Hologic Inc (HOLX) 2003 Q3 法說會逐字稿

Good afternoon. My name is Derek, and I will be your conference facilitator. At this time, I would like to welcome everyone to Cytyc third-quarter conference call. All lines have been placed on mute to prevent any background any background noise. After the speaker's remarks, there will be a question-and-answer period. (OPERATOR INSTRUCTIONS) I would now like to turn the call over to Ms. Anne Rivers. Please go ahead ma'am.

Thank you. Good evening, everyone, and welcome to Cytyc Corporation's third-quarter conference call. If anyone has not received a copy of the news release issued after today's close, please call the Roof (ph) Group at 646-536-7010, and one will be faxed to you. The following presentation will include forward-looking statements within the meaning of the Federal Securities Laws, including statements about the Company's expected sales performance, operating results, financial condition and business strategy. These statements are subject to a number of risks and uncertainties, including those detailed in the Company's press release issued today and in its form 10-K and other filings with the Securities and Exchange Commission, that could cause actual results and outcomes to differ materially from those projected in the forward-looking statements. Please remember that these statements speak only as of today's date and that you should not place undue reliance on them. In addition, please note that this call is being recorded by Cytyc Corporation, and is copyrighted material that cannot be rerecorded or rebroadcast without the Company's express permission. And your participation implies consent to our taping. With that, I would like to turn the call over to Patrick Sullivan, Chairman, President and Chief Executive Officer of Cytyc Corporation.

Good evening, ladies and gentlemen. This is Patrick Sullivan. I would like to welcome you to our teleconference to report on the performance of the Company for the third quarter of 2003. Joining me on the call today are Dan Levangie, President and CEO of Cytyc Health Corporation, Bob Bowen, Cytyc's C.F.O., and Chris Black, our V.P. of Commercial Operations. During this evening's call, I will provide an overview of the business quarter and then turn the call over Bob for more detail on our financial performance. Chris will then provide an update on the core ThinPrep business, followed by Dan providing an update on the FirstCyte breast test.

Overall, I am very pleased with the Company's performance during the third quarter. As noted in our press release, revenues for the third quarter of 2003 were $75.5 million, which associated net earnings of 18.6 million or 17 cents per diluted share. Our core business remains very strong, and we are very excited about the progress we are making on our growth initiatives.

We received FDA approval for our ThinPrep imaging system on June the 6th, and shipped in the first imaging system to Columbia Presbyterian in New York. To date, we have received purchase orders for a total of 17 units. Of these units, six shipped during the third quarter, which is one ahead of schedule and four shipped in October. We continue to scale up manufacturing with the objective of installing 20 systems in 2003 and 100 additional systems in 2004. We are very excited about the commercial opportunity this product represents, as it has the potential to double the size of our existing business and further solidify our relationships with our customers. As you know, CMS has established a reimbursement amount of $37 for the imaging probe, 9 dollars above the existing reimbursement for the ThinPrep pap test. We have conducted a preliminary survey of insurance carriers, and believe that around 125 million covered lives are covered with favorable reimbursement for the ThinPrep imaging system.

We are marketing the ThinPrep system on a recurring or price per test business basis. If you take these 120 instruments that we expect to place by the end of 2004, this product represents a $40 to $50 million in incremental revenue for the company in 2005. On our international initiatives, we are focused on increasing sales in Europe and encouraged by the recently recent information released this morning, regarding the implementation of LBC (ph), the Cytyc pioneered in the United Kingdom. The guidance issued by Nice (ph) marks the completion of the evaluation process we started nearly four years ago. Throughout this thorough clinical and cost analysis, the performance of the ThinPrep Pap test clearly demonstrated why it has become the standard for cervical cancer screening in the US.

In March of 2002, the Scottish Executive announced a major investment in the Scottish cervical screening program to implement LBC (ph). Since that announcement, Scotland is converting exclusively to the ThinPrep Pap test. We welcome the opportunity to establish the ThinPrep Pap test as a standard of care in the UK and throughout Europe. Our FirstCyte breast test continues to gain momentum through the medical community. As Dan will describe later, we are engaged in the conduct of a three-year clinical trial for that product, and have shifted some of our commercial experts from FirstCyte to directly impact the ThinPrep imaging system. While we remain enthusiastic about the product, we believe significant adoption will require the initial results of this clinical trial.

In conjunction with this realignment of resources, we have fully integrated the FirstCyte business into our core organization, and in line with this change, Dan will now oversee commercial operations for the entire company worldwide. During the third quarter, our cash and cash equivalents decreased by 19.5 million dollars to 172.7 million after repurchasing 389 point five thousand (ph) shares of Cytyc common stocks with $5 million in cash. I would like to now turn the call over Bob for the financial highlights of the third quarter. Bob?

Thank you, Pat. My remarks today will largely compare the financial results of the third quarter of 2003 with the results of the third quarter 2002. I will also provide select comparisons to the second quarter of 2003. Additionally, I will be giving guidance for the fourth quarter and full year 2003, as well as for 2004. In compliance with the SEC's regulation FD, this guidance is being disseminated simultaneously to all parties. Further, as noted at the outset of this conference call, listeners are cautioned that the Company's guidance is forward-looking in nature and subject to risks and uncertainties which could cause actual results to differ, including without limitation the risks detailed in the press release we issued earlier today and in our SEC filings, including our 2002 10-K.

Total worldwide revenue for the third quarter of 2003 was 75.5 million -- an increase of 16.9 million or 29 percent from the third quarter of 2002. Domestic revenues totaled 67.7 million -- an increase of 13.8 million or 26 percent. And international revenues totaled 7.8 million -- an increase of 3.1 million or 68 percent. The weaker dollar accounted for approximately .7 million of the 3.1 million international revenue increase. Excluding the effects of varying exchange rates, international revenues were up 54 percent. Revenue from domestic shipments of ThinPrep T2000 and T3000 instruments was approximately .9 million. And we sold 44 new instruments in the third quarter. We believe T2000 and T3000 instrument revenues will be approximately one million for quarter through 2004.

