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Hologic Q2 2022 Earnings Call Transcript


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Participants

Corporate Executives

  • Ryan Simon
    Vice President, Investor Relations
  • Steve MacMillan
    Chairman, President, and Chief Executive Officer
  • Karleen Oberton
    Chief Financial Officer

Presentation

Operator

Please standby. Good afternoon and welcome to the Hologic 2Q '22 Earnings Conference call. My name is Lauren and I am your operator for today's call. [Operator Instructions] I would now like to introduce Ryan Simon, Vice President, Investor Relations to begin the call.

Ryan Simon
Vice President, Investor Relations at Hologic

Thank you, Lauren. Good afternoon and thank you for joining Hologic Second Quarter Fiscal 2022 earnings call. With me today are Steve MacMillan, the company's Chairman, President and Chief Executive Officer; and Karleen Oberton, our Chief Financial Officer. Our second quarter press release is available now on the Investors section of our website along with an updated corporate presentation. We will also post our prepared remarks to our website shortly after we deliver them and a replay of this call will be available through May 27.

Before we begin, we would like to inform you that certain statements we make today will be forward looking. These statements involve known and unknown risks and uncertainties that may cause actual results to differ materially from those expressed or implied. Such factors include those referenced in the Safe Harbor statement included in our earnings release and SEC filings. Also during this call, we will discuss certain non-GAAP financial measures. A reconciliation to GAAP can be found in our earnings release. Two of these non-GAAP measures are one, organic revenue, which we define as constant currency revenue, excluding the divested blood screening business and revenue from acquired businesses, owned by Hologic for less than one year. And two, organic revenue, excluding COVID-19, which excludes COVID-19 assay revenue, revenue related to COVID-19 and discontinued product sales in diagnostics. Finally, any percentage changes we discuss will be on a year-over-year basis and revenue growth rates will be in constant currency unless otherwise noted.

Now I'd like to turn the call over to Steve MacMillan, Hologic CEO.

Steve MacMillan
Chairman, President, and Chief Executive Officer at Hologic

Thank you, Ryan. And good afternoon, everyone. We are pleased to discuss our financial results for the second quarter of fiscal 2022. We posted solid results overall and continued our excellent performance. Total revenue was $1.44 billion and non-GAAP earnings per share were $2.07, exceeding the midpoint of our guidance by over 12% on the topline and over 33% on the bottom.

As we stated last quarter, we continue to deliver in an uncertain business environment. For example, in January, we saw COVID cases spike once again putting pressure on healthcare utilization and certain elective procedures, through February and March, the ripple effects of the war on Ukraine added additional uncertainty to a world already facing headwinds from COVID, rising inflation and interest rates, as well as ongoing global supply chain disruptions. In these challenging times, we continue to deliver.

Our performance is a direct result of the planning and investments we made throughout the pandemic to strategically strengthen our business. We are a stronger Hologic through portfolio diversification, the addition of multiple growth drivers into our franchises and continued growth in our international businesses.

Today, we'd like to provide additional color in three areas. First, we'll discuss Q2 growth in light of the macro environment, including updates on the Breast Health chip shortage we spoke to in Q1. Second, provide progress on acquisitions turning organic in our third quarter. And third, highlight our additional efforts to lean into ESG and how our purpose, passion and promise are elevating women's health around the world.

In our second quarter, both our Diagnostics and Surgical divisions delivered organic growth excluding COVID, while as expected, our Breast and Skeletal Health division declined. In breast, as we discussed in our last call, the semiconductor chip shortage was the primary driver of the divisions temporary decline. Encouragingly, underlying demand remains strong as measured by healthy orders and a growing backlog. As we've seen during the last two years as COVID testing rises, elective annual exams, screenings and going [Phonetic] surgical procedures are often postponed. And as COVID testing declines, we see the opposite, and our base business returns. We believe with the latest rebound, also makes clear, is the demand for our products remains strong despite the unpredictability of COVID surges. We are confident in our business, confident in our people, and excited about our positioning heading into the third quarter.

For example, in Diagnostics, we placed an additional 123 Panthers in the second quarter, surpassing first quarter placements of 119. Only halfway through the year, we have again exceeded our pre-pandemic average of roughly 225 Panther placements per year. This is a phenomenal result given the rapid global expansion of our Panther installed base during the pandemic. Our Panther installed base is now over 3,100 instruments worldwide with over 45% placed internationally. Also in diagnostics, our vaginitis panel, BV, CV, TV continues its growth trajectory. In our Q2 of 2021, this assay generated about $7 million for the quarter. One year later, the panel contributed almost $14 million in worldwide sales, nearly double the year before. And BV, CV, TV is now on pace to become a top three womens health assay in our Molecular Diagnostics portfolio.

Now, let's provide an update on chip supply and Breast Health. Our supply chain service and commercial organizations have been working hard to gain greater visibility and mitigate the impact of the shortage. In Q2, the impact was slightly less than estimated, driven by favorable availability and precise management of chips in circulation within our service inventory. While our teams continue to do a great job navigating the unpredictable supply challenges on chips, the ongoing volatility of supply makes it possible that up to $50 million in additional headwind could surface in the back half of the year. Despite this, we are still materially increasing guidance for the full company, which Karleen will speak to later on. To finish the chip discussion on an upbeat note, we recently received notice of an increased allocation of chips for late in fiscal 2022. While this is very encouraging, given production and delivery timing the benefit from this increase is unlikely to help revenue until early 2023. Said another way, we are optimistic the back half of our fiscal '22 will prove to be the low watermark in terms of available gantries.

