Sonic Healthcare Limited

Good day and thank you for standing by. Welcome to the Sonic Healthcare Financial half-year ended 31st December 2023 conference call. At this time, all participants are in a listen-only mode. After the speaker's presentation, there will be a question and answer session. To ask a question during the session, please press star 1-1 on your telephone and wait for your name to be announced. To withdraw your question, please press star 1-1 again. Please be advised that today's conference is being recorded. I would now like to hand the conference over to your speaker today, Dr. Colin Goldschmidt.

Thank you very much, Joss, and good morning and good day to everyone on this call. I'm Colin Goldschmidt, CEO of Sonic Healthcare, and I'm joined today by my colleagues Chris Wilkes, Paul Alexander, and Diane Ayres. It's a pleasure for me to present the half-year results of SONIC to December 31, 2023. If you can go please to slide three where we'll start, which is showing our headline numbers. First of all, our revenue number at $4.3 billion is 5% above the corresponding period last year. But of course, that now is not truly comparable to last year because of COVID revenue, which was present in the previous period. But if you exclude COVID and take our base business revenue, the growth is 15%. And I just want to call out at this point that the comparatives against the previous period are not entirely pertinent because of the difference in COVID revenue between the two periods. Our EBITDA number at $737 million for the half is in line with the guidance we provided at the AGM last year. And we are on track to achieve our full year EBITDA guidance. And we are pointing to it ending more likely towards the lower end of our guidance range. If you look at base business organic revenue growth, the number for the half is 6.2%. And a further headline on this first slide is that we are full steam ahead with cost reduction programs right around the company. A standout feature of this period is the approximately $500 million, that's Australian dollars, of new annual revenue that's been added, which has come from acquisitions and contract wins. In fact, this feature is very much a standout feature of this result release. And there are further acquisitions and contract opportunities under consideration. If you go to the next slide, and I'm going to point you straight to the chart because it is quite informative. And firstly, I need to say that the numbers in that chart represent actual reported revenue numbers, and they are by half. So first of all, just looking at the base business between this year and last year, that's the blue bars. The 4.27 over 3.70 represents the 15% growth in revenue on the previous slide. The base business revenue growth for the half, and that's H124 versus H123, is 15%. And if you look at the scale over four years, you'll see that we've added something like a billion dollars in revenue, in H1 revenue only. So that's the 3.34 to 4.27. And if you extrapolate that to full year of base business revenue, and I will take you back to FY19 because that's the first or the last year with no COVID revenue in it at all. I think back in 2019, the revenue was just over $6 billion. And if you take consensus for FY 2024, which is over $8.5 billion, you'll see that we've added something like $2.5 billion in revenue over five years. That's an increase of more than 40% in base business growth. Forget about COVID. You'll also notice from the chart going to the red bars that COVID revenue is just about disappearing. So our base business revenue growth trajectory has significantly strengthened more recently. And I definitely point to this fact as a sign of very good health. and underlying strength of Sonic Healthcare. Actually, this chart gives a good general overview of Sonic Healthcare as we stand now and just looking back over the last few years. Firstly, you can see in this chart the tremendous growth that we experienced from COVID testing, and we knew that growth was going to be temporary. Then COVID revenue disappearing, and its replacement by strong base business revenue growth, which we know is permanent. The recent strong base business growth is not just from M&A, but it's combined with strong organic growth. Both of these are very much driven by Sonic's adherence to medical leadership and the very high quality services that are integral to that culture. So you get a good look at just the recent past and everything that happened during the pandemic and how we've come out of that and replacing the COVID revenue with very strong base business growth, which we are confident is going to continue into the future. Onto the next slide in our guidance. As I mentioned, we maintain our EBITDA guidance as issued in August of last year at 1.7 to 1.8 billion. And our impression at this stage is that the EBITDA will land up closer to the lower end of our guidance range. There are a number of factors that have influenced this. First of all, the Belgian fee cut that came in