Earnings Transcript for SHL.AX - Q2 Fiscal Year 2024

Operator: Good day, and thank you for standing by. Welcome to the Sonic Healthcare Financial Half Year Ended 31st December 2023 Conference Call. [Operator Instructions] 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.

Colin Goldschmidt: Thank you very much, Josh, 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 Wilks, Paul Alexander and Dianne Ayers. And it's a pleasure for me to present the half year results of Sonic till December 31, 2023. If you can go please to Slide 3, where we'll start, which is showing our headline numbers. And 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 2 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. And 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 billion over $3.70 billion represents the 15% growth in revenue on the previous slide. The base business revenue growth for the half, and that's H1 '24 versus H1 '23, is 15%. And if you look at the scale over 4 years, you'll see that we've added something like $1 billion in revenue in H1 revenue only. So that's the $3.34 billion to $4.27 billion. And if you extrapolate that to full year of base business revenue -- and I would take you back to FY '19 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 5 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 that tremendous growth that we experienced from COVID testing, and we knew that growth was going to be temporary. And then COVID revenue disappearing and its replacement by strong base business revenue growth, which we know is permanent. And the recent strong base business growth is not just from M&A, but it's combined with strong organic growth. And 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 billion 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 PathologyWatch in January 2024, loss making. And there is a positive factor in this and that's the impact of the delay of the U.S. PAMA fee cut. Our net interest expenses 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 6. 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 labor 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 Suisse in Switzerland and MLD and Diagnosticum in Germany. We've got an additional 3 months of the Diagnosticum acquisition. It settled in October 2023. So we will only have 3 months in the first half, but 6 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 FY '25 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 4 smaller acquisitions. And if you total those up, that's more than AUD 250 million. In Switzerland, the big Synlab Suisse acquisition and Pathologie Enge. That's almost $200 million. In the U.K., we have been -- we've won a new NHS contract, the Whittington Health Trust contract. And there is more to come there. Firstly, the Herts 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 PathologyWatch, which we have down as U.S. revenue and it is U.S. revenue in the first instance. So we are rolling out PathologyWatch in the USA, but of course PathologyWatch 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 Suisse, which is a big business, AUD 175 million, which we bought at low to 0 margin deliberately. So this is a business which will convert, let's say, from 0 earnings or margin to perhaps 20%. And if you calculate that, you're talking roughly $35 million -- and it is growing already in our hands -- $35 million 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 1, 2, maybe a bit more years. Then, the acquisition of PathologyWatch. 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 because the -- and this includes PathologyWatch, Harrison AI and Microba. 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 2 points. The rollout of our enhanced revenue collection system in the U.S. 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, U.K., 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 2.5x. Our debt has obviously increased, the net debt, by just over $1 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 revenues split pie chart. And 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 7% or maybe 8% a year ago. And 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. And 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 we can get to your questions sooner, and just give a few headline points, firstly on the U.S. 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 XiFin. And we've 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 thoracic 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 PathologyWatch, 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 AUD 200 million. And we have a lot of optimism for the benefits that will flow from PathologyWatch in this new dermatopathology division. Australian Pathology, on Slide 13, is growing incredibly strongly at 9%. That's base business organic growth. 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 in -- particularly in our strength in the specialist submarket and hospital referred submarkets. And we expect that to continue for a long time to come. We are 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 3 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 Ramsay Healthcare Pindara 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. We're also 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. And this is where the PathologyWatch 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. The base business -- and 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 on to the Synlab Suisse acquisition, with a huge amount of activity already well underway. We just mention here that we have rebranded Synlab Suisse to the name MEDISYN, which is a play on Medisupport and Synlab, a mix of the 2. And of course, MEDISYN quite a nice name. And really, in Switzerland, we're now as the #1 player with 3 large essentially federated members, 3 brands that are being brought together, the 3 brands being Medisupport; Medica, which is largely Zurich; and now MEDISYN. And our efforts are now to integrate these and to get the required synergies and improve performance out of the entire operation. Very exciting what's going on in Switzerland. In the U.K., 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 Herts 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. Slide 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 3 are planned for the second half. There are 5 new greenfield sites planned for the second half of this year. And we are also using AI applications, principally Harrison AI's Annalise products within our businesses to enhance workflows and clinical outcomes. As you know, Annalise 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 2 main factors

Operator: [Operator Instructions] Our first question comes from David Stanton with Jefferies.

