Sonic Healthcare Limited (SHL) Earnings Call Transcript & Summary

Good morning, ladies and gentlemen, and welcome to the Sonic Healthcare full-year results conference call. [Operator Instructions] I would now like to hand the conference over to Dr. Colin Goldschmidt, CEO. Please go ahead.

Thank you very much, and a very warm welcome to everyone on this call. Sonic Healthcare's full-year results for the financial year ending 30th of June 2022. I'm very pleased to present the results today. They are record numbers, and I'll say right at the start of this presentation a huge thank you and congratulations to all our staff globally for performance through the year to generate these kind of numbers. So if you look at the revenue, we're on Slide 3. Revenue at $9.3 billion is up 7% on the prior year. And both profit numbers, EBITDA and net profit up 11% at $2.8 billion and $1.5 billion, respectively, incredible numbers. In terms of the growth, the 7% revenue growth can be split into 3% growth in COVID testing, 2% growth in our base business, and 2% was added via acquisitions. And the organic revenue growth for the year is 5%. That's a 3 and the 2. We've invested $628 million through the year on M&A and other opportunities. And we are, as always, pursuing further opportunities for the growth of Sonic Healthcare. The profit number this year, so you'll see up 11% versus revenue of 7%, is a reflection of the operating leverage in the company. We've hit a milestone in terms of our dividends. For the full year, the dividend is now $1 per share. That's AUD 1, with the final dividend up 9% to $0.60 per share, and all the dividends this year were fully franked. And the Board is as keen as ever to continue our long history of a progressive dividend strategy. At capital management level, just at headline level, the company is in an incredibly strong position with gearing at record low levels. And very pleasingly, no exposure to current interest rate increases. We have available liquidity of $1.6 billion, and our previously announced on-market share buyback of up to $500 million. We've now completed about 2/3 of that process. On the next slide, the table gives you the numbers related to our headline results. And in terms of cash generation, cash generation from operations was strong with 9% growth. And the conversion from EBITDA at 95% was impacted this year by movements in working capital. In particular, we had increased debtors largely related to COVID testing and particularly in Germany in the third quarter where payments are delayed. So those payments only came through after the end of the financial year. And we also, through the year, refunded a U.S. Medicare grant for COVID testing. So that also impacted that conversion number. If you move to the next slide, which is Slide 5, just going into some more detail with our revenue. So repeating again, total revenue growth for the year compared to last year was 7% up with organic revenue growth of 5%. And then just turning to the base business, so if I can direct you to the chart on the right and looking at the dark blue bars, the base business organic growth was 2.1% against the previous year, so against 2021. But pleasingly, against prepandemic levels, so FY '22 against FY 2019, organic growth was 5.5%, so we have adjusted the revenues in the prior years for currency exchange rates, acquisitions and disposals. So just a statement about our revenue in general, we continue to pursue acquisitions, obviously. COVID testing, we think will continue at a level into the foreseeable future. And we're very confident about the performance of our base business, which I'll talk about in a minute. In terms of COVID revenue, we grew 13% through the year. And this is an opportunity just for me to make mention of the '22 financial year. It was quite a year. We're almost beginning to forget about the difficulties of the pandemic. So at the start of the financial year was when the Delta wave hit most countries in which we operate. And that then merged through into the Omicron wave around about January, that sort of period, so halfway through the financial year. So we had these 2 big COVID waves occur through the year, which have obviously impacted Sonic's numbers through the year at various levels, COVID testing and base business equally. So just looking at the COVID revenue, that's the blue, pink or cerise bars, 13% growth in covered revenue over the year up to $2.4 billion. That's incredible. And again, I want to just say a huge thank you to all our staff, all the labs have been involved in this in all our countries, an incredible performance to complete that many COVID tests through the year. And if you look back to the beginning of the pandemic, we've now completed over 55 million COVID PCR tests to date, an amazing number. We also feel that being in 7 countries, and with some diversity of our business lines, we smoothed out the effects of things like the pandemic and any other adverse situations that occur for Sonic. And so we feel that, that's an advantage. And we've -- it becomes increasingly apparent to us. We felt that before as well. If you go to Slide 6, where we've given some more granular information about our base business in particular. So looking again here at the blue bars in the chart, first of all, and these numbers are now split by half year. So looking at the far right-hand blue bar, which is H2 financial 2022, first of all, base business is at record level. And when you compare it to the first half of the financial year, base business is up 3.4%. Our sense is that as the pandemic is waning right now, our base business is strengthening. And I'll make the comment now that throughout our operations, companies, labs are in strong position. And assuming the pandemic continues to wane, we expect our base business growth to accelerate under the drivers that normally exist. So industry growth drivers, such as aging, growing populations, preventative tests, et cetera, and new tests. If you compare H2 financial year 2022 with the previous corresponding period, which is H2 FY 2021, there is slight growth. Again, you have to consider all the time what was going on in the pandemic at the time. So in this financial year, the H2 was very much affected by the Omicron wave. So COVID testing was up, and our base business was slightly impacted because of that. So achieving a small amount of growth was very pleasing for us, in fact. So the other point to make, just in terms of our base business in general, is that the culture in Sonic remains ever strong. So our medical leadership model together with very strong market positions in all our markets does give us a competitive advantage. So moving on to the next slide, talking about our dividends. And this is, as I mentioned, a milestone year hitting $1 per share for the full-year dividend. The numbers are there in the table, but taking you to the chart, and we've just included this for your interest going all the way back to 1994, when the maiden dividend was paid. That was a $0.02 dividend back in 1994. Remember that Sonic didn't begin its life in 1994. It began in 1987. And so it took 7 years before the first dividend was paid. And ever since then, the dividend has not gone backwards. And so we're calling this a progressive dividend, even though there was 2 years in the middle of this chart where it remained the same. I guess we could put out charts of revenue or earnings or market cap, but this chart in some ways does just give you a sense of the achievements of our people over a long period of time, our staff. And again, it's a shout-out to all our staff to say well done. Shareholders have obviously benefited throughout this 29 years or 20 -- yes, 29 years. And the Board is certainly involved very much in Sonic's strategy and is ever keen to continue this progressive dividend policy. So the record date is the 7th of September, payment date 21 September, and the dividend reinvestment plan will remain suspended. Moving on to capital management. I mentioned a bit earlier that the company, from a balance sheet perspective, is in perhaps its strongest position ever in our history. If you look at, first of all, just the net debt, it's down to $812 million