Hologic Inc (HOLX) 2016 Q1 法說會逐字稿

Good afternoon and welcome to the Hologic, Inc. first-quarter fiscal 2016 earnings conference call. My name is Cassandra, and 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 Mike Watts, Vice President Investor Relations and Corporate Communications, to begin the call.

Thank you, Cassandra. Good afternoon and thanks for joining us for Hologic's first quarter of 2016 earnings call. With me today are Steve MacMillan, the Company's Chairman, President and CEO, and Bob McMahon, our Chief Financial Officer. Steve and Bob both have some prepared remarks. Then we will have a question and answer session.

Our first-quarter press release is available now in the Investors section of our website. We also will post our prepared remarks to our website shortly after we deliver them this afternoon.

Finally, a replay of the call will be archived on our website through February 26.

Before we begin, I would like to inform you that certain statements we make during this call will be forward-looking. These statements involve known as well as unknown risks and uncertainties that may cause actual results to differ materially from those expressed or implied. Such factors include those referenced in the Safe Harbor statement that is in our press release and in our filings with the SEC.

Also during this call, we will be discussing certain non-GAAP financial measures. A reconciliation from GAAP can be found in our earnings release.

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

Thank you, Mike, and good afternoon, everyone. We are very pleased to discuss Hologic's financial results for the first quarter of fiscal 2016.

In short, the Company is off to a good start to the year. We are executing on our key top-line growth drivers and exceeding expectations on the bottom line based on the tremendous earnings power of the company, which has become even stronger over time than I initially thought possible. In the first quarter, total revenue grew 8.1% in constant currency terms, driven by double-digit growth in the United States, our largest and most profitable market. Our US businesses have turned around more rapidly than anyone anticipated, based on better commercial execution and the quality of our products. And, over the last few quarters, our domestic sales and marketing teams have kicked it up a notch, generating robust growth from our key brands.

This commercial improvement has led to significant benefits up and down our income statement. For example, in the first quarter, we posted non-GAAP gross and operating margins that were significantly higher than in the prior year period. We are clearly demonstrating that, despite our already sector leading profitability, we can generate additional operating leverage by driving the growth of our most profitable products.

Working down the income statement, earnings per share were $0.46 in the first quarter, beating our expectations again. In addition, we increased EPS at a pace that was nearly 3 times the rate of revenue growth.

With that introduction, let me discuss the details of our first-quarter revenue performance. Then Bob will take you through the rest of the income statement, the balance sheet and our updated guidance.

Total revenues were $695.2 million in the first quarter, an increase of 6.5% on a reported basis and 8.1% in constant currency terms. Geographically, our US businesses performed exceptionally well in the quarter. We posted 12.8% revenue growth domestically, a slight acceleration over the fourth quarter despite a more difficult comp.

This strong US performance outweighed what was a mixed bag internationally in the first quarter. We showed good continued progress in cytology, molecular diagnostics and surgical outside the United States. In constant currency terms, cytology grew high single digits. Molecular posted modest growth for the second consecutive quarter, and surgical grew in the midteens, albeit from a small base.

In contrast, we saw weakness in our international blood screening business, which was largely expected and which resulted mainly from fluctuations in ordering patterns by our commercial partner, Grifols.

In addition, our international breast health results confirmed, as we have highlighted before, that we are a long way from optimizing our relationships with our dealers and distributors. Lower breast health and blood screening sales OUS contributed to total international sales declining 11.5% in the quarter or 5.4% in constant currency terms.

We are moving decisively to strengthen the international breast business, drawing on the same toolkit that we employed to turn around our domestic franchises. We are unifying leadership of all global commercial activities under our COO Erik Compton so that we may share some of our US best practices internationally.

As part of this process, our head of international has left the Company, along with our head of European breast health sales. In their place, Eric is diving deep to optimize our go-to-market strategy in key markets around the globe. We are highly focused on identifying the right commercial model for each country in which we operate. While there may be some short-term volatility, we remain bullish on our international opportunities in breast health, and we look forward to sharing more details about our plans as they come together.

Now let's provide some more color on our divisional revenue performance in the first quarter. Our biggest division, diagnostics, posted sales of $310.7 million in the quarter, a growth rate of 3.7% in constant currency terms. But the three franchises within diagnostics demonstrated very different results. In molecular diagnostics and cytology, where we control the commercial channel, our results were very good, but blood screening sales declined. Let's discuss each piece in turn.

