Hologic Inc (HOLX) 2010 Q2 法說會逐字稿

Good afternoon and welcome to the Hologic Incorporated second quarter fiscal year 2010 earnings conference call. I am your operator for today's call. Today's conference call is being recorded. All lines have been placed on mute. I would now like to introduce Ms Deborah Gordon, Vice President, Investor Relations, to begin the call.

Thank you, Nancy. Good afternoon and thank you for joining us for Hologic's second quarter fiscal year of 2010 earnings conference call. I encourage everyone to visit Hologic's Investor Relations page of our website in order to view the Power Point presentation related to the comments that Glenn Muir, Hologic's Chief Financial Officer, will be making in his opening remarks. The replay of this conference call will be archived on our website through Friday, May 21. Please also note that a copy of the press release discussing our second quarter results, as well as our third quarter and fiscal year 2010 guidance is available in the Investor Relations section of our website under the heading financial results.

Before we begin I would like to remind you of our Safe Harbor statements. Certain statements made by management of Hologic Inc during the course of this conference call may constitute forward-looking statements within the meaning of the Private Securities Litigation Reform Act of 1995. Such forward-looking statements involve known and unknown risks, uncertainties, and other factors which may cause actual results, performance, or achievements of Hologic to be materially different from future results, performance, or achievements expressed or implied by such forward-looking statements. Such factors include, among others, those detailed from time to time in the Company's filings with the Securities and Exchange Commission. We expressly disclaim any obligation or undertaking to publicly release any updates or revisions to any forward looking statements to reflect any change in our expectations or any change in events, conditions, or circumstances on which any such statement is based.

Also, during this call, we will be discussing certain financial measures not prepared in accordance with generally accepted accounting principles or GAAP. A reconciliation of these non-GAAP financial measures to the related GAAP financial measures can be found in Hologic's second quarter 2010 earnings release, including the financial tables in the release. Please note that today's call will consist of approximately 30 minutes of opening remarks from management followed by a 30 minute question and answer session. We therefore ask each participant to limit his or her questions to just one with one follow-up as necessary.

Before I turn the call over to Rob Cascella, I would like to inform you of several investor conferences Hologic management will be participating in this month and next. Glenn Muir will be presenting at the Citi 2010 Global Health Care Conference on May 26 in New York City. During the second week of June, we'll be participating in the Jefferies 2010 Global Life Sciences Conference and the ninth annual Needham Health Care Conference, both of which will be in New York. Lastly, on June 23 we'll be attending the Wells Fargo Security Health Care Conference in Boston. All of these presentations will be webcast, the details of which will be found on the IR section of our website. I would now like to turn the call over to Mr Rob Cascella, President and Chief Executive Officer.

Thanks, Deb. Good afternoon and thank you for dialing in to our second quarter conference call. Joining me on the call is Glenn Muir, our Executive Vice President and CFO, Howard Doran, head of our Diagnostics Group, Steve Williamson, head of our GYN Surgical Group, and David Harding, head of our International Businesses. All of us will be available during the question and answer session. Our agenda for today's call is as follows. I will review our business performance and the recently completed second quarter and Glenn will discuss in more detail our financial results, as well as provide guidance for the third quarter and full year. We will then open up the call for Q&A. As Deb stated, we will conclude this call in about an hour.

I'm pleased to report that once again our quarterly revenues exceeded, and our adjusted earnings were in line with our guidance. As stated in our earnings release, Q2 of 2010 revenues were approximately $418 million, a 4% increase from Q2 of 2009 and up 1.4% from Q1 sequentially. This compares favorably to our guidance of $410 million to $415 million. Our second quarter growth was broad based with Breast Health, Diagnostic, Surgical, and service revenues all contributing to the increase over last year's second quarter. Slightly offset by a decline in Skeletal Health. For the first time since the economic contraction began, Breast Health posted positive year over year revenue growth, largely due to an increase in service revenues related to our larger installed base of digital mammography systems, and to a lesser extent to sales of our 2-D, 3-D Selenia dimensions and our Aviva breast biopsy product. Our revenue mix remains strongly weighted towards our service and consumable businesses, namely Diagnostic, Surgical, and breast biopsy, which represented 75% of total revenues. Second quarter non-GAAP earnings per diluted share were $0.29, meeting our guidance. This compares to our non-GAAP EPS of $0.29 for the same period last year. Our earnings were impacted by a mix shift, with more capital equipment sales shipped internationally. In addition, we continue to invest heavily in clinical trials across multiple product lines, an expense we believe necessary to strengthen our foundation for future growth.

I would now like to review our revenue performance in each of our four segments. In Breast Health, we exceeded our revenue expectations and recorded revenues of $189.5 million. An increase of 5% from the $180 million from the same quarter a year ago. Sequentially revenues rose 5.8%. As I previously mentioned, the year-over-year increase was primarily the result of strong growth in service revenues, as well as sales of 2-D and 3-D Selenia dimensions. Unit volumes of our Selenia Mammography systems were up over last year, particularly in international markets, although a lower ASP resulted in modest revenue decline versus the prior year. This decline in ASP is due to the ongoing shift to sales of less featured systems and to strong shipments to international markets, which inherently carry lower selling prices. Thus, ASPs continue to be affected by product and geographic mix consistent with recent trends. However, we expect product mix and ASPs will change favorably as the replacement market in the US emerges, which we continue to believe will occur over the next 12 to 18 months. As for the US market, order rates in the first half of the year signal early signs of stabilization in hospital capital spending. Although we did experience some order delays in the quarter, which we believe have already recovered in early Q3 activity.

