Hologic Inc (HOLX) 2011 Q1 法說會逐字稿

Good afternoon, and welcome to the Hologic Inc. first quarter fiscal 2011 earnings conference call. My name is Kelly Ann and I am your operator for this afternoon's conference. Today's program is being recorded. All lines have been placed on mute at this time. I would now like to introduce Deborah Gordon, Vice President, Investor Relations. Please go ahead, ma'am.

Thank you, Kelly Ann. Good afternoon, and thank you for joining us for Hologic's first quarter fiscal 2011 earnings conference call. I encourage everyone to visit Hologic's Investor Relations page of our website in order to view the PowerPoint 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, February 18. Please also note that a copy of the press release discussing our first quarter 2011 results, as well as our second quarter and fiscal 2011 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 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 details from time to time in the Company's filings with the Securities & 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 first quarter 2011 earnings release including the financial tables in the release. Please also note that today's call will consist of 30 minutes of opening remarks followed by a 30-minute question-and-answer session. We, therefore, ask each participant to please limit his or her questions to just one with one follow-up as necessary. We appreciate you may have additional questions, so please feel free to go back into queue and if time permits we'll be more than happy to take your questions.

Before I turn the call over to Rob Cascella, I would like to inform you that Hologic management will be presenting at three investor conferences in the month of March, the Citi Healthcare Conference in New York, the Raymond James Investors Conference in Orlando and the Barclay's Capital Conference in Miami.Dates and times of our presentations will be press released over the next several weeks. I would like to turn the call over to Rob Cascella, President and Chief Executive Officer.

Thanks, Deb. Good afternoon, and thanks for dialing in to Hologic's first quarter conference call. Joining me on the call is Glenn Muir, our Executive Vice President and Chief Financial Officer; Steve Williamson, who is our General Manager of our Surgical Group; and David Harding, who runs our International Operations. Today I would like to briefly review our quarterly performance highlights and then talk a bit about the status of the some of the key strategic initiatives that we covered last quarter. Glenn will then discuss the quarterly results in greater detail and also cover our guidance for the year as well as the second quarter. We'll then open the call for 30 minutes of Q&A.

We're very pleased with the results for our first quarter. Both revenues and adjusted earnings exceeded our guidance. Revenues were $432.6 million compared to our guidance of a range of $425 million to $430 million and represented a 5% increase over the first quarter of last year. Earnings per share for the quarter on a non-GAAP basis were $0.30, $0.02 ahead of our guidance, and just over a 7% increase when compared to prior year, so a strong financial quarter for us. I would like to talk a little bit about the individual business units and start with Breast Health, which revenues grew solidly for the quarter when compared to prior year. Glenn will cover this in greater detail but I would like to note a couple of key contributors to this year-over-year improvement.

Service revenues continued to increase strongly fueled by our growing installed base of our digital mammography systems. Other contributors were the growth in mammography and breast biopsy plus the contribution from our recent acquisition of Sentinelle Medical. The growth in year-over-year mammography revenues was due to substantial gains in the sales of our 2-D/3-D Dimensions systems. Internationally, mammography grew over 25% on a year-over-year basis and these sales consisted of our 2-D and 3-D Dimensions. The increase in Dimensions volumes is having a positive impact on our overall ASPs as well.

As we talked about earlier, the market is bifurcating in the United States where many of our customers are buying low end systems but another segment of that marketplace is buying the ultra-high-end system, that Selenia, or Dimensions 2-D system, and the reason why they're doing that is because it is the platform for the future and it is completely software upgradable to 3-D mammography. In the quarter, replacement units represented just over 5% of our digital mammography sales, so there is certainly a lot of traction. We expect that this pace will more rapidly accelerate when the commercial release of tomo occurs.

We enjoyed a record quarter for our Breast Biopsy division as well fueled by strong demand for our Eviva product. We once again strengthened our market share and although it is a bit early to tell, it would also appear that there is a slight rebound in biopsy volume as well. We benefited by a full quarter of Sentinelle Medical in the first quarter as well.

Moving on to Diagnostics, although we experienced a slight decline of approximately 1% in Diagnostics revenue on a year-over-year basis, primarily as a result of lower ThinPrep volume and unfavorable foreign exchange, this segment did show a nice sequential increase in revenue and volume over the prior quarter.While we're still seeing fewer office visits a year-over-year basis we believe this is beginning to stabilize.

Our US market share remains strong, in fact, we're confident we have not lost share and although our international volume was flat to last year in the first quarter, we believe this business will trend up and grow for the balance of the year. Our Molecular Diagnostic division was very strong with over 27% on a year-over-year basis in terms of growth over the prior year's quarter and specifically with the -- in Cervista and our HPV product, it increased 60% over the same quarter from a year ago and 20% sequentially. We attribute this to continued share gains and are confident that the sales growth will continue to accelerate during the course of fiscal 2011 as we win new accounts.

We are, unfortunately, experiencing a delay with our HAD filing. The FDA has asked for some additional testing data and we are working with the agency to meet the new requirement. As a result, we have not yet filed with the FDA and are studying the issue now and will report back when we have a better handle on timing.

