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

Hi, everyone. Good morning. For those of you who don't know me, my name is Andrew Brackmann, I lead the Diagnostics Research Coverage Franchise here at William Blair. And given this is my first presentation of the day, I'll just point out my team over here, [ Maggie Buoy ] in the pink, Dustin Scaringe in the black and then Kate Janssen, who joined us yesterday on my team as well. Just before we get started here, just a couple of pieces of housekeeping. First, this is going to be a little bit of a modified presentation, more of a fireside chat, and then we'll go to a breakout in the [ mirror ] room afterwards. For a full list of research disclosures, please see williamblair.com. So with us today, we have the team from Hologic, Karleen Oberton and Ryan Simon joining us.

Karleen, maybe just to start out, right? I think there's a wide range of folks in the room. But maybe can you just sort of talk about big picture? Who is Hologic? What are the markets that you operate in? And what really excites you and the rest of the leadership team?

Sure. Thanks, Andrew, for having us here. Pleasure to be here today. Hologic, a medical technology company uniquely focused in women's health care. Hologic is a company that we lead with our purpose, passion and our promise. Our purpose is to enable healthier lives everywhere, every day. Our passion is to be champion -- global champions of women's health. And our promise is the [ science ] assure that we will deliver clinically differentiated products to our customers. In those products, most of our products in each of our franchises are market-leading products, the gold standard of care in women's health. Through the pandemic, we have transformed Hologic to really unique advantage of a COVID opportunity in our Diagnostics business. We are bigger, faster and stronger as a result of that, bigger on track to a $4 billion in revenue and over $4 in earnings per share this year that faster in that we are growing in 5% to 7% in our long-term revenue algorithm and stronger is our cash position, our balance sheet, over $2 billion of cash and really strong cash flow generation. So all those things make us a really strong company and excited about our future. We operate within 3 divisions: our Diagnostics division, as I talked about, was the COVID opportunity in our Molecular business that is both Molecular Diagnostics where we have a unique installed base of our Panther instrument as well as our Cytology business for screening for cervical cancer. We have Breast and Skeletal Health business, which is led by our 2 and 3D gantry mammography machines. 85% of 3D market share in the U.S. as well as interventional and a very large service component of that business. And then finally is our Surgical business, where we have again market leading products with MyoSure and Fluent for the treatment of fibroids, our NovaSure product for the treatment of heavy uterine bleeding and then our laparoscopic products as a result of inorganic investments over the past couple of years. And so what makes me excited about the company and most of our team is that broad strength that each of our divisions have growth drivers, both organic, inorganic, laid on with our balance sheet and the opportunity that, that cash position gives us.

Great. So maybe let's talk about some of those segments in particular, right? You talked about bigger, faster, stronger Hologic. And that growth rate, total corporate average, 5% to 7%, I think prior to the pandemic, it was closer to 4% to 6%, but amongst those key segments, where is that growth really going to be driven maybe a little bit faster than that corporate average or maybe a little bit slower?

Sure. So let me frame the 5% to 7% was long-term outlook that we gave in 2021, that goes through 2025. I am really pleased that we have either met or exceeded that growth expectation. And really, as we look forward, that 5% to 7% is of much stronger base than we had anticipated back in 2021. So again, feel really good about that performance. And when we look at the divisions, certainly in Diagnostics, the Molecular business and again, what we've done with instrument placements, should lead the way in growth, certainly, we would expect the Molecular business to be above the 7%, but within Diagnostics is cytology, which is more flattish. So that gets you back into that 5% to 7% for that rate -- for that business. Surgical: we would expect Surgical be closer to the 7% given the portfolio with continued strength in MyoSure and Fluent as well as outsized growth from the inorganic investments that we've made in that business. And then finally, in Breast, we'd expect Breast to be closer to that 5% as we work through that backlog of gantry from the chip supply challenges we had a couple of years ago. And again, the largest piece of business is actually recurring in our service business, which again is probably more of a single-digit grower, low single-digit grower for that business. Again, the biggest piece of revenue reoccurring in nature and tied to that installed base.

Andrew, I'd say on top of that as well as our International business, which is really growing at low double digits and still in the earlier stages of growth there.

Yes. I'll certainly want to hit on all of those in a little bit more detail. But maybe we can start in Molecular Diagnostics. I think that's where I get the most investor questions on sort of the growth rate. So can you maybe just sort of talk about what COVID did to transform that business, how you've been able to accelerate some growth opportunities there?