on 1 January 2024. There's been currency exchange headwinds since August 2023. We've acquired Pathology Watch in January 2024, loss-making, and there is a positive factor in this, and that's the impact of the delay of the US PAMA fee cut. Our net interest expense is higher than we predicted back in August 2023. mainly due to additional acquisitions but also an increase in base interest rates and also the AASB 16 leasing adjustments due to higher interest rates and rents. The tax rate is likely to be approximately 27% for the year and of course our guidance still assumes current exchange rates and interest rates prevail. The next slide. which is slide six. Now, at November's AGM, we did alert to a more accentuated H2 versus H1 earnings ratio. As you are familiar, the normal seasonality is something like 46 to 54, H1 versus H2 in terms of earnings. And this will be more accentuated for the reasons in those sub-bullet points. Firstly, strong organic revenue growth in the setting of tight labor cost control. Now that's just one little bullet point, but it's a major point for the entire company. In our business, when we are experiencing strong organic top line growth in the setting of a very tight and almost unique labour cost control setting, there is a great opportunity to grow margins. So the ongoing workforce reduction programs to right-size the company post-pandemic continue. They are not yet complete, but certainly well advanced and well underway. It's a difficult one to explain this, but It was a huge challenge for the company given the massive growth that we experienced very suddenly as a result of the pandemic where we had to put on so many additional staff to deliver the services that we did. Then the synergies that will come from recent acquisitions and particularly SynLab Swiss in Switzerland and MLD and Diagnosticum in Germany. We've got an additional three months of the diagnosticum acquisition. It's settled in October 2023, so we will only have three months in the first half, but six months in the second half. There's contributions from recent smaller acquisitions, specific large procurement deals which are already completed more recently. We're in train in a program to rationalize our collection center infrastructure in Australia. And the initial contributions from our enhanced revenue collection system in the USA are beginning to come through now and will escalate, starting in H2 but going into FY25 and beyond, and also acquisition costs of $8 million in H1, which will be lower in H2. Moving on to the next slide, and this table perhaps serves as something of a bridge from the present situation to the near future, and specifically highlighting the earnings potential that lies ahead from recent acquisitions and the major contract wins that we have achieved. I think the big feature of this table is the addition of $500 million of new annual revenue that will come from these acquisitions and contracts. And just to quickly go through them, in Germany, there's MLD, Medical Laboratories Dusseldorf, Diagnosticum Laboratory Group, and four smaller acquisitions. And if you total those up, that's more than $250 million Australian dollars. In Switzerland, the big SynLab Swiss acquisition and pathology, Engi, that's almost $200 million. In the UK, we have won a new NHS contract, the Whittington Health Trust contract, And there is more to come there. Firstly, the Hearts and West Essex contract and the execution of that contract is imminent and its magnitude is bigger than the Whittington Health Trust contract. And then in the U.S., the acquisition of Pathology Watch, which we have down as U.S. revenue and it is U.S. revenue in the first instance. So we are rolling out Pathology Watch in the USA, but of course Pathology Watch will be applied globally across all our skin pathology, dermatopathology around the world. And so when you add to this table our strong organic growth to the 500 million, we're in a very strong growth phase right now. I think it's perhaps unparalleled in Sonic's history. Moving on to the next slide, and having shown the table, I think it's appropriate, and I guess another good segue, to consider the strong revenue growth in terms of or as a means to drive future earnings. So a few points on our earnings drivers, which will start in H2 of this year. but will certainly extend into FY 2025 and beyond. So firstly, the ongoing strong base business organic revenue growth and the operating leverage that comes from that, that's absolutely integral to our very basic business model. And so we're extraordinarily pleased that we've come out of the pandemic in a big way. and particularly at organic revenue growth level. Then secondly, the additional revenue and earnings that have come from recent acquisitions and contract wins, and specifically to mention SynLab Swiss, which is a big business, 175 million Australian, which we bought at low to zero margin deliberately. So this is a business which will convert, let's say, from zero earnings or margin to perhaps 20%. And if you calculate that, you're talking roughly 35, and it is growing already in our hands. 