David Stanton: I just want to start with one maybe for Chris and for Paul. First half depreciation was about 343. Should we be expecting that level of depreciation for second half as well? And is there any reason why it should be lower? Or indeed, it probably should be higher going forward.

Chris Wilks: Dave, look, I think it is a good proxy for a run rate for the second half. And going forward, affected, obviously, by the M&A, a bit of ForEx. That could have a bit of an effect depending on what happens between now and the end of the year on ForEx. And I guess, I'm hoping that the growth rate for that going forward into FY '25, because some of that effect in depreciation these days, as you know, from AASB 16 is the flow-through of rents, partial flow-through of rents, which, I guess, in the last year or so we've had the CPI impact. And I think in nearly all of our markets now the inflation rate is kind of 3% or below. So I think the effect of the kind of rental increase on the depreciation number will abate from '25 going forward.

David Stanton: Very good. And my second and final question. Could you talk to the contributions that acquisitions made that you've outlined to first half FY '24 EBITDA? And what should we expect, I guess, in terms of EBITDA contribution from those acquisitions in the second half, please?

Colin Goldschmidt: Paul, do you want to take that? Or Chris?

Chris Wilks: Yes. Look, there's a bit of a mix there, Dave, because you're aware that Synlab Suisse was about breakeven at EBITDA and a bit loss-making further down. And so that's a work in progress. As Colin mentioned, there's a whole lot of activity to bring synergies through. And so we're hoping that probably in the second half, we'll see some bottom line contribution. And there is some contribution, obviously, from the -- there's some -- little acquisitions that have more happened at the end of the year. So there's probably $5-plus million coming from them. And then there's, obviously, the contribution from the bigger German acquisitions, which we haven't actually disclosed specific numbers, but you'll be able to work out from the announcements that we made when we announced those deals.

Colin Goldschmidt: So Dave, in summary, I think if you look at the dates that these acquisitions were made, the vast majority are not in H1. There are some -- so for example, MLD, Medical Laboratories Duesseldorf, there is -- that was July of last year. So that's in. But the rest of them are either not in at all or only partially in. So Diagnosticum, as I mentioned, you've only got 3 months. We're going to get 6 months in the second half. Synlab Suisse basically 0 in H1. And everything else will flow much the same with Enge. And the Whittington, the contract in the U.K. hasn't yet started. So nothing in H1. And PathologyWatch essentially hasn't happened and will start happening now.

Chris Wilks: Yes, we should probably – we mentioned that PathologyWatch, which I think Colin has touched on it, is loss making. So it will have a slight negative effect on the second half. But with a whole bunch of work that’s going on there, including swapping them from their relatively poor contracts to our contracts, just that move itself will go close to bringing that business to breakeven during the course of the second half. And then beyond, there’s the various contributions it will make through efficiency, revenue growth and the like that Colin has alluded to.

Operator: Our next question comes from Gretel Janu with E&P.

Gretel Janu: I just want to start with pathology EBITDA margins. So if we rewind 6 to 12 months ago, you had talked at that time that pathology margins had stabilized. Yet we've continued to see a further step down sequentially in the pathology margin in the first half '24. So what exactly has driven it relative to your prior expectations? Has it just been the higher labor inflation and cost inflation? Have you not been as successful in reducing those higher COVID labor costs? And I guess going forward from here, is this now the bottom? And how should we think about the trajectory of margin improvement going forward?