Revenue from domestic shipments of the non-GYN products was approximately 2.3 million and was 9 percent higher than the third quarter of 2002. On a year-to-date basis, non-GYN revenue is up 15 percent from the prior year. Revenue from domestic sales of ThinPrep pap tests was approximately 63 million -- an increase of 14.6 million or 30 percent from last year's third quarter. Average selling prices were essentially flat. They increased one penny. And shipments volume levels, which were just shy of 9 million tests, increased 30 percent. The third quarter ThinPrep pap test revenues of 63.0 million compared to second quarter ThinPrep pap test revenues of 63.6 million. Third quarter volume of nearly 9 million tests was a 1 percent from second quarter volume levels of nearly 8.9 million tests.

Average selling price changes in Q3 compared to Q2 were largely accounted for by the new contract request, which was effective on May 1st, 2003. As such, we had three months of new contract pricing in Q3 and two months of new contract pricing in Q2. Large accounts including Quest, Lab Core, Ameripap (ph), the Army, Navy and Air Force, PSA (ph) and JVHL (ph), equaled 57 percent of total ThinPrep pap test shipments in both the second and third quarters of 2003.

Selective (ph) Labs indicated they experienced seasonal weaknesses in July and August. The usage data we receive monthly from Quest (ph) and Lab Core, indicates growing ThinPrep pap test usage levels at those two accounts. In addition, since the early part of this year, we have been tracking usage levels at a sample of the "all other" customer segment. The usage data taken during the first, second and third quarter represents approximately 10 percent of T2000 and T3000 instruments placed in this segment. The data suggests an increased usage in the second collection period versus the first of 7 to 8 percent. Lastly, I would note that the order level from the Navy was about 50,000 tests lower than in previous quarters. And we believe the order level will revert to the norm in Q4. We believe test volume will grow on average at the rate of 100,000 to 300,000 tests per quarter, with relatively stable average pricing through 2004.

Third quarter revenue from all other products, including the FirstCyte breast test, service and accessories totaled 1.4 million, compared to 1.8 million last year. The co-marketing agreement with Digene ended June 30th, 2003, which accounts for the difference in sales. The third-quarter gross margin rate of 81.4 percent was up 1.4 points from last year's third quarter, due to increased sales of the ThinPrep pap test, our highest margin product, as well as stronger margins internationally. Operating expenses of 31.2 million were 6. million or 24 percent higher than last year. Research and development expenses of 4.2 million were one million higher, due largely to spending levels on the ThinPrep imaging system, as well as clinical activities related to the FirstCyte breast test. Sales and marketing expense of 20.2 million was 4.9 million higher, due to higher international expenses, attributable in part to the translation effects of stronger foreign currencies compared to the U.S. dollar, expenses related to the commercialization of the FirstCyte breast test and expenses related to the ThinPrep lunch. G&A expenses of 6.8 million were up 3 percent from the 6.6 million in the third quarter 2002. Operating margins of 30.2 million or 40 percent of sales compared to operating margins of 21.7 million or 37.1 percent of sales in the comparable period of 2002.

The effective tax rate in this quarter was recorded at approximately 39 percent. We believe this rate will hold through 2004. Third-quarter earnings of 18.6 million were 34 percent higher than last year's earnings of 13.9 million. And fully diluted earnings per share of 17 cents were up 55 percent from the 11 cents per diluted share last year. For the September year-to-date period, revenues increased 32 percent to 224.8 million. Earnings increased 89 percent to 56.7 million and fully-diluted earnings per share increased 108 percent to 50 cents. September 2002 year-to-date earnings include 3.8 million of after-tax expenses or 3 cents per share for cost related to the terminated Digene transaction.

We believe fourth-quarter 2003 revenues will be in the range of 77 to 79 million with fully-diluted earnings per share of 17 cents. For the full year, we believe revenue will be between 302 and 304 million, with fully diluted earnings per share of approximately 67 cents. This represents stronger fully-diluted earnings per share performance than we indicated in our last conference call, which reflected a total year earnings per share range between 64 and 66 cents.

Turning to the balance sheet. Accounts receivable totaled 41.2 million -- 6.5 million or 19 percent higher than the third quarter 2002. While year-over-year revenues increased 29 percent. Day sales outstanding of 49 days compared to 53 days at the end of the third quarter 2002. Inventory levels of 15.3 million increased 3.9 million due largely to image reproduction. Internal growth (ph) was essentially flat at 4.3 turns. During the third quarter, our cash and cash equivalents increased by 19.5 million to 172.7 million after repurchasing 389.5 thousand shares of Cytyc Stock for a total value of 5 million. As of the end of the third quarter, we have repurchased approximately 14.5 million shares of Cytyc Stock -- nearly 12 percent of common shares outstanding at the start of our repurchase program at a total repurchase cost of approximately 148 million.

As we look to 2004, we are highly enthusiastic about establishing the installed base of ThinPrep imaging systems that will form the foundation of our next significant leg of growth. Our primary market includes the laboratories that process an excess of 25,000 test per year. These are lab customers we know well and who are largely current users of the ThinPrep pap test. This segment of the market represents about 250 labs, which in total process approximately 40 million tests annually. Assuming the average utilization rate of the imager is 50,000 tests per year, the unit placement opportunity over the next several years is about 800 units -- 40 million tests at 50,000 tests per instrument placed. We shipped 6 units in the third quarter and target to ship 20 year end and an additional 100 units in 2004. In total about 120 units by the end of 2004, which will process, on average, 6 million tests -- 50,000 tests each on 120 units.