35 to 40 million of EBITDA will come from just that one acquisition. And we are very confident through our excellent teams in Switzerland to achieve that within the space of one to maybe a bit more years. Then the acquisition of Pathology Watch. We expect significant revenue growth and efficiency gains from this digital pathology platform. It's important to note that this is not just an efficiency tool, but one that can really drive growth in the dermatopathology market, sub-market, not just in the U.S., but also globally. Then the synergistic acquisitions that we've made in technology, and we call them diagnostic technology investments, and this includes Pathology Watch, Harrison AI, and Microbah. These are not just any technology acquisitions. They are all directly in our space and will add value directly to our core business. Important points to make. And then just the final two points, the rollout of our enhanced revenue collection system in the US is in progress and we expect material upside to accrue starting in FY 2025. And we do have now fee indexation in various markets and contracts, including Radiology UK, Belgium and Sonic Clinical Services. The Board of SONIC has ratified an interim dividend of $0.43 per share. That's 2% up on H1 FY 2023. It maintains our progressive dividend strategy. This dividend is unfranked following our fully franked dividends of 2023. Record date, 4 March. Payment date, 21 March. The next slide is on capital management, and it's an interesting one. We've shown this chart a number of times now, and I guess the standout feature is the return of our debt cover or the return trend of our debt cover towards our long-term average of just under 2.5 times. Our debt has obviously increased, the net debt, by just over a billion. largely due to the acquisitions that we've just mentioned, but we still have current available headroom of approximately $1.5 billion before the interim dividend is paid, and our balance sheet remains extraordinarily strong and well positioned for future acquisitions and other growth opportunities. The next slide shows our traditional revenue split pie chart. Compared to, say, a year ago, I think the only significant difference, obviously the whole pie has expanded quite significantly, total revenue $4.3 billion. Switzerland has increased its share of the pie and is now sitting at 10%, which is really good news. I think it was about seven, excuse me, or maybe eight a year ago. There's potentially more growth to come in Switzerland. You'll notice that the bulk of our growth is occurring in Europe, which is really good news. As I flagged before, the Australian lab segment of this pie chart, which currently sits at 24%, is likely to get smaller and smaller as the years progress. I'm going to whip through the country slides so that we can get to your questions sooner. So, and just give a few headline points, firstly on the US. Our base business organic growth was 4% for the half. At operational level, we've implemented our enhanced revenue collection system. We plan a full national rollout of Zyphon. And we have piloted the product in our smaller divisions with very encouraging results to date. So we look forward to significant upside, which will be at revenue and bottom line levels from this rollout. Our ThyroSeq test, which is our exclusively licensed thyroid cancer genetic test, continues to fly. Growth is incredible. One test, run rate revenue is something like, or it's very high. I don't know if I should mention numbers. And as I've mentioned, the acquisition of Pathology Watch, our initial deployment is in full swing in the USA and we have created a new dermatopathology division which has revenue in it of approximately 200 million Australian dollars and we have a lot of optimism for the benefits that will flow from Pathology Watch in this new dermatopathology division. Australian pathology on slide 13 is growing incredibly strongly at 9%. That's base business organic growth. Excuse me again. And at operational level, This organic growth is outperforming historical rates. We believe we're taking market share. We'll wait to see what competitors say. But we're certainly significantly above the Medicare growth rates. And we don't believe this is simply a COVID bounce. This is ingrained strong growth, particularly in our strength. in the specialist sub-market and hospital referred sub-markets, and we expect that to continue for a long time to come. We're also experiencing strong growth in genetic testing and a particular call-out to the one test that's now received Medicare funding, that's reproductive carrier screening, which is a test for three inherited genetic abnormalities. That test is growing enormously and it's one of those great tests, a bit like ThyroSeq and Oncotype DX which we'll come to. We don't know where that's going to go and I think there will be more and more of these high-end tests which Sonic Healthcare