In GYN Surgical, we had a record revenue quarter for both NovaSure and Adiana product lines. The 6% year-over-year growth was fueled by strong adoption of the Adiana system as well as modest growth in NovaSure. Adiana continues to gain momentum, and we're realizing competitive wins on a routine basis.We also continue to increase the number of physicians trained to perform the Adiana procedure and our reorder rate is averaging somewhere north of 70%. Some other positive notes about Adiana is that we believe that the yield and scrap rates continue to improve. And lastly, we're encouraged that our commercial results and commercial efficacy rates are improved over our clinical trial results, as we would have expected. As for NovaSure, sales rose in the low-single-digits as expected. Earlier this month, we kicked off our direct-to-consumer marketing program and I will discuss that in greater detail in a few minutes.

Overall, Surgical continues to be an important growth driver for fiscal 2011 and beyond in both the US and international markets. In Skeletal Health, our bone product line demonstrated some renewed growth resulting in a 4% growth on a year-over-year basis. This is really the result of an improved reimbursement climate as well as enhanced activity in the replacement cycle within the acute care market. We believe the demand for bone densitometry systems will continue to increase throughout fiscal 2011.

Moving on to some points of interest, I wanted to cover and give a brief update on some of the acquisitions. As you know, Sentinelle Medical was closed in August, and for those that don't recall, this is a company that specializes in custom MR breast coils and other specialty body coils as well as patient positioners and MR-CAD. The integration and training activities of our sales group are completed, and we have had our first full quarter of revenue and the revenues for the quarter met our expectations from back when the acquisition was first closed. Overall we're extremely pleased with the business and believe there are a broad range of imaging applications to this new technology.

More recently, we closed on Interlace Medical. I am extremely pleased to bring this product and this technology to women around the world. Fibroids and polyps can be a painful and debilitating condition for women causing abdominal pain, heavy menstrual bleeding and impaired fertility. The technology called the MyoSure tissue removal system fits extremely well within our surgical product portfolio, alongside other therapies for abnormal uterine bleeding and permanent contraception.

We believe the addressable annual market for MyoSure approaches $300 million to $400 million in the US and we're optimistic that we will garner a majority share of that market over the next five years. In addition, it is a simply elegant technology which we firmly believe will change the way such interventions are conducted in the future. It is an attractive product extension and a great strategic fit to our existing product line.

In considering revenues for the balance of this year, we have taken a very conservative view and expect to achieve something just less than $10 million for fiscal 2011. Interlace is a terrific example of the acquisition strategy outlined in our last quarter's call. This is an ideal tuck-in complementary to other surgical products and easily fits the calling patterns of our sales reps. Needless to say we're very excited about it.

Lastly, I wanted to give an update on some of the incremental investments that we spoke of last quarter. First, I will include an update on tomosynthesis. As you all knew, we were very pleased when we received our approval letter in November just prior to RSNA. The next step was a facility audit and the FDA's inspection of our Danbury operation was completed in December and there were no substantial findings. We now await the FDA's final report and believe we were on track for the March commercial date that we previously discussed.

In addition, we have completed the design of a comprehensive physician training program per FDA requirement and it has been modeled after the successful programs that we implemented overseas where we have been shipping tomo for over the last year. In addition, we're working diligently with various payer groups to be certain that we have both a short-term plan and longer-term strategy for reimbursement. Short-term we're focusing on private payer education to get them excited about the technology and its potential cost savings. Longer-term we continue to have discussions with the ACR, advocacy groups and CMS but we require FDA approval before these talks can be more meaningful.

On an international front, we now have clinical trials underway for tomo in various parts of Europe including Norway, Italy, France and the UK and these are being designed to help gain public sector support and help to spur market adoption on a worldwide basis. We won't see results from these clinical trials until the next 12 to 24 months, but, again, we're very excited to report back to you when those are available.

The next area of investment is our focused international expansion. We have begun to build out our international infrastructure and management resources, particularly in emerging markets like China and Latin America. We have added to the bench strength of our sales, service and marketing groups and more recently are also adding to the ranks of senior management. We hired recently a Vice President and General Manager of Asia Pacific, and in addition to that hired a CFO for our Asian operations. We intend to continue our investment in the leadership of our European and Latin American operations as well. We believe this is a critical element of our strategy as we search for acquisitions in different parts of the world to expand our distribution and manufacturing capabilities.

Regarding our launch of our DTC awareness campaign for NovaSure, I am pleased to report that a couple of weeks ago we officially kicked off our marketing efforts in all of our target markets, with advertising appearing in several leading women's magazines, online websites, television spots and social networks. An increasing number of communications will be appearing over the next 12 months. All-in, the campaign is expected to create 1.6 billion impressions in our target market over the 15-month time period of the program. As a reminder, we are undertaking this critical step in market development because we firmly believe that this market remains substantially under penetrated.We see an enormous opportunity for this product and it all comes down to raising the awareness among women that a permanent, curative solution to excessive menstrual bleeding is available in her doctor's office that can be performed in less than five minutes. In short, we intend to establish NovaSure as the first line of therapy for women suffering from abnormal uterine bleeding.

