Sonic Healthcare Limited (SHL) Earnings Call Transcript & Summary

Good morning. I would now like to hand the conference over to Dr. Colin Goldschmidt.

Thank you, Katie. And good morning, good afternoon and good evening to everyone on the line. Welcome to Sonic Healthcare's interim results presentation. I'm joined this morning by my 2 colleagues, Chris Wilks and Paul Alexander, and we're coming to you from our global office in Sydney in Australia. So I'm going to presume that you have the presentation in front of you, and if I could ask you to start on Slide #3. And Slide #3, we've presented for you a table of our headline numbers in the dark blue column. And then to the right of that, we've given you the growth numbers versus the corresponding period last year, and importantly, against H1 FY 2020, which is an equivalent period in the pre-pandemic -- clean pre-pandemic 6-month period. So it's important that we recognize that the comparative to last year is greatly affected by the reduction in COVID revenue, and you'll see there that we've got a comparative there of $379 million versus $1.3 billion in the prior period. But importantly, so all the numbers that show negative growth are comparatives against last year, except the top row. Now the top row is our base business free of any COVID revenue, and I guess that's the one that we can look at just for the moment because it's showing base business revenue growth of 11% against the pre-pandemic period and 9% against last year. Of course, remembering that this period does have COVID in it and last year -- as the previous year does too, so removing them gives us an idea of our base business. I also want to be clear about what we're calling base business. It excludes COVID, and when we talk about base business revenue, we're talking about organic revenue. So we normalize for working days, currency exchange rates and acquisitions and disposals. So it's a clean look at our base business. So the organic revenue growth is gaining momentum, and this is a good news story from Sonic's point of view. If we look at January 2023, that's the month just passed, it's up 10% against January 2020. And if you look at some of our divisions, it's not quite the same in all of them, but this is a particularly strong number in our Australian Pathology division. So that is up 16% January 2023 against January 2020. And we're seeing a trend particularly in the late stages of H1 and even more particularly in the post-Christmas period of a return to strong base business growth in both pathology and radiology. Now remember, radiology did not have any COVID in it, but of course, was affected by the pandemic as well. Importantly, just going down the bullet points, our base business margins are in line with pre-pandemic levels. And we are spending a huge amount of time, not just on the recovery of our revenue at base business level, but also at rightsizing the company in terms of labor costs, in particular, as we emerge from the pandemic. When you look at these numbers also, earnings per share is up 50% against the 2020 comparative. And against last year, cash generation is strong, including 116% of EBITDA converted to cash flow in the period. We also want to call out that we are well advanced with a number of acquisitions and contract opportunities at the moment. If we go to Slide 4, the Board has ratified an interim dividend of $0.42, that's a 5% increase on the interim dividend last year. And the Board is of a mind to continue our progressive dividend strategy, which has been in place for almost 30 years now since the first dividend was declared in 1994. This dividend is franked to 100% record date 8th of March and payment date 22nd of March 2023. If we just unpack our revenue a bit further on Slide 5 and if I could take you to the chart on the right and first look at base business, so here again, we're talking about a base business that is clean base business corrected for working days, free of currency movements and doesn't include acquisitions or disposals. So this is a good look at our underlying business. And you'll see that it is up 6% against the last half, that's FY 2022, and 8% up on the pre-pandemic first half of 2020. COVID revenue, if we look at the -- that's the red bars, is down 72% on last year's number. So we've gone from $1.3 billion down to $379 million in the comparative period. What we're seeing, as I mentioned, is our base business continuing to grow. Two factors there. One, the underlying drivers of the diagnostic markets continue. There is also some catch-up testing that we're seeing in selective markets, and we're also growing market share as well. In terms of ongoing COVID revenue, it's very difficult to predict the future. We do expect COVID testing to continue. At what level is uncertain, and it will be different in different geographies. Just for your information, in January 2023, COVID revenue was $32 million for the month. And then looking at January, so going past the first half, our organic revenue growth was up 14% versus last year and up 10% versus January 2020. And I mentioned earlier that in Australian Pathology particularly, we've got a very strong trend, with organic growth at 16% versus January 2020. So what we're seeing here is quite a strong return to normal business, if I recall, that in the -- as we emerge from the pandemic. Now on Slide 6, we want to just outline a little bit more about cost management. Normally, we wouldn't have a slide in on this in our results presentation because cost management is an integral part of our business, has always been so. But there is particular focus that we're all putting on the management of our costs because we've gone through 2.5 years of extraordinarily higher volumes as a result of COVID testing, and we're now well advanced with bringing our labor force back into line with normal business. We still have to cater for a small amount of COVID testing relative to our peaks. We are very determined to bring our labor costs right down, and we have largely succeeded already. There's a little bit more to go, but largely, the job has been done. If you look at our base labor cost as a percentage of revenue -- base business revenue, it is actually already in line with pre-pandemic levels. And if you look at the 4D, you'll see that our labor cost growth is 7.5%, but we're keen to point out that 4% of that comes from acquisitions over the period. We will continue with labor cost control as we reduced our COVID testing further as we predict. And these reductions will largely be from COVID-related staff, such as casuals and contractor hours, but also the overtime hours that came not just from additional work but from sick leave that was a real issue over the last couple of years. We're also looking at other areas of the business to find efficiencies such as automation and a number of others like consumable costs, for example, where in fact, our costs have come down in H1 FY 2023 versus last year, and we expect those to continue. We have experienced some inflationary pressures in categories like utilities and transport, and we are mitigating these wherever possible. And remember, these are relatively minor categories compared to labor as an expense category. On Slide 7, on our growth strategy. Our growth strategy really is unchanged, but it's important that we set it out here together with our cost management strategy. And our growth strategy can be divided into organic growth, acquisitional growth and outsource growth. We are continuing to focus on organic revenue growth as we have done since the beginning of Sonic. It's been a major and core strategy of the company to build a company that is able to deliver outstanding services and grow organically. Now, our organic growth is assisted by growing markets under the forces of drivers such as aging, new tests, et cetera. There's also the catch-up testing that we're seeing in selected areas of our businesses. I guess importantly to say -- it's important to say that our culture, which has been established for a long time, itself drives market share. And what we're seeing right now is a dominance in