In molecular diagnostics, quarterly sales of $129.6 million increased 9.9% in constant currency, our best growth rate since the Gen-Probe acquisition. Domestic revenues increased a stellar 11.5% and the formula was similar to recent quarters; strong placements of our fully automated Panther instrument; a healthy number of competitive wins; and growing utilization of our women's health assays.

We said at a recent healthcare conference that the average Panther system globally now generates more than $170,000 in annual assay revenue, despite being less than 30% utilized. This demonstrates both the current value of the system and its future potential for customers and Hologic as we add new tests for viral load and other targets in the years ahead.

Outside the United States, sales of our molecular diagnostics products grew nominally on a constant currency basis for the second consecutive quarter as the business stabilizes after an extended period of decline.

We are also pleased with the performance of ThinPrep, one of our largest and most profitable franchises. Global sales of psychology and perinatal products totaled $120.4 million in the first quarter. US sales actually increased by a modest 0.5% as market share gains more than offset headwinds from longer screening intervals, and internationally we are encouraged that revenue grew 8.7% in constant currency. This drove global growth of 3.1%, our second consecutive quarter of decent constant currency growth.

Our commercial team deserves much credit for transforming a business that was declining at a high single-digit rate as recently as 2014 into a modest grower globally.

In blood screening, worldwide sales were $60.7 million in the first quarter. This was roughly flat sequentially as sales have normalized without the benefit of growth from the Japanese Red Cross contract. Compared to the prior year, however, blood screening sales declined 6.5% on a constant currency basis. This reflects heavier ordering by our partner, Grifols, a year ago, and general declines in blood usage that we are seeing in the United States and other markets.

Now let's turn to breast health where we continue to see strong adoption of our Genius 3D MAMMOGRAPHY exams in the United States. Domestic sales of breast imaging products, including our Genius systems, increased 18.7% compared to the 8.9% constant currency decline we saw internationally. Global sales of interventional breast products increased slightly on a constant currency basis, and we are optimistic that new products will help stimulate growth in this category over the next couple of years. All this added up to total breast health sales of $262.2 million in the quarter, up 9.9% in constant currency terms.

We also remain enthusiastic about our future prospects in the mammography market. We continue to gain share in the United States based on a superior product profile and excellent customer service. Our prices are stable, despite increasing competition, which indicates that our marketing programs are working and that our systems are providing value to customers. And congressional action has prohibited any near-term insurance changes arising from the controversial screening recommendations by the US PSTF. All in all, we have a lengthy runway ahead of us to continue upgrading older, less effective technologies to our Genius 3D exams.

To round out the revenue discussion, we are thrilled with the progress being made by our surgical team. Although the December quarter is typically a seasonally strong one, we certainly did not predict sales of $98.8 million or a constant currency growth rate of 18.8%. These are truly outstanding results, our best overall performance in the last several years. So congratulations to the commercial teams and new leaders who are making it happen.

It is worth mentioning that surgical is Hologic's most profitable division on a gross and operating margin basis. So the magnitude of the topline growth we are now seeing is having a nice positive impact on the Company's gross and operating margins, as well as earnings per share.

Specifically, our MyoSure product hysteroscopic tissue removal posted total revenue of $36.9 million in the first quarter with accelerating growth of 46.1% in constant currency terms.

Equally impressive, global NovaSure sales of $61.7 million increased by 7.5% on a constant currency basis. We do believe NovaSure sales benefited from the recall of a competitive product, but estimate that this benefit was relatively small in the context of overall quarterly sales.

Finally, worldwide skeletal sales were $23.5 million in the quarter, an increase of 7.7% on a constant currency basis, driven by continued growth of our new Horizon bone density scanner, a very solid performance.

Before I turn the call over to Bob, let me conclude by saying that this quarter illustrates the value that our portfolio of products can provide to shareholders. Although breast health and blood screening declined outside the United States, we more than compensated by posting strong growth in mammography, molecular diagnostics and surgical. The net effect was top-line performance slightly ahead of expectations and a significant increase in profitability.

All in all, we are off to a good start in 2016 and remain excited about the future. Now I will hand the call over to Bob.

Thank you, Steve, and good afternoon, everyone. I am going to walk through the rest of our first-quarter income statement, the balance sheet, and our updated financial guidance for 2016.