Lastly, I would like to welcome Mark Myslinski to Hologic as our new Senior Vice President and General Manager of our Diagnostics Group. As you may have seen in the press release we issued this morning, Mark will oversee both our Diagnostics and Molecular Diagnostics divisions. Mark brings to Hologic 30 years of life science and diagnostics industry experience, serving most recently as President and CEO of RedPath, a genomics-based cancer diagnostic company, and prior to that as Vice President and a Board member of Ortho-Clinical Diagnostics, a division of J&J. Mark's expertise complements the strategic emphasis of this very important franchise. I have every confidence that under his leadership our Diagnostic business will flourish. With that I would like to turn the call over to Glenn Muir.

Thanks, Rob. Consolidated revenues exceeded our expectations with year-over-year revenue growth of 5%, largely due to the strong performance in our Breast Health segment led by service and the continued shift to our 2-D/3-D Dimensions product platform. Our Dimensions line now represents 37% of all digital mammography revenues. Service, a steady contributor, was up $13 million or 24% year-over-year. In addition, Breast Health benefited from the inclusion of sales from Sentinelle Medical.

Sales in our GYN Surgical and Skeletal Health segments were also up while a slight decline in Diagnostics revenues partially offset this growth, mainly due to a reduction in ThinPrep volume and unfavorable foreign currency impact. Two of our newer products, Adiana and Cervista HPV, both continue to steadily increase and contributed to our first quarter solid top line results. Our mix of domestic and international sales was approximately 78% and 22% in Q1, and our mix of disposables versus capital equipment sales was 76% and 24%. Foreign currency translation, which primarily affects Breast Health and Diagnostics revenues, had an unfavorable impact of $1.7 million and reduced our reported revenue growth by approximately 40 basis points.

Turning to the rest of the P&L, our gross margins on a non-GAAP basis were 62%, down 100 basis points from last year, but nicely up 90 basis points from the fourth quarter. Gross margins exceeded the high-end of our guidance range of 60% to 61% due to, first, higher service contract revenue and lower service costs associated with our mammography installed base. Second, better than expected NovaSure sales which carry a higher than corporate average gross margin, as well as an improvement in Adiana manufacturing yield. And, third, better than expected volumes in our Diagnostics segment for both ThinPrep and Cervista HPV products leading to favorable manufacturing absorption.

Non-GAAP gross margins primarily exclude $42.1 million of amortization of intangible assets this quarter and $43.5 million in the prior year first quarter. Regarding operating margins, our expenses continued to be well controlled and on a non-GAAP basis, excluding a few charges that I will discuss in a moment, totaled $136.3 million, an increase of 4.5% compared to last year and in line with our guidance of $135 million to $140 million. This increase in expense relative to the year ago period was primarily due to the inclusion of Sentinelle Medical and the investments we are making in our growth initiatives such as our DTC campaign for NovaSure. We continue to invest in R&D and reported a ratio of 6.6% as a percent of revenues in Q1 as compared to 6% in Q1 of last year.

Regarding our non-GAAP adjusted earnings, there are three items we normally exclude from expenses and one new item. Consistent with prior quarters, this quarter we excluded from expenses the amortization of intangibles of $56.6 million, the non-cash interest expense of $18.5 million related to the debt discount on our convertible debt, and acquisition related costs of $3.1 million. In addition, this quarter we incurred a non-cash one-time charge of $29.9 million in connection with the exchange of $450 million of our convertible notes for new notes that extend the first put date out another three years until December 2016.

Although the total convertible debt we have outstanding remains at $1.725 billion, this exchange provides us with greater flexibility in managing our future liquidity needs. Absent the non-GAAP charges, our pre-tax income this quarter was $121 million versus pre-tax earnings of $116.5 million in Q1 of last year, and our non-GAAP adjusted net income increased 7.1% to $79.9 million. We reported fully diluted non-GAAP EPS this quarter of $0.30 versus $0.29 a year ago which was $0.02 above the guidance we provided last quarter. This increase in EPS over expectations was due to the higher revenue growth in margin improvements coupled with a lower than expected tax rate in Q1 resulting from the reinstatement of the R&D tax credit. The total backlog for all of our products was $275 million at the end of December which was flat with the backlog at the end of September.

In turning to the balance sheet, we grew our cash balance to $609 million from $516.6 million at the end of fiscal 2010, an increase of over $92 million. Our plans for use of cash remained focused on investing in our current technologies and operations, potential future tuck-in acquisitions, including our recent acquisition of Interlace Medical, and preparing for the possible redemption of the first tranche of our convertible notes with a value of $1.275 billion beginning in December 2013. Regarding free cash flow, we generated approximately $122 million in the first quarter of fiscal 2011. These cash flows were comprised of approximately $135 million of cash flow from operations less capital expenditures of $13 million.

Now moving onto guidance, which includes the operations of our recent acquisition of Interlace Medical and excludes any anticipated US revenues resulting from the expected approval of our tomo 3-D mammography system as well as any other future acquisitions. For the second quarter of fiscal 2011 ending on March 26, we are expecting revenues comparable to the Q1 results, approximately $432 million. This reflects an increase in revenues in our Breast Health segment primarily related to increased service and Sentinelle MRI coil sales partially offset by a decrease in our GYN Surgical segment due to normal quarterly seasonality.