the specialist and hospital referrer submarkets. This is a very important point, and I won't spend too much time describing how this has happened over a long period of time, but we are now very strong in those higher-end, higher-value submarkets of our businesses in both pathology and radiology. We also are strong in genetic testing. And in fact, genetic testing is probably the strongest growing subsector of our lab business at the moment. And we're seeing growth in pre-natal testing and a range of other testing. Testing for cancers, testing for carriers in pregnancy, et cetera. That is coupled with some of the selected tests that we have licensing for such as ThyroSeq, Oncotype DX and also microbiome testing. As far as acquisitions go, like organic growth, acquisitional growth has been a core strategy of the company for a long time, and we're very set on taking that a whole lot further, particularly with our strong balance sheet. What we're seeing is M&A activity increasing since the pandemic is waning, and we are in the process of taking advantage of some of that. So at the moment, we are currently progressing several acquisition opportunities and our pipeline remains pretty rich. Another source of growth for us is contract growth, and we are currently pursuing several contract opportunities, including a large one in the U.K. The capital management slide, Slide 8, is there really to outline the strength of our balance sheet. If you have a look at the table first up, you'll see that our gearing is at historic lows at around 10%. Our debt cover is at historic lows currently sitting at about 0.5x. You'll also see that our net debt has actually increased a little, $90 million, and that's largely due to currency exchange movements. We've completed $425 million of the maximum $500 million of our on-market share buyback, our headroom is currently $1.5 billion, and we are very well positioned to fund accretive acquisitions and other growth opportunities going forward. On Slide 9 is our traditional revenue split in pie chart. There's not a big change from the last time we presented this. Remember that this is in statutory Australian dollars so there is currency movement in this, although it's not very significant in this half. From an Aussie dollar perspective, there was a little bit of tailwind against the U.S., so the Aussie was weaker against than the U.S. comparatively, and headwind against the euro and British pound. And Switzerland, there was a little bit of tailwind, I think, as well. A feature of this pie chart is our Radiology division, which is now taking up 10% of our total revenue. The Radiology division is performing exceptionally well, strong division. I think we were sitting at about 7% for the Radiology division at the full year result. There is a little bit of acquisition in that, but the organic revenue growth is strong in that business, bringing it up to 10% of our total revenue. We'll move through the country slides just quickly. First of all, the U.S.A., where our base business organic growth versus last year was 6%. COVID revenue down 78%. From an operational point of view, the good news was the PAMA Medicare fee cuts that's protecting access to Medicare Act have been postponed again. They were to have an impact of around USD 15 million on our revenue per annum. There is now legislation still on the table. That's the SALSA Act, Saving Access to Laboratory Services Act. And that act is designed to delay and reduce the cuts, and we're hopeful that it will be successful. Our industry association in the U.S. is working hard, and we are very involved with that to ensure that act actually is enacted so that the cuts can actually be redefined or delayed. I mentioned ThyroSeq, and it is worth singling out. It's a single test. It's a thyroid cancer classifier test that we have exclusive licensing to. It's performing outstandingly. The revenue growth of this particular test is more than 25%, and we're now at a run rate revenue of about AUD 55 million per annum. We're also, from an operational point of view, working to integrate our growing anatomical and clinical pathology operations to achieve cross-sell and synergy opportunities. Moving on to Australian Pathology. Our base business organic growth was 8% against last year. COVID revenue down 76%. And you'll see most of our countries are in that order when you compare the half to the last year's half in the order of around 70%, 80%, something like that. From an operational point of view, good news was that the COVID PCR test fee, as set out by Medicare, has been extended until the end of this calendar year. And our National Aged Care COVID PCR contract has been extended until at least 30th of April 2023. This is an important contract because it is that demographic, aged care centers, where COVID is still a problem. The national cervical cancer screening program has now begun its second 5-year period, and it's at this point that testing is done for a second time. And so we're seeing a great increase in cervical HPV testing as part of the screening program, and we expect that to continue through the year and into next financial year as well. I mentioned that we are experiencing strong growth in genetic testing. And in Australia, in particular, we are very pleased to have very strong positions in the specialist referral and hospital referral markets. We've also taken a good look at our market share gains, which is not easy to calculate. But if you look at your item numbers or episodes or dollars, just Medicare versus the total Medicare markets, and we've done that over the last 10 years, Sonic's market share gains have been achieved every single year of those 10, an outstanding result for this particular division. Moving on to Slide 12, which is Germany. Base business organic growth, 5%, and in this case, COVID revenue down only 54%, so you'll see that there is a fluctuation between countries. And in Germany, there is still higher residual COVID testing, even though we're not sure how this will pan out going forward in any country. From an operational point of view, we're in the process of building 3 new lab buildings in Hamburg, Munich and Limburg. These labs -- new labs are there not only to keep our operations at ultra-modern, world-best standard. But what we have found is that with new labs, we achieve efficiencies in our operating businesses. Our Anatomical Pathology division is growing strongly in Germany, and we're working on getting synergies between our clinical and anatomical divisions in that country, too. Just like ThyroSeq, we have a license, an exclusive license to offer the Oncotype DX breast cancer genetic test, and that is also performing pretty strongly in Germany. We are the exclusive provider in Germany and the only lab offering that test in Europe. Moving on to Switzerland. We had a fee cut in Switzerland from 1 August 2022, with an impact on our Swiss revenues of approximately 7% per annum. However, when we look at H1 base business growth, it is flat, which is an outstanding result in the face of that fee cut reflecting strong volume growth, which has offset the fee cut. COVID revenue is down 71% in our Swiss operations. And just from an operational point of view, our very high-quality services are driving market share gains, and you can see that by the flat revenue growth in the face of the fee cut. We also achieved a successful CEO succession in our large lab in Zurich where Dr. Willi Conrad, a pathologist, replaced Dr. Dr. Franz Käppeli, who was a founder who unfortunately passed away unexpectedly last year. Moving on to the U.K., where our base business organic growth was 5% versus last year. We're experiencing strong growth in our private and NHS businesses, including and especially coming from a private GP market. There seems to be a structural change taking place in the U.K. where private general practice referrals are increasing quite dramatically, and we're in that space and set to offer services in that space. And this is an area that we will keep a close eye on as this change takes hold, which I believe it will. Our COVID revenues are down 77% in