Unless otherwise noted, my remarks will focus on non-GAAP results, and percentage changes will be on a year-over-year basis.

As Steve mentioned, we delivered another solid quarter on the top line with 12.8% sales growth in the US, more than offsetting the international choppiness we saw in breast health and blood screening. Strength in domestic revenue, combined with the early returns of our productivity efforts, helped drive margin improvement at the gross and operating levels, contributing to non-GAAP earnings per share of $0.46, a 17.9% increase over the prior year period.

Even with headwinds from share count and currency, EPS grew at a rate nearly 3 times faster than sales.

Moving down the income statement, our first-quarter gross margin of 65.2% increased 190 basis points compared to the prior year period. Gross margin benefited from mix, both geographic and product and from our cost reduction initiatives. Not only did revenue grow at a double-digit rate in the US, some of our highest margin products also performed well, including our ThinPrep, NovaSure and Aptima franchises. And I should point out that pricing remains stable across our product lines as our commercial teams focus on selling the clinical and economic value that our products provide.

In addition, our operations and procurement teams are executing well, driving efficiencies and reducing the cost to make our products. Total operating expenses of $221 million increased by 11.3% in the first quarter. This increase was driven primarily by sales and marketing expense, which increased 15.6%. We continue to invest to extend our leadership in the mammography market and to explain why code testing is the best way to protect women from cervical cancer.

Despite these investments, better gross margins drove profitability improvement down to the operating line. Our non-GAAP operating margin was 33.4% in the quarter, an increase of 50 basis points from last year. Although our operating margin is already among the highest in our sector, the last several quarters have clearly demonstrated that they can expand further, even as we fund key growth drivers.

Moving further down the income statement, we are beginning to reap the benefits of our efforts to reduce and refinance debt. In the first quarter, interest expense was $32.8 million, a reduction of 25% versus the prior year period.

In addition, we are pleased that a lot of hard work to reduce our tax rate has begun to pay off earlier than expected. We now estimate that our effective tax rate will be around 33% in fiscal 2016, lower than our initial guidance, and this added about $0.01 to EPS in the first quarter. Although this is just a first step in our multi-year tax improvement strategy, we are encouraged by the progress we have made so far.

Finally, diluted shares outstanding were 292 million in the first quarter. As you know, we are focused on minimizing share count dilution by eliminating the convertible notes from our capital structure. In the fourth quarter, for example, we repurchased $300 million in principal of our most dilutive convertible notes, and this had a beneficial effect on share count in the first quarter.

In addition, the recent decline in our share price had the rather perverse effect of further reducing dilution from the converts. The combined effect boosted EPS by almost $0.01 in the quarter.

Now let's talk about cash flows and the balance sheet. Operating cash flow was strong again in the first quarter at [$160.3] million, an increase of 7% over the prior year period. We spent $19.7 million on capital in the quarter, leading to free cash flow of $144.6 million.

Turning to the balance sheet, we ended the first fiscal quarter with $650 million in cash, a 19.5% improvement over the prior year period. This strong cash position provides us with dry powder for potential tuck-in acquisitions even as we continue to pay down debt.

At the end of the first quarter, we had total debt outstanding of $3.6 billion, a decrease of $322 million compared to a year ago and net debt of $2.98 billion. Our leverage ratio net debt over EBITDA now stands at 3.1 times, and we are on track to achieve our goal of lowering our leverage ratio to 2.5 times by the end of fiscal 2017.

To wrap up the historical discussion, adjusted EBITDA was $252 million in the first quarter, up 8.1% compared to the prior year period, and we are tracking to generate EBITDA of more than $1 billion for the full year. Our consistency in delivering strong profit growth and lowering debt has allowed us to steadily improve our return on invested capital.

As of our first fiscal quarter, ROIC was 11.3% on a trailing 12-month basis, 160 basis point increase over the prior year.

Now let's shift gears and turn to our updated non-GAAP financial guidance for the full year and second quarter. We are updating our guidance based on our solid performance in the first quarter, a stronger US dollar and greater than expected earnings power. As always, this guidance is based on recent foreign exchange rates. As you know, the dollar has strengthened since we provided our initial 2016 guidance. Compared to last year, we now expect currency to represent a $25 million top-line headwind in 2016. This equates to roughly $0.03 in earnings per share.