Also in Breast Health, we continue to see positive increases in revenue from our Aviva breast biopsy product and believe we are continuing to take share in the stereotactive market. Relative to the second quarter of last year, we have heard from many of our customers that there was a slight reduction in the number of screening mammographies, and as a result a reduction in biopsy procedures. We believe this is primarily due to the high levels of unemployment and resetting deductibles and co-pays, leading to decreased wellness visits, and to a lesser extent, the severe weather in the US, particularly in the Northeast and Mid Atlantic regions. However, we remain optimistic about the organic growth of our interventional breast business and the likelihood for increased mammography procedures over the mid to long term as employment conditions improve. Finally, as a result of our phasing out two products, which we discussed remorsefully in our earnings release, we recorded $5.7 million less in revenues from these products in the second quarter of this year as compared to the same quarter last year.

Turning now to Diagnostics, we posted revenues of $140 million, an increase of approximately 4% from $135 million in Q2 of 2009 and basically flat sequentially. All of our major products were up with Cervista HPV and international ThinPrep test being the most notable drivers of the quarter's growth. We are especially pleased with the progress of the Cervista roll out thus far, as our test volumes and account conversions are on track with our internal objectives, with all Third Wave's product lines up nearly 24% over the prior year second quarter. Global ThinPrep tests remained fairly steady this quarter, paced by increased volume internationally, slightly offset by a decline in the US. Domestic ThinPrep volumes fell short of recent trends, due largely to a deferral in wellness visits and the ongoing higher unemployment rates. We also believe, as in our other product lines, that weather had a factor in both the Northeast and Mid Atlantic regions.

In GYN Surgical, revenues totaled $67 million, an increase of 5% compared to $64 million in Q2 of 2009 and a decline of 6% sequentially. The improvement versus last year is primarily the result of domestic Adiana sales and double digit NovaSure growth internationally. We witnessed a reduction in physician office visits in the second quarter, consistent with historical seasonality as many deductibles are reset in the March quarter. Further magnified by the effects of unemployment on wellness visits. Even though Adiana's launch remained controlled in the second quarter, we were pleased with the performance and are looking forward to the balance of the year as our launch activities continue to expand. As of today, we have our full sales team focused on training doctors and selling the Adiana product into our target accounts.

In Skeletal Health, revenues totalled $21.5 million compared to $23.1 million in Q2 of 2009, a decline of 6.7% and flat sequentially. This decrease was primarily the result of fewer mini C-arm systems sold. On a positive side, recent reimbursement changes should have a favorable impact for our abundance cytometry systems, as the new reimbursement rates are at a level far more economically attractive than recent expectations would have suggested. These rates are effective immediately and there's a possibility that they may even be retroactive to the beginning of the calendar year.

I would now like to turn to a few topics of interest. The first, of course, being the economy and health care reform. As you know, as the economic crisis and resulting recession developed, we saw an immediate reduction in demand for our capital equipment businesses last year. The good news is that we do see signs of stabilization in equipment sales, however, we are cautious about the effects unemployment is having on the health care consumer. As we have mentioned in today's discussion, we have seen indications that wellness exams are being deferred in favor of addressing the mandatory health care needs of a family. This is translating into lighter procedure volumes for our domestic ThinPrep, NovaSure, and breast biopsy products. We believe the fundamentals of these businesses are sound and this recent softness is short term in nature.

With respect to health care reform, we do believe the inclusion of additional lives entering the health care system and an emphasis on early detection and prevention could result in increased exams. Although the exact timing of the impact remains unknown, the likelihood of increased availability is a positive. On the other hand, the medical device excise tax that begins calendar year 2013 is not a positive. Our initial calculations find the 2.3% tax, based on our current US product sales, would result in an incremental annual tax of approximately $26 million, or roughly $0.06 per share. We will update you in the future as we gain more clarity on the impact of the reform, including changes in reimbursement rates and our efforts to preserve and enhance our profitability in the face of these changes.

On a more detailed basis, I will provide an update on Tomo, which I am happy to report clinical trials are progressing quite well, both from an enrollment perspective and our overall clinical results. As you will recall, we are running multiple clinical trials designed a wide range of clinical data to the FDA. These clinical strategies partly defensive to provide the agency with alternatives relative to the products indications for use and partly offensive to provide a series of product and procedure configurations addressing both screening and diagnostic indications, which we are confident can prove to be a distinct competitive advantage in the market. Regarding our conversations with the FDA, we have met with the agency on multiple occasions and are encouraged with our dialogue thus far. Without more specific indications from the agency, we remain committed to obtaining some level of approval in 2011.