the U.K. From an operational point of view, we've been awarded preferred bidder status for a large 15-year NHS laboratory contract, that's Hertfordshire and West Essex, and we're in the process of final contract documentation right now. And we're also bidding on 2 additional smaller NHS lab contracts in North Central London. Moving on to Belgium. Our base business organic growth was 11% and COVID revenue down 88%. Unlike the Swiss situation, good news was we received a fee increase in Belgium or the lab industry have got a fee increase of 6% linked to inflation, and that commenced 1 January 2023. We also achieved the successful CEO succession in Belgium where Astrid Coppens, a senior laboratory scientist, has replaced Geert Salembier, a founder who retired last year. Now Radiology division, which is Slide 16. I remember, there's no COVID revenue in this, so it's a clean-ish result. Revenue growth, 10%, that does include a little bit of acquisition from the Canberra Imaging Group. Organic revenue growth, 8%, EBITDA growth 12% with margin expansion of 50 basis points. An outstanding result with margin expansion, excellent. From an operational point of view, we are continuing to see growth in the higher-value modalities such as CT, MRI and PET scans, and we are well placed to take advantage of those through our 4 Radiology divisions in Australia. We've also received full Medicare funding at 6 additional MRI sites, and that happened through the period. We've commissioned 2 additional PET CT scanners in the period as well. In addition to all of this, we have now implemented AI for chest x-ray into all our radiology centers with brain CT AI tool to follow, and I'll just mention a little bit more about this in a couple of slides' time. Sonic Clinical Services, which is Slide 17. Revenue is down 13%, and that's mainly due to the cessation of COVID-related services, mainly vaccination services, which we provided so well in the previous period. And the decline in earnings are reflective of the lower revenue. The primary care market is challenging at the moment. However, the level of GP private billing in Australia is increasing to mitigate the challenges in terms of GP numbers and referrals. Our Occupational Health division is recovering and will be bolstered by a new Defense contract that we've won, which will commence in FY 2024. On Slide 18, we wanted to just say a little bit about our artificial intelligence. And I might start off with second major bullet point, which is Harrison.ai, which is the parent company in which Sonic took a 20% strategic stake in H1 FY 2022. Harrison had an existing joint venture called Annalise.ai for radiology, and that's the chest x-ray product that we've now implemented throughout Sonic Radiology. This is a world-leading chest X-ray AI tool, which can detect 124 abnormalities. Our plan is -- or the plan of Annalise is to sell the product worldwide. It currently has approval in 35 countries, with more to come. The brain CT product has now been launched following the chest x-ray product. It detects 130 findings, and it currently has regulatory approval in 8 countries, and chest CT and other modalities will follow. Now on the top major bullet point, Harrison and Sonic have combined to form a joint venture called Franklin.ai, and that joint venture is designed to develop best-in-class AI tools for pathology, as opposed to the Annalise product in radiology. Since we formed the joint venture, there's been a huge amount of activity. It's been very exciting to be part of this where the team has expanded in areas like engineering, product development, et cetera. Within Sonic and around the traps globally, we are digitizing literally hundreds of thousands of histopathology slides and having them annotated as well, and rushing forward to achieve milestones with the hope of releasing our first product within the next 18 months. Very exciting. The plan is not just to use the histopathology tools within Sonic, but to sell them globally. And one of the incredible things to see is the synergy that's been created between this joint -- between the 2 parties in the joint venture, Sonic from the medical side with deep, deep expertise in pathology and histopathology, and Franklin on the other side with deep experience in AI technology and all kinds of smarts that we don't have. And so this is a real synergy in action. On Slide 19, with just a quick mention of our strategic partnership with Microba. We've already announced this, that Sonic took a 20% stake in Microba Life Sciences to deliver Microba's microbiome testing services within Sonic's global markets. Microbiome testing is a rapidly growing field. It uses genetic sequencing to analyze microorganisms in various parts of the body, but particularly in the gut or the colon. And we expect the demand for microbiome testing to increase into the future, so Sonic is now very well placed with an outstanding partner to capitalize on this potentially burgeoning field of pathology going forward. And the last slide in the pack, I won't go through the details on the slide, but just to say that our 2022 Sustainability Report was released in November last year. And it sets out the company's sustainability, governance structure, our key goals, including our Net Zero strategy and our key achievements to date, and we continue to progress our sustainability initiatives across our operations. If I could just end the formal part of this presentation, just with a short summary, to say that over the last 2 to 3 years, Sonic has played a vital role in the pandemic with basically 2 major outcomes from that. Firstly, we made a massive contribution to the pandemic through our testing and vaccination services, which really served to enhance our global reputation as a leading health care company. And I do want to take the opportunity here to acknowledge Sonic's doctors, managers and staff throughout the world for absolutely incredible work delivered under very difficult conditions. I can't say anything less than this was a Herculean effect, of which we are all very, very proud. But the second pandemic outcome is a financial one. We emerged with a greatly-strengthened balance sheet, ready to fund synergistic acquisitions for company growth, and at the same time not being exposed to rising interest rates. Now as COVID revenues reduce, it's a real positive sign to see the return of strong growth in our underlying base business revenues, particularly in the latter half of H1 and then into January and February. And as an example, I mentioned the number in our Australian Pathology division. We're seeing very strong organic growth in January 2023 versus the equivalent pre-pandemic month, January 2020. In our whole laboratory division, which is more than 80% of our revenue, we now have strong base business growth plus the addition of a new test. That's the COVID PCR test, which even in lower volumes is going to add to what we can call our new base business into the future. And then the last point that I'd like to make is that over the long term, and I'm talking here decades, we have been almost obsessive about the importance of culture as a means to build a high-quality and world-leading health care company. Our medical leadership culture has served to enhance quality and service levels in the company and also importantly, to attract the best pathologists, radiologists, other doctors, managers, scientists, technicians and others, making up our staff of now 41,000 people worldwide. And as we emerge from the pandemic, all of this comes together, and we find ourselves back in a strong business growth mode, taking market share in markets that are expanding themselves, and holding a dominant position in the high-value specialist and hospital referral submarkets in both pathology and radiology. And finally, to add to this, M&A activity has now returned post pandemic, and our excellent reputation and strong balance sheet put us in good shape to really bolster our organic growth via acquisitions and contract wins. Okay. I'm going to hand you back to our coordinator, thank you very much for that, to take your questions.