Our models currently assume there is a ninety-day lag from shipment to final customer acceptance and start of revenue recognition. The work that takes place during this ninety-day period includes customer adoption of and training on a new proprietary stain (technical difficulty) installation and training and customer validation upon receipt of the final customer acceptance certificate, the current ThinPrep pap test disposable pricing will adjust to a new contract rate. 2004 will be the first full-calendar year of image replacement. And as such, our revenues will grow as shipments, installation and customer acceptances occur. Based on our current view of the image replacement ramp, we believe 2004 incremental revenues from imagers will range between 7 and 14 million.

We are off to a very good start. The contracts that have been signed to date should generate in the range of $4 to $5 million of revenue in 2004. We expect our core domestic ThinPrep pap test business to continue to grow through 2004 at the rate, on average, of 100 to 300 tests per quarter. On an annualized basis we currently ship approximately 36 million tests at an annualized revenue level of 252 million. For 2004, we believe our domestic ThinPrep Pap test revenue will be in the range of 270 to 275 million and represent unit shipments of 38 to 39 million tests. Outside the United States, we expect to grow at 25 to 30 percent per year. Our international revenues this year will be about 30 million, and we believe next year will be in the $38 to $40 million range. We believe about 30 percent of the increase in revenue will be attributable to the UK conversion and the remainder driven by growth in other markets.

We expect the balance of our revenues, which include T2 and T3 instruments, non-GYN disposables, the FirstCyte breast test, service and accessories will be in the $20 to $20 million range in 2004, about the same level as this year's level. Taken together, we believe revenues for 2004 will be in the range of 335 to 350 million. We expect our gross margin rates to be in the range of 78 to 79 percent during 2004, as we continue to build our service and manufacturing organization to support the imager plan. In addition, we believe our international business, which has gross margin rates in the range of 65 to 70 percent, will grow faster than the domestic business in 2004.

We're targeting our total year operating profit rate in the range of 40 to 41 percent, and expect the operating profit to be somewhat higher in the second half than the first as imager placements gained revenue momentum. If we stay on our plans, we believe 2004 fully-diluted earnings per share will be in the range of 75 to 79 cents. At present, we expect fully-diluted earnings per share in Q1 of 2004 at approximately -- at about 17 cents and improving as imager revenues grow. We expect to continue to deliver strong cash flow performance. Net of working-capital requirements, capital expenditures and funds required to support image replacements, we expect to generate cash of approximately 40 to 50 million.

As we have indicated in the past, our current cash balance of 173 million -- plus incremental cash generated -- is likely to be used for strategic investments or to repurchase Cytyc Stock. We believe the imager presents tremendous opportunity. And we also are extremely encouraged by the opportunities we see outside the United States. We believe these two growth platforms, along with the domestic ThinPrep Pap test business, have the ability to deliver annual earnings growth in the range of 18 to 20 percent over the next three years. I would now like to turn the call to Chris Black.

Chris Black; Thanks, Bob. The fundamentals of the core ThinPrep Pap test business are very strong, and we continue to make progress against the conventional Pap smear as we establish the ThinPrep Pap test as the preferred method of cervical cancer screening. Physicians continue to utilize the ThinPrep Pap test based on the wealth of clinical data, the FDA-approved indications and their own clinical experience. In August of this year, the American college of obstetricians and gynecologists issued a A-cog (ph) practice bulletin, regarding clinical management guidelines for cervical cancer screening.

Cervical cancer screening remains the only recommended screening method based on good and consistent scientific evidence, Level A. The guidelines state that performing multiple screening tests at regular intervals remains the best way to insure existing pre-malignant, cervical disease has been ruled out. The report also goes on to say that according to the FDA-required labeling, the ThinPrep technique may be marketed as better able to detect low cell (ph) and high cell (ph) than the conventional test. According to A-cog (ph), cervical cytology screening is, in many respects, the ideal screening test. In addition, during the quarter, our lab sales team continues to focus on lab standardization. As we have reported, lab standardization means that a laboratory has decided that based on clinical data and their own in-house experience, the full 100 percent conversion to the ThinPrep Pap test is in the best interests of the lab laboratory, their physician clients and patients being tested. Since the beginning of last year, 182 labs have issued standardization letters. This is an additional 10 standardization letters over the prior quarter.

We believe another indicator of increasing conversion is ThinPrep instrument placements. During the quarter, we placed an additional 68 instruments worldwide. This brings the total worldwide installed base of ThinPrep instruments to more than 2600. Our lab sales team will continue to focus on this objective, which we believe will continue to drive conversion. During the third quarter, we placed new T2000 instruments in 32 new customers, which represents approximately 200,000 tests on an annualized basis. We are very excited about the recent approval by the FDA for the ThinPrep imaging system. The ThinPrep imaging system will allow laboratories to benefit from improved sensitivity and specificity compared to manually-reviewed ThinPrep slides and increase their productivity. On June 16th, 2003, we announced the first shipment of ThinPrep imaging system to Columbia Presbyterian Medical Center in New York. Since that time we have placed an additional 8 ThinPrep imaging systems in the U.S. and one international -- internationally -- for a total of 10 placement since approval. We have 32 letters of intent, and we are negotiating numerous contract with current ThinPrep Pap test customers.

We are very encouraged with our early success and received purchase orders for a total of the 17 imaging systems. As previously reported, we received confirmation from the American Medical Association EPT committee that the ThinPrep imaging system qualifies for the new CPT code 88-175. The code has been established for computer-assisted screening, with manual prescreening under physician review. The code allows for an increase in CMS reimbursement from approximately $28 to $37 per test. We will be working with individual payers and laboratories to establish the new code and reimbursement level. We have confirmed that approximately 125 million lives are currently covered by payers that have established favorable reimbursement in the United States.