I'd like to now cover some of our new products and I'll begin with an update on Cervista, which we launched in the latter part of fiscal 2009. We continue to assign new labs at a steady pace and are experiencing advances in testing volumes. The launch of Cervista HPV is accelerated by the release last quarter of our first phase of work flow processing involving vial to play transfer and extraction. So far we have received a great deal of positive feedback on the benefits of faster processing and reduced hands on time. We expect adoption of Cervista HPV to be further accelerated by our high throughput automation, or HTA system, for which we expect approval by mid-fiscal 2011. HTA is designed to enable labs to considerably reduce the amount of time a technician spends with the instrument down the 30 minutes from the 90 minutes with our current phase one level of automation, and importantly, down sharply from the 4.5 hours needed for our semi-automated systems. We believe this will prove to be a very compelling and competitive solution for high volume labs and that we expect to be first to market with such high throughput technology for HPV testing.

We remain very pleased with the strong momentum among labs and the solid progress we have made in gaining market share with Cervista HPV. Based on the contracts we have signed as of the end of fiscal Q2, we estimate our market share is approaching double digits. We are very optimistic about Cervista serving as a key growth driver to our revenues.

Regarding Adiana, we considerably expand our launch activities, as discussed earlier, and as of today have our full sales team focused on training doctors and selling the product. The feedback we have received from those physicians who have used Adiana, get's better with each experience. We estimate our current market share is high single digits.

Now turning to our plans to position NovaSure for accelerated long term growth. As we have stated in the past, there are two key gating variables in achieving broader adoption of NovaSure. The first is the ability to make it easier to perform procedures in the office. And the second is making more women aware such a procedure exists. With respect to the first variable, we are currently providing solutions to physicians on reimbursement, process flow and anesthesia to support the ability to quickly and faithfully perform office based procedures. Regarding patient awareness, we are preparing to launch a campaign to increase awareness of NovaSure among women and to make them aware of the therapeutic alternatives available for treating this prevalent and debilitating condition. I firmly believe the market for NovaSure is substantial and we have only scratched the surface of its tremendous long term potential.

Now for an international update, as we discussed last quarter, part of our strategy to enhance our international business was to appoint David Harding to the position of Senior Vice President and General Manager of International and to focus 100% of Jack Cummings time on many of these opportunities. David is responsible for reshaping and redirecting our international operations. His objective is to identify emerging opportunities for growth, better align our products specific to each opportunity, and make certain we have the infrastructure necessary to execute. Jack's efforts are complementary to David's, that is to identify and analyze opportunities for future growth. Although we have been successful in growing our international business, we firmly believe greater potential exists in our current markets for our newer products while we seek to develop emerging markets with all of our product lines. Thus, we continue to add resources and infrastructure where revenue potential justifies this investment and we'll look to cultivate emerging markets where longer term growth can be realized. Over the next few years, international will clearly be an important contributor to the overall growth of Hologic.

With that allow me to summarize. I'm very encouraged by Hologic's performance in the second quarter, although I do acknowledge the near to mid term path for our device businesses will continue to be impacted by factors such as the economy and more specifically unemployment. Although our capital equipment business is stabilizing, we remain cautious with respect to the dynamics of a mature market and its effects on pricing. None the lees, we are tracking to plan for fiscal 2010 and we continue to deliver year-over-year growth in our major businesses. Moreover, I remain confident in Hologic's longer term growth prospects, particularly as our new products mature and increasingly contribute to our revenue and earnings and as we continue to build our international infrastructure in order to grow our business outside the US. I will now turn the call over to Glenn to provide the second quarter financial details and guidance for the third quarter and full year.

Thank you, Rob. As Rob stated, consolidated revenues performed above our expectations, primarily as a result of the strong performance in our Breast Health segment. Our mix of domestic and international product sales is approximately 78% domestic and 22% international. Foreign currency translation had a modest positive impact on our reported revenue growth of less than 1% year-over-year, primarily within Diagnostics and Surgical segments as most of these are international sales are denominated in local currency.

Turning to the rest of the P&L, our gross margins on a non-GAAP basis were 61.5%, down 150 basis points from the first quarter and down 110 basis points from last year. This excludes $43.5 million of amortization of intangibles and is in line with our guidance range of 61% to 62%. The year-over-year change in gross margins was due primarily to the significant increase in service revenues versus the much smaller increase in product sales. Service gross margins are now at 38%, which is a significant increase over the last couple of years. However, they are still quite a bit lower than product gross margins. In addition, we are seeing a continued shift in the sales of our Selenia digital mammography systems to lower margin configurations, as well as an increased level of lower ASP international sales.

On a GAAP basis, gross margins were 51.1% also in line with the 51% to 52% we guided to. Our operating expenses on a non-GAAP basis of $125.5 million, primarily excluding amortization of intangibles of approximately $13.6 million and the one time litigation settlement payment to Ethicon of $12.5 million came in $5 million below our first quarter non-GAAP expenses and up 3% compared to last year. This was below our guidance range of $128 million to $131 million. This decrease from the first quarter primarily resulted from higher costs incurred in Q1 related to seasonally higher sales and marketing expenses. These decreases were partially offset by increased R&D costs related to clinical studies and next generation products.