Year-over-year this is an increase of revenues in 3% over Q2 fiscal 2010 revenues. The inclusion of Interlace revenues will have a negligible impact in the second quarter. This quarter we are focused on training our sales team, introducing the product to our customers, and beginning to ramp up production. Full market launch will not occur until our fiscal third quarter. We are expecting gross margins of approximately 60% to 61% on a non-GAAP basis declining slightly due to lower consumable sales as a percentage of total revenues. We expect non-GAAP operating expenses primarily excluding amortization expense to increase on a sequential basis from Q1 to $140 million - $145 million or approximately 32% - 34% of revenue primarily resulting from the increased sales and marketing expenses for the NovaSure DTC campaign, the inclusion of Interlace Medical expenses, as well as the other investments Rob discussed in his opening remarks.

We expect non-GAAP interest expense to be approximately $10 million in Q2 excluding $17.8 million of non-cash interest expense related to our convertible notes. Our non-GAAP effective tax rate is expected to be approximately 34% as we will realize the continued benefit from the reinstatement of the R&D tax credit, and we expect non-GAAP earnings per diluted share to be $0.28 on shares of 264 million. For fiscal 2011 which ends on September 24, we are reaffirming or revenue guidance in the range of $1.73 billion - $1.76 billion, or growth of between 3% and 5%. This guidance reflects our expectations that Breast Health will grow in the low-single-digits reflecting the current level of capital equipment market stabilization, continued growth in service revenue, and the contribution from Sentinelle Medical, that Diagnostic will be flat with the prior year, GYN Surgical will grow in the low-double-digits, and Skeletal Health will improve slightly.

We are also slightly increasing our non-GAAP adjusted EPS to $1.22 - $1.24 per share. This guidance reflects the lower tax rate of 34% now expected due to the reinstatement of the R&D tax credit offset a bit by an increase in the share count to 265 million at year end primarily due to the increase in our stock price. We estimate both Sentinelle and Interlace will be neutral to fiscal 2011 earnings. We are still expecting gross margins of 60% to 61% for the year. The key drivers to future margin improvement are revenue growth which will lead to increased overhead absorption and a shift to higher margin disposable sales.

We expect non-GAAP operating expenses to be in the range of $540 million - $545 million, up approximately 8% - 9% from fiscal 2010. This increase will reflect our ongoing commitment to R&D at a rate of 6.8% of revenues, the additions of Sentinelle and Interlace for the year, and increased expenses associated with our NovaSure DTC initiative. We are expecting interest expense to be approximately $40 million, excluding $73 million of non-cash interest expense related to the convert. And we are expecting an effective tax rate of approximately 34%.

Turning to cash flow, we are also reaffirming our free cash flow guidance of approximately $450 million. In summary, we are pleased with our first quarter operating results. We saw improvements in revenues, margins and earnings, exceeded expectations, and improved liquidity by extending just over one quarter of our convertible notes. We remain very optimistic that we will deliver improved results in 2011. With that, let me turn the call back to Rob.

Thanks, Glenn. So in summary, I guess we keep saying we're very pleased with Hologic's first quarter. Our performance improvement was broad based with three business units reporting solid year-over-year gains, and our Diagnostic business showed some signs of stabilization, all very positive. Share gains numbered our Breath Health business, including both mammography and breast biopsy, our Diagnostic business led by Cervista, and finally in our Surgical business led by Adiana.

We expanded our Breast Health and Surgical product portfolios with the acquisitions of Sentinelle and Interlace and we're just around the corner from a PMA approval of our tomosynthesis product. We did all of this while generating tremendous cash flow and better positioning us to continue to fund our long-term growth initiatives. Finally, and as Glen said, we're cautiously optimistic about Q2 and the balance of this fiscal year. Although difficult economic times in the US and around the world, we're extremely bullish about our products and our programs for the balance of this year and beyond. I would now like to turn the program back over to the operator and thank you for your participation in this call. We'll open the call up for 30 minutes of questions.

Thank you. (Operator Instructions)We'll go first today to Thomas Kouchoukos with Stifel Nicolaus.

Great. Thank you for taking my question. I guess I would like to start with the GYN Surgical side of things. I think you talked about record numbers on both products, but it was a little lighter than what we expected. I'm just wondering if you can share the growth dynamics between what you saw US and OUS with NovaSure and then maybe comment on did you see Adiana grow sequentially from your Q4 number?

Sure, Tom. This is Steve. As far as the NovaSure goes, we did see growth both domestically and internationally. I think that the market has been stabilizing as far as the number of patients that are going into the doctor's office. We see that the fewer women have gone in than we were seeing a year-and-a-half ago. It seems to be flattened out where we have got a stable number of patients coming in on a quarterly basis now. So we do see that growth again with NovaSure and more doctors are offering patients the NovaSure procedure earlier in the treatment pathway cycle. Internationally, we saw strong quarter as well.