Chris Wilks: Yes, Gretel. Yes, look, there are a few factors at play, obviously, the main one being the reduction in the relatively higher-margin COVID revenue. There's a little bit with some lower-margin acquisitions, being the -- particularly the Synlab acquisition. And you're right, there's been some inflation pressures on salaries, partially offset by a bunch of initiatives that Colin alluded to. But I think it's fair to say that our view is that this is probably the bottom, and we believe it's the bottom. And if you look at where we're guiding for the second half, you'll see that the margin in that period will be significantly higher than the first half. And the average of the whole year is not too bad. It's probably a couple of 100 basis points below where we were pre-COVID. But with all of the M&A and the synergies that come from that and the leverage effect of the strong revenue growth, I think we're pretty confident we can claw most of that back over the next year or 2.

Gretel Janu: And just in terms of the stronger second half margin, so what is really driving that? Is it just the stronger top line? Or have you seen anything else flow through on the cost line?

Colin Goldschmidt: It's a mix of the points that Chris makes. I mean the big one is the very strong top line growth, especially organic revenue growth. But if you add to that further reductions in our cost structures -- so whilst there is inflationary pressure on salaries, we are moving to rightsize the company and reduce headcount. And that will continue. Plus there's now a moderation of those inflationary pressures, particularly on salaries. As Chris mentioned, I think interest rates appear to have stabilized, and therefore, there will be less pressure on salaries going forward. And this was quite an exceptional period or year in that respect.

Chris Wilks: There's also, yes, the synergies from the M&As, some procurement things. I think Slide 6 gives you a bit of a list of some of the things that will be different in the second half versus the first half.

Paul Alexander : And Gretel, just on the wages expense. We do reference in the 4D that if you exclude M&A and FX rates, the labor expense has gone up 3.8%, which is obviously a combination of less FTEs, but an increase in rate in that period.

Gretel Janu: That's very comprehensive. And then just in terms of the rationalization of collection centers in Australia, how much are you looking to rationalize? And why now? Is it just because you want to have a stronger presence in the specialty market and wanting to reduce further your exposure to GPs?

Colin Goldschmidt: Yes. So Gretel, we have enormous exposure to general practice, even though we do call out our special strength in specialists and hospitals. It’s a story about what’s happened over the last 5 to 10 years, where collection centers have proliferated enormously, including into most medical centers. And there was, I guess, a rationale that, that was potentially a way to drive revenue. But over time, things have changed. Costs have gone up for all players. And many of these co-located collection centers, that means a collection center in a GP practice or a surgery, are perhaps getting to the point of being marginal. So if you can set up stand-alone collection centers close by – it’s probably at this point in time becoming a better proposition to think about rationalizing the great excess of collection centers that we have. And so I think we’re very much at that point and doing it obviously very carefully. But I think it’s going to yield benefits to Sonic. And so this is not something we’re doing to lose top line and bottom line, whereby the net result is negative. That’s not going to happen. So we’ve been very, very careful about this. And we do hold strong positions in all our markets with referring doctors, and we think that, that will come to our advantage.

Operator: Our next question comes from Lyanne Harrison with Bank of America.

Lyanne Harrison: If I could start with the U.S. revenue enhancement project. Obviously, you made some comment today about that progressing. But previously, you talked about the upside being in the vicinity of about USD 1 billion in 2025 financial year. Can you comment on that? Does that number still hold up? And if that's a revenue benefit, can we expect most of that to fall through to the bottom line?

Colin Goldschmidt: I'll give it to Paul.

Paul Alexander : Yes. So look, our expectations from the XiFin system haven't changed. So we still have the same expectation. The USD 1 billion was the amount of our U.S. revenue that XiFin is being applied to. So that's largely our clinical laboratory operations in the U.S. Our anatomic pathology operations in the U.S. are using a different system that we may change at some point, but it's not in the short term. Whereas, our clinical labs is a short-term project. So what was said 6 months ago was that we expect to achieve something in the order of 5%, maybe a little better than that on that $1 billion once we've fully rolled out the system.

Colin Goldschmidt: And that will be top and bottom line.