Moving on to an update on acquisitions turning organic. In our fiscal third quarter, contributions from both Biotheranostics and Diagenode will be included in the organic growth of our diagnostics division. We will provide an update on both today. First, Biotherapeutics, as a reminder, we completed this acquisition in February of 2021. The goal of this acquisition was to enter the high growth, lab based oncology market, an adjacent long time area of interest, and bring our resources and expertise to create an even stronger business. Based on breast cancer indexes earlier than anticipated inclusion in NCCN guidelines in January of 2021. The deal is off to a great start. Last year, in its first full quarter, post acquisition, Biotheranostics posted $13 million of revenue, which was more than 30% higher than their best quarter prior to the pandemic. Fast forward to our most recent quarter, Biotheranostics generated $16.4 million in revenue. This early success comes as a result of outstanding engagement in a successful cross-functional, cross enterprise integration. As planned, we deployed Hologic resources and expertise and paired this with legacy Biotheranostics capabilities to refine operational efficiency and most importantly set a solid foundation for scalable growth.

To accelerate Biotheranostics already strong growth, as an example, we are streamlining the business ordering process, which we believe will simplify things for the customer. We expect this enhancement will greatly improve the customer experience and ultimately result in more orders. We are also excited to share that we are in the process of transferring biotheranostics operations to our diagnostics headquarters in San Diego. While maintaining required division between clear [Phonetic] and IVD activities, we believe the move will lead to an even more unified culture, stronger relationships between counterparts and more collaborative efforts.

Finally, and even more encouraging, just last week, the biotheranostics BCI test was included in the American Society of Clinical Oncology guidelines, another major step towards increasing utilization and recognition of BCI as the standard of care. BCI is now the only genomic test in both NCCN and ASCO guidelines for predicting benefit of extended endocrine therapy.

Moving on, shortly after we closed the biotheranostics transaction, we acquired diagenode, based in Belgium. The goal of the acquisition was to accelerate PCR based assay development for our Panther Fusion and leverage additional R&D capabilities in Europe. So far we have checked both boxes. Since the close of the acquisition, as planned, we have integrated the diagenode organization to optimize the speed and efficiency of our global R&D organization, enabling more effective and more efficient cross border innovation. Today, teams from San Diego and Belgium have worked together closely to improve processes and clearly define a robust product development pipeline. The team is already making meaningful progress towards approval of two viral load assays which will expand our virology portfolio in the transplant testing space.

Overall, for both biotheranostics and diagenode, we are pleased with the integration and progress of these two businesses. As we look forward, we are excited by the opportunity to unlock more synergies from both, and in turn, create more value for our shareholders.

Shifting gears, I'd like to close by highlighting two very meaningful and opportunistic marketing efforts from our second quarter. The first being our Super Bowl commercial, which also ran during the Winter Olympics. And the second, our title sponsorship of the Women's Tennis Association tour. As many of you may have seen, our television commercial titled Her Health is Her Wealth featured Mary J-Blige. The commercial highlighted that despite her busy life, she makes time in her schedule for her annual health exams.

The campaign came at a critical time as an alarming number of women missed annual breast and cervical cancer screenings during the COVID-19 pandemic. In January, the inaugural results of our Hologic global womens health index found that nearly 50% of women ages 16 to 54 had not seen a medical professional in the prior year. The purpose of our message was to encourage women to schedule their annual exams and prioritize their health. Detecting cancer early is critical and can often make the difference between a curable and non-curable prognosis. After two years of the pandemic, with too many women not being screened, and our unique relationship with Mary J Blige, there was no better time and no better stage for us to encourage more women to see their doctors.

Our second effort is our landmark title sponsorship of the WTA Tour, announced in early March. This alliance was forged to make significant progress on our shared vision of greater wellness and equality for women. That partnership has global reach and will emphasize the importance of preventive care through well woman visits. We are proud to stand with the WTA as we work together to jointly raise the profile of women and share importance of early detection and treatment.

Before turning the call over to Karleen, let me conclude by saying that the results of this quarter demonstrate our business is both durable and resilient and the demand for our product is exceptionally strong. Despite multiple macro headwinds, we continue to deliver strong results. We are both excited and confident in our business and see great opportunity to be even stronger in the years ahead.

With that, let me turn the call over to Karleen.

Karleen Oberton
Chief Financial Officer at Hologic

Thank you, Steve. And good afternoon, everyone. We are very pleased to share second quarter results that significantly exceeded our guidance for both in revenue and EPS. Our second quarter performance once again highlights the strength of our diverse business. While the Omicron variant negatively impacted our base businesses early in the quarter, our COVID testing upside more than offset this headwind. It's also important to understand that our balance sheet is stronger than ever, providing key strategic flexibility in this uncertain macro environment.

Further, we continue to generate very healthy free cash flow, funding our capital deployment priorities. In the second quarter, we generated significant operating cash flow and executed $200 million of share repurchase, both of which I'll touch on in more detail shortly. Before we do that, we will provide color on our consolidated and divisional results for the second quarter.