Your first question comes from David Low with JPMorgan.

Just wanted to start with the pricing environment. We see from your U.S. peers that they talk about their average price per requisition. I was just wondering, given you've talked about the genetic testing and other newer services, whether you could talk to what's happening with your average price? And then perhaps expand that to indexation, and whether you're expecting price increases to match inflation as we saw in Belgium and any other regions, please?

Yes. So we can all have a shot at this. I'll start. So what we have seen, I mean, you've actually outlined exactly what's happened. Average fee or price per acquisition, as we call it in the U.S., has increased fairly substantially over the course of the pandemic. And if you take out the COVID test, which obviously has an impact on our average fee, it has still increased significantly. Now whether this is solely due to the shift towards higher-end tests and modalities or whether it's that plus a reduction in the lower-value episodes, we're not quite sure yet. But the bottom line is, and we saw this happening through the pandemic, the average fee has gone up in almost all of our countries.

Yes. Maybe -- David, it's Chris here, just to add a little bit more to the second part of your question. It was great to get the indexation in Belgium, in the U.K. It's a relatively small market in terms of Sonic's broader business that we have CPI indexation in most of our contracts, NHS contracts, and we also obviously have some pricing power in the private market as well. So in some ways, inflation might be [ our friend ] in that market. In other markets like Australia, it remains to be same whether or not there's any scope for indexation of the fees as such. But we -- as Colin said, we have benefited a fair bit by index, by the enrichment, if you like. So our average PPA, price per [indiscernible] is going up, and that's particularly true in the specialist part of our business, which we dominate. So look, this remains to be same what happens with PAMA in the U.S., and I think we're starting to see some opportunity to maybe increase fees in the private sector in the U.S. It will be interesting to see how that pans out. But we're hearing also from Quest and LabCorp that they're getting some positive outcomes with negotiations and fees with the private insurers. So maybe I'll leave it at that, unless...

That's it.

Yes.

All I would ask is that you might put a number out there on what's happening. I mean, you've said it out.

Look, it's pretty hard to put a number on, Dave, because it's very different in every geography, but it will flow through to that revenue growth number. And I guess that's why we gave the January number, which is actually pretty strong particularly here in Australia, as Colin mentioned.

I might just press a little further. I mean, CPI is mid-single digit. I mean, what are we talking about with average price? Is it low single digit, high single digit? Any sort of sense you could give us, please?

Look, I don't have a number across the group. We haven't announced it, so I don't think we can really give you that. But as you know, inflation is varying across the world. But in the U.K. right now, it's double digits, and so I believe that will flow through into our contracts in that market. So that gives you one little example of what's happening there.

All right. So one other topic. M&A, I mean, we've heard fairly similar commentary than what we've heard for many years now, and understand that it's part of Sonic business model. Can I get you to talk a little bit to what the pricing environment or competitive environment is like in the M&A space? I did note that [ Synlab ] has stepped back on their plans, and just wondering whether that's indicative or whether you're seeing that -- a degree of reduced competition for assets as we sort of move into a more difficult economic environment, please?

So David, I think what we can say is that there hasn't been any escalation of multiples or in valuations. And as we've said before, some deals are done in a non-competitive process, in which case the valuations will be more favorable for us. But we're not noticing a big difference in the metrics as we move forward, and we are looking at a number of near-term opportunities at the moment.

David, maybe one other thing to add to that is that during COVID, whilst there were opportunities we looked at, it was challenging because of the COVID, and expectation about value because of that and how do you value that going forward. So with a bit more visibility on where we think COVID is heading and appropriate earnout type structures, I think M&A becomes a little easier going forward.

Your next question comes from Andrew Goodsall with MST Marquee.

The first one, just when I look at the EBITDA, the constant currency and reported numbers are flat. I would have expected with a bit of tailwind -- FX tailwind, that might have been a little bit up. But just trying to understand whether that is a good reflection of where your offshore costs and mix might be, or maybe a bit of COVID playing into that as well?

Paul, Go ahead, take that one.

Yes. I guess one of the things about our geographic expansion, Andrew, is that we are exposed to a number of different exchange rates, and there's sort of a hedging component kind of build in that. So whilst the U.S. dollar went one direction in the period, the euro very much went the other as did the pound, as I think Colin touched on earlier. So the net exchange rate impact was very small in the period. So it's not really about any significant change in cost versus one market versus another, that's purely the offsetting impacts of the [indiscernible].

I think it was actually only about $40 million of the revenue line, which when you consider our revenues, is nominal.

Yes. Got it. So more [indiscernible], movement. Mention just -- just back of envelope, when I backsell your Australian Pathology business versus pre-pandemic, as you say, you seem to have recovered to where you should -- where we should be, say, a 5% CAGR off that base. But when we look at the market data, that hasn't recovered. So I guess you've talked about perhaps gaining some share and particularly specialist recovery. Is that -- yes, just any more color you can sort of add on what you think -- what you're achieving versus ?

Yes. So Andrew, it's what I touched on. And obviously, we can't give out numbers, but we have done extensive work looking at our market share as a percentage of the whole Medicare market. And Sonic in Australia, and it applies to each of our divisions in every state, grows progressively each year over -- almost 10 years. So we continue to take market share, and therefore, looking at just the bare Medicare numbers will not reflect how Sonic is performing. So we are continuing to take market share. There's no evidence to suggest any change. I think a big part of that is our very strong position nationally in the specialist and hospital referral market because with the slightly lower GP numbers, the referrals from GPs are affected, whereas specialists are now back at full capacity. And hospitals are busy again as well, and we are benefiting from that.

Okay. So that percentage share of specialists, which are much more dominant, is probably giving you more of a tailwind, perhaps? Anything [ else ] -- that has that exposure?