with a gearing ratio of 9.7%. It's come right, right down. And if you look at the debt cover history, which is charted on the right, we're down to 0.3 with interest cover at an incredible 47 times. I mentioned earlier also that we do not have exposure to interest rate movements with all our bank debt now fully repaid, and the remaining debt, that's $812 million, is in long-term fixed rate notes. I mentioned the share buyback, which is continuing with a headroom of $1.6 billion. And so we are in a very strong position to make further acquisitions into the future. And we have said before that our longer term -- or medium and longer-term strategy is to return to the pre-pandemic long-term average of our debt cover, which is just under 2.5x. The pie chart on Slide 9 is a good segue into some commentary about our country operations. But just looking at that pie chart, first of all, the pie itself has expanded to $9.3 billion now. And you'll see that we have now 3, what we would call, large divisions. That's Australian lab division, U.S.A. and Germany, all exceeding $2 billion in revenue for this financial year, incredible performance that. And then we have 3, what we call, medium divisions or medium-sized divisions, U.K., Switzerland, and radiology, in the $600 million to $700 million revenue ranges, all pushing inexorably towards the $1 billion mark. And that's not to leave out our other divisions as well, Belgium, New Zealand, and Sonic Clinical Services. And if we move on to the first one, which is Australian Pathology, or Australian lab division, total revenue growth was 24%, driven largely by incredible numbers of COVID tests. And these accelerated through the Omicron wave. So January, February was peak levels of COVID PCR testing in Australia, but they've continued at different times in different states in Australia. Base business organic revenue growth was 1% down against the last year, and that was a reflection of the pandemic. But if you look at base business against prepandemic levels, it's up by 11%. And so we do not have any concerns about the base business in Australia, and we're seeing that it's already coming back as the pandemic continues to wane. In terms of operations, our contract -- it's a national contract to provide COVID testing for nursing homes right around the country, has been extended to at least the end of September, and we're hoping that it extends even further. And this gives you some indication of where sustainable or ongoing COVID testing will come from, particularly in the setting where Omicron is having quite a significant impact on the elderly. So nursing homes and ongoing routine COVID testing, we believe, is here to stay or are here to stay. Another feature of our operations is the expansion of our genetics offering within Australia under the name of Sonic Genetics. Our growth in genetics exceeds our baseline other business growth. And we certainly now believe we are in a preeminent position in terms of genetic testing within Australia, something that we're very, very proud of. The other thing is just talking about all our labs around Australia, we now have absolute state-of-the-art labs in every capital city excluding Darwin and including Wollongong, where we have total lab automation fully installed. This is a big achievement and really puts our labs in Australia at the absolute cutting edge of modern laboratory operations. We've also already embarked on the second stage of the Sullivan Nicolaides Pathology lab in Brisbane. We had already completed stage 1. And this is one of our many facilities around the world, which are not just ultramodern, but providing essential services and critical infrastructure for the communities they serve. And in the case of the Sullivan Nicolaides lab serving the whole of Queensland and even Northern New South Wales as well. And I could say the same thing about all our operations around the world. It's worth just mentioning that we do provide absolutely essential services. The health care systems in these areas are dependent upon Sonic Healthcare's services and laboratories throughout. If we move on to U.S.A., the total revenue for the year was down 6%, largely as a result of COVID revenue falling in the U.S.A. So I mentioned earlier that there is a difference in COVID testing in different countries, depending on when COVID waves hit. So in the U.S.A., down 38% COVID testing, and you remember the slide before, Australia COVID testing was up. Base business organic growth in the U.S. is up 2%. And at operations level, the ProPath acquisition, which was previously announced, completed December 21, is integrating smoothly into Sonic Healthcare in the U.S.A. We're very proud of our exclusive arrangement to provide ThyroSeq testing throughout the U.S.A. ThyroSeq is a genetic test, which classifies thyroid cancers. And what we're finding is that the revenue is growing strongly. This is something that we are putting a lot of effort into. The revenue is pretty significant from 1 test. We've now set up a dedicated lab in New York, and we've staffed it with incredible experts in that field. We're selling and marketing the test throughout the United States, and it's a test that is providing huge utility to patients with thyroid nodules. So this is a test, which is not only financially significant, but at a medical level very important. We've achieved labor productivity gains through the pandemic and continue to push that way in our workforce in the U.S.A. And we need to make just a point that there is a possibility of PAMA fee cuts commencing next year, which was known for a long time. But new legislation has been introduced into both Congress and the Senate to delay and reduce those cuts. So this is known as the SALSA legislation, Saving Access to Laboratory Services Act. And it is gaining support from congressmen and senators, and we're hoping that this legislation is passed before the end of the calendar year. And if it is, then those PAMA cuts will be changed completely. They will be delayed and then reduced. We've also been 1 of 5 labs in the U.S. who has been appointed by the government to provide monkeypox testing, and we've launched that testing in our Sonic Reference Laboratory in July of this year. The volumes are currently quite low, but we're proud to be one of those 5 appointed labs. Moving on to Slide 12, which is Germany, revenue is 5% up. Base business revenue, organic revenue is 3% up, and our COVID revenue is also up at 9%. Unlike in our other countries, we have the honor in Germany of being selected to provide whole genome sequencing of COVID variants by government. This is a national program, we are one of a handful of labs performing this. And we've currently now sequenced more than 140,000 sequences. And this will continue at least until July of next year, July 2023. We are also in the process of building new labs in both Hamburg and Munich, and my comments about the Sullivan Nicolaides lab in Brisbane apply equally here, where our labs in Germany are absolutely at cutting-edge level. And in the case of the Hamburg lab, we're building a facility for that city where we will merge 3 labs into 1, 3 Sonic labs into 1. And in Munich, a big city in Germany, we are building a sizable facility there, where we will merge 2 of our labs into 1 in that city. And so these are not only to create cutting-edge facilities for our staff and our services, but at the same time, they are generating efficiencies and providing capacity for future growth. Another feather in our cap in our German operations is that we have been appointed as the exclusive provider of the Oncotype DX test. The Oncotype DX test is a test for patients with breast cancer, and it's a genetic test, which looks at, in fact, 21 genes in breast cancers and is of great use in terms of determining recurrence rates and also the responses to therapies. So we are the exclusive providers of this test in Germany and the only lab currently in the whole of Europe providing the Oncotype DX test. Moving on to the U.K., which is Slide 13. Total revenue for the year -- revenue growth for the year was flat. And the standout feature in the U.K. business is our very strong base business organic growth of 