As a reminder, revenue in our fiscal second quarter is typically seasonally lower compared to our first quarter, which benefits from increased patient activity before calendar year-end. In the quarter, total revenue of over $1.4 billion was very strong and came in more than a $150 million higher than the midpoint of our previous guidance. In addition, EPS of $2.07 in the second quarter far exceeded our guidance range of $1.50 to $1.60.

Turning to our divisional results. Diagnostics global revenue of $987.1 million declined 5.6% compared to the prior year. However, excluding COVID, worldwide organic diagnostics revenue increased 4%. As discussed, the division's results early in Q2 were negatively impacted by the Omicron COVID-19 variant. Our base diagnostics business is inversely correlated to spikes in the pandemic as women tend to postpone office visits when COVID cases surge. However, we were encouraged by improving trends throughout March as COVID cases declined. This gives us great confidence in the underlying health of our base diagnostics franchise.

Moving specifically to our molecular diagnostics business, we will again exclude the impact of COVID. Making these adjustments, base molecular revenue grew above 7% organically in the second quarter. This growth was driven by strong uptake in newer assays, such as our vaginitis panel, and menu within our urology product line. As it relates to our COVID results, we generated $584 million of COVID assay revenue, far exceeding our guidance of $400 million. We shipped about 28.5 million tests to customers as ASPs held steady around $20 per test globally. The United States represented about 60% of total COVID assay revenue, however, testing demand was strong in international markets as well. Rounding out Diagnostics, our cytology and perinatal businesses were essentially flat compared to the prior year as these segments were also impacted by COVID-19's influence on womens' wellness visits.

In Breast Health, global revenue of $310.4 million was down approximately 7% as expected, primarily driven by the chip shortages that we have discussed. In our interventional business, incremental supply chain pressure of a few million dollars surfaced during the quarter. Specific to our disposable biopsy needles. As a result, our interventional business was down slightly less than 1% in the period. While supply chain challenges persist, demand for our best-in-class Breast Health products remain strong. And as Steve commented, we expect to see improvement in 2023.

In surgical, second quarter revenue of $117.3 million grew 3.5%. As we foreshadowed during our first quarter call, the Omicron caused a pull back in elective procedures in the first half of the quarter, but this is a trend as proved later in the period as COVID cases declined. Furthermore, we saw a nice resilience from several of our newer products such as the Fluent Fluid Management System and solid contributions from both its CoolSeal devices. Lastly, in our Skeletal business revenue of $20.9 million decreased 6% compared to the prior year period.

Now let's move on to the rest of the non-GAAP P&L for the second quarter. Gross margin of 71% was well ahead of our forecast, driven by higher than expected COVID-19 testing volumes in the period. Total operating expenses of $338.2 million increased 22% in the second quarter. As we have done throughout the pandemic, given the benefit from COVID-19 profitability, we took the opportunity to reinvest in our base businesses. We also allocated spend to key marketing initiatives to help drive awareness for women's health.

For example, second quarter operating expenses included our Super Bowl and Olympics commercials, as well as expenses associated with our WTA partnership. The combined total of these initiatives contributed slightly more than $25 million to operating expenses in the quarter. In addition, within operating expenses, recent acquisitions added slightly less than $35 million in the quarter, about $25 million higher than the prior year period. Finally, our tax rate in Q2 was 20.5%, marginally lower than our expectations, given the higher COVID-19 revenue outside the United States.

Putting these pieces together, operating margin for Q2 came in well above our forecast at 47.4%, and net margin was very strong at 36.5%. Non-GAAP net income finished at $524.2 million and non-GAAP earnings per share was $2.07, nearly 35% above the midpoint of our prior guidance.

Moving on from the P&L, cash flow from operations was $1.06 billion in the second quarter, inclusive of tax refunds totaling approximately $418 million, related to sale of our previously-held Medical Aesthetics business in 2020. When normalizing for these refunds, cash generation for the quarter was still exceptional. These robust cash flows continue to provide tremendous financial and strategic flexibility. For example, as referred to earlier, we repurchased 2.9 million shares of our stock for $200 million in the quarter. We continue to view our ongoing share repurchase program as a lever to drive value for our shareholders. Further, we continue to diligently pursue M&A opportunities in each one of our division.

Based on our strong operational performance, we had $2.3 billion of cash on our balance sheet at the end of the second quarter and our leverage ratio was 0.3 times. Our capital structure is fortified. And while we ended the quarter with an elevated cash balance, we continue to be thorough in exercising discipline as we evaluate opportunities. Given the macro environment, we have comfort with our elevated cash balance and the ability to be patient as we identify high quality opportunities.

Now, let's move on to our updated guidance for the third quarter and full year fiscal 2022. In the third quarter, we expect to continue our track record of delivering strong financial results, with total revenue in the range of $875 million to $915 million. For the full year fiscal 2022, we expect total revenue in the range of $4.6 billion to $4.7 billion, significantly exceeding our prior full year guidance by $175 million at the midpoint. We are raising guidance once again in the face of an uncertain macro backdrop highlighting our confidence in our business.

Given the continued strength of the US dollar into aid with constant currency modeling, we are assuming foreign exchange headwinds of approximately $20 million in the third quarter of 2022 and $65 million for the full year. This FX unfavorability to revenue is higher than our guidance from last quarter.

