an opportunity more than not.

Great. We'll take a pause here, yes.

So when you're not having fun with us, tied back in the office or logic and around the executive conference table, it's like the 1 or 2 questions that are taking the most healthy debate that is [indiscernible]?

Yes. Certainly, it's -- one of the things that we talk about is the M&A opportunities. As we look at, like I said, our capital structure, our balance sheet, we certainly have the firepower to do acquisitions. So we've been required on the acquisition front, but it's more a reflection of discipline, right? So we want to make sure that we maintain high standards and that we acquire the right assets that really improve the growth rate of the company as we move forward. I think we've also -- what's around the table has been for over a year now, has been recognition that the COVID revenue is going to go away, and let's make sure we don't get over our skis in terms of headcount and talent. And so we've really maintained almost a neutral head count for the last year, 18 months. It allows us to be not focused on like other companies, headcount reduction that focus on growing the business because we've had a constraint over the last 18 months. And then it's also -- again, Steve is always challenging us on what are the other opportunities? What are the other regions that we should be exploring. What are -- from an innovation standpoint, should we be exploring outside the U.S. or other opportunities? So it is about those growth drivers of revenue and efficiencies beyond where we're at today that we talk about.

I would just come back to pandemic [indiscernible] and how important that is to drive further assay utilization. At that point [indiscernible]?

Yes. So I would say our biggest assays run on Panther alone. So it's more some of the respiratory or newer assays that run on that fusion capability. So I would think about the biggest opportunities clearly on the Panther less on the fusion, but it is an opportunity for sure.

But you kind of cap in terms of [indiscernible] it's not like you go from [ 2 ] to [ 4 ] on the [ 5% ] [indiscernible] different assays [indiscernible].

Yes. So I'll clarify. You can actually get to [ 6 ] just on the Panther alone. The newer assays, as Karleen mentioned, will be on the Panther Fusion. But in most cases, it's not typical for a customer to just sign up for all [ 6 in 1 ], like Karleen mentioned earlier, it takes time for them to validate the assay and also build the business for their assays as they educate physicians in their region that they're starting to test for those particular analytics.

And clearly, there's been a proactive push towards ESG, which I think is appreciated by everybody. Do you feel that -- I mean you've really made some great progress there and achievements. Do you feel like that's translated into new opportunities or new clients in the investment community? Or is that sort of a lagging situation?

Yes. Well, I would say was -- one, as a health care company uniquely focused in women's health, I mean that our purpose is part of who we are, and it's always been who we are, wasn't new with ESG, right? And I think if you look at our corporate presentation, we have our virtuous circle, which talks about -- as we work to -- on things like market access and market development and bring more of our screening, which helps women detect cancers earlier, saves lives, saves health care systems money the earlier you detect it. The more we do that, the more revenue we generate, the more we're able to put money into organic -- in organic developments for women's health and improve women's health across the globe. So it's always been a part of us. It's very authentic to us. COVID has allowed us to invest and elevate our investments in our purpose through the global Women's Health Index, through our Project Health Equality, and our partnership with the WTA. So we believe that we've just elevated our profile to give you how the virtuous circle is -- during the height of the pandemic, we were able to bring Panther solutions and really elevate our name with health ministries, government officials. And so now they know what we do and what we bring. And so we're able to have access which does market access and development that we didn't have before. It's just a higher profiled organization.

Yes. And I think just something worth calling out because it's been evident over the past even a few quarters and few years which is...

To speak to new investors, we're certainly seeing it -- I'm certainly seeing it firsthand with respect to it opening doors to European interest, for sure.

Okay. Great. Well, we have -- I think we might have time for one more question here. So I guess -- yes, go ahead.

[indiscernible] Investment [indiscernible]. Maybe quite an opportunity [indiscernible] and then any sort of [indiscernible] the downside having a place, maybe just to think of just [indiscernible].

Yes. I mean our largest shareholders, I think, understand the story. It's the only talk with them, they understand it. They understand the opportunity, certainly with the molecular business. They understand the opportunity from our M&A strategies and that will diversify and elevate the growth drivers. And certainly, from our industry that accelerated revenue growth is what drives PE multiples. I think as I mentioned earlier, people who aren't as familiar with the story or -- the questions are COVID impact. Supply chain recovery, I think there's been -- is a business issue or really just supply chain. And I think we will prove that it's just been a supply chain issue, isn't a demand issue that we've experienced. And certainly, we've had such elevated earnings growth such -- we've been opportunistic in our operating expense. Is there a headwind to our earnings profile? And I think I try to go through the '23 and how there really isn't, that the base business is still a strong earnings growth business, and we'll continue to invest.

Yes. So in -- optically, right, '23, it's -- just because of the success you had in the prior year, right, for people that might be new to the story, they might be thinking, okay, what's going on here. But I mean, that could be one thing. And then number two, I'm sure you still feel confident in the recapture rate of any breast health systems leverage [indiscernible] and whatnot...

We feel great about our backlogs, yes. Yes, absolutely.

Well, we're up on time. Thank you so much for joining us. I really appreciate it.

Thank you.

All right. Thank you.