In the first quarter of fiscal 2010 the Company adopted a new standard that changed the accounting for convertible debt instruments with cash settlement features. The additional charge resulting from the adoption of this accounting guidance was $18.1 million this quarter and $16.7 million in the second quarter of last year. This non-cash interest expense charge has been excluded from our non-GAAP results of operations for all periods presented. In addition, in February of this year, we entered into a settlement agreement with Ethicon. The settlement agreement relates to two patent infringement lawsuits previously filed by Ethicon and one we previously filed. As a result of the settlement agreement, all outstanding litigation between the parties was dismissed and we paid Ethicon $12.5 million. We recorded a charge of $12.5 million related to this settlement in our results of operations for Q2 and excluded that charge from our non-GAAP results of operations.

Absent the acquisition related and other charges, pre-tax earnings this quarter were $118.7 million. Using our annual effective tax rate of 36%, non-GAAP net income was $76 million versus non-GAAP net income of $74.4 million last year, an increase of 1.7%. We reported fully diluted non-GAAP EPS this quarter of $0.29 versus $0.29 a year ago and equal to the guidance we gave last quarter. Our total dollar backlog for all of our products was $297 million at the end of March, down from $326 million at the end of December. This decrease was primarily in Breast Health and related to fewer Selenia orders than the prior quarter. We believe timing was the culprit at quarter end and the decrease is not indicative of a trend, as evidenced by the strength of our April order rate. We experienced a higher Selenia order rate than any recent first month of a quarter. We continue to believe that the mammography business has stabilized.

Turning to the balance sheet, during the second quarter, we repaid $72.5 million on the $540 million term loan borrowed in connection with our acquisition of Third Wave and we paid off the remaining $47 million in April. We therefore have fully repaid this loan well within the 2.5 years we originally guided to. Regarding free cash flow, we generated $95 million in the second quarter of fiscal 2010, comprised of approximately $107 million of cash flow from operations less capital expenditures of $12 million. Our free cash flow excludes the $70 million cash payment received from KV for the pending sale of our Gestiva assets.

Moving on to guidance, for the third quarter of fiscal 2010, ending on June 26, we are expecting revenues in the range of $415 million to $420 million. Comparable to the second quarter. We expect gross margins of approximately 61% to 62% on a non-GAAP basis. We are expecting operating expenses, excluding the amortization of intangibles, to increase slightly on a sequential basis from Q2 to $128 million to $130 million, or approximately 31% of revenue. We expect interest expense to be approximately $32 million in Q3, including approximately $18.5 million of non-cash interest expense as a result of our adopting the new accounting guidance in fiscal 2010 related to our convert. Our effective task rate is expected to be 36% and we expect non-GAAP earnings per share of approximately $0.29 per diluted share. For fiscal 2010, which ends on September 25, we are reaffirming our total revenue and non-GAAP EPS guidance. We are guiding to full year total revenues of $1.64 billion to $1.665 billion, reflecting the current level of stabilization as experienced during the first half of fiscal 2010 and the outlook for flat to slightly increased revenues for the remainder of the year. We are guiding to non-GAAP adjusted EPS of $1.16 to $1.20 per share. This guidance reflects stable gross margins of 61% to 62% for the year.

We continue to expect operating expenses to be in the range of $490 million to $500 million, up approximately 2% to 4% from fiscal 2009, and excluding the amortization of intangibles. We expect interest expense to be approximately $125 million, including $73 million of non-cash interest expense resulting from adopting the new accounting guidance related to our convert. And we are expecting an effective tax rate of 36%. Turning to cash flow guidance, in fiscal 2010, we continue to expect to generate close to $500 million of free cash flow, excluding the $70 million payment from KV we received in January. Capital expenditures are not a big part of our business and we are expecting CapEx of close to $60 million and depreciation of approximately $75 million for the year.

In summary, we are pleased with our second quarter performance in the face of reduced doctor visits caused by economic factors impacting unemployment and insurance payments. Despite these headwinds, we were able to increase our revenues, which we believe has resulted in us picking up additional market share for our products. We still remain cautiously optimistic about the economy, recognizing that there is still external pressure and therefore continue to be conservative in our outlook. Now with that, let me turn the call back to Rob.

Thanks, Glenn. To wrap up, with the first half of the fiscal year behind us, we are solidly on track to meet our full year guidance. I am proud to say, as I have in the past, that one of the hallmarks of Hologic is that we remain steadfast in our commitment to deliver the finest quality products in the world and an uncompromising when it comes to exceeding customer expectations. More over, our mental long term success is further enhanced by the tireless dedication of our Hologic associates and further by the strength of our products, our obsession with market leadership, and our potential for future growth. This now concludes our opening remarks. We will be happy to answer any of your questions. With that, operator, please open up the call for 30 minutes of Q&A.

Thank you, sir. (Operator Instructions) We'll pause for a moment to assemble the queue. We'll take our first question from Amit Bhalla from Citi.

Hi good afternoon.

Good afternoon.

First question is on the Breast Health business. I was wondering if you could us some more detail in the US on the types of accounts that you're selling to right now. Are these replacement systems in the US because it looks like the US unit volumes are down. I think you even mentioned that. Also give us a little bit of color on Selenia Dimensions overseas? You highlighted that as part of the growth in the quarter.