Lyanne Harrison: Okay. And then if you could talk about that first anatomical pathology project that's in conjunction with Franklin AI. In terms of the validation study, you mentioned that, that will be completed to 2024 and launched in that time period. Is that expected this half or you're referring to calendar year then?

Colin Goldschmidt: I'm referring -- I don't want to be too specific about this, but it's going to be commencing very shortly. So it might be straddling both. But we're definitely starting in H2 in the financial year. Whether it goes through into the latter part of the calendar year, I can't say at this point. And -- but we are hopeful that this will be achieved very soon and in a short period of time because all the indications are very positive about this product. And so we'll obviously keep the market informed. And I'm sure Harrison AI, which is Franklin's parent, will also keep the market informed about this product as it goes through its final validation steps.

Lyanne Harrison: Okay. And if we think about the launch timing across different geographical regions, is it likely to be simultaneously or sequentially?

Colin Goldschmidt: I cannot answer that question at the moment. I mean we’ll probably start with Sonic labs and then move beyond that to commercialize the product globally. And of course, we’ll – none of this has been announced to the market yet, so best that I not say anything further.

Operator: Our next question comes from Saul Hadassin with Barrenjoey Capital.

Saul Hadassin: Just a quick question. You've mentioned sort of the second half weighting for EBITDA. I'm just wondering if you can also give us a sense of the weighting for the revenues as well.

Paul Alexander : Well, we haven't specifically -- sorry, we haven't put that in writing, so we can't be too specific about it. But there is a normal seasonal weighting of revenue to the second half. It's not as acute as the weighting at EBITDA. But there is -- there certainly is a weighting there. I think if you could -- if you go back in our history, you can probably work it out for yourself in general. And obviously, this time it's accentuated because of the timing of acquisitions this year.

Saul Hadassin: Yes. So Paul, on that basis, if I use sort of a slightly heavier weighting for second half versus seasonality -- I guess the implication is that the EBITDA margin that Sonic needs to deliver to get to the full year guidance at the bottom end is about a 200 basis point implied EBITDA margin step-up from 1H '24. And I know Chris talked to the margin enhancing measures that are in place, but do you think that's a realistic outcome just based on the revenue seasonality and the cost out that's taking place?

Paul Alexander : Yes, that's absolutely our expectation and hence why we've reconfirmed guidance. So I'm not commenting on the specific number you've put out there, but as Chris mentioned before, we certainly are expecting a margin uplift in H2.

Saul Hadassin: Yes. And then just finally, looking at the -- if I take the bottom end of your EBITDA guidance again and an estimate of the revenues, I think it translates to a group margin, EBITDA margin of roughly 18%. If I go back to first half '20 pre-COVID, the group did 21%. What's the expectation in terms of the ability to close that gap back up to that pre-COVID margin?

Chris Wilks: Yes. Look -- so I think I touched on that in an answer to an earlier question. So I think with the position as it looks for the full financial year '24, we're probably a couple of 100 basis points behind where we were in pre-COVID. And bear in mind, you've got to adjust for AASB 16 effects and all that sort of stuff. But I guess we're pretty confident that into '25 and '26, barring anything unexpected, that with -- if we maintain growth rates of 5%, 6%, which is great for us, the marginal profit that can come from that sort of organic growth combined with the synergies coming from the M&A and the cost-out regime and I should say the reduced pressure that I expect we'll get on labor, because most of our markets -- probably Australia is the highest, still at sort of 4-odd percent for CPI. But all the rest are coming down and still reducing. I think the pressure on labor costs going forward will abate as well. So all of those factors together is quite positive for our business for margin.

Paul Alexander : I mean if you think about just the Synlab Suisse acquisition, in this half, it's something like a 50 basis point dilution to margin. And as Colin touched on in his presentation, we are expecting a very significant increase in profitability in that business over the next couple of years. So as one anecdote, that's where some of that uplift will come from.