Exactly right. [indiscernible] just one more point. Remember that here in Australia, which is what you've asked about, the GP market is additionally burdensome because of all the collection centers that we have and the rents applicable to them, which does not apply in the specialist market.

Yes. As the margin flows from it.

Correct.

Your next question comes from Lyanne Harrison with Bank of America.

I might just follow on from Andrew Goodsall's questions there, but focusing on the Imaging business. 8% organic growth is better than the Medicare data suggests. Can you provide some color on that and where that growth is coming from?

Paul is going to take that.

Yes. So Radiology, in particular, the growth over the last couple of years has been very different in different states at different times because of COVID-related lockdowns, et cetera. And so mix of business and location of your business does come into play there, to some extent. And so to some extent, the 8% just reflects the comparatives. However, as Colin's pointed out as well, we have been growing strongly in that division. We have been focusing on the higher-end modalities and achieving growth through that. So we probably have also been gaining some market share in that market as well. But it's difficult because of that -- the distortions that the COVID period has caused.

And in terms of the -- can you provide some color, I guess? You mentioned the cross-sell opportunity between anatomical and clinical testing both in the United States and Germany. I know you can't provide any numbers around that, but can you provide some color about how we should be thinking about that cross-sell opportunity and the timing as well?

Yes. Look, it's going to be difficult to put numbers on this, but what our objective is to use our customer base as efficiently as possible. So if we have a clinician referring us anatomical pathology, we would like to access that clinician's clinical pathology and the converse as well. Now this is not just theory. It is quite possible given that you have a relationship with the clinician, you have couriers going there. You have connections. And so what we're doing in the U.S., for example, it's actually a very -- we've got a great example of that. Our recently acquired ProPath business in Dallas, began -- it's like as an anatomical pathology division, a company, and got bigger and bigger. And in the more recent past, decided to add clinical pathology to its menu because of all the connections and relationships it held with clinicians, and it's been very successful. So they've built a fairly large clinical pathology lab together with an anatomical pathology lab, like we have here in Australia. Remember that in the U.S. and in Germany, the evolution of pathology has been different from Australia where the 2, anatomical and clinical pathology, are being quite distinct and separate. They're not consolidated into single labs as they are here in Australia, and this has something to do with training of pathologists. So it's just very interesting that we have now a great example at ProPath to guide us in the U.S. as to how we can achieve similar outcomes with our clinical pathology labs. And given that we have a lot of anatomical pathology as well, this should be quite possible. And a similar thing happened in Germany where the 2 disciplines have been quite separate. And there's an opportunity, if not to bring them together physically, to at least capitalize on the relationships that the respective subdisciplines have. Sorry, if I can't give you any numbers, but this is going to be caught up in the growth of each of those 2 subdisciplines going forward. It would be very difficult to give you a number.

Your next question comes from Gretel Janu with Credit Suisse.

Just in terms of the outlook into the second half, so the 22.5% EBITDA margin that you achieved in the first half, can we now assume that that's the base, and then we would expect improvement to come to margins in the second half?

Yes, look, it's a good question. There's probably going to be some reduction in that margin because some of that is driven by the COVID volumes, which were AUD 390 million, I think, in the first half and will probably be something less than that in the second half as indicated, even the January number at [ 32 ]. So that will have a bit of a negative effect on margins in the second half, I suspect. At the same time, as Colin said, we're working on costs. And we alluded to the fact that we think that our base business margins are pretty much in line as best we can calculate with what they were pre-pandemic. So it wouldn't surprise me if they're down a little bit in the second half, depending on what happens with that COVID volume, but hopefully not anything material.

Understood. And then just in terms of the reduction in consumable costs you called out, are you able to split what's actually happened from the base business costs as opposed to the COVID consumable costs there? And what kind of quantum of procurement savings you're achieving?

Yes. Look, the procurement effort is still in full swing. And there is a little bit of pressure from some suppliers with inflation coming through, but we've been able to resist that partly because we have contracts, partly because we're a big customer and we can use that buying power. We're also running -- continuing to run RFPs. We've just completed one in Germany, which saw a more than double-digit savings. So I think we're pretty comfortable that we'll see a continued reduction because the COVID cost was, in percentage terms, a little higher than our average cost. So as COVID comes down, I think you'll see the percentage continue to come down, but we're pretty comfortable for the foreseeable future that we won't see any actual increases in prices for the items we buy in our procurement efforts.

Your next question comes from Sean Laaman with Morgan Stanley.

Colin and Chris, hope you're both well. It seems that Sonic is a bit of an outlier from the health service companies that we look at, so you've been able to deliver good cost containment and inflationary environment. Just wondering what confidence or what could you tell investors looking forward over the next sort of 12 to 24 months that at some point, we might not see a cost up with inflation and cost jumping up with inflation, and we can see continued delivery of the margins that you described?

So maybe I could just start. So the major category you're talking here is labor, and so we're very mindful of what's going on around the world with inflation levels. In general, our labor costs have been -- that salary cost increases have been contained to around 5% or less even in this environment. So we're not expecting it to get much worse. I mean, one can never tell, obviously, but I think that's our position at the moment. So given that, that would be a little higher than what we would normally have. And we're using all kinds of means to mitigate any potential increases in that particular number. So we can take a lot of time over our head count, and I mentioned, in particular, casuals, contractors, overtime, et cetera, in the post-COVID world. And in a range of other cost categories also, we're constantly looking to find efficiencies. So we are very conscious of the point that you're raising, and we certainly will not want any cost category to get away with itself and affect our margins. So that's all, I guess, as much as I could say at the moment. Unless Chris and Paul, do you want to add something?

Now I guess maybe just to add that we've -- obviously, there's ways of managing our labor costs through technology that we're working on digitization in histopathology. There's all sorts of things that technology is our friend in a lot of ways in terms of managing costs. But as Colin said, we can't be sure what's happening with inflation. If we could, it would be nice, but -- so we're just trying to do our best in this environment and so far, so good.