Sure, I will take that. The domestic units, if we think about the market, we are at a level of market maturity relative to penetration of digital so that the remaining buyers, those that have not converted to digital yet, are really buying at the very low end. And we are competing for products against the lower end offerings of the likes of GE or Siemens and certainly to some extent, Fuji CR. There is some bright spots in the US market and that is that some of the aging early installs of digital are converting to new systems and those new systems tend to be the Dimensions product. We are having relatively good success with Dimensions 2-D in the US, albeit at a small percentage. As we said in my script, the replacement market in the US is expected to accelerate over the next 12 to 18 months. So although we are picking up systems, it's probably 10% of the Selenias that are being sold are Dimension types that are being sold in to replacement customers I should say.

On an international basis, we're selling both the 2-D and 3-D versions of the product. And we remain pleased with the progress that we're making tomosynthesis, but we're also realists that it does require significant clinical efforts. And each market that we're targeting, and in fact have four to five clinical studies going on right now in places like Oslo, right outside of Paris, outside of London, and so on and so forth. And we're doing so in order to gain some clinical validation, but then also to use that clinical validation for public sector support and reimbursement. So we're happy with the progress, but again, the international markets, and if we particularly focus on Europe, is one that is slower to move within the public sector for the reasons I just gave.

Rob, and my follow-up is in the Diagnostics business. Did Third Wave -- I know you said you grew year-over-year 24%, but did it grow in revenues quarter over quarter? And can you tell us about Cervista adoption HR versus the 16/18 in the accounts? Thanks.

Yes, Amit. This is Howard. So the first part of your question is did we grow quarter over quarter and the answer is yes from a total revenue perspective. On how it's going, we continue each and every month to bring on new customers that begin offering Cervista high risk out in the marketplace. And the amount of customers we brought on this past quarter are pretty much in line with the last couple. In addition, this past quarter, the national accounts both launched Cervista 16/18 on a national scale. They've been working for the last few months on validations that were concluded in our sales team out in the physician level in combination with both of those customers are out talking about the changing guidelines and how 16/18 can fit within those. We're very encouraged by the traction as far as new customers. We're very excited to now have a national presence with 16/18 and I think I answered your revenue question.

Thanks.

And we'll move on to our next question from Thomas Kouchoukos from Stifel Nicolaus.

Hi, thanks for taking my questions. Wanted to ask you on the Surgical side with respect to NovaSure. I think -- obviously you pointed out to the economy being an issue and unemployment bringing in fewer women for wellness exams. Are you seeing any increased competition in that space? Do you feel comfortable that you held share? And as a follow-up, maybe just talk about, you are increasing the awareness level sounds like some direct advertising, but also wanted to see what you're strategy or approach would be with respect to bundling NovaSure, Adiana, and also your new hysteroscopy tower.

This is Steve Williamson, thanks for the questions. When we look into market for market share obviously, as you mentioned, the office visits were down for the quarter. And we always go up, there's different ways we can check to see what the market share percentages are. We do some checks through our sales channels. We also go to outside sources. And all the checks that we did actually showed that we're growing our percent to share or holding it. They were all very positive checks for us.

When you look into -- you mentioned different things that we might be doing to drive patient awareness. We have really been focusing on programs to increase patient awareness since the inception of the product. It's something global endometrial ablation is really a procedure that a lot of women don't know about. Now moving forward, we will plant to invest more and more money into these programs until we find that optimal investment level that provides the greatest return for us. In the coming months and quarters, we will continue to play with the mix to make sure we're getting the optimal return for the investment there.

And finally, I believe your third question was about bundling NovaSure and Adiana. We will provide combined contracts where customers require them and we see that in limited areas across the country. But we really believe that each product stands on its own economically and they don't really need to subsidize each other. But for customers that want to serial use or use both products, we're happy to work with them in any way that we can.

Thank you very much.

And we'll move on to the next question from David Lewis from Morgan Stanley.

Good afternoon. Howard, just a quick question on Diagnostics. Obviously given the procedure slow down we have seen across multiple providers, it's hard to say whether that is procedure or industry related or it was tied to share loss. Do you think you held share, gain or lost share in the quarter, specifically for ThinPrep in the US and internationally?

David, we certainly grew internationally because we had an increase in test volume. As far as in the states, we get a lot of data from larger laboratories and many regional ones as well that are open in sharing volumes with us. We also track wins and losses and I can tell you the wins are always very low -- excuse me, the wins are actually well ahead of the losses, excuse me. So I really don't think this is a share shift at all to competition. I just think we were dealing with, obviously, many labs that reported weather being a problem this past quarter and we still think there's a lingering effect of the economy as folks have lost benefits throughout the long duration of unemployment.

Okay, very helpful. Glenn, just a quick financial hit here. Did guidance for free cash change incrementally here sequentially from greater than $500 million to almost $500 million?

David, we're around that $500 million figure. I think we're a little bit -- coming out of the gate a little behind where we thought we might have been at the beginning of the year on the earnings side, just a little. And we have a little bit of a timing difference on some of our tax payments between Q2 and Q3. That put us back a little bit in Q2. But at the end of the day we expect to be around that $500 million for fiscal 2010.