In diagnostics, we expect molecular to continue to drive growth based on our Panther installed base of over 3,100 instruments globally, over 80% larger than the start of the pandemic. We are all are also seeing encouraging uptake of our newer assays like our vaginitis panel, viral [Phonetic] and Amgen, as well as the tremendous international expansion opportunities. In terms of COVID sales, we expect COVID Assay sales to be at least $100 million in the third quarter of 2022 and approximately $1.25 billion for the full year. COVID related items inclusive of small amount of discontinued product revenue are expected to be approximately $35 million in the third quarter and $215 million for the full year.

In Breast Health, our organic and inorganic investments continue to perform well and highlight the diversity of the division's revenue streams. For example, Brevera had another great result growing mid teens in the last quarter. In addition, recurring service revenue represented more than 40% of total sales in Q2. In terms of the Breast Health chip shortage announced last quarter, given significant uncertainty still exists in the chip market, the possibility of an incremental $50 million headwind in the back half of 2022 exists and we have incorporated this into our guidance. While we are seeing early signs of improvement in chip supply, we are forecasting conservatively. To reemphasize, this headwind is purely a supply issue and not one of underlying demand which remained strong.

Finally, in surgicals, we feel great about the trajectory of our business as COVID trends improve. MyoSure and related organic products such as Fluent continue to drive near-term growth. We expect meaningful contribution from both Acessa and Bolder over the next several years. As a reminder, our organic guidance backs out of revenue from acquisitions until the first full quarter after the deal annualizes, as well as revenue from our divested blood screening business. In terms of the deal, Biotheranostics and Diagenode will become part of our organic revenue in Q3 '22. Therefore, the organic revenue adjustments for Q3 include Mobidiag and Bolder. In Q4, Bolder only.

Moving down to P&L, for the full year, we forecast our non-GAAP gross margin percentage to be in the mid to high 60s and our non-GAAP operating margin percentage to be in the high 30s. Both estimates are higher than our guidance last quarter.

Further, our second half guidance incorporates the margin impact from our Breast Health supply chain revenue shortfall. As a reminder, gantry gross margin is accretive to the consolidated averages and we have maintained operating spend in order to be in a position to move quickly once we receive chips. In addition, we have again incorporated inflationary supply chain cost into our guidance as it relates to electronics plastics and logistics. Despite these headwinds, for the full year, we expect both growth in operating margins to be above pre-pandemic levels.

In terms of operating expenses, we expect spending to be up compared to 2021 but be lower in the second half of 2022 compared to the first half. As we have continued to highlight in quarters with higher COVID testing revenue, we will take the opportunity to invest for future growth. Below [Phonetic] operating income, we expect other expenses net to be a little less than 25 million a quarter for the remainder of the year. Our guidance is based on effective tax rate of 21% and diluted shares outstanding of around $255 million for the full year. All of this net debt to expected EPS of $0.67 to $0.72 in the third quarter and $5.45 to $5.65 for the full year, 10% above our prior guidance at the midpoint.

As you update your forecasts, let me remind you that macro uncertainty due to the pandemic related supply chain challenges in geopolitical conflicts remain high. We would therefore encourage you to model at the middle of our ranges which incorporate both potential upsides and downsides.

Let me wrap up by saying that's Hologic posted very strong second quarter results that far exceeded expectations and guidance. We are also raising our financial guidance for the year, even as we are increasing anticipated supply chain headwinds, highlighting the multiple growth drivers we have added to each of our franchises and benefits from COVID testing. With a strong balance sheet and best-in-class cash flow generation, we are well positioned.

With that, we ask the operator to open the call for questions.

Questions and Answers

Operator

Thank you. [Operator Instructions] And we'll take our first question from Jack Meehan with Nephron Research.

Jack Meehan
Analyst at Nephron Research

Thank you and good afternoon.

Steve MacMillan
Chairman, President, and Chief Executive Officer at Hologic

Hey, Jack.

Jack Meehan
Analyst at Nephron Research

My first question is on Breast Health and the semiconductors. So last quarter, up to 200 million you talked about, I thought it was fully derisking, began true exposure, and then the quarter actually came in a little better than you were thinking. So I'm just trying to square this commentary with the additional 50 million you're building in from here. Can you just maybe help me through that? And kind of second off that just can you give us a little bit more color on the order book and just your confidence that you're not losing share given some of the supply chain shortages there?

Karleen Oberton
Chief Financial Officer at Hologic

Yes. So, Jack, it's Karleen. I'll start off on the evolution of the numbers. So, first, let's recognize in this quarter we did a little better and that was really a lot of efforts between our service and supply chain folks really prioritizing and remanufacturing chips for the service needs, which allowed us to sell more new gantry. So, great effort there.

I think when we think about the additional possibility of an additional $50 million, it has a little more to do with timing. And so, we are pleased that we got a higher allocation of chips than we had thought -- than we had originally expected, but the timing of that is such that it won't come in until 2023. I think we thought if there was additional allocation, we might get that benefit '22, but it's looking like it's 2023.

And I think I just -- on the second part of your question on demand, again, we see our backlog growing in our Breast Health business. Its growth [Phonetic] strong. We're working really strategically with customers to make sure that we're not losing any business because of this and that. And I think our intelligence would be that our competitors are probably like in the same position as us.

Steve MacMillan
Chairman, President, and Chief Executive Officer at Hologic

And I think the reps [Phonetic] feel good.