And, importantly, compared to when we initially guided in November, the stronger dollar is subtracting an incremental $11 million from our top line.

So for the 2016 fiscal year, we are maintaining our guidance for constant currency growth of between 4.4% and 5.5%. But, on a reported basis, we are updating our guidance to reflect the additional currency headwind. So based solely on the stronger dollar, we now expect reported revenues of $2.8 billion to $2.83 billion, representing reported growth of 3.5% to 4.6%.

As Steve said earlier, we continue to forecast improvements on both the gross and operating margin lines based on favorable geographic and product mix, as well as early returns from our productivity efforts.

In addition, as you probably read, the Omnibus budget bill that was passed by Congress in December included a two-year moratorium on medical device excise tax among other key provisions. We are thrilled that Congress has recognized the negative effects of this tax on domestic innovation and job growth. In fiscal 2015, we paid $23.6 million under this tax, which was reported under general and administrative expenses.

It is important to note two points, however. First, since the moratorium took effect on January 1, we only recognized three-quarters of this benefit in our 2016 fiscal year. In addition, we plan to reinvest most of the benefit in some of our more attractive R&D and commercial programs.

Continuing with our full-year guidance, we now expect our effective tax rate to improve to approximately 33% for the year and believe diluted shares outstanding will total between $296 million and $298 million for the full year. Given these updates and our strong first-quarter results, we are increasing our non-GAAP earnings-per-share guidance.

For the full year, we now expect EPS of $1.86 to $1.90. This translates to growth of 13.1% to 15.5% in constant currency terms or reported growth between 11.4% and 13.8%.

So despite the currency and share count headwinds, we anticipate growing EPS at more than double the rate of sales, demonstrating bottom-line growth and operating leverage that seemed unlikely at best just a few quarters ago.

Turning to guidance for the second quarter of fiscal 2016, we expect revenues of $680 million to $690 million. Compared to the prior year period, this range reflects revenue growth of 4.5% to 6% on a constant currency basis and reported revenue growth of 3.7% to 5.3%. We expect a sequential decline in revenue for two main reasons. First, our surgical business is seasonally weakest in the March quarter, especially in comparison to the strength we saw in the December period. Second, we are allowing for some potential choppiness in our international business.

In terms of the bottom line, we forecast diluted non-GAAP earnings-per-share of $0.45 to $0.46 in the second quarter. This represents growth of 11.2% to 13.6% in constant currency terms or 9.8% to 12.2% on a reported basis. It is worth mentioning that we anticipate a substantial R&D increase in spending in the second fiscal quarter based mainly on the timing of projects.

Before opening the call for questions, I would like to reiterate that Hologic is off to a good start in 2016. In the first quarter, our momentum continued with Genius 3D MAMMOGRAPHY and our surgical and molecular diagnostics businesses surprised to the upside. As a whole, our domestic businesses performed great. These positives outweighed weaker than expected results in our international mammography business, which we are dealing with aggressively. In the middle of the income statement, we are demonstrating the tremendous earnings power of the Company by improving gross and operating margins, and below the line we are beginning to see the benefits from our efforts to reduce debt, as well as our effective tax rate.

With that, I will ask the operator to open up the call for questions. Please limit your questions to one plus a related follow-up, then return to the queue. Operator, we are ready for the first question.

(Operator Instructions) Tycho Peterson, JPMorgan.

Steve, I guess I want to start on the international breast health where we have been getting a lot of questions on the decline. Can you maybe just walk through the extent of the dealer issues, how contained this is, how quickly you can work through it, and what kind of cushion you are baking in for the remainder of the year?

Yes. On the wall of worry, Tycho, it is something we think about. I wouldn't be overly freaked out by it. I think the way we are thinking about it is, we have got just about every business performing better than we expected. But I think the deeper we dug in the second half of the year, you continue to here us say, really going back a few quarters, hey, we are probably closer to a startup than a real turn around here, and we have a lot of work to do, even on just building our relationships with the dealers. And I think as we go back and look at it, clearly, our fourth fiscal quarter was really strong and followed by a weaker quarter, and that is not what we want to be delivering and don't have that sustained relationship.

So we are making some changes internally, and we are not going to blame the dealers. We are always going to look at ourselves. And I will say that we need to be a little closer to it, but it is the only little piece of the puzzle, I think, right now for us to continue to work on.