24%. So COVID revenue down 41% and base business growth up 24%. This is a standout amongst all our divisions. And if I could just talk about that base business growth of 24%, it's being driven by our routine-based business growing, but also a significant increase in private sector GP referrals. And so what's happening in the U.K. is that GPs are setting up practices in the evenings and on weekends, outside of the NHS system, to provide services at a private level, at a fee-for-service level. And I think this is a response to the difficulty in being able to see a GP in the U.K. We've also extended our contracts with Ramsay Health Care and Circle Health, previously was known as BMI. These are networks of private hospitals throughout the U.K., which we've been servicing for several years now. Those contracts have both been extended for 5 years. And we've also commenced operations in the Cleveland Clinic London Hospital, which opened in March of 2022. We're very proud to be associated with the Cleveland Clinic, of course. And this is an incredible hospital, smack bang in the center of London, and we expect that work to grow as the hospital settles in. Our regular NHS-sourced business work has also resumed and back to normal and growing again. And so in terms of base business in the U.K., we're sort of very optimistic about where that's tracking. In terms of COVID testing down 41%, the main reason for that is that our search laboratory, which we set up under contract with the NHS concluded its operations. And so that lab was actually closed down. So there's a contract which ended. We continue to provide COVID testing at a routine level to NHS and private patients as well. Moving on to Switzerland. Total revenue growth there was 8% with base business organic growth rate of 5% and COVID revenue up 27%. And you get a sense through all these countries at the different levels of growth of COVID testing. Some it's up, some it's down. And our expectation, I'll just say again, is that with the current trend continuing, the current COVID or pandemic trend continuing and waning, we expect to reach a baseline level of COVID testing in all our countries. Exactly where that level will be is hard to predict. But it's going to be at something like maybe 10% to 20% of peak levels is what we think, and that's according to our experts within Sonic. In terms of operations in Switzerland, we've appointed a new CEO for our Zurich business, that's called Medica following the passing of the founder of that lab, Dr. Franz Kaeppeli. Dr. Kaeppeli set up this lab decades ago. And since we acquired the business, it has gone from strength to strength. The appointment of Dr. Willi Conrad has been seamless. Dr. Conrad comes from our second -- our other business in Switzerland called Medisupport. And he has moved into the Zurich operation as leader and being welcomed and very well accepted by the medical staff. We are facing a 10% reduction from a national fee schedule cut from 1 August of this year. And that cut has impacted our business by about 7% per annum. But with the strong base business growth and efficiency gains that we're putting in place, we expect to temper that. So we don't think it's going to be all that significant for our Swiss operations. Moving on to Belgium, where our total revenue was down 4%, COVID revenue was down 13%. And when you look at our base business, it was down in the first half, but then up in the second half. And so we're seeing growth returning in base business from the second half onwards and through into July as well. At operational level, like in Switzerland, we've appointed a new CEO for our Belgium operations to replace Mr. Geert Salembier, who was the founder -- 1 of the 2 founders of that lab and our CEO of the operations. Geert has now assumed a nonexecutive chair role, and the transition there, like in Switzerland, has been seamless. So these are 2 examples of internal appointments in terms of succession that have gone seamlessly up. We do favor at all levels at this senior level to a point from inside the company. And these are 2 examples of the strength of our management teams right around the world. In our Belgium lab in Antwerp, we're almost completed with the installation or reinstallation, so this is a refreshment of our total lab automation system in that very modern lab. Moving on to our Radiology division, where revenues were up by 14%, with organic revenue growth of 2%. It's important when you're looking at our Radiology division to remember that the year before was a very strong year where we had 15% growth. And so it's just something to bear in mind as you look at these numbers. In terms of earnings, EBITDA growth was 3% up, but net profit was down 10%. The current year profit excluding acquisitions, however, was significantly higher than the year before and versus pre-pandemic as well. When you're assessing these numbers, our profit in this year was impacted by the cycling of that extraordinary strong year the year before, also the effects of the pandemic and also by the acquisition of Epworth Medical Imaging, which at this stage is at breakeven level. Epworth Medical Imaging is a highly reputable and respected name in the Melbourne and Victorian market. And we have acquired this business as a foundation and platform to grow in that state, interestingly enough. And so we expect the earnings to be turned around in the years ahead. So we've bought -- this is a hospital-based radiology practice which we have now acquired. And in our hands, we're confident that we will turn this into a profitable venture in itself. But very importantly, we will use it to -- as a springboard to set up community sites within Melbourne. And to that effect, we've already opened our first one, and it's called Radiology Victoria, and it's performing extremely well. And the 2 operations, Epworth Medical Imaging and the community site, are working in tandem to grow our radiology in Victoria. We've also acquired Canberra Imaging Group, which was previously announced. That was completed in September 2021. The integration is going well and its revenue and earnings are now added into the division's revenue and earnings. We've established 4 greenfield sites through the year, 3 of which incorporate PET CT. And we now have 9 extra MRI licenses, which are Medicare eligible. And those will all serve a great purpose for the division as well. Moving on to Sonic Clinical Services. We're on Slide 17 now. Revenue growth of 5%, largely driven by pandemic-related services, and in particular, vaccination services provided by our team at Sonic Clinical Services. So we've now delivered more than 1.1 million COVID vaccinations through clinics, mass vaccination hubs, which we ran and also in aged-care facilities and workplaces. We've also facilitated testing in occupational sites or workplace sites testing for COVID-19. This has been facilitated by Sonic Clinical Services. And just a final point on Sonic Clinical Services is the fact that -- or the issue that you've probably read about, and that is the -- there are issues facing primary care in Australia and elsewhere in the world. A shortage of GPs and the movement away from bulk billing to private billing in the GP sector. So we are working actively with both industry and government on various initiatives to address the GP shortage and workforce shortages in the primary care space. Okay. Slide 18 talks about our partnership with Harrison.ai. So this is about Sonic's endeavors in the artificial intelligence space. First of all, our investment in Harrison.ai. As previously announced, Sonic took a 20% strategic stake in Harrison.ai. That was in the first half of the financial year. And at that time, Harrison already had a joint venture with another radiology operator. That joint venture was called Annalise. And the Annalise chest x-ray product is a world-beater. It had leapfrogged the entire world in developing a chest x-ray product that detects 124 abnormalities. That's an amazing thing. This is an instant 124 abnormalities shown on the screen as an assistant to radiologists looking at a chest x-ray. So that product has now been installed in over 500 sites globally, including in more than 100 Sonic