Jack Meehan
Analyst at Nephron Research

That is -- Okay. Yes, that makes sense on the timing. Very helpful. As an unrelated follow up, obviously in molecular, big focus on kind of share shifts in the diagnostics industry with COVID, I was wondering if you could talk about your relationship with the National Labs and just with the larger customers, whether you think you're gaining or losing share as we transition eventually into an endemic environment?

Steve MacMillan
Chairman, President, and Chief Executive Officer at Hologic

Yes, Jack. And by the way, I'd also clarify that we're not going to use the cash on the balance sheet to by the Eagles. I know you've [Speech Overlap]

Jack Meehan
Analyst at Nephron Research

Hopefully, they make some good picks tomorrow.

Steve MacMillan
Chairman, President, and Chief Executive Officer at Hologic

Yes, exactly. Hey, in terms of our relation with the national labs, I probably couldn't be more proud of our teams. And even, we've always had good relationships, but when you think about the way we responded, and particularly, if we look at the two big major labs in the United States, but even a number of the other big ones right below the top two, when they were really under the gun, and you think back to the April, May, June timeframe of 2020, when the evening news around the world, around the country, it was always about the eight day turnaround times for PCR tests and all of the problems with molecular testing. And that's when we dispatched and our teams went around the clock to put Panthers in all over the place. And we really worked so well to help those, both of those customers dramatically reduce the turnaround times.

And I think we've used both the relationship in coming to their aid during that time, as well as frankly, I think they increasingly understand that we're building markets. When it comes to how we approach the women's health market, we are also working the reimbursements, we're working the physician recommendation, we're working the guideline developments. And all of that is helping to grow the market, which by definition is growing them.

So, I would tell you, I feel like it's more of a partnership that is valued than just a traditional vendor-vendee relationship. And I think our teams have worked so hard to have many good relationships throughout all levels, both operationally within the marketing teams and we like where we're positioned. We really do.

Jack Meehan
Analyst at Nephron Research

Thank you, Steve.

Steve MacMillan
Chairman, President, and Chief Executive Officer at Hologic

Great. Thanks, Jack.

Operator

Our next question comes from Vijay Kumar with Evercore ISI.

Vijay Kumar
Analyst at Evercore ISI

Hey guys, thanks for taking my question. Steve, maybe one big-picture for you. I'm looking at the base business here, the segments, it looks like it was light across the board. Breast imaging perhaps, it's understandable given the chip shortage. But it looks like underlying diagnostics came in below, street models, GYN, a similar trend. How much of this was a utilization impact due to Omicron? And the reason I ask is we're seeing other device companies coming up with improved procedure trends. I'm curious, was there any one-off items that impacted Hologic in the Q?

Steve MacMillan
Chairman, President, and Chief Executive Officer at Hologic

I think, Vijay, part of it on the surgical business is probably as some of the hospitals came back up post Omicron, they tended to prioritize some of the cardiovascular procedures and some of the more immediate procedures, whereas our GYN surge is viewed as a little more elective. So I think there was a little bit of that probably in the quarter that we think shakes out completely over time as women's health issues come back. And I think our base molecular diagnostics business was up 7%. Not too shabby in a period where a lot of our machines ended up running a lot of additional COVID tests. So nothing that we are concerned about. And I think as we continue to look all of these quarters, there is variability and there's puts and takes, and we keep managing our business overall. That as one part goes up -- the reality is we do see trade-offs. We did sell $584 million of COVID in the quarter. There is a bit of a trade-off on our base business with that. So as that goes back, I think we're very optimistic about where the base business comes here as that COVID testing really does probably really subside here.

Vijay Kumar
Analyst at Evercore ISI

That's helpful perspective, Steve. And maybe one up related -- there has been a lot of debate on this, what is the underlying base margins, base earnings power for Hologic? Now, I know what the Street is trying to do. We're trying to do a COVID P&L and a base business P&L, and in reality, that may not be how corporates think about their businesses. How much of reinvestment is going on in the business, Steve? And the reason I ask is, if I look at it implied Q4, EPS guide, I think it's $0.60 to $0.65, so that's annualizing at 2.50. I'm assuming Q4 has very minimal COVID testing, but also it has some impact from Breast imaging, the chip shortage, right? So what is the underlying earnings power here for Hologic that we should be thinking about?

Karleen Oberton
Chief Financial Officer at Hologic

Hey, Vijay, it's Karleen. So, I'll take you through it. So if we look at the second half of 2022, you're right, that is the worst impact of the Breast Health chip shortage. And so don't think of the back half earnings power and the math you just did on the Q4, as what we call our base business earnings power. There is definitely an impact there, significant impact with pretty minimal COVID revenue in the fourth quarter. The other thing I would point to is that if you look at the back half, we have a higher operating expenses and simply dilutive operating margins from our acquisitions, which actually will be a tailwind as we move forward into 2023 and beyond. And we do have some incremental investments in both Q3 and Q4. Those investments will either not occur in 2023 or be significantly lower. So to reiterate, the back half earnings power is not reflective of the base business because of the one-time items, I'll call them, that we have there.

Steve MacMillan
Chairman, President, and Chief Executive Officer at Hologic

And Vijay back to even -- building on the comment on the base business, I'd remind you in a couple of simple things here. We've not only passed through the full beat on top line and bottom line through the balance of the year. So the second half is every bit is intact as what it was prior, despite more headwinds, all of which should underscore the confidence that we have in our base business. And to Karleen's point, that is -- the fourth quarter is not the ongoing run rate.