Great. I might try and ask this next question clearly, so sorry if it sounds a little jumbled. But ThyroSeq, you've given -- has an exit rate of AUD 55 million, which is pretty impressive. I'm thinking, is that a U.S.-only exclusive licensing? Is there opportunity to take it global, if not already? And then you mentioned Oncotype DX. I think you mentioned that a German label or license, sorry. So is it the opportunity to do the inverse with that one and perhaps take it to the U.S., if not already? And could that be a similar magnitude to what you're seeing with ThyroSeq, just looking at stats of the various tests required? And then thinking if you are, I guess, sort of an innovator that's come up with a new type of genetic or diagnostic pipe tests, and I'm looking to maximize the distribution and market approach of such a test. I'd kind of think of Sonic as having the broadest global presence of pathology or laboratory testing facilities in the world, so is that a strategic advantage for your company as an appealing place in which to market your tests, and is there a pipeline coming for you?

Okay. So to take the 2 tests one by one. In terms of ThyroSeq, we can take the test to countries other than the U.S., but the problem there is the funding of the test. So we are already offering that test here in Australia, for example. But is a very expensive test, which is fully covered by insurance companies in the U.S. Therefore, it's a test that is being ordered by relevant clinicians. Here in Australia, it's not covered by Medicare, obviously, and so it's a patient pay test, and you're talking here a few thousand dollars per test. So -- and the same thing would apply in other countries around the world. The penetration would be low because there's a price resistance, simple as that. And now that might change going forward because this is a very useful test, which actually saves health care systems significant dollars. And just to put it very quickly, the ThyroSeq test allows a clinician, an oncologist, to decide whether somebody with a thyroid cancer, early cancer should have surgery or not have surgery. And the not have surgery decision saves tens of thousands of dollars in delaying or averting an operation, so it's a cost-effective test. And therefore, other health care systems might fund the test in their best interests. In terms of Oncotype DX, our license cannot extend to the U.S. The test is already being offered by somebody else in the U.S. The test originated in the U.S.. It's Exact Sciences, and so our license is for Germany and Europe at the moment and no further. Now your point you make about Sonic being in a position to offer tests such as these is exactly our plan for microbiome testing. So our partnership with Microba is intended to achieve that, where we can roll the test out in multiple countries around the world in addition to wherever else Microba wish to offer the test as well. And so going into the future, yes, I think there will be more tests like this where we can achieve the licensing agreement and begin to roll the test out in multiple countries, not just 1 country. And they won't be like ThyroSeq, which is an extremely expensive test. So microbiome testing, whilst it's not cheap, is affordable. And we see that in our microbiome lab in Germany, that's in Limburg, where it's largely patient pay for the test that we offer there, and it's a very successful operation, offering a microbiome test that is not quite the same as what Microba offers.

Your next question comes from Mathieu Chevrier with Citi.

Sorry, just to go back on the Australian growth number of plus 16% versus Jan 2020, that's about a 5% CAGR. Are you confirming that the growth there is really driven by your specialist work rather than the more broad, for the lack of a better word, community work?

Yes. So I don't want to give the impression that we are not growing in the GP market as well, but I think I can say unequivocally that we are extraordinarily strong versus our competition in the specialist and hospital markets. And so we hold a big piece of the GP market, which has become very competitive with the collection centers and the rents that are paid for collection centers. But we stand quite a part in that high-end specialist and hospital market, and that's really a function, that's what I was trying to say at the end, of really decades of development of a culture that attracts the top pathologists, top managers, top scientists, where you can expand your menu and offer very high-end super specialized services because those are the services that specialists and hospitals require. So this is something that will continue into the future. And it's not just in Australia. The same thing can be said in Germany, for example, although the competition is perhaps a bit closer in Germany. But here in Australia, because you asked about Australia, we separate ourselves out in that respect. And I can point to probably 2 or 3 decades of strong culture under the medical leadership model to get us to this position where it's very, very difficult to catch up or copy.

Yes. Understood. And then do you expect the growth to accelerate from here, or do you think that the backlog of patients has largely been worked through at this stage?

No, I think it's only beginning. And by the way, the catch-up testing doesn't apply to all areas of pathology testing. So we're seeing, for example, in histopathology, anatomical pathology, what appears to be a very significant catch-up of operations procedures that were not done during the COVID period. And yes, this ranges from significant operations like breast lumps, thyroid lumps down to colonoscopies where biopsies are done and skin cancer clinics where skin lesions have taken off. There's -- what appears to be a definite catch-up phenomenon, which has only just begun. So we anticipate that this could run for a good 12 to 18 months. And there has been something written about this where surgeons and hospitals are saying that in order to catch up from lost procedures during COVID, might take 1 to 2 years is what I've read. So that's not to say that we're going to continue with 16% growth for 2 years. I probably won't. But I think the trend has now established that it's an upward trend of growth in our Australian Pathology division. And it's probably going to stay up for quite a bit -- several months, if not more than a year.

Your next question comes from Craig Wong-Pan with Royal Bank of Canada.

Just wanted to touch on the near-term acquisition opportunities. I know you can't sort of pinpoint particulars, but just -- should we think of these as kind of small bolt-ons, or could they be sort of more sizable being large- or medium-sized acquisitions?

I'll let Chris deal with this one.

Thanks, Colin. Obviously, Craig, we can't give you any detail, but look, the pipeline is pretty stronger than it's been for a number of years. I understand, I guess, during COVID when things were a bit tougher to do M&A but -- yes, look, I don't -- we haven't announced anything other than what we've put in the paper today, but they're not tiny. I'll say that.

Okay, sure. Yes. Okay. That's helpful. And then just on the -- in the U.S., the change to the CMS reimbursement for collections or withdrawals. Just wondering how much revenue that might provide you?

Paul?

Look, we haven't quantified that anywhere publicly, but I think some of our U.S. competitors have. So if you look at what they have said and apply our market share versus theirs, you'll come out somewhere near it. It's certainly a positive for us. But yes, I don't have that number at hand.

Okay. Okay. And then just wanted to touch on Harrison and Franklin.ai. Were there any significant costs that you were incurring to as part of that joint venture that were in this period that might not repeat going forward, or is there any kind of large share of losses for Harrison that's within your first half '23 numbers that we should look to normalize going forward?