radiology sites. So we are using the product every day now. Annalise has also now completed a brain CT scan product, and that's about to be commercialized as well. So it was following this that we invested in Harrison, and then formed a joint venture with Harrison.ai. That joint venture is called Franklin.ai. And the purpose of Franklin.ai is to pursue AI in the space of pathology. And I must say, since commencement, this joint venture has really taken off at great speed. So we're working incredibly efficiently. We've built a team of 30 experts covering all aspects of the project, and there's a huge interaction between Harrison and Sonic. So we're using Harrison's smarts at AI level, at technical level, and we're adding Sonic's experience, expertise, intellectual property, and material to provide a venture, which has enormous potential. So we're currently in the process of a mass digitization of slides process, not just in Australia, but globally. And the whole product plan is now well underway, and we're targeting the release of our first product within a 2-year timeframe. You might be interested to know where these names came from, and that name Annalise is a play on the word analyze. And the Franklin name, I don't know if anyone could guess this one, is an acknowledgment of Dr. Rosalind Franklin. Dr. Rosalind Franklin was an expert in X-ray crystallography working with Watson and Crick in the early 1950s in England. So she was working at London's Kings College, and Watson and Crick were working in Cambridge. And Watson and Crick had done a lot of work trying to determine the structure of DNA, but it was really the X-ray crystallographic photography of Rosalind Franklin that absolutely nailed the structure of DNA in 1953. Interestingly enough, her famous photo, which is now called Photo 51 was actually given to Watson and Crick without her permission, without her knowledge. And Watson and Crick famously went on to win the Nobel Prize for the discovery of the structure of DNA. And Rosalind Franklin didn't get anything. She died 4 years later, and the Nobel prize to Watson and Crick was actually awarded after her death, and the rules of Nobel prizes is that nobody can be awarded anything posthumously. So we're delighted to be honoring Rosalind Franklin in this joint venture. And of course, the link with Sonic's own logo, which you'll see at the bottom of the page, that double-stranded helix fits very well with the Franklin name. It's incredible that, that discovery, 1 minute molecule has enough information in it to create a whole person. Moving on to Slide 19. And that's our sustainability. So this is something that is now very important in Sonic's overall strategies, and we are moving ahead at speed. The sustainability report that we put out every year will have a lot of detail that will come out in November of this year. But just going quickly through some of the recent progress that we've made in the space, we've set up governance and management structures at Board, executive and operational level. We've set up a sustainability steering committee, which has now determined the company's sustainability topics and our net zero strategy, which will be included in the sustainability report. We've appointed a new Chief Leadership Officer that's at C-suite level in our global office here to promote Sonic's culture of medical leadership. We've established baselines for Scope 1 and 2 emissions. We're accelerating the transition of our global courier fleet and other cars to low-emission vehicles. And we've commenced Sonic's global transition to renewable energy. And in Australia, we've set 2030 as the date where we will be fully under renewable energy. We're also doing work on Scope 3 emissions, which are much trickier. And the baseline will be established during financial year 2023 and targets to reduce will be set as well. In terms of the Sonic Healthcare Foundation, which fits into the sustainability/ESG topic, we've established the foundation in 2022, as previously announced, with an initial contribution of $40 million by Sonic. We have a majority independent Board now appointed as well as investment managers, and we have commenced our charitable activities with further projects to be considered as we go forward. Looking ahead to financial 2023, we have not provided guidance once again. And the reason for that is because of the great unpredictability related to the pandemic. That's unpredictability at base business level and COVID testing level. We do expect our base business growth to accelerate under the forces of the underlying industry growth drivers and market share gains. There's also the factor of potential rebound from postponed tests during the pandemic. We've given you just some insight into July's numbers there. If you look at July of this year, we're showing growth of 3.9% versus July of last year. And if you look at July of this year versus July pre-pandemic, we're showing 11% organic revenue growth. The demand for COVID testing continues. And I mentioned earlier that we're expecting to settle out at what we call a sustainable COVID testing or revenue level. That level will depend on the evolution and fluctuation of the pandemic. So assuming the pandemic continues to wane, as it is now, we expect it to settle out at a level and then continue medium and long term. Coronavirus is here to stay forever. We have also found that there's a heightened sensitivity of the non-COVID respiratory viruses as well. So at a seasonal level, when people get coughs and colds and other respiratory symptoms, we are now testing not just for COVID but for a panel of respiratory viruses. And so there's this cross-shift or cross-demand from both. COVID is driving non-COVID respiratory virus testing, and non-COVID respiratory virus tests are driving COVID testing. So somebody gets symptoms, you want to know what is it. Particularly if there is a need to use anti-COVID medications, you'd want to know whether it's COVID or not as opposed to the other respiratory viruses. Again, just giving you a little bit of insight into July, our COVID revenue globally was $94 million. So that's in a setting where the pandemic is waning. At cost management level, we're obviously keeping our eye very closely on inflationary pressures that exist in the marketplace. We expect wage increases to be moderate, and they will be staggered because of the multiyear agreements that we have in place in various countries around Sonic's operations. We're obviously working very hard to adjust our staffing levels to match COVID volumes. And we also are focusing very much on automation and innovation. Interestingly enough, we've done extremely well with consumables through the year with our consumable costs actually going down in financial year 2022, and we don't expect any price increases in 2023 financial. And there will be some pressure on some of our minor cost categories, utilities and transport are examples, but we don't think they're going to be material in the scheme of Sonic's results. And looking ahead also in terms of dividend, I've mentioned that we expect our progressive dividend to continue into financial 2023 and beyond. And just very briefly going through a summary of this presentation. This was a record result, which was driven by COVID testing growth of our base business and acquisitions. We expect substantial ongoing COVID testing into the future. Dividend was at $1 per share, which is up 10% and franked to 100%. We've invested $628 million in the year, and we're looking at further opportunities as we speak. Our gearing is at record low levels, and we're insulated at the moment against interest rate increases. Our share buyback will continue. We're making huge pressure at sustainability/ESG levels, and we will update the market on that in November of this year. Our AI initiative with Franklin is progressing at pace. And we continue to strengthen, ever strengthen Sonic's medical leadership culture because it's given us enormous strength over Sonic's 3-or-so decades of life and giving us market differentiation and competitive advantage. So thank you very much, and I'm going to hand you back to our host, who will coordinate your questions. Thank you.