Operator

We'll take our next question from Patrick Donnelly with Citi.

Patrick Donnelly
Analyst at Smith Barney Citigroup

Hey guys, thanks for taking the questions. Maybe a similar follow-up on that. I mean just on, in terms of the Breast Health ramp back up as we get into the beginning of '23, what's the visibility into the supply chain normalizing there? I mean the confidence level that kind of correct itself as we get into '23. So we think of it as more kind of slowly ramping back up and being a bit of a drag on revenue margins at the start of '23? Is the expenses -- kind of to Karleen's point, those are intact, growth is going to catch up, what's the right way to think about that as we look out to the start of '23?

Karleen Oberton
Chief Financial Officer at Hologic

Yes, I would say that I would expect it not to be compared to -- as we will see benefit from increased supply early in '23. But I think we'll see a point of normalization throughout the year, is what I would think would happen because even though we have building backlog, it's going to take multiple quarters to work through it as these installs of this equipment is highly scheduled, with hospitals and Breast Centers typically have to take the rooms down, its construction, as well as the install takes almost a week. So it's going to take several quarters to work through that. So, I would say a normalization over the course of the year.

Patrick Donnelly
Analyst at Smith Barney Citigroup

Okay, that's helpful. And then, Steve, on the capital allocation side, what's the right way to think about, obviously you guys have done some share repos, you've done some deals. How do you balance the priorities there? Obviously, the market is volatile and presents opportunities here and there, but what's the internal thinking? How largely you're going on the deal side? What does the pipeline look like? Just an update there would be helpful.

Steve MacMillan
Chairman, President, and Chief Executive Officer at Hologic

Yes, I think the biggest thought we should leave you with is we're comfortable being patient right now. Just because we have a very strong amount of cash on the balance sheet, doesn't mean we feel pressure to go do it in the next quarter or two. We know the deals will present themselves in the quarters or years ahead. And I was showing Karleen an old headline, the late '08 timeframe at Stryker where we were sitting on a pile of cash. And at the time I was being criticized for being too conservative, and opportunities presented themselves over the next few years. And I think we feel very confident and frankly should feel great. In an uncertain world, to be sitting with the balance sheet that we have relative to what we had 8 or 10 years ago in this company, and it just gives us the ability to be patient and therefore make great deals and continue to do a combination, some buybacks, but we still ultimately are looking and think there will be some good deals that will present themselves.

And we're not going to get into the specific size, but obviously we've got a fair amount on the balance sheet right now and it doesn't mean we're ready to go blow it all at once or anything else. I think we've been shown over the last five years or so. We're being very disciplined and rigorous.

Operator

Our next question from Puneet Souda with SVP VB Securities.

Puneet Souda
Analyst at SVB Leerink

Yes. Hi, Steve and Karleen. Thanks for taking the question. So maybe just the first one on some of the Panthers that you highlighted, the recent sales, are those still going into a demand for COVID or was that still a function of demand pull through in January from COVID or our customers are now looking at the broader menu and saying -- looking at Panther purchases from a broader menu perspective? Could you update us on any utilization trends? I know this is a major question in terms of the utilization of COVID conversion into other test, maybe just walk us through sort of what's happening as we somewhat emerge out of pandemic into this endemic situation?

Steve MacMillan
Chairman, President, and Chief Executive Officer at Hologic

Yes. The placements are really going for both COVID and new business. I think the magic for us is we've been able to expose Panther to so many new customers around the world and they've seen the benefits, both in COVID, and it's also given us the chance to talk about the menu and the expanded menu. So we're really getting them in on both fronts. And I think every time we start to see customers getting ready to port some of the newer assays onto their machines, we have yet another spike. And candidly, we would have expected more base business growth this quarter. And then lo and behold, we did another 28.5 million COVID tests.

As a reminder, that's as much as we were doing practically globally, more than what we were doing globally, pre-pandemic, on all of our businesses combined. So it's -- I think people have become dulled [Phonetic] to the numbers, but that has an impact in terms of our customers being able to adopt the other parts of the menu when again they just got thrown back into huge testing.

Now, I think as it plays out here in the coming quarters, we're assuming much, a much stronger and prolonged ramp down here in the COVID testing, that's going to really, that we believe allow, the underlying strength of our core menu to start to shine through and you'll start to see it in these quarters.

Puneet Souda
Analyst at SVB Leerink

Okay, that's helpful. And then just a one-off question that we've been getting from investors, given the China shut downs, anything that you're baking from that side into the guide? And maybe just could you -- if you could remind us your exposure there, both in terms of the revenue and impact of the supply chain? Thank you.

Karleen Oberton
Chief Financial Officer at Hologic

Yes, it's Karleen. I'll [Technical Issue] into that. So less than 3% of our revenue comes from China, so we have pretty minimal exposure. We do think there is some impact that is factored into our guide and we really don't have any manufacturing presence within China. I think what we're dealing with is the kind of global supply chain chips issue related to China. But from a revenue perspective, it's pretty immaterial.

Operator

We'll take our next question from Brian Weinstein with William Blair.

Brian Weinstein
Analyst at William Blair

Good afternoon. This is Christian on for Brian. Thanks for the questions. Just starting on continuing to talk about that old US strength [Phonetic], I guess specifically in diagnostics, historically, those markets [Technical Issue] less favorable reimbursement and just lower testing volumes with less screenings, and are you seeing any change in either of those dynamics as you think about the OUS outlook?