So we do equity account for the Franklin joint venture, and so we have booked a small loss in the half year period. And that will probably create continued ongoing until we start to get to profitability, but it's not hugely material. I don't know, it's a few million dollars probably. It's not material in the scheme of things, but -- and we're reminding, as Colin said, we're excited with what that -- the potential of that business could be, and that we might be starting to get first revenues in -- within the 18-month kind of period, which is quite exciting. So we probably will be able to leverage off the sister company Annalise in some way. Annalise is getting some pretty good traction with their product, and some of the offshore partners who are starting to use that and enjoy it are saying when is your pathology product coming. So there's probably a bit of a nice symbiotic relationship between those 2 offerings.

Great. And just my last question. On Germany, with the new labs there, I just wanted to -- I wasn't really sure. Are you building new labs and then moving your existing lab work to those, or is this like additional labs, so you're expanding your footprint?

No, these are new labs to house existing labs, but it will involve mergers of -- so 2 or 3 labs into 1 building in both situations. There's a number of permutations in different locations. The Limburg lab is a new lab for a very successful business, that's our microbiome business. But in both Munich and Hamburg, we're talking about merging multiple labs into a single new facility.

We're talking about labs, we didn't mention specifically, but I think we might have mentioned previously. We're also working halfway through a major expansion of our lab in Brisbane in Bowen Hills. And so those labs in the Germany and the Bowen Hills explains some of the increase in property CapEx that you'll see in the cash flow.

Okay. And then just a follow-up, sorry, to that point around the litigation in Brisbane and new labs, could you provide any expectations for CapEx?

Yes. Look, probably not because we've got so many things happening, they're all happening at different times, and -- but the Brisbane project is a [ AUD 70 million ] project. it will be largely finished by the end of this year. And I think other than Munich, the others will probably be largely finished by the end of this year as well. So I suspect for going forward, there aren't any -- there aren't any major building projects on the way for FY '24, so we probably should see that number drop down a bit the CapEx number.

Chris, with the contract in the U.K. Once that signed, there is a significant building [indiscernible].

I suspect the actual might be more in FY '25, yes.

Your next question comes from Saul Hadassin with Barrenjoey Capital.

Just the first one, just a comment about base business margins being in line with pre-pandemic levels. Is that a reference to the group level margin, or was that focusing more on the pathology division? And what assumption have you made regarding PCR margins to arrive at that conclusion?

Paul?

So clearly, it's not a precise science, Saul. Because as we've explained before, the reality is the COVID business is mixed into our labs with all of our other work. But to answer your first question, it is at the group level that we've looked at that. And all we can really say is it's not a precise science. It's our best estimate, if you like, of what the COVID and base business margins were in that period. But that's why we view sort of terminology like in line with it because it's impossible to be precise in looking at that split.

And it's now getting a bit more complicated because the COVID test is now finding its way into panels and the like, so that makes that kind of calculation even a little more complicated. So as Colin said before, before too long, this will be just part of our base business. But it's probably a net positive part of our base business.

Yes, fair enough. And just on the outlook. You've got January based business growth across all regions now. You've got a month's worth of PCR revenues across all regions, so why you're not in a position to provide more quantitative guidance regarding FY '23 earnings?

Yes, look, we [ costed ] around. But on balance, it is still moving around a bit, and so I'm sure we'll probably be thinking more about that when it comes to FY '24. I'm sure the things will probably stabilize to a point where that would make a whole lot more sense. So I think we decided at this point that we wouldn't look at that for the second half.

Your next question comes from David Stanton with Jefferies.

Just following up then on previous question there. I understand if you can't give earnings guidance, but do you think that January revenue growth rate is sustainable through the second half, please?

So just remember, David, that applies to 1 division of Sonic. We've given you a rough idea of the whole group, so it varies by country and we're following it closely. Nobody can predict what's happening, but it really does look like base business is coming stronger than historically. Definitely in the Australian Pathology division, but we're also seeing it in other markets. So for example, the U.K. market is particularly strong as well, and there's different reasons in the U.K. for it. And it's slightly below average in the U.S. and slightly stronger in Germany, was strong in Switzerland. And so it's very difficult to actually predict each market, but we think it's going to remain strong for the next several months.

Understood. And then can you sort of explain the consumable cost decline journey that you've been undertaking in terms of these new contracts? I mean, how many countries have you -- how many do you have to go, and I guess, are you looking for sort of a global contract? And anything around the scale of decline per contract? You mentioned one at double-digit decline. Is that the way we should be thinking if these get rolled out further, please?

Yes. David, we run what we call a center-led procurement effort. And so we've got a team here that plays a role in Australia, obviously, because we're here. But we also play a role in overseeing what's happening in the other markets. So in each country, we've got a procurement team who are running their own RFPs, but we all work together. And when it makes sense to look at a global contract, we do, and that happens on occasions. And so it's not something that we run out of head office because there's too many complications to that, and this has worked very, very well for us. But we find when we run RFP, but -- I mentioned double digit was actually closer to 30%. That when we run RFPs and because we're a significant player in all of our markets, the vendors have to take the attitude -- either we win this and we'll have this business for the next 5 to 7 years or we lose the business, and we don't have that business for 5 to 7 years. And so that puts a fair bit of pressure on the suppliers with pricing. So -- and I guess they put pressure likewise on their own supply chain, because it surprises me from time to time just how we can achieve those sort of changes. There's also changes in technology, which help them as well. So -- but obviously, we're also in the face of some inflation pressures too. So I guess our strategy would hopefully be that we can -- with those RFPs, we can offset any inflationary pressures that we may not have so much control over in the consumable space. And maybe with a bit of luck, it might be a net saving as well. But there's so many different platforms and different countries, it's hard to be kind of specific.

But just as a follow-up to that then, is -- Germany is about 30% of our pathology business. It sounds like you're close to done Germany, is it fair to say that [indiscernible]?

There's no done here, David, but it's a bit like painting the Sydney Harbor Bridge. You get to one end, and then you start to -- start again. And with technology developments, those -- it surprises us. You run an RFP for a platform and you get a, call it, 25%, 30% reduction. And then 5 years later, you do it again, reduction. And you think where can this end, but it's kind of the way it works.