Saul Hadassin: Yes. No, that makes sense. I’m reflecting back on a year ago, and I think commentary was base business margins were effectively back to pre-COVID levels. It seems like it’s going to take a longer period of time, albeit with some dilutive acquisitions, sure. But it does feel like the OpEx growth has been a bit more excessive than maybe what was expected. But that’s fine.

Operator: Our next question comes from Laura Sutcliffe with UBS.

Laura Sutcliffe: First question is just around some of the increasing lease costs that you mentioned. Could you just give us a bit more color on where those are rooted? For example, is there anything geographic that you've noticed? Is it that you are leasing things that previously you might otherwise have bought? Or is it a rate consideration?

Chris Wilks: Yes, Laura, it's probably more that when I was referring to rents, I was talking about our property rentals effectively, which tend to have clauses of something like 2.5%, 3% or CPI, whichever is the higher. And so with CPI, quite high particularly here and in other parts of the world that was flowing through in the rent cost, which then appears in depreciation and interest. With inflation abating, then we'll see a reduction of that impact going forward. Does that make sense?

Laura Sutcliffe: Yes. And then second question is just back on the anatomical pathology piece. You mentioned you have about $1 billion of revenue that sits in that bucket. Do you have a good sense of how that positions you versus large competitors internationally in terms of size?

Colin Goldschmidt: Unfortunately, we don’t, Laura. I think we can say confidently that we’re the #1 player in Australia and we’re probably the #1 player in Switzerland. The anatomical pathology market share in the States is very hard to determine. As you know, we bought an entire anatomical pathology company, that was the Aurora Practices, which boosted our anatomical pathology in the States dramatically. But I don’t think our big competitors actually separate out their anatomical pathology revenue. So it’s very hard to say. I guess we could just say it’s a major part of our business and always has been because it goes so closely with the medical leadership culture within Sonic.

Operator: Our next question comes from Andrew Goodsall with MST Marquee.

Andrew Goodsall : Just sticking with the margin questions for a little while, particularly those U.K. contracts, just wondering sort of the cadence of the margin opportunity there. Does it start pretty low before it actually increases? And maybe just quickly while I'm there just -- obviously, we know you have the Whittington won, but just wanted to confirm with the Herts and West Essex that the complaint on the process there has been resolved, and therefore, you've got a green light there.

Colin Goldschmidt: So Andrew, the answer to the last question is, yes, it has been resolved. And that's why we're able to say that execution is imminent -- execution of the contract is imminent. I think, in general, your statement is correct that when we take over these contracts, we take them over at a margin and then work to improve them, given that we have a large modern comprehensive lab in Central London to assist in achieving synergies. That's generally what has happened with our other contracts. In the Herts and West Essex contract, there's going to be enormous potential to drive synergies and margin accretion, but it might take a little longer in that particular case. And -- but nevertheless, we will take on the contract with profit. And we're optimistic about where that's going to go because it's a big one.

Andrew Goodsall : And is that likely to be more an FY '25 event for you in terms of getting started? Or could it begin earlier?

Colin Goldschmidt: Yes. I can't say at the moment, and we obviously can't say too much more about the whole thing until it's actually announced formally. I think it will be -- the contract will be done in the second half, but probably don't put anything in FY '24. That's probably the sensible way to go. It will be FY '25 and beyond.

Andrew Goodsall : And just coming back -- you did touch on the efforts to get indexation. And I know that Pathology Australia has made a submission to treasury for the budget. Is that the sort of process you're working through now? And if you had any sort of early feedback about how the department will brief on this?

Colin Goldschmidt: Yes. This is being run by the industry association. Obviously, we’re members of it. But I don’t think there’s any recent feedback. I think there’s – the approaches from the industry association to government were warmly received, and I think our position is understood. And so I guess that’s about all we can say. I don’t want to mislead anyone about what the outcome is because we don’t know.

Operator: Our next question comes from Steve Wheen with Jarden.

