Thank you for standing by, and welcome to the Healius Limited FY23 results. All participants are in a listen-only mode. There will be a presentation, followed by a question and answer session. If you wish to ask a question, you will need to press the star key, followed by the number one on your telephone keypad. I would now like to hand the conference over to Ms. Janet Payne, Group Executive, Corporate Affairs. Please go ahead.
Hello, and welcome, everybody, to the Healius FY 23 results presentation. I will hand you straight over to Maxine Jaquet, our CEO and Managing Director, to kick off the presentation.
Thank you, everyone, for joining us today. Before we get into the presentation, there are three messages I wanted to convey to set the scene. First, it's been a big year for Healius, and it's been one characterized by reset, specifically resetting our leadership team, resetting our culture, and resetting our cost base to position for growth. Secondly, we have a plan for our earnings growth, and we are executing it with focus, and it's already delivering value. And finally, we are optimistic about the year ahead, both in terms of market fundamentals and our positioning to realize market growth.
I will kick us off with an overview of the results this year. That includes what we've achieved in the last 12 months, as well as our priorities for the next year. We also have Jan van Rooyen, our new head of pathology, and Dr Phil Lucas, head of imaging, who will both speak to their respective areas. And our Group CFO, Paul Anderson, will then take you through the financials in more detail. After that, we've left some time for Q&A, as we usually do. The underlying EBIT for FY23 is AUD 99 million, which is in line with guidance.
This reflects group revenue growth of 6% for the year at AUD 1.6 billion, and the drop-off of COVID PCR testing in pathology. The cost reset and performance improvement we described at the first half results have come through in the year-end result. H1 to H2 saw a 240 BPS margin improvement. A leading driver of this is labor productivity. We are focused on the operating leverage of the diagnostics businesses to increase both pathology and imaging labor productivity by 8% and 9% respectively. Cash conversion was strong, and gearing is within covenant.
Reported earnings includes an impairment charge in the pathology division, which Paul will explain shortly. We also have made some material steps in our sustainability plan, such as continuing to reduce our Scope 1 and 2 emissions and developing our green energy contracts, which will be cost neutral. The theme of reset is clear in these numbers as we come out of an extraordinary period of COVID. And now, looking ahead, there are four main goals for the Group. First, we need to participate in the market recovery, and then some.
It is our goal to better leverage our well-established brands and clinical capabilities to grow above market in targeted customer segments. Secondly, the leadership and operating culture is changing for the better. There's a new level of expectation for leaders and managers and the front line. We are more competitive, customer-oriented, and data-driven. This will always be underpinned by the highest quality clinical standards and governance. Thirdly, performance will also be dependent on maximizing the value of our fixed cost networks.
We will continue to challenge ourselves to evolve our operating processes, to reduce our cost base and improve our revenue mix. And finally, our capital management strategy will continue to favor organic growth, with a careful management of the balance sheet to improve ROIC. In looking to Healius' performance, it's worth putting this in the context of the overall market. I think by now it's been well canvassed that pathology revenue has grown below the historical averages of 4%-5%, and this has largely been driven by the slower recovery of GP services post-COVID.
We continue to be confident in the structural growth drivers of pathology and the clinical needs of the Australian population. Regardless of this temporary point in the cycle, pathology will continue to be a critical input to the diagnosis and management of most diseases. Early screening and diagnosis is also fundamental to reducing downstream healthcare costs. This is what gives us confidence that there will be reversion to the long-term average without trying to speculate on the exact timing or rate of growth. You can see from this page that specialist attendance has recovered faster and did not fall as much as GP attendances.
The pathology market is dependent on both these types of referrals, and it is clear that the market growth is being driven by specialists in the near term. Also worth mentioning is that specialist pathology referrals are more valuable than GP referrals. That is, they attract a higher average fee for pathology services. Now looking at the diagnostic imaging market. This market looks to be reverting to the long-term trend of 6%-7% growth, and pleasingly, Lumus Imaging outperformed the market over the last year. This market is being driven by modality mix.
The three blue tone segments at the top of the bars are MRI, nuclear medicine, which includes PET and CT, are driving significant growth in the overall market. As you'll hear shortly from Phil, our strategy is to grow these high-end modalities via existing community site footprint. Before that, I wanted to briefly update you on our digital program and how it is underpinning our growth objectives. There's a lot here because we wanted to be as specific as possible on what we're doing, how it creates value in the core business, and what stage of build and rollout each module is up to.
I won't go through everything now, but happy to answer questions on this in the Q&A. Let me, for now, give you some highlights. Everything we're doing in digital is an investment in growth and earnings for pathology and imaging. For example, the new collections portal helps us to better serve patients in the ACC, including how we register patients, protocol tests, collect specimens, and handle payments. Another way we're providing better products and services to clinicians is through our new results portal. This will now provide clinicians with a great experience for viewing patient history, getting more clinical insights, requesting further tests, and collaborating with other doctors.