Understood. And then while you're running hot, Chris, just 2 questions from me more around depreciation for the second half compared to the first half. And tax rate was a little higher than I had expected in the first half. Can you sort of give us an idea of what we should be thinking for the full year potentially, please?

Paul, do you want to run that one?

So depreciation -- I mean, I think the level of the first half is a pretty good guide for the second half. We are, as touched on, working on some building projects, et cetera. So it might be a little higher in the second half, but not materially. In terms of the tax rate, it's always hard to predict because it depends on the profitability in each market in the particular period as well as other factors as well. But somewhere between sort of 26.5% to that 27% level is roughly where we would expect it to be, but it's obviously at the higher end of that in this particular period.

Your next question comes from Steve Wheen with Jarden.

But I just wanted to touch on the Australian business again, just with that dominance in the hospital specialist channel. Sort of 3 parts to that. Is there some part of that strength, recent contract wins within hospitals? Also, just interested in whether or not you've been able to take price through co-payments within that channel, and if so, how much? And whether now you're in a position to be a bit more, say, judicious with your collection centers and perhaps move away from some of the less profitable ones, because you've got the flexibility within the hospital and specialist channel?

So Steve, just to go through these. No, it's got nothing to do with the contracts. So just -- I'm very keen to make this point that the referrals we get from specialists in an outpatient market, they increased progressively over a long period of time based on the standard of service and super specialization that a lab has. And in our case, we have spent energy and dollars based on a medical leadership culture to build a huge team of outstanding people, this is pathologists, scientists, managers, to build departments that can actually cater for that high-end work. And so this is the real heart and soul of medical leadership. What it's done is it's put Sonic in a position now where we are the specialists' friend. We can service them in a way that many of our competitors are not able to do. So it's not contracts, and in fact, if there are contracts that some of our labs -- some of our competitor labs hold, I think it will be worth checking because those -- you don't necessarily hold forever. We're not in that position at all. Your second question was, are we able to achieve gap funding or patient pay? And the answer is essentially no. So most of -- the vast majority of the specialist referral and hospital referral work comes at no gap to the patient. So in the hospital setting, there might be 1 or 2 exceptions. But the vast majority, we have negotiated outcomes with insurance companies whereby there is no gap to the patient. And in the outpatient market, most of the work is bulk billed. There will be a small proportion that we privately billed. And particularly, if the test is not covered on the Medicare schedule, then it will be privately billed. But that hasn't changed much over the years. That's not the reason why we have grown to a dominant position in that market. And the third question related to collection centers. We do -- what you said is absolutely logical that the cost of servicing GP medical centers, and particularly the collection center rents, is a burden. However, we are -- we try and manage that cost as best we can, so we're trying not to get into arrangements whereby we're in a losing position. We don't just open up collection centers willy-nilly. In fact, we're very disciplined with the number of collection centers that we operate. And so I don't want to say or suggest in any way that we are reducing our efforts in the GP market because we're very, very strong in that market as well and always have been. It's just that we've grown our dominance in the other submarket, which is now a very significant market and growing faster than the GP market.

Your next question comes from David Bailey with Macquarie.

I will try and be quick. Second half '22 for the base business looks pretty similar to the first half '22. 6% was the growth you got in first half '23. Should we expect a little bit better than that in the second half of '23?

Paul, do you want to...

Maybe one thing I'll mention, it's Chris here, is historically, the second half, if you guys will remember, has a little bit of a seasonal effect. I recall before COVID it was kind of at the EBITDA line, 55-45, something like that in terms of -- so we might see some of that come through. But it's probably -- it's a little hard to tell because we're still coming out of the COVID. And then Paul, anything else you'd add?

I think the only comment I'd really make is that it started well on those January numbers. So I think the January numbers would have been better than the corresponding period. And so hopefully, the rest of the half is as well.

Sorry, this is not a clear cut -- I mean it's a very good question, but not a clear cut answer. Just going on from what Paul said, given that we're coming out of the pandemic and returning to normal base business activity in the clinical market, with some -- potentially with catch-up testing, it's possible that the second half of this year will have a bigger skew relative to H1, excluding COVID, of course, just base business, that the 55-45 might be there or even a bigger delta between the 2. It's not clear, and it's part of the reason why we haven't given guidance because it's just so difficult to predict. But you can -- I mean, I think it's quite possible. And certainly, in our Australian businesses, it's quite possible that there will be a bigger gap than that 10% that we would normally have had between H2 and H1 in this particular financial year.

Yes. Got it. And then just in terms of labor costs, it looks to be about 3.5%, excluding acquisitions. ProPath should be in the PCP now. I mean, is that the kind of the growth we should expect for labor costs in the second half?

Well, I guess that's a combination of the FTEs and the pay increases. And as we've mentioned, depending on what happens in COVID, we're trying to manage labor costs down in line with that. So if COVID plays those out, there might be still a little bit of a saving in labor that we can make. But if COVID keeps going down, we'll probably be moving labor costs down a bit as well. Is there anything, Paul, that you'd add to that? That was the end of the end.

Our next question comes from Andrew Paine with CLSA.

I'll try to be quick. So just looking at your EBITDA margins, trying to compare them to your update in December and then the exit rates last few months -- month of the half. So looking at that, EBITDA margin was about 22.1%, so stepped down from 22.8%. So just trying to see, is that 1 or 2 months kind of reflective of what you think will happen over the second half this year, knowing COVID is going to step down, but you've got that increase in the base business for us to potentially offset that?

Andrew, there is a seasonal impact with December. And so we would always expect the margin for the -- for a short period that includes December to be a little bit lower than the rest of the period. So I wouldn't read too much into that.

Okay. So like 22.1%, so you think that's like on the lower end there?

I don't think we're giving margin guidance, so I'm not going to answer your question.

But just to emphasize what Paul said, with the number of -- with a bunch of fixed costs and a number of holidays in December, that has an impact on margins. We don't normally -- we don't really give details on 1 month, so it's a bit unusual to have that visibility on the 2-month period.

There are no further questions at this time. I will now hand the conference back to Dr. Colin Goldschmidt.

Thank you, everyone, if you're still on the line, and have a good day. Thank you very much, and thanks for coordinating, [ Stacy ].