I would also say, I think we are all accustomed to not every business is always firing on every cylinder. The day it does, we are probably in trouble. This is kind of one of our areas of opportunity.

I think the next couple of quarters we will probably be a little bit softer. We're going to plan for that while we get to the right longer-term place. But as Eric Compton after his first reviews of it said, it obviously reminds him a little bit of when he walked in the door of Hologic two years ago and some of the same rebuilding needs to occur. And things like pricing discipline, marketing, market access, just a lot of the fundamentals that we have never put in place.

Okay. And then just to follow-up, the management changes you are alluded to, are the changes done? Do you have a team in place now you need for Europe?

No, we are putting those in place. So we have exited a couple of people, and we are in the process of putting new ones in. So that is why I think, over the next quarter or two, we will probably still have a little softness, and that is basically what we baked into our guidance.

Jonathan Groberg, UBS.

Congratulations on an incredibly solid quarter. Obviously, a lot of questions on international breast health, but you just answered some of those. So can you maybe talk a little bit about your -- it looks like, for the quarter, at least to start the year, your operating expenses grew quite a bit more than sales. What is your expectation for OpEx growth for the year versus gross margin for the year?

Hey, Jonathan. It is Bob. So as we mentioned in our prepared remarks, what we're looking at is actually very strong performance on our gross margin basis combination of product and geography mix, as well as some of the productivity efforts that we are doing. And we are looking to reinvest a portion of those.

So our gross margin is probably operating a little better than what we had anticipated, and we are looking to reinvest that in those growth drivers in places like our marketing and, to a certain extent, some of the R&D investments to drive that growth rate on the top line.

That being said, we are still expecting operating margin expansion consistent with what we had guided to in November, and we believe that we are able to do that, and we have demonstrated that, certainly, in the first quarter. We continue to have operating margin leverage, and we expect that throughout the course of the rest of the year.

So just to follow up on that and kind of tie it into the first part of the conversation around international, is it more about getting the right people? I know you thought you had the right person in your first hire. But is it more about getting the right people, or is it more about throwing more money at the issue, and have you contemplated how -- is that kind of in your guidance now, the outlook for how much you might need to spend in order to get the startup going internationally?

It is all about the right people. It is not about spending, Jonathan. So we will have it nailed.

Jack Meehan, Barclays.

Good afternoon. So just wanted to ask about the US mammography business and just curious on your view for the landscape this year, whether it is hospital CapEx trends or the competitive dynamic? Just your view on the rate of placements from here.

Jack, we still feel really good. The US -- as we said, the US breast imaging business was up 18.7% in the quarter. That is coming off of some pretty good comps. And everything we are seeing and hearing is, we continue to feel we are making very good progress both with our own customers, as well as competitive inroads. And I think we feel as good, if not better, about that business and the fact that we are going to end up -- by the end of the 3D curve, I had said early on, we think we will end up with a little bit higher share than we started. And I think, if anything, we feel better and better about that prediction. More and more confident every day that goes by. We continue to hear great stories from our teams.

Got it. And then, just curious, as you see hospitals taking on the new 3D units, do you still see them adding new capacity, or are you seeing some replacements of 2D units as well?

It is largely replacement is the way to think about it. I don't think we see the number of gantries being significantly different at the end of the 3D curve versus where we are today.

Doug Schenkel, Cowen and Company.

I just wanted to cover, really, two topics. One is really just the math on guidance, and then really the other topic is just on pricing in certain product categories.

So first, on guidance, just to try to run through the waterfall, you beat earnings guidance at the high-end by $0.04 this quarter. You increased EPS guidance for the year at the midpoint by $0.06. We estimated lower share count gets you to $0.03 to $0.05 and lower tax rate gets $0.03 to $0.04. So it seems like we might be missing something here. Is there a change in mix that you expect to occur? Are there areas that maybe you are investing a little bit more in, either in sales or R&D relative to your last guidance? Why don't I pause there and then I will come back with the pricing question?

Yes. Hey, Doug. This is Bob. You are generally on top of it for both the share count and the tax benefit. I think what the other piece that we alluded to is the incremental headwinds associated with FX. So if you think about at a very high level the tax and tax benefit and share count roughly, we think, about $0.06 offset by about $0.02 of FX, and then the operational beat in the Q1. That gives you about the $0.06 growth.