We're also doing a lot to improve core processes to extract more value from the fixed cost base. For the LIS upgrade, out of the legacy Ultra system, 2 out of 5 modules have been completed. Finally, we're using digital products to run the company in a more transparent and efficient way. We have platformed 14 years of diagnostic data already, which we will be starting to use to drive better clinical insights. This data platform will also be fundamental in data-driven AI. Looking at the next wave of technology opportunities, it would be useful to address what we're doing in AI and digital pathology.
There are clear clinical and productivity benefits from AI for diagnostics businesses, and we've already deployed some of these, such as the Qure.ai partnership for tuberculosis screening, which underpins one of our important government contracts. We're currently working on more use cases, particularly around cancer detection, across both pathology and imaging. Given the unprecedented growth in AI solutions worldwide, our strategy is to work with an aggregator to draw on an evolving and ever-changing suite of AI vendors, rather than building in-house or partnering with few vendors whose technology may not emerge as the market leader.
Digital pathology is also a promising development in targeted tissue types, and when added with AI tools, has the potential to drive real benefits around speed of processing and greater clinical insight. We have the scanning infrastructure already deployed, and we are working on validation studies for three areas of human histopathology. I would now like to introduce two of our key executive appointments this last year, Dr. Jan van Rooyen, who leads Healius Pathology, and Dr. Phil Lucas, who leads Lumus Imaging. Both of these healthcare leaders bring decades of clinical and commercial experience. I'll hand over to Jan to introduce himself and the priorities for pathology. Thanks, Jan.
Thank you, Max. Good morning, all. This is a wonderful opportunity, and I'm really thrilled to be here. Over the last couple of months, I've had the chance to look at Healius and the pathology market in Australia, and I see nothing that I've not seen before. When I think about pathology, it's a science business, a logistics business, a data insights business, and a customer service business. We're going to enhance our operations across all four parts. Each part is capable of optimization. To begin with, I'm laser-focused to make us the easiest possible partner to deal with.
Over the medium term, I see promising opportunities to improve our clinical mix towards higher growth areas like genomics, oncology, and other chronic diseases. What's more, we are at the cusp of an exciting time for service delivery. We now have new enablers for value, being digital and AI. We are positioned at Healius to exploit these. We will do this through our digital agenda, which Max shared with you, and the standardization of our state laboratories. All in all, it is a great time for me to be here at Healius. The cost base has been reset, and there are a lot of growth opportunities.
Thank you. I'll hand over to Phil now.
Thanks, Jan. I joined Healius in January 2023, and it's been exciting to lead Lumus Imaging, a business of national scale that is regarded highly for its clinical quality. Over the last eight months, I've had the opportunity to spend time with our 2,000 clinical and administration staff to see that in action every day. Together, we have developed our five year strategic plan, and building on our current above-market growth, we will be carrying on implementing this strategy. In this plan, we are aiming for new sites, larger margins, and greater efficiencies, resulting in a larger and more profitable business.
I'll share some of these initiatives with you today. Firstly, we are expanding our community site footprint and increasing the revenue per site to a target average of greater than AUD 5 million. We have continued our shift to high-end modalities, adding strategically placed additional MRI units and increasing the number of PET scanners across our network. We are in for a busy year with a strong pipeline of new community and hospital sites in the coming 12 months, including a new site to open in February 2024 at the Ramsay Northern Private Hospital in Melbourne, and seven other sites across the country, including two new PET installations.
We are also partnering with leading cardiologists to expand our cardiac imaging offering in the eastern states. We have increased our private billing with out-of-pockets for targeted modalities, including MRI and ultrasound. This has been generally well accepted, and the relatively small volume drop-off has been easily offset by the increased average fees. The engagement with our radiologists has been pleasing, and I have a good understanding of the career aspirations for both our older and our younger generation radiologists.
We have had 21 new radiologists join Lumus on our new employment contracts over the last 12 months, which is an amazing result, with a good pipeline of new recruits over the next year. This is a credit to our fellowship education program and the changing culture at Lumus. Finally, the technology rollout in Lumus to improve our productivity and quality continues. We will expand the use of our AI in our business in the most cost-effective way, especially in screening programs and in studies that require long dwell times by radiologists to assess disease burden.
This year will also see us exploit the Healius digital program and commence online bookings, delivering an enhanced results portal for image viewing, and introduce new radiologist workflow management systems. Thank you, and I'll now hand over to Paul.
Thanks, Phil, and good morning, everyone. So first up, our group results. As Maxine set out earlier, core revenues for the period were up 6.3% on FY 2022. Pathology was up 3.6%, and imaging, at a gross level, was up 7.3% and ahead of the market. Agilex, which we bought halfway through last year, accounts for AUD 21 million of additional revenues. The comparisons are, of course, impacted by an 89% drop in COVID revenues. Our underlying costs, including D&A, finished at AUD 1.6 billion in FY 23, which has delivered on the cost reset program, as set out in the first half 2023 results presentation.
There were non-underlying items of AUD 45.1 million. We have been consistent in our treatment of these when compared to H1. The increase in H2 was due to an increase in activity in the digital spend as this program accelerates, restructuring and termination costs as we completed our cost reset program, and defense costs related to the hostile ACL takeover bid of AUD 5.4 million. There are also impairment charges in both divisions. Lumus Imaging, as we reported in the first half, relates to the imaging leases in our old medical centers.