As Pat mentioned, the ThinPrep imaging system has the potential to double our current business. Cytyc International performed well in the third quarter, with a significant increase in the number of ThinPrep Pap test versus the same period last year. As we announced earlier today, The National Institute for Clinical Excellence, or our NICE, has issued guidance recommending that liquid-based cytology be used as the primary means to process samples for cervical cancer screening programs in England and Wales. NICE provides national guidance on treatment and care for those using the NHS in England and Wales. The NHS provides cervical cancer screening for approximately 4.5 million women annually. We entered into this evaluation nearly four years ago, and we are extremely pleased with the outcome. The clinical and cost benefits of the ThinPrep pap test were clearly demonstrated in this extensive analysis. Given the clinical performance of our technology and the unique strength of our infrastructure in Cytyc UK Ltd, we believe we are extremely well-positioned to exceed -- achieve a significant market share in England and Wales. The rollout to the training schools will begin in April of 2004. And we are currently in 10 of the 12 training schools. In March of last year -- in March of this year, the Scottish government announced a major investment in Scottish cervical screening programs to implement LBC. Since that time, Scotland is converting exclusively on the ThinPrep Pap test. The implementation of the Scottish cervical screening program with the ThinPrep Pap test is nearly complete, and is a strong contributor of results. At this time, I would like to turn the call over to Dan.

Thanks, Chris. As we have discussed on previous calls, the cornerstone of our efforts to increase utilization of the FirstCyte breast test as a focused clinical-referral center strategy that capitalizes on the structure and experience of Cytyc sales and marketing organization. As of this time, we have established partnerships with 100 breast centers throughout the United States. Each of the centers is in a different stage of rollout, with some being fully up and running and operational while others are in the early stage of development. We continue to work with each of these centers to announce their partnership with Cytyc to their referring clinicians, to incorporate FirstCyte into their risk-assessment protocol, to customize risk-assessment educational materials for the clinicians, and to generally prepare for increased patient referral and use of the test.

A number of these centers have scheduled or conducted local, medical education events, and most importantly, have begun to see referrals already from community-based physicians who are conducting risk assessment discussions with their patients and recommending further evaluation for those with increased breast cancer risks. During the quarter, we trained an additional 27 centers to perform the FirstCyte breast test, bringing that total to 338. Further, four additional labs were trained during the quarter to interpret FirstCyte specimens, bringing the total to 188 laboratories.

On the reimbursement front, we continue to make progress during the quarter with coverage policies announced by Geisinger (ph) Healthcare in Pennsylvania and HSMA in Hawaii. Together these plans represent an additional one million-covered lives, bringing the total covered lives to almost 40 million. During the quarter, we completed investigator agreements, and received IRV approval at a number of sites for our pivotal clinical trial of FirstCyte called the seed trial. The seed trial, which stands for serial evaluation of ductal epithelium (ph), is a long-term outcome study designed to define more clearly the value of Lavage(ph) cytology in high-risk women and their outcomes. We believe the results of this study will allow a series of publications and FDA-label claims that will serve as a springboard for widespread use.

In this trial, high-risk women will undergo ductal lavage (ph) every six months for a period of three years. We will follow these women for a period of two years, following the initial three years of active enrollment. And the result will be a statistically valid understanding of the value of benign cytologic results in high-risk women -- a question which we routinely encounter in the market. We will also clearly understand the predictive value of an abnormal lavage (ph) result at the conclusion of this trial and will thus answer another routinely-asked question. We believe that our investment in this large multi-institutional control study will build the foundation necessary for commercial success. We look forward to beginning patient enrollment in the near future. I would now like to turn the call back to Pat.

Thanks, Dan. Operator, if I could now open the call for questions.

+++ q-and-a.

(OPERATOR INSTRUCTIONS) We will pause for just a moment to compile the Q&A roster. Your first question comes from Glen Reeson(ph) with Morgan Stanley.

(indiscernible) Jason is at different location, so he may be calling in, as well. Can you just maybe just simplify things for me a tad and just sort of tell us what has changed from Q2 to Q3? The bottom line --- it doesn't look like you have any problems making. The top line was a little bit light this quarter relative to guidance. Fourth quarter also looks like relative to previous guidance, but next year actually looks okay. So maybe you can just sort of synthesize stuff and talk about the top line and maybe how the bottom line has also evolved over the last 90 days.

Hey, Glen, this is Bob Bowen. I think I'll take this one. If you look at Q3 versus Q2, it's largely top line. Everything else was very much spending -- margin rates were all very much in order. Our core ThinPrep pap test business delivered $63 million in revenue in Q3 and 63.6 million in Q2, so it was down a little bit. Volume was up a little bit. Pricing was down a little of bit. It was on balance pretty much a flat quarter. We think this is because of seasonality that we saw in July and August at selected labs. I would, however, mention -- and I tried to articulate in my comments -- that to the extent that we've been able to collect data around underlying usage levels, we see that the usage levels are still -- look to be still pretty strong. Both Lab Core and Quest continue to grow their usage in the third quarter versus the second. We get usage numbers from them on a monthly basis. And we've conducted a sampling of about 10 percent of the "all other" segment which shows about a 7 percent increase in usage levels. So whether there was some timing of ordering leading into the summer or ordering not catching up following people coming back from vacation, it's hard to say. But we think the underlying usage is pretty good.

The other thing that impacted Q3 versus Q2 is the Quest new contract. We had two months worth of new contract pricing in Q2 and three full months in Q3, so the price points were down in Q3 largely as a result of that full-quarter impact of new pricing on Quest. Other than that, our instrument T2000, T3000 instrument sales were about 300,000 lower in Q3 than Q2. I don't see that as being a big issue. That number tends to move around from quarter to quarter, in any event, between a million and a million and half. And the Digene co-promotion agreement ended in Q2. We had about $.5 million worth of revenue in Q2 from the Digene co-promotion, and we have essentially zero in Q3. So we've got minus .5 million in ThinPrep pap test -- minus .5 million as a result of co-promotions and minus 300,000 as a result of the lower instrument revenue.