Gets you in the neighborhood. Okay. And then, on pricing really quickly, some of our recent checks suggest that there may have been a pickup with more aggressive pricing from competitors, particularly in chlamydia and gonorrhea, CT/NG. Can you talk about if you are seeing anything that is really different from the normal pricing pressures you see in the market and if there is basically what is baked into your guidance outlook for pricing changes in molecular? Thank you.

Yes. I will tell you, I think we feel as good as we felt since we have been here about pricing, and I think we have gotten so much more discipline. I will tell you, we are hearing more and more competitive attempts, frankly, about the molecular side, as well as on the mammography side where there are some pretty big disparities and with Bob McMahon and Eric Compton's leadership and the divisional presidents, we have been doing a much better job of fighting on price -- or not fighting on price -- fighting on the features and benefits and not going down there. And it is part of the hidden piece, I think, that we are seeing in our gross margin expansion.

As we talk about the gross margin piece, clearly, it is the incredible progress we are making on the operational side. It is a mix benefit, but also, frankly, I think much better pricing discipline. And we are holding pricing far better and, in some cases, getting a little bit of upticks even in what is a much more competitive environment.

Isaac Ro, Goldman Sachs.

Wanted to maybe just come back to the breast imaging comments that you guys touched on earlier and wondering if you could put those in contact with what we are seeing from the other major equipment players this quarter. And I am specifically curious if you are seeing any more signs of aggressive bundling or pricing practices from those players and whether or not that is a factor that we should be considering in the market.

We are seeing it, and Isaac, I will tell you what, I am really, really proud of our team fighting it off. I think we are actually winning more based on the overall success of our business. The combination of our product, our label, the ease-of-use, and our Genius marketing campaigns, which, frankly, has probably been the single biggest differentiator of hospitals understanding they are better aligned with us in the mammography space than with anything else because we are driving patients to the hospitals that have our systems, and I think it has been a dramatic step change in our own organization's ability to ward off going down the pricing games. And I have heard more and more anecdotes of much bigger pricing discounts from competitors on accounts that we have not lost and, in fact, we have won.

Yes. Just to build on that, Steve, I mean over the last 18 months, we have had two competitors come into a market where we were the sole competitor. We have not only maintained stable pricing, but we have gained share. That is a huge credit to our domestic breast health team led by Pete Valenti and that team. Just a tremendous job.

That's helpful. And then maybe just a separate question on the balance sheet and M&A. It didn't come up so far this quarter, but I'm curious if it is possible that we might see you guys in the marketplace this year with a tuck-in deal or two to augment the business. And, if so, how does the shopping list look? How would you characterize valuations and deal funnel? Thank you.

Sure. Isaac, I think we are still in the earlier stages probably than I would prefer to be on the true business development side. We have rebuilt the capabilities, aligned them with the divisions. I think the divisions are starting to look and starting to get the shopping list. But I put it really in probably the first inning, and we have started to look at a few things we have said no to. I do think valuations are going to be our friend as we go forward, and obviously, with the tremendous cash generation and getting our balance sheet cleaned up, we're going to be ready.

I think our teams have been so focused on great commercial execution and getting the R&D pipelines back in shape, that is sort of the next piece that will start to play out. But we are probably still a little slower, so I wouldn't anticipate anything super quick on that front.

Bill Quirk, Piper Jaffray.

First question, Bob, you mentioned that obviously there is a number of factors that help drive the gross margin improvement year over year, and you alluded to the fact that we are kind of in the early days from a supply chain standpoint. So I guess a two-part question here. One, can you help break this down a little bit further in terms of what the contribution was from aligning your supply chain? And then, again, I don't want to put words in your mouth, but (inaudible) the really early days for this initiative.

I am not going to give you the level of specificity that you probably would like to have there. I would say it is a -- the productivity enhancements that we are talking about are through our sourcing organization, as well as looking at running our factories more efficiently, and I think our operations team has done a great job of driving that.

Obviously, we started that last year, and we are seeing, one, a full year benefit. We are starting to see the full annualized effect of that this year and feel really good about that. And I would say it was a fairly meaningful component of the gross margin expansion. Obviously, with our US business driving significant growth, that also had a big impact as well. And as we are thinking about the way that the US business grew with the higher margin products in our surgical business and so forth, that actually helped us overall as well. So it was a nice balance between the three of those things. But I think we are in the early innings of sustained improvement on the gross margin basis.