We have also booked a non-cash impairment charge of AUD 349.8 million to goodwill in the pathology cash-generating unit. This impairment relates primarily to Agilex, lower forecast cash flows post-COVID, and an increase in the weighted average cost of capital to 8.5%. Rounding off the statutory results, there was a AUD 12.2 million profit in discontinued operations, which incorporates both in-year trading and the profit on sale of the day hospitals division. Now, if we turn to the next slide, we've set out both halves in FY 23, and what this demonstrates is the improvements that we've made in the second half of 2023 following the costs reset program being finalized.
As you can see, we have delivered 240 basis points of improved margins from this reset, despite a 70% drop in COVID revenues. We've removed the majority of COVID direct costs, and we've reduced our labor costs, especially pathology, laboratory, labor costs, and group-wide support costs. With the cost reset complete, our ongoing efficiencies will continue, but as part of our business as usual. The next step change in our cost base will come from automation and digitization over time. Now, this next slide expands on the cost reset slide that we've shown at the first half 2023 results presentation and shows these cost buckets as a percentage of revenue.
The box at the top of the slide sets out total costs for the half. As you can see, all ratios have improved on H1, apart from a minor increase in network costs, which we expected, and are due to selective pathology ACC expansions and some inflationary costs. Our labor ratio is a key call-out, reducing to 50.2% in the second half. Encouragingly, pathology labor for the half was circa 45%. Now for the pathology results. Core revenues were up 3.6%. As Maxine has said, referrer mix has impacted these results. Soft growth on PCP was due to constrained GP attendances, and growth here will return when the GP supply and access issues are sorted.
Clearly, the pathology results have been impacted by an 89% drop in COVID revenues.... Importantly, though, second half 2023 margins grew 260 basis points to 7.5% due to the success of resetting of both COVID and BAU costs. As a result, domestic FTEs are 11% lower than PCP after an efficiency program that was led by our pathology team. BAU labor costs were flat despite EBA and other inflationary increases. Overall, the pathology results show we are well-placed for volume growth, with our cost base now reset.
A significant amount of effort has been made over the past year to rebase the Agilex business. The main takeaway from this slide is the Q4 run rate of AUD 9 million in revenue, which is growing, and augurs well for FY 24 financial year. The operational issues we had from the ownership transition, along with scaling up the business through appropriate staffing levels and a business development pipeline, have now been fixed. We've invested in people and laboratories, a second laboratory in Adelaide, and a toxicology facility in Brisbane.
Agilex is also in advanced negotiations for a commercial relationships to provide, to provide a global bioanalytical offering for all three phases of drug asset development, leveraging the Australian advantage for preclinical and Phase I work. We remain confident in the market fundamentals of this business, the strategic rationale for the acquisition, and Agilex's expertise and competitive position. As Maxine said, we have been, we are benefiting from a very good referrer mix in Lumus. Our gross revenue grew above market at 77.3% on PCP, and the community and hospital channels combined grew gross revenue by 9%.
The EBIT nearly doubled due to the benefits of the cost reset program and digital initiatives, as well as the leverage impact of higher volumes on a fixed cost base. As Maxine has already told you, compared to pre-COVID, we have improved efficiency, measured in exams per FTE and revenue per FTE. As Phil has mentioned, Lumus has now recruited a number of radiologists in the period, supported by the new employment model. We remain focused on increasing our revenue per clinic through upgrades and expansion to large-scale comprehensive sites, and developing a greenfield and brownfield pipeline.
With this focus, coupled with further capacity in the hospital channel, above market growth is again expected in FY 24. Looking at the key points in our cash flows and capital spend, gross operating cash flow conversion was 108% of underlying EBITDA. Maintenance CapEx remained at our historic and sustainable level of approximately AUD 40 million. We had selective investments undertaken in growth initiatives, including digital customer and referrer portals, and as part of our LIS upgrades, the extension to our ACC network, a new toxicology laboratory, instruments and instrumentation upgrades in Agilex, along with upgrades to imaging facilities and modalities.
We believe that we are in line with global peers in our CapEx spend, who are sitting at a spend of around 3%-4.5% of revenue for a sustainable long-term model. We also received AUD 127 million from our day hospitals sale. To give you some guidance on our expectations for FY 24, maintenance CapEx in the next twelve months is expected to be in the region of AUD 40-50 million, and growth CapEx, whilst we're not giving guidance on the absolute number, will be oriented towards organic growth and with a disciplined focus on returns on this incremental capital.
We're looking at a range of technology spend, ACCs and imaging sites, both brownfield modality expansions and greenfield sites. As we set out earlier in the presentation, we have made a non-cash impairment charge of AUD 348 million, AUD 349.8 million dollars to goodwill. Healius carries significant goodwill on its balance sheet regarding historic acquisitions, primarily relating to Symbion. The impairment charge is non-cash and relates primarily to Agilex, lower forecast cash flows post-COVID, and an increase in the weighted average cost of capital to 8.5%, which was previously 7.7%.