And Glenn, just one quick follow-up, then I'll jump back in queue. If you are a little bit behind would you say it's time to grow incremental gross margin pressures on the top or is it tied to increased spending in the middle income statement?

It is not on the OpEx side, David. We have done a fairly good job of controlling the expenses and coming in under. Where we're seeing the pressure right now, even though revenues are increasing, is on the gross margin side. And it's a combination of things, I pointed out that number one, our fastest growing segment of the business right now is service, but service is also our lowest gross margin item, even though it's increased dramatically over the past couple years, it's still much lower than even product gross margins. And Rob, certainly pointed out that when we look at the capital equipment business and Selenia in particular, there is today, still that continued pressure to the lower configuration units and then also a pickup in some of our international business. So it is clearly on the gross margin side of the business that we're seeing a little bit of pressure today.

Great. Thank you very much.

And we'll move on to our next question from Bill Quirk from Piper Jaffray.

Thanks, good afternoon. A couple of financial questions. First off, given the impact of both weather, as well as the deductibles resetting in the quarter, why should we be thinking about the third quarter top line being more or less flat with the second?

I'm sorry, Bill. Maybe you could restate your question. You would expect that the quarter would be higher?

That's right. We shouldn't have the weather effect. As we progress through the year, deductibles should be incrementally less of a headwind for us.

Yes, and I think that certainly makes a lot of sense. I think we are approaching this on the basis that we certainly want to maintain a level of conservatism going into Q3 for the reasons that we gave earlier. And that is are we seeing any kind of effect on the consumer side of the health care model, which would then relate to ongoing lower procedure volumes. We see some recovery, but we also have seen, as evidenced in Q2, that there was a defined drop in procedure volumes that we responded to by, we think, greater market share, but none the less it is not yet clear to us as to whether or not we'll see an ongoing and persistent affect from unemployment. We did take a more conservative view of Q3.

Okay, understood. And if we think about the Third Wave instrument launch, obviously the initial product is going to be on the HPV side, how should we think about the menu expanding from there? I assume you are considering things like chlamydia, gonorrhea, trichomoniasis et cetera?

You're certainly -- think about the various tests that can come out of the ThinPrep vial and out of our solution. You just hit the nail on the head. The two most obvious are CT/NG and trich. Those are things that we will be looking at in the future. And obviously, we're looking at other areas as well. Those are the two that have the greatest market potential in regards to the amount of screening for those that are done today. Those are the two most opportunistic and those would be past the writing down.

Very good. Thank you.

And we'll take our next question from Vincent Ricci from Wells Fargo Securities.

Hi. My first question in the back of the Power Point, you referenced the limited launch of a next generation NovaSure system. Can you walk us through what that is a little bit?

Steve why don't you -- a little bit of a description of the -- our next generation NovaSure system that we're just introducing.

We are actually in a limited market release with the next generation NovaSure device. It has a couple of different benefits to it. Some are for the physician and some are for the patient. We've actually improved the safety mechanism that we've built in, so it's a little bit easier for physicians to pass the cavity assessment check that takes place before the procedure. There's some ergonomic benefits that have been made to the device as well. And lastly, we've actually put smooth access tips on the end of the electrode array, which allows the device to open smoothly within the patients cavity. We have gotten excellent feedback from the physicians that have used the product so far, and as I mentioned, we're in a limited market release in our physician offices right now. And we'll expect to have a broader release as we go into ACOG and beyond that.

Okay. Great. And my follow-up. Now with the term loan paid down, can you just remind us what are your primary uses of cash and how do you intend to address the convert, albeit the -- we're pretty far below the strike price right now?

Vincent, we've talked for quite some time about our number one focus being paying down the term loan. We now have to change that a little bit. We've always talked our desire to increase our cash balance, which is what we plan to do right now. We have a number of different options. As you know, that convertible will come due in December 2013. And we have to recognize that. At the same time there's other good uses of our cash as well. And we're a little bit hesitant to go into too much detail. We're still trying to formulate exactly what path to go down, but in the meantime, we're very comfortable that we do generate quite a bit of cash flow and we're going to continue to build up that cash balance.

Great. Thanks for taking my questions.

The next question comes from Peter Bye from Jefferies & Company.

Thanks. Maybe push you a little bit more on the gross margins, specifically. I appreciate the greater service revenue in Breast Health. But it's a pretty big sequential decline and you did grow Breast Health service revenue in Q1 $12 million, so you are only up $2.5 million on a growth basis sequentially. The GM is down a lot. Is this the new level? Or was last quarter sort of an anomaly in terms of what the gross profit is out of that, given what you see from a backlog, even with an improving April?

You know what I think it is. If we try to dissect the quarter, it was a combination of higher service revenue at the effective gross margins that Glenn summarized, but in addition to that we really had a mix shift and we can't forget about that and that mix shift is a higher content of capital equipment, as well as a higher content of capital equipment being shipped outside the United States. All of which create what would appear to be gross margin erosion.

So, I don't want to put a stake in the ground and say that's our new level because as as soon as we say that we'll have a shift in the other direction and the device businesses will have an up quarter or represent a higher percentage of our total revenues and as a result we will have 100 basis point shift in gross margins to the positive. Variability of this business from the quarter to quarter.