Steve Wheen : Just a question on the Australian pathology business and your exposure to the GP referral channel. I'm just wondering how -- what that looks like at the moment. Clearly, the specialist segment is working well for you. But just trying to understand with the shortages of GPs and the reduction in, I guess, face time visits, I'm just wondering what your performance has been like out of that referral channel.

Colin Goldschmidt: Yes. So Steve, I think your point is well taken that there is a reduction in consultations in general practice. But we're -- we've always been very strong in both -- in the 3 submarkets, so GP, specialist, hospital. And the GP market is a very important one to us, but there's no doubt that it's not as strong as the specialist market at the moment. We're also very involved with referrals coming from online GPs as well, which has taken over a proportion of the face-to-face GP market. But we're well advanced with taking on referrals in that subsegment, and it's a new one. Because -- that is part of the reason why the consultation rates are lower because a significant proportion of patients are accessing GPs online. So we're not at all concerned about our position in that market. And I think I can say that confidently because of our great strength in the specialist and hospital markets as well.

Steve Wheen : Great. And just one for Chris just on the tax rate. Just trying to understand why that's now going to sort of end up at the top end versus your original expectations?

Colin Goldschmidt: Yes. Maybe Paul can answer that one.

Paul Alexander : Yes. So if I cast you back to the second half of FY '23, we had an unusually low tax rate at that time, and we explained that, that was because of the potential tax deductions associated with employee options and where our share price stood at 30 June last year. Share price, unfortunately, at December this year was lower than that. And as a result, some of the benefits that we saw in the second half of FY '23 has effectively reversed in FY '24. So depending on what happens to the share price from here, that might move the rate around for the rest of the year. But based on current share or released -- yesterday's share price, let's say, we expect it to come out around that 27%.

Steve Wheen : Great. That's understood. And then finally -- you've already talked to this just on the collection system. You mentioned -- I did have some expectation that, that might contribute in the second half, but it sounds like that's more like an FY '25 story now. And I'm just wondering with the pilots that you've done, what the sort of improvement in the doubtful debt experience has been. If you can give any sort of anecdotal or landmarks from those pilots, that would be helpful.

Paul Alexander : So there is some impact in H2. Nothing has changed in terms of our timing, just to be clear. So if you look at Colin's slide, you'll see that one of the reasons H2 earnings will be accentuated is because of the revenue system in the U.S. But what we're saying is and what we've said all along is that the major impact will be in '25 and onwards as we roll it out to the bigger entities in our clinical lab business in the U.S.

Steve Wheen : Okay. Got it. And then the performance, just how it's -- how the pilots are tracking? What sort of experience you've seen in terms of the improvement on the doubtful debt provision?

Paul Alexander : So it's in line with our expectation, which I think, again, we touch on in the presentation. So it's going well. It's at around that 5%, potentially better. But it's -- we're still talking about -- the evidence we have so far is still with smaller entities in our group. Some of the larger entities that have more recently gone on it, it's too early yet to make that assessment. But we have every expectation that it will still be around that sort of level.

Operator: Our next question comes from Mathieu Chevrier with Citi.

Mathieu Chevrier: I just had one on the fee cut revisions, the cut in Belgium. It's a small market for you, but a bit of a surprise. I was just wondering if there are other markets where your fees may be under review. Because back just in November, you had mentioned the expected fee indexation, but there was no mention of a potential fee cut.

Colin Goldschmidt: Yes. So back then, it was not at all clear that there would be a fee cut. So obviously, if we knew about it, we would have said that it was a certainty. So in the rest of our markets, there's no indicator of any other fee cut coming in. And as you know, there was one in Switzerland 1.5 years ago. And other than that, there's nothing on the horizon, nothing in Australia. In fact, we're asking for the opposite here. And we're getting indexation in a number of markets, which is really good news. The strange thing in Belgium is the indexation plus a fee cut, where you get a net -- which was a net negative obviously. It's 15% against 6% indexation. That's probably it.

Paul Alexander : There is still obviously the potential for the PAMA fee cuts that were deferred...