In terms of our debt management, our gearing ratio was within our original debt covenant of 3.5 times. The net debt to EBITDA or gearing covenant has been increased to four times for the June and December 2023 reporting periods for additional flexibility. Our cost of debt has increased during the year with rising interest rates, and we were hedged at 72% as at June 2023. For next year, gearing is expected to remain within our covenants. We also have AUD 500 million of our debt coming up for renewal in March 2025, and we will be considering our refinancing strategy as part of this refinancing program. With that, I'll hand you back to Maxine.
So coming back to the three messages from today. The last 12 months have been about reset, so that we are best positioned for earnings growth. Looking ahead to FY 24, we are optimistic given the second half momentum. As for Agilex, we've been disappointed with the delay in earnings growth, but we are confident those challenges are now addressed and that our aspirations for that investment will be realized, albeit on a deferred basis. We will continue to be disciplined with capital, dividend, and balance sheet management.
So in all, we're getting on with it, and I look forward to sharing the progress with you over the next year. Thank you. Let's take your questions now on today's presentation.
Thank you. If you wish to ask a question, please press star one on your telephone and wait for your name to be announced. If you wish to cancel your request, please press star two. If you're on a speakerphone, please pick up the handset to ask your question. Your first question comes from David Lowe with JP Morgan. Please go ahead.
Thanks very much. If I could just start with the cost base. So, Maxine, you've talked about the reset, and we can obviously calculate the costs in the two main divisions. Just wondering how you'd guide us to think about the cost base going into FY 24. Can it stand still on where it was in the second half of 2023, or are we now gonna see a natural uplift with inflationary pressures?
Thanks, David. Great question. Look, I think what we've done on the slide is outline percentage of the various cost buckets to revenue so that we capture the proportional revenue growth. I think... We're very comfortable with where we sit with our FTE levels, although we are gonna continue to look at processes to reduce costs over time. And the only cost that we can foresee in the labor line is in our EBAs, which we have to absorb over the course of the year. Property has been relatively flat, and look, we are, my view is that there is actually sufficient capacity in, certainly in ACC networks.
So, I, unless there are, you know, major major opportunities that we see, we see that as being pretty steady. Consumables, well, that's, you know, it's an ongoing battle of renegotiating contracts and trying to offset inflation. So broadly speaking, I think that we see those percentages flowing forward to the coming year.
Great. That's helpful. Thanks very much. And if we could just touch on the interest and particularly the level of hedging. Maybe if you'd give us some help with where interest costs are likely to come in in FY 24. I mean, given we're aware of the sale of the hospitals and the cash that flowed in, but I'm just a little cautious that I don't fully understand the level of hedging that's in place and how that'll play out over FY 24, please.
Yeah, so that's Paul here. So look, our, our hedging was 72% at 30 June. A chunk of that drops off in September this year. We think our interest costs will be around AUD 70 million for next year. So clearly this year, you know, interest rates had gone up, and our, you know, our average debt level was higher as well. So that's our, that's our sort of best guess at the moment.
No, no, that's very clear. Thanks very much.
Your next question comes from Lyanne Harrison with Bank of America. Please go ahead.
Hi, good morning, Maxine and team. If I could start with, there was an interesting chart on page 7 where you, you looked at, I guess, the pathology segment, and, you know, note that, you know, by the time you look at that chart, sort of through July, it was starting to flatten out. Has that picked up again in August, based on what you've seen in Healius? And then also, second part to that question is, you made a comment around pathology volumes trending higher in second half 2024. What's your view on first half 2024? Is it that it's still likely to remain soft for the pathology business?
Thanks, Lyanne. Yes, look, I mean, you can see from the chart that there is a general trend up in referrals in GP, and obviously a stronger trend in specialists. And we see that continuing, but you can see it is well below historical averages. I mean, that's a rolling 12 months, but it doesn't matter if you go back to the 2019 period, it's still about 12% down, so it's coming off a pretty low base, but still coming back. It's not whether it's coming back, it's just what that rate of recovery is, which is what we're all following pretty closely. So look, we're expecting to see that. Look, I think it's just a reflection of that rate of recovery.
I think it would be bold to say, to predict what actually the rate is. But, you know, based on the current trend and what we're seeing in the last six months and going into this year, we are seeing a continued recovery, so that will just build in the second half.
Okay. Thank you. And, one question here, probably for, for Dr. Phil, was around, I guess the Lumus business. Obviously, we've seen very good margin expansion as you exited, 2024, you know, towards, or margins at, at around 8% EBIT margin. How do we think about margins going into next year? I know you're not providing guidance, but can we expect it to move, to the low double digits as early as, you know, the end of 2024?
We, we definitely think that the margins should stay there or even, and, and increase. I, I don't think we can predict yet, but we're certainly seeing coming into this, from a revenue point of view, definitely, continued growth. Medicare, numbers just came out, and we're growing above the Medicare, you know, line for revenue. So, you know, keeping the, the way we're going, yes, we should see our margins continue to increase. And that-that's the aim of the community, expansion of community centers, to grow that margin from that 8% up to towards the levels of 11%-13% for the EBIT margin in the future.