We did see good growth throughout Europe, the majority of the growth we saw was in the UK and Australian and markets for us. And then as far as Adiana goes, we're typically, we see a lot of our doctors are focused on going through the training right now, so we're getting the doctors scheduled. We get them through the online training. We get them through the hands-on. They schedule their patients and then move through. So we do see growth in both product lines and we'd expect it to continue through the rest of the year.

Okay. If I could ask one quick follow-on, just more big picture, we have seen a nice string of bolt-on acquisitions here over the last several months with Sentinelle and Interlace. What can we expect going through the year? Have you met your quota near term or do you expect more tuck-ins as we go through the year?

We're really looking at things on an ongoing basis. These were just two of the acquisitions that we felt very good about initially, and we remain feeling very positive about those, but we're continuing to look at acquisitions across all of the different business units. The one constant will be that these are going to be tuck-in acquisitions.

We're looking at spending no more than perhaps a quarter's worth of cash flow, and the requirement is that they fit within our sales calling pattern, possibly our manufacturing, and even our engineering organizations. So they're very efficient acquisitions for us to effect.

Okay. Great. Thank you very much.

We'll go next to Bill Bonello with RBC Capital.

Thanks for taking my questions. Can you just give us some sense of your expectation for how service revenue will grow over the next several quarters and just maybe when we should expect that growth to taper off a bit?

As the mammography business matures, the growth in service revenue will slow, and so we actually are seeing that today. One would expect that as long as the installed base continues to increase, there will always be some growth in service revenue. The next real growth spurt for service revenue will be a year following the introduction of tomosynthesis. We'll sell many, many more new products, with the commercialization of that product and following the warranty there will again be a pickup in service revenues. But I would say that I think we're experiencing today really the slow down in the growth as a result of the revenues for the mammography business slowing down, and won't really see a pickup until, again, there is another new product that creates this notion of technological obsolescence where everyone needs to then have access to it.

Okay. Thanks. And I would be lying to call my next question a follow-up so I will hop back in the queue.

Okay.

We'll move on to Jayson Bedford with Raymond James Investment Bank.

Good afternoon. Thanks for taking the questions. Just on the gross margin, appeared to be a nice bump up sequentially, and you mentioned higher service contract revenue and lower service costs, and I am wondering is this a dynamic that you will see going forward and did you change the service infrastructure at all?

Jayson, it is Glenn. I think we're getting better efficiency from service itself. Rob talked a little bit about the service contracts and the trend as it related to digital mammography systems. What's happening today is we have been very successful in capturing service contracts, so we're getting over 90% of the contracts coming out of warranty are being captured. So it is an efficiency that we have in the marketplace today with our service for us, coupled with better reliability of the product, and it is a function of being in the market for eight years, and it is a combination of system itself and also the detector being very steady at this point.

We are expecting to continue that as we go forward. As we talked about in the past, one of the big drivers for us in helping that overall gross margin will simply be an overall increase in revenues, and that affects all of our products and all of our businesses including service because of the efficiency we derive.

Okay. Thanks. And just as a second question, I don't know if this is follow-up or not. 25% growth internationally, you said, on Breast Health or mammography? What is the real driver there? Was it just a soft comp or did something change in the quarter? Thanks.

Hi, this is David. I think there are a couple of factors. Number one, as you know, the European countries went through a pretty tough time in 2009, and I think we're seeing a rebound in volumes there that is helping us. But I also think there is a real strength in our tomosynthesis and overall Dimensions offering that is driving that growth as well. We're seeing a lot of strength out of emerging markets such as Latin America, the Middle East, South Asia, and Asia, so we're very encouraged by not only growth in Europe but also in the emerging markets.

Thank you.

Josh Jennings with Jefferies & Co. has our next question.

Thanks a lot. Just start off back on a follow-up on the gross margin side, I know you guys expect a little bit of a down tick in Q2 from outstanding Q1 performance and you give us a little bit more color on what's going to drive that? I know you talked about decreasing level of consumables. If you look at each of the business segments' gross margin in the quarter, they were all up nicely sequentially, and I was just wondering if that's a trend that can continue and just maybe just some more color?

Josh, it is Glenn. I think this is just the peculiar to Q2. Once again, the guidance that we gave on the revenue side for Q2 is pretty comparable or flat with Q1 at $432 million, but there is a mix shift of the products. We're expecting, in particular, one of our highest gross margin products, the NovaSure product to be a bit softer in Q2, the March quarter, as it always is due to seasonality, and we expect the product line within Breast Health to make up that difference both on digital mammography and in service. But that capital equipment side of the business is somewhat the lower gross margin products, so we're expecting a slight shift for Q2 and then probably bounce back in the Q3/Q4 time frame.

Okay. Thanks, and just on tomosynthesis, I know it hasn't been too long since you made other public commentary about potential reimbursement strategies, but can you comment on any discussions you've had with commercial payers, and then sort of reoutline your outlook on reimbursement and your strategy in terms of securing premium reimbursement going forward for tomosynthesis once its approved? Thanks a lot.