Just let me push you on two items. I'm going back to my notes from last quarter. You were saying you were looking for this quarter at 77 to 79 million and then 300 to 315 million for the year. That sounds to me like it's not just a third-quarter seasonality issue that you, in fact, are coming in on the lower end on the top line, at least in the fourth quarter as well. So and now maybe you can explain little bit?

Well, I think the question -- if I understand your question -- it's why isn't the fourth quarter stronger if it's just seasonality in Q3?

Correct.

We are -- frankly, it's just caution. It may very well be. But -- (multiple speakers)

Does it share anything on Tripath (ph) side or --? (multiple speakers)

No, we don't believe it's --

Well, as I say, from Lab Core and Quest, our usage -- the utilization is up. We know that by fact because it's data they provide to us. And we do not believe it's share in the "all other" accounts segment. As I indicated, the sample that has been done -- which we think is a pretty good sample -- shows increased utilization at the end-user level.

The other thing I would say, Glenn, is that what we're talking about here -- we shipped 9 million tests -- we're talking about 100,000 tests difference, which would be the equivalent of $700,000 or $800,000. So it's about one day's worth of shipments that were off here, one way or the other.

What about just higher (multiple speakers) what about just higher copayments as having indication (indiscernible) -- having an impact on volumes?

I have no reason to believe that that is the case.

Okay, and then the last question then -- can you talk a little bit about this gross margin in the quarter -- very good, but you're not indicating that that's necessarily a sustainable number.

Well, we think that as we move into '04, we are building out our service organization, which is part of our cost of goods sold, to support the image replacements. And those costs will be incurred in advance of the revenue from the imagers because of a lag between shipment and installation and ultimately revenue generation on this recurring-model basis. And we're also building out, to some extent, our manufacturing organizations. So as we actually indicated on our call last quarter, we are incurring some imager-launch costs upfront in order to support what we think is going to be a very healthy growth rate in '04 and into '05.

Okay. Thank you very much. I will let Jason play good guy now.

Your next question comes from Tom Gunderson with Piper Jaffray.

Hi. If we just take a look at -- maybe at 30,000 foot level -- U.S. is reaching saturation just at the same time that you're kicking in with a lot of conversions of good things internationally and at the same time the FDA just comes in with the imager which could double sales. Is that a fair way of looking at it just in the big picture?

Yes, it is. But we still believe that we are going to grow the ThinPrep conversion by 100,000 to 300,000 tests per quarter going forward. So we're not tapped out yet. The way I think about it, Tom, is we've got a new S. technology -- S-curve that is up and to right of the ThinPrep, and as we reach higher in that S-curve, the imaging system and the international initiatives are kicking in with a new technology S-curve.

And the service build-up that you have to do that kind of gets caught into the cost of goods sold -- that eventually -- we can think of that almost as a one-time right? I mean over the course of two years, you need to train everybody. But the 80-20 rule would tell you that the big guys -- most important guys -- are going to be done and up and on their own after two years. Is that a true statement?

Yes. That's a cost that will flatten out. Yes.

And we're hiring probably six months ahead of requirements on the service side.

Alright. And then on the sales going down -- and you and Glen and the whole conference call kind of went through it -- but it is the first time it's been down sequentially since '97 except for hiccup kinds of things. What the naysayers are going to say -- and I just want to make sure we've got this straight -- what the naysayers will say is, hey, Tripath (ph) is out there -- you say, "No," can you give us some evidence of why you think not other than usage, salespeople aren't coming in and saying, gee, you know, we have got a ThinPrep machine here, so don't expect my numbers to be as high? And secondly, there's going to be -- and I just want to hear your reaction to this -- there's going to be naysayers saying, well, gee, this is just a change in the medicine of pap smears and women are coming in less frequently.

This is Chris Black. Let me answer the last one first. We haven't seen any evidence that the interval is changing at all based on any guidelines or the approval of the DNA (ph) Pap. In fact, all of the research that we have done has said, counter to that, that medical practice is going to change a lot more slowly, and they're going to need a lot more data to execute those changes. And although there may be some beneficial or favorable impact relative to insurance carriers, now adding that to their covered benefit -- the ability to manage intervals from the payor or from the doctor, it's probably going to be a number of years away. On the Tripath side -- or the competitive accounts -- this quarter we closed on 32 new accounts -- a number of those were competitive-bidding situations. A number of them were going after conventional pap smears. We continue to fill the bucket. It's very competitive out there. We have a competitor on every call. However, we don't believe that we are losing to the rate where fundamentally we're going to go down overtime. In fact, we believe our close rate is increasing overtime when you look quarter over quarter.

Okay. And then, Dan, on the clinical trial on SEED -- if I'm reading this right -- maybe get enrollment up and going in a year, maybe a little bit longer, and then three years of testing and two years follow-up?

Yes, we would hope to a complete enrollment sometime around the third quarter of next year and then once those patients are in they have two -- they have two more years of -- active follow-up where Levage (ph) is performed. And then we passively follow-up for two years after that. We will have good data about midway through, we believe. So about a year and a half, we'll have some information to look at and to begin to talk about.

What would be -- can you just give the end (ph) and the primary endpoint?

Yes, total of 850 patients -- all with risk scores that are above 1.7 on the GALE (ph) index. The outcomes that we are looking at are -- the development of cancer.

Breast cancer?

Yes.

Okay. Thanks. That takes care of it for now. I will get back in queue.

Your next question comes from Jason Woodey (ph) with Morgan Stanley.

Mr. Woodey, your line is open.

Sounds like he is on cell phone. Go to the next one, operator.

Your next question comes from David Lewis with Thomas Weisel Partners.