is so well equipped to offer. We've won a new contract at the Ramsey Healthcare Pindarra Private Hospital on the Gold Coast in Queensland. and operations have commenced there. As I mentioned earlier, we're now well into a program to rationalize our collection center infrastructure in Australia. And also, we are lobbying intensively through the Pathology Industry Association for indexation of pathology fees which have basically not gone up in 25 years. No indexation of pathology fees for 25 years, and there is a campaign under foot that some of you might have heard about, and we're hopeful that we get some positive response, possibly even in this year's Australian federal budget, which is in May. Moving on to Germany, again, base business organic growth rate is particularly strong, running at 8%. And like Australia, we have continued strong growth coming from specialists and hospitals. And this includes anatomical pathology, molecular testing, microbiome testing, and genetic testing. These are all high-end tests as opposed to the routine testing that we do as well. I mentioned Oncotype DX. We are the exclusive providers of Oncotype DX in Germany, and the growth is particularly strong in that test as well. The acquisitions that we've made, we are well advanced with the synergies that will come from these acquisitions in the near and medium and long term. participating potentially as a lead player in the consolidation of the anatomical pathology market in Germany and focusing very much on synergies that will come from automation in anatomical pathology and especially digital pathology and AI. This is where the pathology watch acquisition will tie in at some point in the near future. And procurements continue to add value in Germany. We've recently completed a number of deals with some success. Moving on to Switzerland, the base business growth there has been at 4%, which has been impacted by the fee cut which commenced 1 August 2022. So we're pretty pleased with that 4%. At operational level, obviously there's a lot of attention onto the SynLab Swiss acquisition with a huge amount of activity already well underway. We just mentioned here that we have rebranded SynLab Swiss to the name MediSyn, which is a play on MediSupport and SynLab, a mix of the two. And of course, MediSyn, quite a nice name. And really in Switzerland we're now as the number one player with three large essentially federated members, three brands that are being brought together, the three brands being Medisupport, Medica, which is largely Zurich, and now Medicin. And our efforts are now to integrate these and to get the required synergies and improved performance out of the entire operation. Very exciting what's going on in Switzerland. In the UK, on slide 16, our base business organic revenue growth is at a very healthy 13% and it's coming from both the NHS and private markets. I've mentioned that we've been awarded the 10-year contract for the Whittington Health NHS Trust and we're the preferred bidder on Harts and West Essex NHS Trust and the contract execution is now imminent. And there are further NHS contracts under consideration and negotiation at the moment. In Belgium, on slide 17, our base business organic growth is 6%. We suffered a 15% cut to the national fee schedule on 1 January 2024. That was partially offset by an indexation increase of 6%, and we're working to mitigate the effect of that fee cut through a variety of measures, particularly automation and other efficiency gains. Flight 18 is our radiology division which is performing amazingly well. Organic revenue growth is 11% and EBITDA growth of 19% and margin accretion of 160 basis points. Incredible performance from this division. It's coming from outstanding divisions and radiologists and staff all under Sonic's medical leadership culture, but we are investing in greenfield sites, brownfield sites, and really riding the wave of this trend towards higher modalities in radiology. That's MRI and PET CT, essentially. We've commissioned a new PET CT site in Brisbane in the first half, and another three are planned for the second half. There are five new greenfield sites planned for the second half of this year, and we are also using AI applications, principally Harrison AI's Analyse products within our businesses to enhance workflows and clinical outcomes. As you know, Analyse has released an amazing chest X-ray tool with a CT brain tool to follow very shortly. Sonic Clinical Services, that's our primary care division in Australia, revenue growth 12% and organic growth 4%, with EBITDA growth of 9%. The organic revenue growth reflects two main factors. One, an increase in our private billing. That means above the Medicare government rate. And also the targeted fee increases, which commenced on 1 November last year, which have been applied across the board. We're also ramping up all our operations to service the new Australian Defence Force contract, which involves pre-recruitment medicals for the ADN. Going to end the last two slides on