Colin Goldschmidt: Oh, the U.S. one, yes.

Paul Alexander : From this year, but in theory, will happen next January. But obviously, industry continues to lobby in that regard and continues to push for the SALSA legislation, draft legislation that would mean that cut wouldn't happen. But...

Colin Goldschmidt: How many years has it been delayed?

Paul Alexander : I think it's 4 now, isn't it?

Colin Goldschmidt: 4 years in a row that PAMA fee cut has been shelved temporarily. So we're hoping that, that continues.

Mathieu Chevrier: Yes. Understood. And then just on Radiology. I saw your margins expanded quite healthily again, and you have those new greenfield sites opening in the second half. I was just wondering where should we think margin will be going from here sequentially and into next year.

Chris Wilks: When you look at -- you sometimes get a bit of a negative effect on margin -- not on profit, but on margin from greenfields because it takes a little while for them to build up. So there's probably some effect of that, that might flow through. But ultimately, we're pretty selective about where we put our greenfield. So you'd have to think that reasonably quickly we'll get into a healthy margin situation. And there's some brownfields kind of things as well. We're adding in some PETs. And that's quite margin accretive, obviously, in existing centers.

Mathieu Chevrier: Yes. Got it. And just one final one on labor costs. You have mentioned that your labor cost control is almost unique. I was just wondering if you could elaborate on that. And whether you think your labor costs in the U.S. could be somewhere around the 3% to 4% mark, like your competitors are forecasting for calendar year '24?

Colin Goldschmidt: So I think that’s probably more or less in line with where we are in the States. When I said unique, I was really referring to the job that was ahead of us post-pandemic. And so we had to climb a mountain to deliver that service, and that required a lot of additional people to provide that service, different in different markets. So for example, in Australia, we ran so many drive-through centers. And we did millions and millions of COVID tests right around the world, which requires people not just at that department testing level, but also at courier level, at front-end level, where you’re accessioning the cases. So once the pandemic was over, the big job was to downsize the company or rightsize the company. And of course – so that was unique. It’s never really happened to this extent, obviously, because we’ve never had a pandemic with that kind of volume increase ever before. The interesting thing about this, and I was hoping to get that across in the presentation, is that, as the pandemic dissipated, so – we’re experiencing probably stronger growth than we’ve experienced potentially ever before. And so with that growth – you also have to handle that growth with equipment and manpower, person power. So we’ve sort of – it’s a balancing act of making sure that we are rightsizing the company to the most efficient level to deliver the margin accretion that we’re talking about. And we’re confident that we’re going to do that because we have a very clearly laid out plan in the next 6, 12, 18 months to achieve that.

Operator: Our next question comes from Sean Laaman with Morgan Stanley.

Sean Laaman: In the Radiology division, you've seen some really good margin improvement there, which is a disparate performance for Trip. I'm wondering sort of what are some of the key elements of the point of difference that you might be observing.

Colin Goldschmidt: So our managers would say brilliant management, which they are. But we do have an outstanding Radiology division. And when I say that, I'm talking about the leaders and all our radiologists and all our staff. Radiology often depends on the expertise and efficiency of radiologists and their enthusiasm for the job. It's a little different in pathology, but radiology is very radiologist centered. So that's the first point in this. When you have that in place, an outstanding team of people in a division like this, and you have a professional or an industrial change that's occurring, and that's the shift towards the higher-end modalities which are higher paying and higher profit generating, then you will get margin accretion. And then thirdly, if you add to that, astute greenfields and brownfields additions to the existing infrastructure. And all 3 of those are actually applying. So it is an opportunity to say a big congratulations to the leaders of our division and all the radiologists and staff because the performance is outstanding. And we certainly expect it to continue. I think I -- I always add on top of this is that Sonic's medical leadership culture provides the right environment for this to occur, where doctors, our radiologists trust the system and are happy to work in the system and feel fulfilled. This is very, very important to answer your question.