Hey, Bob, I wonder if I can get a couple of quick follow-up items here. In the first quarter, you mentioned Large (ph) Labs constituting 51 percent of shipments, second quarter 50 percent of shipments and this quarter you mentioned 57 percent of shipments. I just one to make sure those numbers are apples-to-apples. I mean, I'm having a hard time reconciling how Large (ph) Labs could constitute 57 percent but gross margins be so strong.

Okay. So the Large (ph) -- let me, we might have a slightly different array here, David. Let me tell who is in the group, and I'll give you the numbers that you're looking for. Quest, Lab Core, Ameripap(ph), Army, Navy, Air Force PSA and JVHL. 57 percent in Q3 and Q2. 58 percent in Q1.

Okay, so it went 58, 57 and what was this quarter -- another times 57 again?

Yes.

Okay, so what you have essentially done is, instead of just having the big commercial reference labs, you're adding in Army, Navy, JDHL? As opposed to historically we used to talk about the B-labs?

Right, because there's been so much consolidation, we have added Army, Navy, Air Force, PSA and JDHL, and replaced what had been Uni (ph) Lab, APL, AML.

Okay. And you also mentioned the second quarter -- that Large (ph) Labs grew roughly 7 to 9 percent versus small labs growing 11 to 13 percent. Do have those growth rates, Bob?

Versus last year?

Versus -- there was a second quarter number. I assume that was year-over-year when you gave them -- do you have this (indiscernible) the third quarter?

Okay. So large labs were essential essentially flat. And small labs were up 2.3 percent.

Okay. So slight that (ph) -- if the small labs are growing slightly higher, does that explain the better-than-expected gross margins?

That's part of it. We get part of our pricing -- it's part of it as the small labs have better pricing than the larger labs. Sure.

Okay. Great. And looking to 2004 -- I want to make sure that I did these numbers straight -- I believe this 36 million test number, was that a current a PTM number like (indiscernible) twelve-month number or annualized number or --?

The 9 million tests this quarter times 4.

Okay, great, that's 36 million, and for 2004, we're talking about 38 to 39. So, if my math's correct, that basically assumes your current market share in the low-70 percent in this country and then next year kind of going to high-70's -- kind of 77 percent or something like 1 to 1.2 percentage points per quarter. Is that close or --?

That's right. That's right.

Okay. Great. And you think that's basically 7 percent market share for the next four to five quarters and you think that's pretty reasonable?

Yes.

Okay. Great. And then maybe a question for Pat. Pat, you mentioned that revenue because of the imager -- the S-curve -- could double. Is there a timeframe? Where revenue could double due to the imager?

We think the next three to five years we can double revenue. I'm very encouraged about where we are right now. When we put out the goal of 5 units by the end of September, I think the organization has responded very positively, as well as customers. We're one ahead. It may seem like a little bit but it actually -- you know, getting extra units this early in manufacturing process is quite remarkable from the organization's perspective. And it does have the opportunity, based upon the 9 dollar-incremental reimbursement and the price points that we are charging the laboratories, to double the size of the business. And the purchase orders Chris talked about are coming in at price points that have the ability to do that.

Okay. And while you are looking at -- hospitals are very enthusiastic about the imager. And they mention two key points. One, obviously increasing through-put (ph) and secondarily, they can make more money. The one thing we have not heard is that they can improve clinical medicine. And I guess from a managed-care perspective, do you think it's possible that over time managed care is going to allow us to add another 700 to $1 billion to the screening budge for cervical cancer, given there's no improvement in clinical benefit. So is it possible to double our sales over the next three to five years if managed care cannot stand up for that? Or do you think you will see some managed care pricing pressure as the imager gets more and more traction.

That's a pretty complex question. Let me it go (ph) to Chris Black.

Chris Black (indiscernible) Where we are at with our package insert, we do have an improved sensitivity and specificity claims. In fact, there was about a 40 percent reduction in the false negative rate in the clinical trial when you looked at both the image slides and the slides that were manually reviewed without the imager. And the clinical trial that was in as part of our package insert is really the first phase of data. If you go back when ThinPrep was first approved, there has been numerous clinical trials with increased performance compared to our package insert. So we really believe that as time goes on and people have experience with the imager, the ability to improve upon that reduction in the false negative rate and defending that story for improved quality in diagnostic confidence, in fact can happen. But already our managed care coverage in the U.S. today on 88-142 for ThinPrep is about -- is somewhere between 235 million and 240 million. And at this early stage, we are at 125 million covered lives already.

And I think further, David, the Medicare rate that was set, was done as part of a public process that was gone through in August and November of 2002, where CMS held a public meeting that was participated by the College of American Pathologist (ph), American Clinical Lab Association, American Society of Cytopathology (ph) and other interested parties (indiscernible) established the program memorandum amount. And as a result of that open hearing and the hearing that they had at CMS, they established the 9 dollars.

Okay.

We think it will hold.

Okay. Great. And then Bob one more last question. You gave some really nice granularity on -- from a unit standpoint, how we should build-up the imager business for next year. Should we be modeling something like a 4 to 5 dollar price point to Cytyc per pap image?

We're not going to talk at this early stage about the pricing per test for commercial reasons, David. We're tremendously pleased by what we're seeing relative to the list price of 9 dollars. And as Pat mentioned, we think that those price point levels and the volume levels we are talking about, we can get pretty close to doubling the size of the business.

Great. But for all intensive (ph) purposes, this is going to be (indiscernible) rental or a per click model -- very, very little CapEx spending by the hospitals anticipated?

Yes.

Yes.

Great. Thank you so much. I will jump back in queue.

Your next question comes from Wade King with Wells Fargo Securities.

Hi, guys, can you hear me? My condolences on the Red Sox. (laughter) (multiple speakers) First, question for Bob. You know, Bob, thanks for the detail. The only thing I didn't hear you break out was international instruments versus disposables.