I'll leave it there.
Your next question comes from Andrew Goodsall with MST Marquee. Please go ahead.
Oh, thanks very much for taking my question. If I could just go back to those labor costs. Obviously, we can see it's down 4% on consecutive halves, and I know you've spoken to this a bit, but just trying to get a sense of where it might have landed in terms of an exit rate. Because I guess the way you progressed across the half was probably a lot faster exit rate at the sort of end of the fourth quarter.
That, that is right, Andrew. And look, you've got a blend there, too, in terms of pathology. Labor costs as a percentage of revenue, which has now come down to 44%-45%. Imaging is always naturally higher. And so, I think we are pretty comfortable with where both of those are in terms of their percentages at the end of the period. And the only cost change we see in the 2024 period is the EBA costs across our staff.
If I could push a bit harder, obviously, you know, we've looked at second half margins, and where they've got to, and just heard that they're continuing to grow. Again, you know, just directionally in that fourth quarter, could you give us a sense whether the extent to which they were better than the overall half?
Look, I don't think we're not gonna give a breakdown. There's obviously a crescendo effect when you're putting in place. I mean, most of the cost reset sort of was March, April, and then really coming through in May and June. But you've also got revenue cyclicality in that, Andrew, so I don't think it's particularly instructive to look at breaking it down into the quarters.
Understand. A final one for me. Just when we do look at those labor expenses through the PNL, just trying to understand if the redundancies are in there and if they're weighing into that number as well?
So they, they are included in the non-underlying costs, and so it was a fairly substantial reset program. And total cost for that... Jan, it's gonna give you later, I think.
Total cost for the reset program was AUD 14 million in the non-underlyings. That's in your PNL.
That's great. Thank you very much.
The next question comes from David Bailey with Macquarie. Please go ahead.
Yeah, thanks. Good morning. I might just follow up on Andrew's questions, actually. Just that labor cost taking partway through the second half. I mean, could you give us a bit of a sense as to what the incremental benefit might be for first half 2024, either in dollar terms or, you know, maybe a better question is the percentage of revenue on an exit rate basis rather than the average for the second half of 2023?
Oh, look, I think where we're sitting in terms of labor margins, we're running pathology more at 45. Imaging, there is an interesting nuance because we're transitioning from radiologist costs being contract revenue, so coming out of the revenue line and going into the labor cost line. But on a steady state basis, imaging costs should be around 60%-62% of revenue in terms of proportion.
Got it. That's helpful. Thank you. And then, just on the imaging piece, if we look at the outlook for 2024, there's some indexation coming through, there's a mix. Just interested in, your expectations maybe around volumes, and then what are some of the things you're doing to get to that AUD 5 million target per center?
Well, I might make a comment on volume, and then I might just hand to Phil, Phil, around what we're doing in terms of dealing with sort of above market growth. So interestingly, we talked about the imaging market recovering, and it certainly is. Most of it has been, though, in mix and the resulting impact on fee. I think the CAGR in growth in imaging was still around about 1.6% over the last period, not this year, over the last four years. So volume is usually a higher proportion of imaging, so 6%-7% imaging growth should really be more like, you know, 7%-8% normal sort of recovery. And look, Phil, hand to you to talk about specific initiatives.
Yeah, look, one of the ways to increase volume is to actually make sure that we've got fully staffed clinics, and we've, you know, recruiting radiologists is key. We're about 84% coverage FTE for our clinics on site. So as we move that to the right, we'll, you know, start to get. We know that when there's a radiologist on site, we tend to get more revenue through than when it's unmanned with a radiologist. So that's one thing. We have got indexation. We've got out-of-pockets that have been relatively well accepted, and so the volumes will increase again once, you know, our competitors also have gaps there, and so the volumes slowly will creep up.
That's often the case when you increase, you know, put a gap on, you get a small drop in volume, and then it eventually comes back to normal. So that will also come. And then the final thing to shift towards these higher revenue clinics is to get the modality mix shifting towards that, right, to get the MRIs, the PET scanners in, and having, the, you know, the radiologists on site and volume there. So we've got a number of things driving not volume as well as the increased average fee.
Your next question comes from Sean Laaman with Morgan Stanley. Please go ahead.
Good morning, Maxine and team, and thanks for taking my questions. Given the write down in pathology, you're able to give us a bit of a sense what the ongoing carrying value of Agilex is, is the first question. And secondly, given the EBITDA performance over fiscal 2023, is there a chance that you get back to the original guided target that you hoped to achieve in fiscal 2022?
So, Sean, I'll answer the first part of that question. So look, Agilex is, it's around about half of that, that three hundred and fifty million dollar impairment charge. So, you know, that hopefully puts a little bit of color around it. It's obviously made up of, you know, a number of, a number of factors. Weighted average cost of capital is obviously a big part of that as well. But, you know, to give you some guidance, roughly half of that, is Agilex related.