Okay. So the device business -- you mean the device business within Breast Health?

I mean the device business is represented by biopsy devices, surgical devices, and to a lesser extent ThinPrep. And what we had was a shift of capital in the quarter. So we shipped more capital and we shipped more capital outside the United States. That's what created margin erosion compounded by a higher content of service. In a following quarter we could have a pickup in the device businesses, meaning breast biopsy, GYN Surgical and the like and we will have 100 basis point improvement in gross margin. I think what we need to do when looking at Hologic is understand the diversity of the four segments and understand that what happens when there is a change of the volumes in each of those businesses, because they all are at different and varying profit levels. And we have different profit levels when we ship in the states versus outside the states. What I'm saying is I think what we saw in the quarter is the reality of what happened relative to the nature of the sales in this quarter. That does not necessarily mean that the sales will follow that same nature from a profitability perspective next quarter.

I do appreciate that. I was actually more talking specifically the Breast Health gross margin. We do model it by division. So that was down a far amount sequentially, so that is pretty much just the international mix and the ASP there?

Yes.

A quick follow-up on, again, gross margin from maybe some of the benefits you might start seeing at whether volumes increase or not out of your facility south of the border. How is that going? Can you talk to us about -- is that something we'll see more fiscal 2011 or even if some office visits stay softer in fiscal Q3, fiscal Q4, we can get some offset from down there. Just qualitatively or qualitatively or both?

Our sense is that we'll start seeing improvements in 2011 as we work through volume pickups on the Adiana product line. We think we have seen some absorption benefits on the NovaSure of recent. We expect those to continue as a much higher level. What we don't want to do is shift the overhead problem from one product to another. In order to really fully appreciate a benefit from Costa Rica, we have to get Adiana up to a reasonable volume level.

Okay, great. And last one. You mentioned -- I'll push you a little bit. You mentioned on the backlog, it's -- April is improved. And if you're going to pick now, May 3, are we talking it's better than the end at 297 which is 300? Or is it closer to flat quarter over quarter if you are going to normalize it?

We felt that the back log was a little bit of an anomaly, seeing it drop at the end of Q2, the March quarter. We saw a very strong pickup in April that we directly attributed to deals that we thought would close in March for no real reason. This was just bad timing for a week or so. We don't feel it's any kind of trend whatsoever. I feel like the backlog, even though we reported it down $20 million, $20 some million, was really fairly flat between the two quarters.

That's helpful Thanks a lot, Glenn and Rob.

And we'll move to our next question from Tycho Peterson from JPMorgan.

Good afternoon. Maybe just kicking off with another question on Cervista. Can you talk a little bit about your go to market strategy for the HTA, fully automated analyzer? I'm just trying to get a sense as to how much pent up demand there may be out there because you have talked about it for a little while here.

I think certainly we have labs that are highly anticipating it and are waiting for it. With that being said, the majority of our customers have seen the offering that we have through our class one devices, our multi-purpose instruments. And I think if they weigh the other benefits to the product that we have talked about numerous times. If they sit there and look at the results they provide the clinicians from a QNS perspective, gray zone et cetera. I think what they do is they look at what we have today and they think that's a very fair offering and it does cut the work flow from four hours manual with our competitor, to 4.5 on our semi-automated and it can drop down to approximately 90 minutes.

So, they see work flow advantages today, even with what we have. Yes, they like the HTA in the future, but I really think they are looking at this as an opportunity to go out to the OBGYN and differentiate themselves based on the benefit at that level, which is again QNS and gray zone. And I don't think the lack of having HTA is a deal breaker, although it will cause some customers to wait. But I think we're very competitive today without it.

And will it be a full commercial roll out or will it be somewhat controlled? You talked a minute ago about NovaSure, gen two being controlled. Is it the same strategy or is going to be full launch?

I think we'll go basically in the full launch. We will have concluded plenty of testing by that time, both internally and externally and we will be very confident in the instrument. I would not see us putting ourselves into a position where we could not put enough hardware to meet the demand in the marketplace.

Okay. Wondering if you can talk about the competitive dynamic in mamo. It sounds like Phillips has gotten a little bit more aggressive in Europe. Can you just talk as to whether there's any kind of change in the competitive dynamic, both within the existing landscape, but also from modelaties such as breast MRI?

Sure. I think that if we stay within the breast imaging side and restricted to mamo for a moment, I think we're seeing pretty aggressive competition abroad. And that's primarily (Inaudible). I think that is primarily Europe. I think if we move out to Asia, it's a GE and Fuji competitive threat. I think here in the States it has really been a combination of GE and to a lesser extent Fuji on the CR front. I don't think the competitive dynamics have changed significantly from even six months ago. I think what is changing is that obviously, we're all scrambling over the same few stragglers now that haven't converted on a first time digital perspective.

So, with respect to that, I think there is -- it certainly becomes a price battle and that is not something that we're particularly good at. But we have seemed to prevail because of new configurations that we introduced to the market and the like. I think it will get tougher when it's the FDA's pronouncement about lowering the regulations here in the states occurs. I also think that it will get tougher if Siemens gets approval of their new platform here in the States, but I would say that as we look at the market, I don't see that as being a dramatic change as of yet. What was your second point, Tycho?