Sure. It is a bit of a multi-pronged effort, so the initially we're really focusing on private pay. We think that we can make a convincing argument to private pay that there is a cost savings advantage to tomosynthesis as a result of reducing the recall rate. We think that that's a great interim strategy, but a lengthy one. There is 1,000 private pay sources in the United States, some obviously national and others not. But it is an effort that will commence over the next month with multiple private pay panels where we will hope to educate them. In addition, we're looking at multiple CM/CPT type strategies that will be both interim related and more permanent and as we have said in the past, those are difficult conversations until it is FDA approved but we have ongoing discussions with the ACR and CMS, and we will turn up those activities once we have a commercial release of the product.

We'll go next to Tycho Peterson with JPMorgan.

Good afternoon. Question, just maybe starting off on Cervista, you talked about nice growth there and then obviously you talked about the automation delay. Can you talk a little bit about how that may factor into the adoption going forward of Cervista or has it mainly been lower volume customers that aren't necessarily going to upgrade to a fully automated system anyway?

Yes. Virtually no impact on revenue for the near- to mid-term. We're really carving out a nice place in the low- to mid-tier labs, either because of a decentralized effort on our part in the labs or otherwise. It is not to say that we're not going after the larger labs, and the volume levels are trending up, but in no way does any of the time delays on HTA jeopardize that revenue trend.

Okay. And then on Adiana you talked about improving the yields there. Is that business profitable for you now and if not, what's the timeline there?

We think over the next year we are running at a bottom line that it is about break even with that product, and over the course of this year as yields and scrap continue to improve, that we hope that the contribution margin of the product improves as well which we would fully expect.

Okay. Thank you very much.

We'll go now to David Lewis with Morgan Stanley.

It is actually James in for David. I have a couple of questions on Interlace. First, where do you see the business mix in terms of end market between physicians office and hospital settings, and maybe give us, maybe what do you think the first 12 months after launch might be and where that might develop kind of three to five years out?

Steve, would you like that or would you like me to handle it?

Sure. So the business mix in the coming years right now reimbursement is already set up for the product in the hospital. There is very favorable reimbursement for both the product and the physician, so the hospital, it is very similar to the NovaSure procedure. The physician gets very attractive reimbursement in that side of service as well. It is also reimbursed in the ambulatory surgery centers.

Right now reimbursement doesn't exist globally in the physician's office, so that's going to take a little bit of time to put in place, but there are several physicians that have gone out and gotten carve-outs from payers because they understand that the product fits nicely into the office. It is a very low-anesthesia requirement. It is a procedure that can be done quickly and can send the patient back home immediately after and to get about whatever it is she needs to do.

And can you give us any more color there on what you might be doing to drive the -- what your strategy around driving reimbursement might be?

There is several different things. First of all you need to put the clinical data together that shows that it is safety and efficacious in the physician's office. We've already put together a clinical strategy on that and Interlace had already been working on that as well. We'll put that information together and we'll put it up to the committees and, obviously, we'd look for backing from ACOG as well as AAGL for that as well.

And as a final, would you care to venture a timeline for when we might see a more meaningful reimbursement there?

It is probably a few years out. I don't think it is that important in the short term because it is a procedure where the doctors will start using it. There is a very, very large patient population that can benefit from the procedure. So if they can have it in the hospital right now and that works for the physicians and it works for the patients and works for hospitals, that's great.

It is just over time as the doctors want to move into the office and you'd think more and more patients will have the procedure done in that side of service, then I think it becomes a benefit for everybody. I don't necessarily look at it as a detriment, though, that it can only be done in a hospital or ambulatory surgery center right now. Just to add onto that there are some physicians, some of the larger practices that have gone out and shown the payers what the benefits are to doing a procedure like that for the patient, so we're seeing that in some areas already.

Great. Thank you.

Yes.

And Amit Bhalla with Citi has our next question.

Hi, good afternoon. The comments you made about Dimensions and pricing stability, I thought were good. I was hoping you could expand on those and quantify what kind of growth rates you're seeing in Dimensions units and pricing stability quarter-over-quarter? Is it 5%, 10%, 20%, what are you seeing and just some numbers there?

Because it is a relatively small base, that percentage growth numbers are very, very high. So on a unit basis quarter-over-quarter we're clearly north of a 20% quarter-over-quarter growth, but as I say, I think we're relatively new with the introduction of that product and we would suspect that that would stabilize over time.

And the pricing, you talked about stability in pricing, and I have one quick follow-up.

Yes. We have not had a lot of pushback on the Dimensions product. I think the people that are buying it are buying it because it is the next generation of a new platform product that is also the their platform for doing 3-D mammography. So it does sell at a premium, it sells at a premium over the competition, it sells at a premium over its predecessor products, and although we certainly have a mission to remain competitive, we have not seen the downward pricing as of yet with that product.

Rob, you mentioned with the HTA delay you said the FDA is asking for more data but you really didn't go into much detail about what specifically the FDA is focused on. Can you talk about that?

Yes. I think what we'd like to do is -- similar to what we did with tomo. I think we need to spend some time with the FDA, better understand what the requirements are and then come back to you folks with something a little bit more comprehensive. Quite frankly, I am not certain we're in the best position today to be able to give you a definitive timeline or explanation of where some of the shortfalls are, but that is what we are working on today.