Sure. So the biggest thing that COVID did was accelerate Panther placements. So prior to the pandemic, we had about a 1,900 Panther installed base that has grown to over 3,250 at this point in time. So almost doubling that installed base of Panthers in a very short period of time and really what we found prior to the pandemic and we continue to find that now even with new customers is that they love the Panther, high throughput, best workflow, random access, it's really an unbelievable instrument that it gets really sticky once it's inside the lab. And many labs are still dealing with work shortages. So this is really critical to keep up with the workflow is the automation of the Panther. So again, accelerating that installed base, essentially recapitalizing some of our largest customers. Think about our largest customers had our legacy TIGRIS platform, which generally has 4 assays approved on it. We're able to recapitalize with Panther and Panther has over 20 assays approved on it, including our Panther Fusion sidecar. So just a tremendous opportunity there. And as I talked about that Panther and the stickiness, when we look at our total customer base, 90% of our customers are running at least one other assay besides COVID. If we look at our new customers, the ones acquired since say April 2020, 85% of those are running at least one other assay and over 55% are running at least 2 other assays. So again, that stickiness of the Panther and the platform and the menu that we offer creates tremendous value for our customers.

You mentioned everybody loves Panther. I think that, that was apparent during the pandemic, and we're certainly seeing it now. But can you maybe just sort of dig a little bit deeper there and sort of talk about some of the key assays where you're seeing some of that greatest uptick. Where are they transferring some of that share from?

Yes. Well, certainly, our kind of leading portfolio is our women's health portfolio were screened for STIs, and that's more of a mature market, and we have a leading share certainly here in the U.S., I think tremendous opportunity still outside the U.S. to grow that piece of the business, but it's going to be coming from our newer assays to our BV/CV assay that was launched in 2019 just prior to the pandemic. We did about $10 million in revenue in 2019. It's well over $100 million of revenue now and on track to be our second largest assay. And I would say we're in the kind of mid-innings, if you will, of growth for that. So still runway there to grow that business, and that's one where we're essentially converting what is a lab developed very manual test to an IVD on a high-throughput system. We have our respiratory menu on our Panther Fusion that is a newer menu in that we're seeing contribute to growth, and that will be -- continue to contribute, but be seasonal in nature. So that would be something that we'll have to address. And our new 4-Plex assay that was recently approved, contributing to the growth there. And I think over the longer term, we'll see other assays approved, including GI assays and hospital-acquired infection. I would expect those to be on the trajectory that we see for BV/CV, but still will be nice contributors to growth.

Yes. I think one of the things that both you and Steve say is Panther's ability to grow markets. So can you maybe just sort of talk about how you've been able to do that over the last couple of years?

Yes. So think about screening for STDs. In the U.S., the high-level metric is only about half the women who should be screened for STDs actually are. In back, I think it was in 2021, the CDC changed guidelines so that basically universal screening, it's -- you have to opt out. So a physician doesn't have to have an uncomfortable conversation with the women about our sex life or if the young woman is there with her mother, she may not be totally truthful about her sex life. So we have actually a physician sales force that partners with the lab and the lab sales force and target physicians and educates them on the screening guidelines and how they should be doing more universal screening. So that's an element of how we can grow a mature market by educating physicians.

Yes. Maybe just in the interest of time, we'll move on to Breast Health, right? And that's a business that's been in a bit of recovery mode. You mentioned some of the chip supply issues that impacted you a couple of years ago. Can you maybe just sort of remind us about what happened with the chip supply issues, where you're at in sort of impacting that moving forward and sort of the growth rate that you expect from here?

Yes. So I think it was back in early 2022, it became clear that we were being put on allocation by our suppliers, for our key chips, lengthened delivery times. And we had to really take a step back and say, how are we going to address this because those chips that we put in new gantries are also the same chips that service our installed base. So think about that very large installed base in the U.S., the most important thing we can do is keep those customers up and running. So we had to even put ourselves on allocation of what are we going to do for chips for our installed base versus new gantries. And so we basically had a period of time, let's call it 6 quarters where we were in that allocation phase of -- and partnering with our suppliers to understand the supply chains and how they're addressing it and when we would get availability to chips and it was really a little over a year ago that we got really confidence in our Q2 of '23 that we had an outsized quarter in delivering chips. And now we're -- believe we're in a more normalized supply chain scenario where we can start to work through backlog. So over that 6 quarters of allocation, we built a backlog of gantries. Now this is a business that normally has the backlog because once a customer places a gantry, there's a lead time to deliver and a lead time to install and facility readiness, et cetera. So I would say the backlog is outsized at this point in time, gives us better visibility for the next several quarters as we work through that and get to more normalized levels as our sales teams continue to book orders. So even though we're working down the backlog, we're absolutely booking orders for new gantries.

What about on the COGS side of things with those chips sort of working their way through the P&L. Can you maybe just give us a little bit of color on where you are and sort of working through some of those higher cost chips?