Steve MacMillan
Chairman, President, and Chief Executive Officer at Hologic

I think we see opportunities, again, over time to more directly influence the size of those markets and everything else. So I think what we do see in it in the near term is the ability with a lot of the additional Panthers we've placed to have more menu running through them. And then the second piece would be really helping to grow those markets more significantly over time. So I think we feel very encouraged short term from all placements, and longer term because of the strength that we've put in our teams. And frankly, the additional access we've gotten to a lot of the Health ministers of the world through both COVID time, as well as the Hologic global womens health index, to I think start to get womens health moved up the priority list where we will be able to get more screening guidelines and things put in place in the coming years, particularly in Western Europe.

Brian Weinstein
Analyst at William Blair

Okay. And then on the CT/NG you noted, we're back to pre-pandemic levels, any notable changes and how you think about the basis of competition here, pre-pandemic versus endemic starter [Phonetic] post pandemic, particularly with some of the point of care molecular entrance in the STI market?

Steve MacMillan
Chairman, President, and Chief Executive Officer at Hologic

Yes, we'll see where that all plays out. We're always very, very cognizant. But I think as we continue to think about how women are going to get these tests and the doctors and the reimbursements and everything else. I think we continue to feel very good about our position.

Karleen Oberton
Chief Financial Officer at Hologic

Yes, I would just emphasize that most of the CT/NG testing is asymptomatic. So when you think about at home testing, it would be generated by a symptom. Most -- vast majority of the testing is asymptomatic, and again, part of that well womens visit.

Operator

We'll take our next question from Tejas Savant with Morgan Stanley.

Tejas Savant
Analyst at Morgan Stanley

Hey guys, good evening. Just a follow-up on some of your earlier comments on the chip shortages and the Breast outside, Steve and Karleen, you spoke about that new allocation that you're expecting to see come through at the end of the second quarter, how -- can you quantify that relative to that 20% number that you had spoken off earlier? And in terms of seeing the benefit in fiscal '23, is this largely sort of outside your control or other things you can do to accelerate those timelines, perhaps looking into different suppliers, et cetera?

Karleen Oberton
Chief Financial Officer at Hologic

So in rough numbers, I think the increased allocation increased our expected unit production by about 20% to 25% in 2023. And I think from that initial -- hopefully, we'll get -- we just don't know. We don't have that visibility if that allocation gets any higher but that's what we're planning on right now.

Tejas Savant
Analyst at Morgan Stanley

Got it. And any comment, Karleen, on the possibility of new suppliers coming in here or is that sort of all incorporated into your fiscal '23 recovery commentary?

Karleen Oberton
Chief Financial Officer at Hologic

Yes. And what we know is kind of incorporated into the guide in our commentary. I think to try to bring on new suppliers would take multiple quarters. And I think the issue, the supply issue is not just our suppliers, it's all the suppliers. So it doesn't really solve the problem.

Operator

Our next question comes from Casey Woodring with JP Morgan.

Casey Woodring
Analyst at JP Morgan Cazenove

Hi guys, thanks for taking my question. Can you talk a little bit about Breast service and if there is maybe any kind of pull forward you could do there to offset some of the near-term gantry sort of headwinds?

Karleen Oberton
Chief Financial Officer at Hologic

Yes. So, Breast Services, a lot of our Breast service revenue is, I think that the common [Phonetic] was about 40% of the Breast revenue in the quarter, but that, most of that revenue, the majority is tied to long-term service contracts. So it's contracts that are over multiple years where the revenue is basically amortized over the contract period. And really it's tied to our installed base. So if we're not putting out more gantries, it's hard to do more service contracts. So that's really, that's more of a stabilizing factor in that division versus just limited ability to pull forward.

Steve MacMillan
Chairman, President, and Chief Executive Officer at Hologic

Yes. Nor would we want to pull it forward to be quite honest. Yes, I think what we love about that businesses is it's stable. And candidly, we've got all the additional COVID revenues this year. What we're really looking forward to is, people will start to see the underlying strength of our base businesses in 2023, and the last thing we would want to do is mortgage some of that.

Casey Woodring
Analyst at JP Morgan Cazenove

Got you. And then just how should we think about the Panther competitive environment in the hospital setting as it relates to some of these smaller benchtop platforms when you think about Cepheid and some of the other instruments out there with overlapping menu? Do hospital customers have both the Panther and a bench-top instrument and sort of how should we think about this dynamic moving forward, given all of the COVID placements?

Steve MacMillan
Chairman, President, and Chief Executive Officer at Hologic

Yes, many do, but there are still largely used differently. A lot of the benchtop stuff is really for symptomatic and especially respiratory or other symptomatic stuff, whereas ours is largely asymptomatic and ongoing screening. So I think this is going to be a question of and not or, and there is going to be meaningful opportunities on all fronts. I do think we are very well positioned and feel great about where we are with the Panther placements. So I think we're very confident. You're going to continue to see that. And that will unfold even more as the COVID revenue goes away.

Operator

Our next question comes from Mike Matson with Needham.

Mike Matson
Analyst at Needham & Company LLC

Hi, this is Joseph on for Mike. I guess maybe one around gross margins. Given the capacity expansion to really meet COVID testing during the surges, and as we start seeing that decline, we see the volumes decline, should we expect some type of a gross margin headwind in these next couple of quarters?