digital pathology and AI, and just to set the scene Just a couple of definitions, if you don't mind, because there is some confusion about the terminology. So anatomical pathology is defined as the study of organs and tissues to determine the cause and effect of disease. It is the tissue that's usually cancers that are studied for cause and effect. Anatomical pathology is necessary for 100% of all cancer diagnoses. These are important points because anatomical pathology is an essential part of the whole laboratory industry or pathology space, and Sonic is one of the biggest players in anatomical pathology in the world. So digital pathology, refers to the digitization of anatomical pathology workflow, and this digital pathology and AI are set to transform anatomical pathology and bring about big steps in efficiency, quality, capacity, and workflow. The diagram that you have with you gives a quick explanation of what digital pathology actually is. So on the left we have a sonic pathologist at a microscope with a tray of slides sitting beside her, and that's the system that's been in place for a long, long, long time. Now radiology has already long ago digitized their workflows and their processes, but in pathology it's happening, about to happen, whereby we take that glass slide, that would normally be placed on the stage of a microscope. We digitize that. We scan the slide, that's the scanner below the arrow, and digitize it to provide a whole slide image to be viewed on a screen, which you see on the right-hand side. This is a revolution in anatomical pathology and one that we are keen to be absolutely at the forefront of, and I believe we are. And so going to the last slide of the presentation, just to re-emphasize that Sonic Healthcare is one of the world's largest, if not the largest, anatomical pathology providers. We have annual anatomical pathology revenue in excess of one billion Australian dollars, and we employ well over 1,000 anatomical pathologists around the world. It's probably not surprising that we are keen to become leaders in this space and as a result we are making significant investments in digital pathology and AI to unlock upside potential opportunities and also to drive revenue growth in this space. And the two major investments that we've made in this space are Pathology Watch and Franklin AI. So Pathology Watch as we have announced before, is a unique product. It's an end-to-end digital pathology platform incorporating all the necessary components that are needed to go digital. It's been designed specifically for dermatopathology, skin pathology, but of course it can be used for all the other disciplines or systems in the body where we also do anatomical pathology. So the first port of call is the USA. We have a large dermatopathology operation, as mentioned, in excess of 200 million Australian dollars. And we are in the process of adapting Pathology Watch to digitize our dermatopathology and to use the tools in Pathology Watch to our benefit, both in terms of quality and services, and also financials. So what it'll do, Pathology Watch, is actually accelerate Sonic's transition to digital pathology globally. First in the US, probably second in Australia. And we'll commence with dermatopathology, which is a large proportion of the entire anatomical pathology space. So something just in excess of 50% of all cases That's not slides, but cases of skin pathology in the whole anatomical pathology space. Pathology Watch also has an AI algorithm built in for skin pathology, and it has been working and is well advanced on an AI algorithm for melanoma. So this is a prognostic algorithm for melanoma. So there's blue sky upside on the side, not part of everyday operations. There are significant synergies that we've already identified between Pathology Watch and Harrison AI or Franklin AI. And moving on to that joint venture, that's Sonic with Franklin AI. As you know, Franklin AI is in the process of developing an AI tool for prostate cancer is the first product and there will be many more to follow and we're very excited about this particular product because validation studies will be taking place very shortly and it's fully supported by sonics pathologists globally and we plan to employ the Franklin AI product the initial one and subsequent ones within Sonic and to sell and commercialize these products globally. So I just want to reiterate as we end that this is really the exciting end of where we are at the moment where a big part of what we do is being digitized and it's going to represent a revolution for us and set to bring in huge benefits in this important space of pathology. So thank you very much. And Josh, I'll hand back to you so that we can take questions. Thank you.

Thank you. As a reminder, to ask a question, please press star 1 1 on your telephone and wait for your name to be announced. To withdraw your question, please press star 1 1 again. One moment for questions. Our first question goes from David Stanton with Jefferies. You may proceed.