And just a quick one for Glenn. On the Surgical division gross margin looks like the adjusted gross margin grew over 300 basis points sequentially. What drove that and how stable is that business gross margin going forward?

If we look sequentially from the September quarter there is a couple of things that happened. Number one was the growth in the NovaSure devices themselves. That contributed to improved absorption.

But, number two, we're making a lot of changes on the Adiana product itself, and we're having improved manufacturing yields, really from engineering, design changes, and manufacturing process itself. So it is a combination of increased NovaSure coupled with better Adiana manufacturing costs down in Costa Rica. And we do expect that to continue as we go forward as it relates to volume. So if we look at Q2, because we are expecting NovaSure to come down a little bit due to seasonality, I would expect to see that gross margin just soften a little bit going into Q2 and then bounce back in Q3 as typically another up quarter for NovaSure.

Moving onto Tony Butler with Barclays Capital.

Thanks very much. Two brief questions. One is, the average international customer, when looking at an instrument, are they principally looking at and are you placing you upgradeable systems or are they looking principally at de-featured units? And, second, could you provide some color on the percent of total shipments or orders that are upgradeable systems? Thanks.

Thanks for the question, Tony. I think it is pretty difficult to characterize the average international customer. I would say, close to 50% or so are looking at the Dimensions system, whether that be a full scale 3-D system or probably more predominantly the 2-D Dimensions system. But I would say a good half of those are looking at the Dimensions side of the ledger, and those are, as you know, pretty full-featured systems that we are offering.

When we get to the Selenia offerings it really runs the gamut from very de-featured systems to the standard-based Selenia and it is difficult to say what those numbers are at the moment. But I would say depending on the market that you're in and the type of customer that you're talking to, whether is it be a small-scale private practice or a large-scale research institution, that sort of determines what kind of offering we're putting out there.

Thank you.

Bill Quirk with Piper Jaffray has our next question.

Thanks. Building off an earlier question, thinking about the approval letter and the fact that you have had it for three months and obviously the sales force is aware of that as well, any feedback from them in terms of sentiment changing from the customer base in terms of the potential pace of uptick here once approved?

I would have to say that we're hearing a lot of excitement. I mean, our people are still really forbidden from selling the product because it is not FDA approved, but we certainly are just hearing a lot of, anecdotally, stories of excitement about the enthusiasm over the technology, the clinical benefits of it, how will trade-ins be orchestrated, and things like that. But I would have to say that we're probably being pretty conservative until we get this product commercially approved, to actually go out in a very broad way and start marketing it.

Understood. And then as a follow-up, and I guess kind of, again, building off of a recent question, just is it relates to the US side of the business, guys, where are we, remind us rather, what percent of systems out there are field upgradeable at this point?

Yes. I would think that the -- we're probably running at around 25% to 30% of our systems are 2-D Dimensions, but I would have to remind everybody that I really think that the customer that is buying a 2-D dimensions in the United States today is late to the game in terms of terms of digital mammography. I do not think they're the likely near-term tomosynthesis upgrade candidates. I think they wanted to invest in tomo, or in Dimensions, because they wanted a product that would be viable for the next seven to ten years and had upgrade capability.

My sense is when this product is approved it will be older Selenia users that will want to trade in their Selenias and buy the complete gantry of 2-D and 3-D together and it will be less of the upgrades and much more of the new placements that I think will drive our revenue during that period, that initial period.

Appreciate the color. Thanks, Rob.

Sure.

Jonathan Block with SunTrust Robinson Humphrey has our next question.

Thanks, guys. Good evening. First one maybe on Diagnostics. You mentioned some of the pressure in the Pap business and maybe if you can try to tease out how much of that pressure is from straight patient volumes versus what may be the result of interval lengthening or ACOG guideline changes or even price? Thanks.

I think if we look at what happened last year, I think we had a non-linear drop in the business for a lot of external reasons, meaning those that are perhaps the economically related. Although without a doubt as a result of interval expansion and market consolidation, that we're going to see very gradual declines in that business. The drop of last year was not gradual and it was very significant relative to patient volumes. When we said today that we thought our ThinPrep business stabilized, it is that portion of erosion that we think has stopped.

That's not to say that market is going to grow domestically because of all the things that we just mentioned in terms of interval expansion. But, again, I think that is a very gradual three- to five-year process before we start to materially see the impact of further market consolidation and interval expansion.

Okay. Great. And then, maybe just second question, just with tomo, maybe if you can speak just to work flow, in other words, here in the US CAD is still prevalent, almost a one-to-one with 2-D. When you get Dimensions approved and it is out there, can you speak to how people will integrate it from a workflow perspective, so they will use without CAD and what do you do? Do you have to wait until approval until you turn around and submit sort of a CAD system with 3-D? Thanks.

Sure. The configuration of the product is a combination imaging product, so it fuses 2-D and 3-D mammography. 2-D CAD is available on the product. It is the same 2-D CAD that's on the current Dimensions 2-D product. So the user today will have the benefits of 3-D and the efficiency of CAD in the 2-D world and, yes, after this product is approved we are currently developing a 3-D CAD offering which would have a series of algorithms and feature matching that would take place within the 3-D feature set versus the 2-D feature set. We think that's a lengthy clinical trial and a fairly rigorous FDA process.