Yes. Bill, I would add to that, you heard me say certainly a year ago I didn't think the Company would probably see much gross margin expansion. And, if I say things that have changed over the last year in my own outlook, that is one that I think we are seeing much better opportunity than I ever imagined possible. So it is back to there's always puts and takes. That is one of the really good guys coming our way.

Good to hear. Second, I guess just kind of a bigger picture question on blood screening and blood utilization in general. I mean, certainly, we have had the trend of the lower hemoglobin transfusion triggers in the US for a while. You alluded to that we may be starting to see this internationally as well. So I guess similar question here, guys, how much through the process are we, both in the US and OUS? I would just be curious what your partner, Grifols, has been telling you on that.

Yes. I think we see in the US -- I think we see continued low single digit declines, probably in the blood screening business. Internationally, probably more flattish as more countries adopt our nat testing, but some more advanced ones start to cut back a little bit. So I think we see the international business more flattish.

Having said that, we got a couple of quarters right now that we are absorbing the inventory fluctuations, particularly from the year ago with the JRC where, frankly, we were both doing consumption plus inventory build. And now as the inventory is contracting back, we have just got a couple of rougher comps that we are getting through.

The underlying business slightly down, but still a very good business for us. But, certainly, it is not going to be accretive to our top-line growth rate over time. It will be dilutive to that.

Richard Newitter, Leerink Partners.

I was hoping just to start off on the investments that you guys are making and one of the more frequent questions we get are about your pipeline and when we will get greater visibility into what you guys have in store as you eventually come out on the other side of the tomo ramp. So first, can you give us any sense as to whether organic or external -- where the priority is? You alluded to some of that, Steve, earlier. And then, two, any color (technical difficulty)?

A lot of what we are working on are what I would call singles and doubles, and the company was built historically on every eight years we launch a mega product like 2D and then 3D tomo. And a lot of what we're looking at is how do we cushion the blow in between and looking at some smaller things that we can be doing to bring in between those big cycles.

And on the diagnostics business, it is about building out menu. In the breast health business, it is not just what is the replacement for 3D tomo, it is, hey, there is a lot of other stuff that we can bring out in IBS and other stuff along the way. So I think what you will start to see and, as you know, with me, stylistically, I like to get a few points on the board before we start talking about them. And given an organization we inherited that had a few launches on the table that we had to scrap when I got here because they were not really ready for prime time, want to make sure we really have our ducks in a row before we, a), start talking a lot more. But I would tell you we feel better and better, but it is going to be more singles and doubles than probably triples and homeruns. So we will continue to update you as we go, but that may give you a little more flavor from what you have had so historically.

That's helpful, Steve. Thanks. And then just maybe one more on the surgical business.

Yay!

Yes, there you go. Nice growth acceleration there, and I am just trying to get a sense for how sustainable this is. Should we be thinking of this business on a kind of a newer double-digit trajectory going forward, and then do you have the portfolio you need to achieve that? Thank you.

Yes. Thanks, Richard. I wouldn't go there yet to the sustainable double-digit. Having said that, they posted several quarters in a row. The 18.8% clearly shocked us.

We quietly put a new leader in that business late last summer, and we don't talk about all the changes we make, but that business actually just in the last six months, we have a new VP of Marketing, a new President, a new Head of Business Development, a new Head of R&D. And I am more bullish and excited the team that Eric has put in place there is really, really good, and they are doing that with just two products today.

We stopped the declines on NovaSure. You know it better than most that, hey, just two years ago, NovaSure was a high single-digit decliner. We stopped that one and actually turned it into a positive. And MyoSure, I know when I first came here, it was growing at 20%. People figured we were about maxed out. Last year went to 30%, and we just had a 46% growth quarter. And that is even one that people asked us the market size a year or two ago, and I couldn't quite answer it. And I think we are seeing there may be some more potential there. And then, it is a great sales team that clearly can take on another product.

So I think that is an area we are very willing and stepping up our activities looking at bolt-on acquisitions. It is an area we are in the nascent stages. Frankly, have started to expand internationally. And it is a business that can do a lot for the profit and margin and profitability profile of the Company. So it is one we are more and more excited about. I would still model single-digit growth. But, like everything, we are certainly aspiring to continue the great trend.