Our disposables are about 85 percent of international sales.

Okay. And is the non-GYN part of the disposables internationally of significance or (indiscernible) was that respectively (ph) all ThinPrep pap?

I included the non-GYN in that 85 percent number.

Okay. Very good. Thanks for the ongoing detail on the imager. Can you kindly (ph) given your test (ph) of first imager at Columbia Presbyterian at the end of the second quarter and then obviously the ninety-day period we've been aware of until the customer does validation and training with the new stain (ph). Thus, the timing is such that I would think that Cytyc would start to be paid by the first imager's place very soon or should have begun around the first of this month. So are any of the imagers now signed off by the customers and then paying the Company?

We have one customer acceptance at this point of (inaudible) ship.

Okay.

And, Wade, I think to your other point. There is currently a ninety-day lag time between instrument shipment and recognition of revenue or acceptance by the customer. And we have active programs. It's our goal to reduce that to 30 days beginning early next year.

And the items involved once the unit is shipped is obviously -- just tell me if I miss anything -- installation, training of the Web (ph) Test on the stains, some throughput (ph), understanding on the part of the lab, some local validation, if appropriate, and then turn on the juice once they give you the acceptance letter, is that right?

You got it.

And Pat from that time on should we -- I know there's been discussions in the past about the various scale up of volume of slides processed once the customer send you the acceptance letter. It sounded like, though, from the comments earlier that once that happens, you're actually billing a 100 percent of their volume at the increased revenue level for Cytyc. Is that right or will they actually scale up the volume of slides imaged once they sign-off on the imager? The customer acceptance letter, will they scale it up one-third, two-thirds, 90 percent, what not over several months? What actually happens?

It's our expectation that they would -- after they go through the initial process, start a pretty rapid acceleration of conversion to the imaging system, and basically do all of their slides on the imaging systems since they're going to get in an incremental reimbursement on those slides imaged.

But is that something you are controlling -- in other words, once they sign-off, are you billing 100 percent of the volume at the higher level or are you allowing them time to scale it up according to their plan versus yours?

Yes. The way it will work -- the way that is working, Wade, is that the actual disposables that we shipped to the imaging sites contain a ThinPrep slide that is special because it has fiducial (ph) marks and that kit will be different than the existing ThinPrep slide kit, and they will order those for use on the imaging system.

So once again -- (multiple speakers)

They may have a couple weeks of so of inventory of the core existing slides that they'll work through. But the new disposables that they order -- once they have an imager placed -- will be billed at the higher contract rate. And the expectation is that they will be using the imager to read them.

Right. Okay, Bob, and there's no change in the amortization schedule? The expectation there is that it will be amortized straight line over three years?

It will be the length of the contract with the customer but not less than three years. Most of the contracts we're signing are 5. So use an average of 4, and you're probably in good shape.

Okay. Very good, and just a couple additional small points. One for Bob. Can you outline your plans on the share repurchase program looking ahead? What might be our expectations on either the dollar volume deployed in 2004 or the number of shares -- obviously that will fluctuate with the share price -- but could you give us your plans?

We have left in our current authorization about $52 million. I prefer not to say specifically under what circumstances we will use that $52 million or when, other than to say that we are certainly prepared to defend the stock on weakness.

And, Bob, that $52 million will last through what date please? Is it through 2004?

Oh, yes. I mean, yes, unless we announce another tranch (ph).

Right. But it's through 2004, is that right?

It's part of a five-year program.

It's part of a five-year program?

Yes. The program that we have announced is $200 million in total. And I think all but fifty (ph) million of it is part of a five-year program. So, basically, what we have left was part originally of a five-year program that we have announced that we have been working through much quicker than five years.

Okay. So the 52 million left on this particular program and -- you could, of course, add to it if you choose?

Right.

Okay, last question -- could you just on a macro-level, guys, address the issue of the recent New England Journal article which basically looked at almost a million slides and made some commentary basically aimed at the questions -- is it safe practice to prolong the screening interval? And they were -- you know, they very focused on three years -- they weren't more nebulous about it as some of ACR and A-cog guidelines had been 2 versus 3. And address the issue also, is it safe practice to do this, etc.? And I think between the two sets of professional body guidelines and the recent New England Journal article, which was rather explicit in talking -- in addressing any physician-type fears that might be associated with less-frequent-than-annual screening. Could you just give us your macro view of what you expect to happen to the market looking ahead? I realize you've obviously gotten a lot of feedback which says the practice patterns are not changing. And, I agree, the clinical community here is rather conservative. But you've got some significant bodies issuing these guidelines and significant journal articles addressing, is it safe? And I just want to understand what your thinking is here about how the U.S. market looking ahead.

Wade, the article you are referring to -- the author described a situation which you could extend the screening interval and still have the safety that you would have with annual screening. And in that idealized model that he published in that paper, that's probably true. Unfortunately, that idealized population doesn't exist. So that's kind of point number one. The second point is, those recommendations to screen women at a longer interval following three consecutive annual, normal Pap smears have been in place since 1988. And we know that the clinical community has largely ignored those recommendations. We expect that they will do the same thing now.

Furthermore, I think it's our understanding that there are 24 states that actually have laws requiring cervical cancer screening intervals -- 17 of those 24 states require annual screening. So I honestly don't believe that practice patterns are going to change as a result of these articles.

Okay. Listen, thanks very much.

Your next question comes from Jason Woodey with Morgan Stanley.

Hi. Can you hear me? Sorry I got cut off earlier. First question, this may be a case of nomenclature. I thought last quarter you ended with 17 letters of intent for the imager, and you are ending again with another 17. Am I -- is that correct? Or am I misreading it? Or you (Multiple Speakers) haven't really added that many letters of intent this quarter?

Actually what we have as 17 for the quarter, is actual purchase orders for imaging systems.