[Operator Instructions] Your first question comes from Andrew Goodsall with MST Marquee.

Just going even mind just contextualizing -- is that better?

Yes. That's much better.

Just when you mentioned with COVID testing, your expectation, standard rebate, 10% to 20% versus your peak. Could you just contextualize that against the $94 million you did in July on COVID testing? Just would you expect that 10% to 20% is below that $94 million? Just trying to get a sense because we don't see the absolute peak.

Yes. So Andrew, we obviously don't want to give out numbers that we haven't released formally, and that's really just a guideline. This is not something that I think you can hardwire into a spreadsheet. Nobody knows exactly where the COVID testing is going to settle out. But that is an estimate based on experts within Sonic and others. Now, peak levels are different in different countries. So we would have to actually lay this all out country by country to give you that peak level. But it's just to give you a sense of -- at the height of a wave, where this is going to be going forward. So I guess maybe you can take the total revenue for the year and do some sums yourself and work out more of where that's going to be.

And maybe to give you a bit more guidance. Andrew, it's Chris. It would be obviously more than just 10% of the $2.4 billion we did for the year because that's an average rather than the peak, but it's something less than 94% extrapolated for the year. So it's somewhere in that gap.

I think if I just look at some of the charts across your countries like you can sort of probably get a bit of a bolder number that at least like certainly looks below the $94 million, so I'll work with that. And then just moving on, obviously, you've got a pretty significant war chest there. Just where you are on M&A in terms of near-term opportunities and just what you're seeing in terms of geographical focus and pricing?

Yes. So we haven't seen any real movement in terms of pricing up or down at this point. One of the things that I could just say at this point is that the market never knows what the deals we don't do. So we're looking at opportunities all the time. And obviously, our biggest opportunities are going to be in Germany and the U.S.A. Also, in our Radiology division. And there's opportunities elsewhere as well. So we're not flagging anything in particular here. But I can say that in Germany and the U.S.A., we are looking at opportunities all the time. In the U.K., you've got to add that where we are looking at contract opportunities with the NHS. And we believe those will continue significantly into the future. I look back at our U.K. division, and it's a stunning growth result that I can go back when the number there was about $30 million. We're now at $700 million. Yes, so you can add the U.K. to this equation. But there's opportunities in other countries, too, like Switzerland, for example, there will be opportunities as well. So -- and that's leaving out any decision by Sonic to enter new countries as well. So I'm not flagging anything in particular, just saying that with the company in its very strong position right now, and it's not just the balance sheet, it's also the culture and the people. We are very well equipped to take advantage of growth opportunities at M&A level in particular.