Second part of the question relates to, I think, the targets that were set out at the, for the acquisition of Agilex. So we're expecting within two years from now, that we will be getting to those targets. I'd like it to be earlier than that, but to give a sort of safe guide around where we think that will be.
Thank you. And, next question, just on some of the one-off costs and what we could expect for one-off costs for next year. So on the, digital transformation costs, I think you called out roughly AUD 22 million this year, AUD 11 million last year, and I think in the presentation pack, you said the digitization program is 50% complete. So, what's your sort of expectations for, costs for that, that program going forward over the next couple of years?
Maybe I'll just answer that question. So for next year, what we expect is the digital non-underlying cost to be around AUD 19 million, as that program accelerates. So that's really the only thing that we anticipate being in non-underlying, apart from, you know, any further costs that we incur as part of the ACL takeover bid.
Cool. And just to clarify, those takeover bid costs, that's just lawyers and bankers, is it?
Correct.
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Bank and lawyer costs. Correct.
Awesome. That, that's all I have. Thank you.
Your next question comes from Craig Wong- Pan with Royal Bank of Canada. Please go ahead.
Thanks, and good morning. My question is just firstly on the D&A within the imaging division. I noticed that kind of dropped in the period. I was wondering, is that what was the reason for that? And then secondly, is the second half D&A number there, is that sort of what we should expect kind of going forward? I guess, taking into account the kind of growth in community centers that you might be sort of driving into FY 24.
Yeah. So that's, so that drop, the primary reason for that was the impairment of those medical centers. But the run rate going forward, we would expect to be relatively similar.
Okay. And then with Agilex, I mean, there's the commentary that you had a good fourth quarter run rate. Are you able to provide any comments around what sort of run rates you saw in that fourth quarter for that business?
Yeah, well, I think we said that, revenue for that fourth quarter was, was AUD 9 million. So that just gives us some confidence, as we head into FY 24. There's obviously, the business development pipeline and the one work that we have, under contract at the moment also gives us some confidence that, you know, a chunk of our revenue that we've planned for in FY 24, is going to be delivered, given that, you know, we've now staffed up and have the right level of staff. And we also have the right, you know, or a much better commercial, process in terms of business development to keep that pipeline flowing.
And then just following on with kind of questions on Agilex, that commercial relationship that you're in negotiations with, do you have an expected timing for when that might complete? And I guess the arrangement there, or, sorry, potential arrangement, is that like as a kind of subcontractor type role to that other lab?
Oh, look, we won't go into the details of what the commercial terms are, but safe to say, having a proposition whereby you are able to sell phase I all the way through to phase III with similar set of standards is highly attractive. It's attractive for us because for us to be able to offer that as a proposition when we're selling phase I work to, say, phase II and three is done through our partner. And to be able to have a global partner to do that is attractive for our selling capacity, and it's also attractive for a phase II, phase III operator to have a phase I partner that is cost efficient, is in Australia, and can get the benefits of the Australian speed of phase I clinical trials.
So it's a mutually beneficial partnership, but the specific timing and commercial terms we will talk to at a later date.
Okay, great. Thank you.
Your next question comes from David Stanton with Jefferies. Please go ahead.
Morning, team, and thanks very much for taking my questions. I'm interested to understand why you see growth in pathology in the second half of FY 24 as opposed to perhaps, you know, continuing from the exit rates you're seeing in second half FY 23. Why won't we see sort of a growth in first half? Or is that not the implication from that statement on the FY 24 outlook?
Yeah, no, look, I don't think that's the implication. I think, look, second half is generally always stronger than the first half. I mean, I think we all know that. And I think it's just that continuation of that curve, particularly around seeing the uptick in particularly GP attendances, and obviously specialist attendances are important as well. So it's more a seeing a building of that continued growth more than a reflection of first half, second half differences.
Understood. Have you won or lost any pathology contracts that will impact FY24 that we should know about, please?
FY24? Look, I think, no, I don't think there's... We've won, I think we've won 2, 2 and lost 1, I think, so net ahead.
Okay. Net ahead. And my final question is, I guess, you know, you've obviously cut pathology costs, you know, very well. Does that, in your view, lower, you know, your revenue growth opportunities in pathology, given what we've seen as sort of flat to slightly down sequential BAU revenues in second half FY 23 compared to first half 2023?
Look, I think there's a very important context here, which is the cost outs, A, focused on COVID-related activity, and B, they focused on non-revenue generating roles, and we were very deliberate about that, so it's more, back-end efficiency. And the third thing I would say is, although there were some targets or, expectations set of a reset, this was actually done by the pathology division. I'm not gonna say it was easy for them, but they did it, and they did it carefully, and they did it well. Some of it, was done through natural attrition, which always helps, but it was done in a very measured way.
I mean, hopefully the theme that you are getting from this presentation is that our shift is towards revenue growth, and that actually is where we want to be investing and certainly not cutting.
Understood. Thank you.
Your next question comes from Saul Hadassin with Barrenjoey. Please go ahead.
Yeah, good morning. Thanks for taking my questions. Just on the digital transformation costs and that guidance for 2024. So I guess total costs are now building to excess of AUD 50 million. Is there a targeted return on that investment that you're thinking about from a ROIC perspective? Or how do we think about the benefits of that program over time?