Thanks, guys.

We'll go now to Vivian Cervantes with Maxim Group.

Hi. Good afternoon. Thank you for taking our question. A quick follow-up on Diagnostics. This morning you had announced, and even before the call, a new change in leadership for Diagnostics. Is there because of this going to be a change in strategy or an approach in how we drive this business going forward?

I think it is going to be a little bit of both. We want to nurture and preserve the good about what we're doing today, but we also want to change some of the things that we think might be legacy issues within that business group. So it is a little early to tell, but the expectation is we really want to focus on the molecular part of the Diagnostic business and look at ways that we can grow through core development of our own [assays], out licensing and partnering, a way to leverage our Invader platform as we have not done thus far.

So there are many elements of it, and, as I say, we don't want to throw out the baby with the bath water. So it will be a matter of Mark spending time to get familiar with the business and then he and I developing what we think along with the General Managers on a divisional basis, what we think a growth strategy will be for our Diagnostic franchise.

That's helpful, thanks. And then a follow-up on the replacement cycle. You had mentioned roughly 5% or so of volumes today are replacement and that that should increase with the 3-D approval. Given the CapEx environment, with the 3-D approval have you saying there is going to be an expedited replacement or is it going to be the typical five- to seven-year wait before you replace? Could you give some color on that?

Right. No, it is a very good question, and what we believe, although we would also say it is going to take time, is that tomosynthesis has the ability to do to digital what digital did to analog, and that is create a market dynamic of technological obsolescence. That will require clinical validation. It will require reimbursement, but once that happens, then I think our customer base will rush to acquire tomosynthesis because clinically it will have been proven to be more effective.

I think women will read about this as a more effective tool for screening, particularly those women with dense breasts. All of those benefits will start percolating to the top of the market and it will become everyone's priority, and as a result of that it will cause the replacement cycle to accelerate. Similar to what happened with digital mammography, five years after it was introduced and the American College of Radiology came out with their [deamnus] study stating that that product was better for women with dense breasts, women that were under 50, women that were pre- or perimenopausal, well, that became the reason why everyone needed to have digital at that point. I don't think it is going to take five years for tomo because I think the clinical benefits of tomo are far more compelling than digital was over analog, but nonetheless, it is going to take some time. When it does, that will also drive an acceleration in the replacement cycle.

Very helpful. Thank you.

We do have time for two more questions today. We'll go next to Jon Groberg with Macquarie.

Hi. Thanks a million for taking the question. Maybe just one quick clarification back to the ThinPrep business. I think you actually said you thought that Europe should trend up and grow for the rest of the year, kind of in contrast to some of the other trends you were talking about. So maybe you can just explain why you thought that was going to happen? Thanks a million.

This is David. We have seen really good growth in a couple of markets in Europe that are continuing to grow and mature. If we look at countries like France where we've had lots of great large-scale competitive wins, new reimbursement protocols in place in some of the Scandinavian countries that are driving growth, and then just good, steady growth in some of our other European markets. And also, outside of Europe, we have also seen good adoption of the ThinPrep technology, places like Brazil, the Middle East, eastern Europe. We're seeing good growth in each of those different areas and as a result of that we really believe that there will be excellent growth outside of the US, not to mention China where there is still a massive untapped market and we continue to see strong growth.

We'll take a follow-up question from Bill Bonello.

Thanks. Can you just give any sense of what your expectations are in terms of any data from your US clinical trial on tomo coming out over the course of the next year, and sort of how results from that trial might be disseminated out into the marketplace?

In order for there to be data that becomes part of the public domain, all of these clinicians need to write research reports, and we are certainly encouraging them to do so. Obviously, that's a significant commitment but we believe the data are very encouraging and this is all but for now getting the clinician to actually devote the time. And we think that's going to happen through either Mass General, UPMC, some of our earlier beta sites that were at the forefront of tomosynthesis for the last two years. It just has not happened as of yet, and as I say we would expect that will be happening over the next year.

Okay. So think of it, though, as stuff that gets published in journals, et cetera, as opposed to some kind of consolidated data release at a conference or something like that?

Yes. I don't think -- we could publish the data today, but it would not be independent at that point. Obviously, we have aggregated the results. We know that they're very favorable. We know that there were findings that were not present in our original clinical trial meeting, cancers that were found in only 3-D and not 2-D, and things that were very, very positive, albeit, selective. But I think it carries much greater weight and value if it is a peer-reviewed independent study versus the Company publishing its clinical results and that's why we have been hesitant to do so.

Now we will use that data in talking to payer groups and CMS because we think that it is a compelling reason for both private pay and CMS to look at this as saving lives as well as saving money, and I think that will be a good outlet for this clinical data initially.

Okay. Thanks a lot.

Sure.

That is all the time we have for questions today. I will turn the conference back over to Hologic for closing remarks.

I just wanted to thank everyone for participating on the call and we'll look forward to reporting to you over the balance of fiscal 2011. Thanks very much.

That concludes today's conference. Thank you all for joining us.