Next question comes from David Low with JPMorgan.

Colin, I see the comments on operating leverage, and we can obviously see the margins, which are way above where things were prepandemic. I was wondering if you could talk to some of the dynamics there. I mean, in trying to think it's COVID testing that is quite significantly higher margin than the base business, but I recognize there's some operating leverage. And I guess what we're trying to understand is what's likely to happen to margins as COVID normalizes. I know you're not giving guidance, but if you can talk through some of the things to think about directionally, please.

Yes. So just to repeat your point there that we can't talk about things that are not announced. So you are right, there is leverage in our result as a result of COVID testing and the reverse leverage if COVID testing falls. But bear in mind that we are so conscious of this and working incredibly hard to manage the fall in COVID testing that is occurring and will occur as the pandemic dissipates. So I can't give you any numbers. But I think you've got the theory as well as we have is that there's operating margin in Sonic. We have established facilities, and the ability to turn on a new test like COVID PCR testing. But I think we also have the management smarts and capacity to actually manage the converse of that as well.

It looks to me like margins in the pathology operation is 10 percentage points higher than they were in the pre-pandemic period. I mean, do you think you've done enough and there will be an ongoing benefit from COVID that we should assume margins will be better than they were prepandemic?

Just as a general, I would say, yes, because -- but it is going to depend on the fees for COVID PCR testing, which will probably come down and become incorporated into the panels that I spoke about. So in time, COVID testing is going to be just another respiratory virus that we test for, and it won't be just kind of stand out different tests. It's a PCR test. But in general, I think there will be more PCR testing at respiratory virus level than we've ever had before, and it will be driven by COVID testing, settling out at whatever level it settles, and that will give us a benefit over prepandemic levels. That's in theory. So we're not at that point right now because the levels are quite high. So you're asking what's going to be the steady state once we settle out, I presume. Is that correct?

Look, I think the simple analysis that's being done is the margin is being applied to COVID testing and taken out. And the question that drops out of that is, particularly in an inflationary environment, there seems to be a real risk that underlying margins might in fact be lower as we end up on the other side of the pandemic. Now, I know there's lots of moving parts in there, but I'm really just trying to understand how you're thinking about managing it. And frankly, I'd like to understand whether you think COVID margins are already starting to fall in the period that we've just seen.

Look, intuitively, I can just repeat in another way what I was saying earlier is that -- no, won't repeat exactly, but we will have a new test on our menu that's going to be a very popular test, and that will be the COVID PCR test in whatever form, whether it's alone or in a combination with other viruses. And I think that's going to be a positive factor on our margins.

Maybe just to add a bit more from me, David, as you said before, there are lots of factors at play. There's the thing we get for the test, which varies around the world, and it's changing at times around the world. There's what we pay for our consumables, which now that things have settled down with supply, we can put more pressure on consumable costs. But overall, if we do -- if it does settle at 10% or 20%, we think that gives us pretty good insulation for the group's overall margins, even in an inflationary environment, and that's what we're trying to achieve, including as part of that, managing our labor cost down as volumes of COVID testing moves around. So we don't know exactly where we're going to be because if we did we would have given some guidance, but we feel pretty comfortable with being able to maintain margins going forward at this point in time.

Our next question comes from Chris Cooper with Goldman Sachs.

Just back on the expectation that COVID PCR settles at 10% to 20% of peak. So just crude analysis, but the U.S. is currently around that range. Europe is about the upper end, maybe just slightly above. I just want to clarify that you intend to imply in aggregate the current volumes of COVID PCR are kind of where they're going to settle more sustainably. Is that the intention of those comments?

Chris, it's Chris Wilks here. I guess you're looking -- I guess we're focused more on our numbers rather than the country numbers that -- look, it is varying around the world. We haven't seen it come down to below 10% in any of our markets. And I guess our feeling is that on average we think for all the markets we sit in that we should be able to achieve something between 10% and 20%. And that's, as Colin said before, not just the gut feeling based on discussions with our doctors and the like about where they think demand is going to sit. So it might be found in a year or 2's time to be wrong there, but that's our best guess at this point in time.

Okay. And margins as well, so to come back to it, but obviously, it's a pretty dynamic space. I think you showed pretty good control, consumables and labor in that half, but still margins fell quite steeply first half to second half. You mentioned, Colin, in terms of where this profitability level settles over the longer term. You had the key swing factor is really where COVID PCR pricing stabilizes. You also mentioned you think this is going to be more or less in the form of a panel going forward. In the markets, where COVID PCR is already a part of a panel, is the margin on that test still above base business profitability?

That's a very tough question. I would, again, intuitively think it is. But I mean to actually work out the numbers on 1 test is never easy. So because we've got all kinds of services leading up to the actual test at the bench. So it's an impossible question.

If you are marginally costlier, I think -- that would be the case. That's why knowing what the volumes will be going forward because it is all marginal business. We've got all our infrastructure in place. And so it's marginally costlier, but there's also an argument of fully costing it. So -- but on a marginally costlier basis, yes, you think the margins would be better than our base business.