Karleen Oberton
Chief Financial Officer at Hologic

Well, certainly as COVID revenue comes down, the gross margins will come down from where they have been. But from an absorption perspective, our manufacturing of COVID is fungible with all of our molecular diagnostics manufacturing. This is not a separate COVID line where we'll have a -- you'd have to mothball, if you will. I think the other piece of what has happened over the last few years, as we have expanded our manufacturing, but that's been substantially funded by the Department of Defense and our contracts with them. So there's really no big hit, if you will, for idle capacity, if that was the question.

Mike Matson
Analyst at Needham & Company LLC

Yes, absolutely. That's very helpful. And then I guess maybe one more around the Panther systems. I know you guys have touched on that a lot. But as we're kind of looking towards that capacity utilization and non-COVID assays really going into these systems. I guess maybe there's been a lot of surges up and down, and obviously hospitals are very flushed, but I guess what are you guys looking forward to really push these forward, whether it be trainings that you guys have to schedule or whether it's just kind of waiting for total COVID cases to really reach a manageable level?

Steve MacMillan
Chairman, President, and Chief Executive Officer at Hologic

Yes, in terms of the base business, if that's the core, J, it's really around having the time to get the new assays up and running on the Panther within each hospital and each lab. But I would tell you, just from having, we're in our strategic plan process right now where we've been sitting down both with the US Diagnostic team, but also our international teams. And as we look at the optimism that they have for the underlying growth rates of our molecular business for the next few years, it gets pretty exciting. So we're not ready to give guidance or anything on that front. But I think there is just the additional placements and the additional opportunities. And don't underestimate in a world where labor constraints and labor costs have become a huge issue. I think people are forgetting, one of the massive benefits of the Panther is the workflow automation, the random batch access, this is -- the pen caps that we have. This is a remarkably efficient system that we think is only -- and that's part of what the customers are seeing and looking forward to the future. So I think it's going to bode very well for us.

Operator

We'll take our next question from Derik de Bruin with Bank of America.

Derik De Bruin
Analyst at Bank of America

Hey, good afternoon. Thanks for taking my question. Hey Steve, how do you feel about the long-term guide that you've set out? You put out that 5% to 7% core growth CAGAR, move 25 on the 3Q '21 call. And I'm just wondering, given the chip shortages, given you know what that is, I mean how do you, how is your confidence about it, looking at the results this quarter? I think some people are a little bit nervous, are you still comfortable with that 5% to 7% number?

Steve MacMillan
Chairman, President, and Chief Executive Officer at Hologic

Very. You know it's a long-term thing. Obviously, we did not anticipate the chip shortage. And having said that, you know what, think about what those growth rates are going to be when we index against these quarters next year. But even on a long-term basis, I think we feel very, very good about what the growth rates of our base businesses will probably be doing over the next couple of years. We've got a couple of punky quarters here right ahead of us to finish a year that's already a very strong year. And its -- growth rates as we start to look into '23, probably looking pretty good.

Derik De Bruin
Analyst at Bank of America

Okay. And as a placeholder for COVID for next year, that fourth quarter number, that $40 million to $50 million in flight recovery testing in Q4, is that a good way to sort of think about it just for now?

Steve MacMillan
Chairman, President, and Chief Executive Officer at Hologic

Yes, I almost don't even want to go there, Derik. The quarterly swings, who knows where it all goes? And I think we're poised either way. But I would put in a de minimis number for 2024 and yet, I think we'll certainly expect some volume just to continue to be there. So probably not a horrible estimate, but we're nowhere near being able to give guidance.

Operator

And we'll take our final question from Ryan Zimmerman with BTIG.

Ryan Zimmerman
Analyst at BTIG Research

Thanks for squeezing me in. I'll just keep it to one in the interest of time. So, on the Breast Health business, Steve or Karleen, we've seen from some of your peers on the equipment side, certainly commentary around softer demand, cost of debt is rising. You had alluded to the fact that the order book is pretty healthy or the backlogs healthy on the breast side. What do you attribute that to in terms of your capital equipment? Is it is a site of service? Is it price points relative to maybe some of the million dollar plus robots that are out there? Just be curious to understand kind of how you think about the capital equipment demand market at the hospital level?

Steve MacMillan
Chairman, President, and Chief Executive Officer at Hologic

Yes, I think it starts with always having a superior product and we have not gotten where we've gotten from a market share standpoint, particularly in Mammography and especially in 3D without having a superior product. And I think -- and also superior workflow throughout the whole gamut. And I think hospitals are seeing what we bring to them in a critically important area.

To your second point, and I will say, we're not of the high-ticket items. In a grand scheme, a hospital recapitalizing a few rooms in mammography or even several suites is nowhere near the magnitude of some of the bigger iron, the massive -- whether it's robots, MRIs and those kinds of things. So I think it does allow us to kind of be in a sweet spot where even if there is a little bit of capital contraction that we think we'll be fine there. And I think our team is feeling very, very good.

Ryan Zimmerman
Analyst at BTIG Research

Thank you.

Steve MacMillan
Chairman, President, and Chief Executive Officer at Hologic

All right, thank you. That sounds like it, operator? Lauren? Yes, sir, that concludes today's question-and-answer session. [Operator Closing Remarks].

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