Yeah, look, I, I might take that for a bit, and then Paul can, Paul can fill out some more, some more of the details. I think at the outset when the money was raised for the digital program, there was an expected benefit of AUD 20 million a year. Some of that is very easy to see, because we're frankly just carrying the costs of dual systems for a period. So at least half of those benefits will be a retirement of legacy systems. And the rest of it is in simple things like auto validation of tests and not doing things four ways. So, I'm still confident that there will be those benefits at the end of the program.
Look, I, both Paul and I are pretty focused on any dollar we spend, has to create, has to be, have a return. We can all build fantastic systems, but unless it either reduces costs or grows revenue, we have to be really conscious about that. So once we get past what I would call the sort of, you know, remediation of spend and bringing us to a platform that we think is, is appropriate, any incremental spend will go through our, threshold tests. And my, and my view is that any digital spend needs to have a much faster return, because every- it's generally always easily replicatable.
So, so we're gonna be pretty careful about once we get to that sort of platform of what we think is, market competitive, how we do spend. Paul, I don't know if you want to add anything more on-
No, I was gonna say, look, we, we've said that we're 50% the way through this project at the moment. We, as part of our planning for 2024, we do have both, you know, a reduction in some costs, but more so, revenue initiatives attached to the plans for 2024. So we're not gonna break those out. All I can say is that, you know, as we progress through this, you know, we are setting targets in terms of revenue, and eventually we will be able to reduce the costs as well. But we're kind of halfway through that at the moment.
But, you know, internally, that's absolutely the way that we think about things, is that, you know, the cost of capital, you know, is a very important part of any project when we undertake it.
Thanks. And that AUD 20 million per year in savings, when, I mean, what, when would you expect to achieve that full run rate? What year?
So if you said retirement, so lion's share of program 2024, 2025, migration off legacy systems. So, you know, 2026 would be the first year, I think, for those benefits.
Thanks, Maxine. Just one, one other one maybe for Paul. Just the balance between resuming a dividend versus debt pay down and just maybe your, where your net debt peak to EBITDA is. Is there a target gearing ratio that you have, as opposed, is the preference to pay down debt before, reinstating the dividend? Just some comments there.
Look, you know, I can't really comment around the dividend. It's more a board issue. Yeah, our focus is clearly on capital management and paying down debt. You know, it's a bit hard to, I think, at this stage in the cycle, to have a definitive gearing ratio other than to say it's our focus to, you know, reduce that as much as possible, so.
Great. That's all I had.
Your next question comes from Steve Wheen with Jarden. Please go ahead.
Yeah, good morning. Just wanted to ask a question about the corporate costs. When you look at the EBIT contribution, it's obviously nearly halved from 2022, and it talks to the, you know, one of the drivers being the lower accruals from management incentives. What might that therefore look like for 2024? I assume that would start to increase again from that level. Is that correct?
Well, I think it's our ambition that we would like it to increase. So look, you're right. So in 2023, there's no, you know, no short-term incentives for the management team. And, you know, dependent upon performance, you know, we would anticipate that, you know, if we hit all our targets, then that cost would go up naturally. But, you know, on that basis, everyone wins.
Can you give any sort of what proportion of the reduction in 2023 is related to that, and what proportion of it might be due to tight cost control?
Look, I might take that offline. I think, look, the lion's share of that reduction relates to short-term, to short-term incentives. But look, we have reduced costs as well, across corporate. But, you know, but we obviously have an envelope of corporate costs that are recharged right across the business as well. So it's a combination of both.
Those incentive targets, correct? I'm just trying to factor that in, because that's a driver for our, for our 24 EBIT.
Sorry. Yeah, yeah, we understand that.
Okay, cool. Second question I had was just with regards to the new employment model for radiologists. Can you just explain that in a little bit more detail as to what that encompasses?
Yeah, sure. This is Phil. Previously, most of our radiologists, as you heard, were contractors who got a percentage of revenue. The new model is to bring on the radiologists on a base salary, which is appropriate to their degree of level of time out of training. So the younger ones on the lower base to the more older generation who've got the big referral base, if they bring referral base to a larger base, and then above that, if they exceed their reporting billings, exceed their base, then we have a percentage of revenue incentive for them to reach as their volumes increase.
So the benefit of that for the younger radiologists is they don't feel that they're competing necessarily against the very fast senior radiologists. They have ability to go out and talk to referrers without losing revenue, sorry, without losing income, and build up our referral base, and so, you know, build their careers. And as they get, feel more comfortable in getting through larger volumes, then they can benefit from a, an incentive with, of a percentage of revenue. So it has been very well accepted by the younger radiologists coming out of their training schemes.
Okay, and then the next part of that, I guess, does that carry any payroll tax implications given the scrutiny on, you know, contractors versus employees?
Yeah, well, as you heard from Maxine, we're definitely moving all our contractors into these new employment models that will, yes, have payroll tax on them. But we adjust, you know, we, we're adjusting, you know, making sure we're adjusting for that. Yeah. But yes, we are moving to everyone being covered under payroll tax.