So, in other words, you have converted most of those intent -- ? (technical difficulty)

Yes, and some additional customers, as well. But, for letters of intent, I announced in my text that we had 32 letters of intent in total and that includes the 17 purchase orders.

Includes the 17. So you basically -- okay. (multiple speakers)

About half of the letters of intent that we have generated go through a process of coming in for a VIP visit. We show them the imager -- hands-on experience and then we get into contract discussions.

So, basically, another 15 letters of intent this quarter?

Exactly, yes.

Okay, the other question is (Multiple Speakers) is also the interpretation question. I had assumed you would get another 80 imagers next year. So you would end next year with 100 imaging systems. Now it sounds like you are talking 120. Is that a change?

It's not a change from what we said last quarter. He said 20 by the end of this year and an additional 100 next year.

Okay. And in terms of the --- you've talked about manufacturing constraints. Is there an update on that? I mean, if you, first, have got a larger order from one of larger labs, would you be able to fulfill it next year?

We expect to be at between 9 and 10 units starting per month next -- in January of next year.

Be able to produce 9 to 10 units?

Right.

Per month?

Per month.

Is that what you expected, I guess, a month -- last quarter? Or is this a little bit better than you originally said?

That's a little bit ahead of what I anticipated last quarter. And we can and have the ability to ramp that up next year, as well, with about a 98 lead time.

Okay. Thank you.

Operator, should we take one more question, please?

Yes, your last question comes from Bruce Cranna with Leerink Swann.

Good evening, everyone. A couple of things. Just, Pat, can we go through the volume guidance again? Maybe it's a question for Bob, but I'm trying to reconcile if we are at, I guess, 36 million tests or so in the U.S. in '03, and we're thinking about 39 million in '04. So if its 70 percent -- let's assume 70 percent converted today -- that's 36 million tests. So if I'm moving that up to 39 million -- 3 million tests over the course of the next 4 or 5 quarters. It sounds like 600 million tests per quarter -- not the 1 to 300's -- so I guess that's question one. And secondarily, if -- you know, we used to think of share gains -- or penetration gains sequentially being two or three points and clearly that's, I guess, slipped a little bit. Is it -- I mean, do you think we are kind of topping out here in terms of the ability to convert conventionals and sort of -- I don't know, maybe the market at 80 to 85 percent or something? Or does your guidance contemplate losing some accounts in that math?

Yes, Bruce, it's Bob. Maybe we can talk off-line. I will go off through the numbers with you. But if you take where we are today at about 9 million tests, and 1 to 300,000 tests per quarter sequentially, you'll come out with 38 to 39 million tests for '04. On the terms of the share increasem we are certainly getting to a higher point on the S. curve -- on the technology adoption S. curve adoption S. curve. And I think as many know, two of our very large accounts are very highly converted to our tests. And so although they could potentially grow additionally, you know gets to a point where I don't know if they will go to a hundred percent or not. But they are getting up to high levels of conversion. So I think a lot of the growth will come out of the "all other" segment. And that's essentially why the market share percentage increase drops from where it had been at one time at 3 to 5 percent down to more like 1 to 2. Because we're only working with a smaller piece of the market.

And we did place 32 new units in the -- (multiple speakers)

I'm sorry. I lost you right at the end. Can you still hear me?

Yes.

You kind of broke up there at the end. So, sort of a combination of things then? Or, I guess, what's your sense? Where does the market top out? When can you longer -- no longer convert conventionals?

100 percent because it would be hard to convert once we get to that level. I think the vast majority of the market is going to, over time, move to liquid-based psychology. I just think that the growth rate as you get at increasingly higher levels of market penetration slows. That's just the math.

Okay. And did you lose any accounts in the quarter?

We placed 32 new customers during the quarter, and I would say that we continue to be competitive with -- we haven't seen the impact that one would have thought when they got their improved labelings (indiscernible) in May.

Okay. And one imager question, if I could. I thin, Bob, you mentioned 90 days sort of start-up time, is that right?

That's correct.

And if the objective is 120 placements in '04, is your thought process that's all existing accounts or do you think you can have success outside of your of your current base?

I'm not quite sure I understand the question. I think that in my comments I tried to indicate that the market is about 800 units in total. By the end of next year, we have -- we intend to ship 120. So we're 15 percent of where we're going to.

No, I'm just saying that number -- the 120 -- contemplates placements into existing accounts or is there -- part of that 120 is converting accounts that are either competitor or -- ? (multiple speakers)

Well, we are already -- have ThinPrep tests in the majority of these accounts.

Okay. So it's converting existing users?

Yes. Yes.

And lastly, someone mentioned, I think on the imager, 125 million-covered lives at favorable reimbursement. Can we -- I know you don't really want to kind of push the envelope here -- but favorable reimbursement, can we take -- does it take away that 9 dollars per on the reimbursement side -- not maybe sort of the split between Unilab (ph) -- but favorable reimbursement, is that in your mind equate to 9 dollars per test on an average basis?

What you normally find is that there is a normal shaped curve around the CMS rate. So there are -- and this is true with the 88-142 ThinPrep pap test code, as well, which has got CMS rate of $28. And most of the labs are bundled around that number. There are some at both ends of the normal curve.

But 9 dollars would be a good average to use?

Yes.

Okay. Thank you.

Thank you, operator. Our final comments are that we are very proud of the performance of the Company for the third quarter. We continue to remain extremely focused on our five key initiatives, which are continued conversion of the market to the ThinPrep pap test, the launch of the ThinPrep imaging system that is ahead of schedule, the increased clinical adoption of FirstCyte breast tests, capitalizing on what we believe is a tremendous opportunity and the good news out of the NICE committee this morning and continuing to evaluate business development opportunities to leverage both the technology and our distribution channel. Thank you very much.

This concludes today's Cytyc third-quarter conference call. You may now disconnect.