Just are you seeing more competitive threat from breast MRI?

I think there's a place for other modalities, be it functional imaging or breast MR. I think the notion of there always being a place for that kind of technology and the quality that it brings to an improved diagnostic, we are screening for that matter in dense breasts or high risk women. I truly believe that if anything although there is a greater utilization of it that we will segment the market and the breast imaging market will always use x-ray, at least for the foreseeable future, because it is so efficient to use and is at a price point that makes it easily adaptable to high volumes of screening. We also believe that with the introduction of tomo, that we, at some point when that becomes a reality in the United States, we'll have an opportunity to offload the magnet, particularly with those women that have dense breasts and are in routine screening. What we believe to be the benefits of that technology for breast density.

Okay. And then just is that MammoSite, the ML, is that -- are you viewing that as a market expander to go into more complex cases? Or can you talk about how you're viewing that market opportunity?

We keep getting more conservative about what we think the overall market opportunity is for breast [breaking]. But we do believe we open up an opportunity that puts us on an equal footing, if not better footing, than some of our competitors. And in fact, when we recover some of the share that we lost without having that product, we will focus on broader market adoption as well. I would say that our opinion about the market is that it's probably -- the extent of that market is less than what we initially thought and we say that because of recent guideline changes. Some of the economics that surround external beam and so on and so forth.

Thank you very much.

And we'll move to our next question from Sameer Harish from Needham & Company.

Hi. Quick question on Adiana. Can you talk about where the share gains are coming from? Is it coming competitively? Are you opening up new markets there?

Yes, this is Steve. We're pretty much taking competitive gains right now. We have gone into many accounts that currently use NovaSure and use our competitor's products as well. And those are the ones that have been quick to trial the product. And those are the ones where we're seeing the gain.

Okay. And just in terms of the long term outlook on gross margins, as you balancing the international growth and some of the new products at higher margin, faster growth at NovaSure and contribution from Adiana and the like, where do you see gross margins moving long term from here? Do you think international will be a drag as it gets larger or is it going to be offset by the newer, higher margin products?

Sameer, it's Glenn. Yes, no, I think today as we look through for the balance of this fiscal year, we're in the 61% to 62% range. Now some of the things that are going to positively impact us we believe will really hit in 2011. And that's really revenue growth. And that's going to be the number one item for us as we begin to cover more overhead. If we think about the new products that will be coming out over time, many of those products are the higher margin disposable products as well, the Cervista, the Adiana, the new NovaSure product, were all in the 70% gross margin range.

So, we do believe that when we do come out with the 2011 guidance, we'll be able to move the gross margin up as long as everything else has basically stabilized. And hopefully, we get down to a point where we begin to see more Dimensions in the 2-D mammography and Dimensions in the 3-D tomo that would take it another step even higher than that. But that's probably the 2011 plus time frame.

Okay, great and if I could follow-up with one extra on NovaSure. We have talked a lot about for the trends as far as patient flow to the physicians. Can you talk about controller placements, how that's tracking versus last couple quarters?

Controller placements are interesting not that big of an indicator for our business. They are not really a KPI that we track. The majority of the surgeons out there that are doing global endometrial ablation already have access to some form of a NovaSure controller. Whether it be at the hospital, in the ambulator surgery center or we have several different programs that we put in place to get them in the physicians office as well. It's not the best metric to track. Unfortunately there's not a whole lot of information beyond that.

Thank you.

And we have time for one last question and that will come from Bill Bonello from RBC.

Hi, thanks for taking my question. Just wanted to go back to Cervista one more time and make sure I understand. The timing that you mentioned on the high throughput automation, is that a change from what you had been planning earlier?

Yes, Bill. This is Howard. Yes, it's a change. Basically I would say the main purpose or main cause is we've expanded some of the testing we're actually doing through the validation phase of our product development process. And we're doing it just to strengthen the submission before we send it to the FDA. As we are becoming aware with all of our products, the stronger package you send in on the front end, the higher probability you'll have success. We are just taking the extra time to make sure we have a real tight clean package when we submit and it's just going to take a little bit longer period of time.

And you're still thinking that's probably a five 10-K though?

No, it's a PMAS supplement.

And then any additional color you can give. You talked the national labs rolling out the 116/18 genotyping and I was kind of under the impression that they'd been doing that -- offering that already. If you could give a little bit more color, what sort of adopting at an international level means versus what they had been doing?

I think what you've probably heard is that they were in validation. And an active full scale launch with our sales reps included started at the tail end of this past quarter. There was a lot of infrastructure, reps being updated, test codes needed to be out there and so forth. It just took time as well as the validation with the laboratory, But now, both organizations, in combination with our sales team, are actually really out pressing at the OBGYN level this new offering. And I think before we get crazy excited about the testing lines, this is a very narrow indication of where you'll use genotyping. What I think is impactful however though is OB clinicians now exposed to the Cervista brand for the first time. And leveraging 16/18 allows us to have a more global discussion about Cervista high risk as well. So we view this as a tremendous opportunity.

Great. Thank you.

Thank you. That is all the time we have for questions today. This now concludes Hologic's second quarter fiscal 2010 earnings call. Have a good evening.