Okay, and so does that have implications in terms of margins for that division?
It does, because you're essentially moving, so there's gross and there's stat revenue, and maybe I should get Paul to answer this question, given it's really his question. So there is a movement from contracted revenue down to the labor cost line, and I'll let Paul answer it.
Yeah, look, I don't really have much else to add, other than obviously we're just changing the model so that they are employees, they pay payroll tax, and, you know, we, at the same time, you know, we've got various changes to our revenue model as well. So our aim overall, I think, as Phil set out earlier, is to increase those margins, irrespective of the way that we've got our business structured, so.
Yeah, and then also, once we get them on these contracts, it reduces our reliance on locums, and locums are much more expensive than these new employment contracts.
Yep. Okay, great. That's all from me. Thank you.
Your next question comes from Mathieu Chevrier with Citi. Please go ahead.
Yeah, good morning. Thanks very much for taking my question. My first one is for Maxine. You referred to earlier in the call on increasing, you know, the return on capital over time. Can I ask what measures you're using, and what are you targeting, and by when?
Yeah, sure. Look, internally, we are using for any new capital, we'd like to see at least a 15% return on invested capital. But it does depend, it does depend on the investment. I mean, so when we start to talk about some of the imaging investments, which we think are lower risk, so, for example, adding an MRI where you've got, you know, waiting lists for three weeks, and you've got a referral and patient base, that obviously carries a much lower risk. So, you know, in those circumstances, we would drop that return hurdle perhaps a couple of points.
But when it comes to things like digital investments, I would put that at a higher return threshold, given that you need to get a much faster return. But generally, around about 15% return on invested capital.
Just for the group, is that on a pre or post-tax basis?
Sorry, did you ask a pre or post-tax basis?
Yeah. What, what, what are you targeting for the group, and are you targeting a pre- or post-tax 15%?
Yeah. So that's, So Matthew, that's pre. And it's, for the group, it's the same for, you know, all projects that we analyze. So we've basically just set up a process internally, as Maxine explained, to go through whether it's pathology, growth, CapEx, or imaging, and all go through the same process, and generate an understanding within our business that the return on our invested capital needs to be significantly higher, than, you know, our weighted average cost of capital. So we've set that 15%, that's our benchmark, and then we assess each one individually.
Okay. And then just on imaging, I mean, what are you seeing on the competitive landscape, given that, you know, everyone is trying to get into, you know, into the higher-end modalities and expanding, the number of MRI licenses that they have?
Yes, that's true. We, you know, there's been deregulation, as you know, in the more than two to seven regions, and for our—we had a lot of rebadged magnets in those areas, but it, we've actually seen little impact on us. That's actually one of the reasons why some of our competitors' revenues have grown so much. I think Sonic has 8 MRIs, which are all in these regional areas. The MRIs in metro, there, at this stage, it's not deregulated. We have got a good number of rebadged magnets in metro, but we still feel there's opportunity.
That's one of the reasons we're expanding. There is an opportunity potentially that it will get deregulated in the coming years, and so we are planning for that to make sure that we've got a good fleet of MRI. When you say is it worth doing, expanding into these areas, these are the growth areas. PET is a very big growth area, and Lumus is rapidly expanding. From our 7 PET scanners, we've got 2 more in store for this year. And MRI is still a very big growth area in imaging. So yes, we're all competing in that market, but we think we've got a very good footprint to keep expanding in that area.
Great. Thanks very much.
Your next question comes from Chris Cooper with Goldman Sachs. Please go ahead.
Hi there. Thanks. Paul, just on the, the impairment of AUD 350 billion, so I, I'm interested in the wording, suggesting that, you know, the, the sort of component related to the lower forecast cash flows post-COVID. Is that a statement on COVID testing itself, or is that a statement on base business recovery being a bit below expectations or, or something on cost? Just a bit of clarification on that component of the write down, please.
So it's more about the first, it's around COVID. Obviously, any impairment model is based around cash flows, full stop. So, look, I think, you know, the main point here is that, the pathology CGU itself had AUD 1.8 billion of goodwill sitting there, which, you know, 1.5 of that was historic. So it's not a statement about, you know, future growth at all. It's, as you know, impairment is an accounting standard, it's non-cash, and something we have to deal with annually, so.
Okay, thanks. And just a quick clarification. I think you said earlier, the majority of direct COVID costs have been removed. Just on slide 18, can I confirm how material the residual is and in which buckets the remainder sits?
Chris, I'll take that. So, during COVID, we, for a fair amount of the time, the COVID equipment we that we had in labs was on a cost per reportable basis, and we made a decision that it was more economic for us to purchase that equipment, which we did. So there's about, I think, AUD 5.5 million, which still sits there in terms of COVID-related equipment, which can be used alternatively, but that's the main overhang.
Okay, thanks.
There are no further questions at this time. I'll now hand back for closing remarks.
Thank you very much, everyone, and if there's no more questions, we'll close the presentation there. Thank you for attending.
Thank you.