Okay. And very lastly, just on the base business, you mentioned some positive sequential trends you're seeing there. I just wanted to ask quickly on AFP. I know we saw a decent AFP benefit on the base business when volumes were suppressed due to the pandemic. So we see the opposite, we see AFP pressure as base business volumes recover. And as part of that is just how important could genetic testing be as part of that rate assumption you called out today in a positive way.

I'll give this one to Paul.

Chris, it's Paul here. So in terms of base business average fee, so you're right to highlight the genetic things like genetic tests will sort of push that up over time, and that's been the long-term trend for decades that our average fee per patient does rise over time, and there's no reason to think that, that will not be the case going forward. The ThyroSeq test that Colin mentioned, the genetic test in Germany as well, Oncotype DX, all have much higher average fees than our total average fee for base business, so those will drive it up. And I think, this -- as I say, there's general trend over decades that doctors request more extensive tests over time as new technologies come on board. So we do expect that trend to continue.

And just another point to this is that in our Australian market for one, we are seeing -- because we are very strong in the specialist and hospital sectors, we are finding that there's a slight shift towards the higher complexity tests because of that dominance in those 2 sectors. And it applies less so in our other countries, but it's quite a marked difference here in Australia between Sonic and our competitors.

Okay. So you don't expect -- as the lower acuity tests continue to recover, you don't expect to see AFP pressure in the base business?

No.

Next question comes from Sean Laaman with Morgan Stanley.

Colin, Chris and Paul, hope you're all well. I have a question on the AI developments. Colin, any product is going to be exclusive to Sonic or more broadly available? And on Franklin.ai, what proportion of your current volume or revenue do you think these products could ultimately apply to?

So our plan is like with the Annalise product in radiology is not to keep it exclusive in-house, but to sell the product to the world. So Sonic might get first-mover advantage and possibly advantageous pricing, but the idea is not to keep it in-house. As to the second part of your question, it's going to be a minority, a smaller portion of our revenue, definitely. So I'm thinking at the moment the AI initiative is around histopathology, and that's a very broad field with different projects in mind. So you're talking -- I don't know whether it's relevant to talk about what percentage of our revenue AI will cover, but more about is it going to improve our service and make us more efficient. So as an assistant to a radiologist or a pathologist, this is going to create enormous improvements in efficiency. And so I think that's probably a better way of measuring this as opposed to on a revenue basis. It's in terms of cost and accuracy.

Got it. Got it. And then thinking just along these lines of potentially transformative initiatives and a bit tongue-in-cheek, but we're past the threat, so-called Theranos threat. Could you talk about the new automation system in Belgium? But is there anything along those lines that Sonic may be doing or going to implement that, that could really introduce further efficiencies and see costs go up?

I mean -- so there's small things that we are doing all the time. Total lab automation was one of those big initiatives. And if you go back to when automation started 2, 3 decades ago, that was a big step change. Total lab automation is a step change. And I think Sonic is very much a leader in this space because we've made the decision to spend the capital to install automated transport -- automated transport systems for specimens in our laboratories. And so that is hugely labor saving and more efficient. So you get the results quicker and it's done cheaper as well. Whether there's anything like that on the horizon? Probably not. I mean, we keep a very sharp eye out for any sort of new advance in technology that could be another step change. I know the whole world was kind of influenced by the Theranos phenomenon, but we now know where that's gone. So there are movements to try and miniaturize testing to try and do more in the way of home testing, but there's nothing that's really significant that we could call a step change on the horizon.

There's quite a few things shown on the IT front. So using bots to do simple processing, back-office functions, including process of implementing a new system to help with billing in the U.S. And some of those have a fairly significant economic benefit. So that's kind of outside of what happens in the actual lab, but certainly have potentially significant impacts on the broader Sonic business.

And there are other automation projects like automation of microbiology departments, for example, where some of our labs around the world already have automated microbiology systems, but a number of our labs are looking to move that way in the coming year given the focus on cost control and potential inflationary pressures.

Squeeze 1 last 1 in on the U.K., if I may. Now, really stretching my memory here. I think when you guys first acquired TDL, it was largely a price-making business and then the business evolved to NHS contracting. And then you're calling out today, I guess, sort of benefiting from more private work. Can you give us a bit of a description on what the mix is on the U.K. business on NHS versus privately insured?

Yes. I don't have exact proportions off the top of my head, but you're right that there's been a huge shift into contracted NHS work, absolutely, because remember the U.K. is 90% NHS anyway. The whole health care system is dominated by the NHS. So our Harley -- so-called Harley Street business, which was the TDL business when we acquired TDL was price making, yes, correct. And that was private, non-NHS work. The growth that we've achieved in the U.K. could not have happened if we didn't enter the NHS market. So that's just a peculiarity of that country. And it's not really a negative. So if you think about it, it's not a problem that we are price-takers in a sense. We negotiate contracts, obviously. So to some extent, we do have some control, and we do not have to accept contracts that don't make sense to us. But once the contracts are locked in, then it's up to us to make the best of those contracts. So what's happening now with the GPs is an interesting additional phenomenon because that's a return to, in a sense, private work. I'm not quite sure if you'd call it price making because many -- there's now a much more private insurance in the U.K. as well. So if you go into a private hospital in the U.K., for example, that's covered by insurance, where we're not really price-makers, we're price-takers there as well. And the private work that we're getting from GPs right now, it's private. We do have a fee schedule where we set the costs of those fees. We negotiate some of those fees with insurance companies, and some of them are patient pay. So it's a mix at the moment. But I do find it a fascinating phenomenon that there's this shift at primary care level now into the private sector. That's quite -- it's quite a dramatic turn of events.

A little more color there. It's around -- laid in very broad terms, it's about half-half between NHS-sourced revenue and private or private-sourced revenue in the U.K. at present.