Yes. So during that period of time where we were on allocation, we were trying to secure chips from nontraditional sources, which were at elevated prices. So as we procure those, they kind of went on the balance sheet, and we're working through them. I would say that I would expect to be through most of the higher costs through the balance of '24 as we get to a more normalized backlog level.

Maybe just last on Breast Health. I'll throw out the buzzword AI. Can you maybe just sort of talk about some of your efforts to deploy AI into that business specifically?

Yes. So we think about AI is how do we assist the radiologist, right? So the reality is that more cancers, less breast cancer is detected in the afternoon than in the morning and why is that because that's the human fatigue of reading images. So we already have technology that assists radiologists with kind of look at these slides because tomosynthesis is a series of slides that form the image, so we can direct the radiologist, how do we get to better assist in that actually [ rating ] images red, green, yellow. These are the ones, the red ones that's focused here. And how do we eventually get to maybe autonomous where AI can read a [ tomosynth ] system for those images and tell the radiologist, it's clear, it's good. There's nothing suspicious that you need to look at. So that's where we're investing both internally, R&D. We have some small investments in early-stage companies that we think are exciting. So we think we'll be certainly leading with AI with breast cancer screening in the future.

Yes. Maybe just a follow-up on Breast Health. You sort of talked about in the past that used to be more a boom-bust cycle, right, with the placement of gantries and you've transitioned that to more services over time, how does something like an AI service sort of continue to affect those efforts to continue to kind of smooth some of those revenue growth.

Yes. So I think selling AI is a software enhancement where a customer can kind of add it to a machine that they have today. So we don't take some of these improvements and wait for next-generation gantry. So you kind of get -- avoid that boom-bust, issue technology along the way. AI is an opportunity to maybe even selling a subscription model versus the capital model that is that boom-bust type of activity. So I think it's an opportunity to continue to sell and an opportunity to sell in different revenue models.

A little bit outside of AI, what we've done to that business is really built a very strong service business as well as build out the continuum of care with interventional products as well, which are consumables that kind of smoothen out that cycle as well.

Ryan, you mentioned the international business as an area that saw tremendous growth during the pandemic. Can you maybe just talk to us big picture around what the pandemic did for that international business broadly? And what areas of the portfolio that you're seeing some of that outsized growth today?

Yes. So I'd say at the highest level, it really got our name out there, right? The response that we had during the pandemic, being able to place Panthers, being able to supply assays outside of the U.S. across the world, really elevated our name and acted as a kind of beachhead for us with the other elements of our business like Breast and like Surgical. So we're definitely in the early stages today and still kind of growing out beyond Western Europe, and it's a really exciting time for us there for each of the divisions.

Yes. And I would just add on COVID obviously another opportunity to invest in our Global Women's Health Index, which is an annual survey of the health and well-being of women and girls around the world. And so that data opens doors, opens doors to have discussions with health ministries, with government officials about not only our products, but more holistic about screening, what screening activity should happen for women in their countries in their region. So those are the types of things that has elevated Hologic coming out of the pandemic.

Yes. I guess within the portfolio, obviously, Molecular Diagnostics has seen some nice growth from the international business. But what about areas of opportunity in Breast Health and Surgical?

Yes. Certainly, in Breast Health, we -- if you go back 5 years, we primarily were sold through a dealer network. We've gone direct in key markets. And what we find is with our market access and market development activities and capabilities that we bring, those markets usually perform better when we go direct. So we've activated those opportunities. We see several more of those opportunities ahead as we look over the next couple of years. And then Surgical has been really outsized growth for international off a smaller base, but as we focus, we get reimbursements for those products in key regions, we're seeing really nice uptick.

And can you maybe just sort of classify some of the investments that you're putting into the international organization? Is it continued sales force expansion? Is it continued new market development? What do those investments look like?

Yes, both. So it's definitely market access and market development capabilities, really, again, how do we partner with health ministries and government officials to impact guidelines that, again, more holistically support women, but typically, we're the gold standard of care. And so those are the things that we try to drive.

Maybe just switching gears here to a topic that's been belabored over the last ample of quarters. USPSTF and potential updated cervical cancer screening guidelines. Maybe can you just give us a quick overview of sort of what's being potentially proposed and the impact on...