Sean Laaman: Sure. And on the AI piece, so the adoption of Annalise AI and the [indiscernible] program you're on, what might you be able to tell us, whether it be quantitative or qualitative, of the impact of that adoption on the Radiology division? And what learnings might there be for when you get the Franklin AI product out on the anatomical pathology side?

Colin Goldschmidt: Yes. So that’s a difficult question. I don’t want to say too much about whether there’s – I don’t want to preempt Harrison and what they might say. But in terms of Sonic, I think it’s important just to realize that the chest x-ray product has upside potential, but it’s not material because the chest X-ray is a fairly quick examination. So the opportunity for increased or enhanced performance is fairly small. But when you go on to CT brain, which is a more complex examination that requires more expertise and more time, the upside potential for efficiency is much greater. So we’re certainly expecting benefits to come rather than being already accrued as the brain CT product is rolled out. On the question of the Franklin product, that’s a very different story, because the Franklin product – the prostate product is applicable to the diagnosis of prostate cancer, which is no easy task for an anatomical pathologist specialized in that field. The reports are required to be detailed and fairly lengthy. And often, there’s a lot of material that needs to be examined. So in terms of efficiency gains in that particular tool, I think there’s quite a lot of upside to come just in Sonic labs. So we’ve kind of flagged that the Franklin products will be applied to Sonic’s operations but also to be commercialized globally. So if you offer this product to a lab anywhere in the world and can demonstrate, which we hope we can do via Sonic’s trials, that there is efficiency gains, where pathologists are comfortable with the product and see that it’s actually a great tool to assist them with the diagnosis, then I think there is a huge upside that will come to the Franklin joint venture. So we’re around 50% of that. And of course, within Sonic, we do a lot of prostate cancer work right around the world. There will be upside for us in terms of pathologist efficiency as well.

Operator: Our next question comes from Craig Wong-Pan with Royal Bank of Canada.

Craig Wong-Pan: My question, just wanted to ask about the cash flows. I noticed that the accounts payable did drop quite significantly from the last period to now. I just wanted to understand what has driven that?

Colin Goldschmidt: I'll give it to you, Paul.

Paul Alexander : Yes. So look, we touch on that in the 4D, Craig. Just really timing of the credit to payment.

Craig Wong-Pan: Okay. So should we expect that to kind of revert back sort of after December?

Paul Alexander : I think -- so some of that buildup was, I think, really related -- in some ways pandemic related. So I don't think it will build up to that same degree again.

Craig Wong-Pan: And then just my last question on how we should be thinking about CapEx for FY '24, given you've got a number of brownfield and greenfield investments. Could you provide any thoughts around how we should think about the full year CapEx number?

Chris Wilks: Yes. Craig, it's Chris here. Look, there are a few things at play that have probably affected the first half more than the second half. We've got -- we're building a fairly significant extension to our Sullivan Nicolaides lab in Queensland, which is a $75 million spend. It's almost finished. There's a lab we've built in Munich, a lab we've fitted out in Hamburg. And as you've identified, we've mentioned we've got a bunch of greenfields and they're all sort of circa $5-plus million each. So I think the second half is probably going to be a bit lighter than the first half because of the runoff of those 2 bigger projects. That's probably what I can really say right now.

Operator: [Operator Instructions] Our next question comes from David Bailey with Macquarie.

David Bailey: In the interest of time, I'll be fast. Just in terms of the guidance, you've called out some currency exchange headwinds versus August. Just wondering if you could help quantify those as you're seeing at the moment. And sort of what are you assuming for the rest of the year? When you say extreme current exchange rates, is that as of now? Or is that assuming rates back in August '23?

Paul Alexander : So it's assuming rates effectively as of now or the last few days. And in terms of the headwind versus August, it's kind of in the order of, call it, $10 million, something like that, a bit below maybe. $10 million at EBITDA line that is.

Operator: Thank you. And that concludes the conference call. Thank you for your participation. You may now disconnect.

Colin Goldschmidt: Thank you very much, Josh, and everyone.