The next question comes from Gretel Janu with Credit Suisse.

Just thinking about the short- to medium-term growth rate fee-based business and test mix. So do you think COVID has driven any structural change in either behavior of patients or indeed the referral behavior that may actually impact overall industry growth rates into medium term? I guess has COVID impacted the frequency of screening tests, which might be more muted going forward? What are we seeing there?

Okay. That's an interesting question because definitely during the pandemic, we have noticed that some of the routine tests that need to be done on the public were at lower volumes than pre-pandemic. Whether there's been -- now those tests, we certainly expect to resume if not rebound as the pandemic wanes. As the question about, has there been any permanent structural change, it depends on which country you look at. Here in Australia, what's happened is that GPs have started doing many more consults by teleconference. And so that became a very popular way of consulting during the pandemic, and it's still continuing, albeit at a lower level right now. Now, the question then is our GP is going to do this permanently and will that have an effect on referrals for pathology and radiology, for example? And of course, the industry is working very hard. We at Sonic are working extraordinarily hard to make it as easy as possible for a GP doing a teleconference or tele-consult to request pathology or radiology. And this is largely now completed in radiology, where it's very easy for a doctor to order radiology. And it's all done electronically via apps, via your cell phone. And it's almost completed in the space of pathology as well. This is less of a phenomenon in our other countries of operations. But the point that I mentioned earlier, where we're seeing sort of a slight shift in favor of the higher-end tests. It's hard to tell at this point, well, it might just be a hangover from the pandemic because as the pandemic ends, so all the routine tests, things like even Pap smears, doing lipid studies, checking thyroid function, just doing a normal full blood count, stuff like this that is very important for people once in a while, those will all return once patients return to GP surgeries. Remember, GPs were reluctant to see patients throughout the pandemic for fear of spreading infection in their surgeries. And that's what drove the telehealth. And so there was a temporary change in practice at GP level. We have not seen that at the specialist level. So at a specialist level, yes, volumes were down at the peak of the waves because elective surgery was canceled, colonoscopy centers were closed, et cetera. But that's come back with a vengeance now. So all the specialist work is kind of in catch-up mode. And I think that's going to continue for quite some time because to clear the backlogs, I've heard it's going to take up to 18 months, and that's with specialists working nights and weekends as well. So it's going to take quite a long time to clear that backlog.

Gretel, just a couple of other little anecdotes on that catch-up and the rebound. I was reading the other day that in the U.S., there's been -- since 2020 there were 43% less melanomas diagnosed now. That doesn't mean they've gone away. And so that's another little anecdote about the evidence that there's a fair bit of catch-up in Australia. In 2021, I think it was, there were 15% less colonoscopies done. So I think, as Colin was just saying, that we probably do expect in the next few years a fair bit of catch-up, which will flow through to our labs.

Great. Understood. And then just in terms of reimbursement for base business, so you've seen Switzerland's cut base. Is that because the government is trying to pull back on pathology funding given the strong levels over the pandemic? And I guess is that a risk that you see for other countries?

Switzerland is a bit of a unique market in volume and structure, but there's a whole lot more work done in the general practices, and the labs that we run tend to do the more esoteric work. But the fee regime in Switzerland has always been a little stronger than or better for us than other European markets. So I think this is essentially the government trying to rightsize the cost compared with neighboring countries essentially. And as we said before, the effect on us is about 7%, but we're growing only last year at 3%. And we think with rebound and the like, we should be able to absorb that pretty easily.

And no risk for other countries at this stage?

No, I think everything else we think is generally pretty stable.

The next question comes from David Stanton with Jefferies.

Just like an update on your Aurora business, U.S. anatomical pathology business, how has that been going during COVID? And given Chris' comments just then I would expect it's likely declined during the COVID period. And what are they -- what's the outlook for it, please?

David, you're right. In line with many other specialties, Anatomical Pathology volumes declined through the pandemic. And we're inversely related to pandemic waves. What we're seeing is now a recovery in those areas. So remember, there -- what we're now calling it the Anatomical Pathology division, the Sonic Healthcare U.S.A., not Aurora by the way, but that's fine. Because we've added ProPath to that, which is a big new anatomical pathology practice. Remember that all of these labs get their referrals from procedural specialists like dermatologists, gynecologists, urologists, et cetera, all of whom were affected in the pandemic. So it was fully expected that the volumes would dip during the pandemic and that they would begin recovering as the pandemic ends. So that's what's happening, just like our anatomical pathology elsewhere in the world, including here in Australia.

Understood. And a couple of housekeeping questions, if that's okay. Can you give us sort of some color on what you expect the increase in depreciation or the change in depreciation might be for '23, tax rate for '23 and potentially CapEx for '23? Any color there would be greatly appreciated.

David, Chris again. Yes, look, the CapEx, I believe, Colin alluded as we're working through the deck that we've got a few building projects on, a couple of buildings we own. So the Brisbane lab in Bowen Hills. We own -- the new Munich lab we will own. So I think there's something in the order of the $120 million to be spent on those labs, most of it over the next 12 months, but some of it might flow into '24. Depreciation, we don't get to see it quite the way we used to with AASB 16, but I think we've always had the rule of thumb that we try and manage within that with the management of the CapEx spend that we -- as we're growing it's probably the old depreciation plus or minus 10% as a rule of thumb. What was your other question? That was...

Tax rate.

Yes. Tax rate is a bit of a function of where the profitability sits, in which country, but I think we would be guiding we hit 27% this year, as you would have seen, somewhere between 26% and 27% to '23.