Sure. So let me take a step back. United States Preventative Services Task Force is a group under the Affordable Care Act that gives ratings to different projects -- products of screening activities that to the extent it has an A or B rating, then public insurance, Medicare, Medicaid, there's no out-of-pocket cost to the patient, right? So it's just that population, it's not commercial insurance, which if you think about what we're talking about cervical cancer and the population we're talking about typically women 20s to 60s that is in the private insurance coverage. So in the bare scenario is that -- let me say, right now, HPV primary and co-testing are both A ratings. Both have the same rating under the USPSTF. A bare scenario would be that co-testing is a step down or not covered, right? We don't believe that will be the case. There's been no new scientific data that would support a change in screening guidelines. And it really would be detrimental at a time when we're actually seeing the rate of cervical cancer in younger women increase in the United States. This is a cancer that we basically eradicated from this country. It used to be a leading killer, and now we're seeing rising incidences of it. And why is that? Because we've had interval expansion, because when I grew up, I'm a little older, you went for your well women visit and you had a Pap test every year. Now with interval expansion, it's just -- there's not that discipline and that rigor in women to get that screening, especially younger women. So let's hope for the sake of women in this country, there isn't a change in guidelines. But having said that, even if there is, if you think about guidelines from 2018, HPV primary and co-testing of PAP alone in certain instances have the same rating, but we believe about 99% of physicians practice co-testing or PAP. So even though they've had the same rating, they haven't converted to HPV primary because they know HPV primary and this is 1 in 5 cancers, leads to higher colposcopy rates for women, which are typically a necessary because HPV can resolve on its own. So this is just would be a bad answer for women. Having said that, if there was a change in guidelines, we believe in the worst case, it would be a leaky bucket that would happen over years, not quarters, for sure. And again, physicians, the guidelines, the same rating haven't changed practice. We believe it would be a lot. I think physicians know that co-testing and the PAP are the best science for women and that they should continue in that manner.

I go back to 2017 or 2018 when the initial draft came out. At that time, it didn't recommend co-testing, but the final did. There's also precedent to reverse that in the final as well.

Yes. I think certainly, we have specialist teams that activate and work with KOLs in different societies. And I think it was that really collaborative effort that got the right answer and the final guidelines.

In the meantime, you've innovated and developed the Genius digital systems. Can you maybe sort of talk about how that product and the launch of that product may also assist in these efforts to kind of continue to build out your moat here?

Yes. Certainly, the digital cytology is the latest innovation in cervical cancer screening. And really what it does is a workflow solution really. So it basically what converts what was a very manual process of evaluating a slide under a microscope, and then imaging it, it can digitize the slide. So you can layer on AI and again, assist in reading that image s well as you have more workflow efficiency that you don't have to be, again, over that microscope. You can be remote in a different area, able to look at that slide on your computer wherever you are. So again, our -- it's early days. Minimal contribution '24 was just approved a couple of months ago. Our customers are super excited about what that does, again, cytology labs suffering from labor shortages as well. So really a lot of excitement of what this can do.

Yes. Maybe just switching gears to the margin profile. I think we've sort of hit on some of the revenue drivers. But on the margin side of things, can you just sort of talk about -- you're on track to finish the year around 31% operating margin for the full year. What are some of the drivers of that? And how do you sort of think about the durability of potential margin expansion?

Yes. So let me frame the discussion in that. Through COVID, we had outsized margins and then COVID coming down and dealing with the higher cost chips, our margins kind of dipped -- operating margins dipped a little bit below 30% for a couple of quarters. And so what we're seeing is getting back to those pre-pandemic levels, which was low 60s gross margins, about 31.5% operating margins. As Andrew said, as we kind of work through those higher-cost chips, we expect to exit the year approximating a 31% operating margin. Again, managing operating expenses, we had some outsized investments. Again, when we had higher COVID revenue and as we realize COVID would eventually come down to more normalized endemic levels, we have normalized operating expenses. So we see lower costs on the chips. We've had some network investments as we consolidate manufacturing facilities. We see that resolving as we get into '25. So those are the things that will give us confidence to get back to those pre-pandemic operating margin levels.

Great. And then maybe just last one, right? You're continuing to expand your operating margins from the trough here. You're generating a lot of cash. So can you just sort of talk about your capital allocation strategy and where you'd like to use some of that cash?

Yes. What I would say is if you look at our track record over the past several years, it's going to be more of the same of M&A and share repurchase. We did announce the acquisition of Endomag. I think that's a good example of a tuck-in acquisition and deployment of capital as well as in the first quarter, we announced an ASR as well as did some open market purchases as we saw disconnects in the market. So I don't think it's -- the allocation strategy hasn't changed. Each of our divisions has BD groups that are out there identifying assets, cultivating relationships and really, the key is what are the assets that we think were the rightful owners of and that we'll see accelerated performance as part of Hologic.

Perfect. Okay. I think we'll leave it there and take the rest of the questions in the breakout in the [ mirror ] room. Thanks, everyone.