But clearly, we did mention there was a competitive recall, we think, that helped us in that last quarter. And so that -- we certainly don't see the 18.8% growth as sustainable. Aspirational, yes, and we will take it back to the division head and set that as a new goal. But pragmatically speaking, we are not that good yet.

And, Rich, I guess the only thing I would add to that on surgical is the quarter that we are in now, which is our second fiscal quarter, does tend to be the seasonally weakest quarter for us, and typically the first quarter of our fiscal year is the strongest one.

Yes. This quarter is typically a 7% to 10% decline just because of the reset of insurance plans and all that stuff from a sequential basis.

Brian Weinstein, William Blair.

Just wanted to ask a little bit about breast imaging again. You commented last quarter that quarters in-house had never been higher. I'm curious what your backlog looks like right now and if you have seen any impact at all in terms of time to close from any discussion around the task force or any of these insurance companies that have been kind of reiterating nonpayment for tomo. Is there anything in the field that you are picking up on that?

Hey, Brian. This is Bob. What I would say is, our backlog continues to be very robust, and we have not seen any extension of time to close or anything like that. I think that is a lot of noise that people may hear about in the press, but when it actually comes to actually making purchase decisions and so forth, that hasn't affected us one bit.

Great. And then if I -- I'm sorry. Go ahead.

Go ahead.

I was going to say, on cytology, you continue to reference share gains. Can you talk about what inning you are in on those share gains, where you think you are in terms of market share at this point?

Sure. We are not quite sure on market share, but we feel very good. We are obviously a very strong leading bank probably in the three quarters of the market share range. So up in that 70%-plus, certainly in the US. We think we are much lower outside, and I think part of where we are really encouraged and where I think we have made great progress internationally over the last year, year and a half, is starting to get the belief and the conviction of what we need to do to grow the cytology business outside. And you remember we said, hey, one of the first things we could do to return this company to growth would stop the sharp declines on the ThinPrep business, and I think we feel pretty good about what we are doing there. I actually feel great.

Raj Denhoy, Jefferies.

Wondered if I could ask -- maybe start with Panther. You have given this metric now of $170,000 per machine. Is there any updates you can give us in terms of timing on when you can get the menu expanded and when you expect viral load in the United States and then subsequent tests beyond that?

Yes. We are just rolling out viral load outside the US. We got the CE marking, and so we are rolling that out off of -- and I think that will help our molecular business. We are obviously coming off of a pretty weak base, candidly, internationally. It is nothing like what we have here. And, really, it is going to be a fiscal 2018/2019 event in terms of the true viral load impact for us in the US. We will get HIV approved sooner, but, frankly, we ultimately want to have the full range of HIV, HBV, HCV, which we won't have really until later on in 2018.

So the way we think about that is, it is probably going end up hitting at a beautiful time for us as some of the mammography business may be slowing a bit in the US and that one kicks in and provides another leg up for us.

Okay. That is helpful. And maybe just another question, too, on R&D spending was actually down this quarter relative to last year. And although you did make a comment that you expected to step up pretty dramatically, as you move through the back half of the year, is there anything you can give us in terms of what dramatically stepping up means and why it has been somewhat low up to this point?

Yes. This is Bob. It is simply timing. When we look at the clinical programs that we have, we expect to ramp up in Q2. So don't read anything into that other than it was timing.

Jon Block, Stifel.

Maybe just the first one, Bob, for you. Constant currency growth was left unchanged for 2016, but how do we think about the changes to the components of the guidance that you broke out last quarter? Again, GYN was so big. International breast health was maybe a little shy. Should we just flow that through the best we can or any official changes, again, to the components of the top line?

No specifics. I think you would flow those in. Obviously, we were pleasantly surprised to the upside on the surgical business and in the US. I think our US business is doing a little better than what we anticipated in our international business, a little more choppy and so forth.

So outside of that, we are not going to give specific guidance to the individual components, other than to say that any softness that we may be seeing in the near term or the short term internationally, is going to be offset, we expect, by the strength in the US business.

Okay. Got it. And then, Steve, my apologies if I missed this on some of your call there, but we have seen the international breast health business bounce around a good about before, but when you talk about what is currently going on and we have the headline risk of international and what we deal with every day from where we sit, can you just give a little bit more detail? In other words, is it the way you are working with dealers, the relationships that you think you guys can strengthen in the coming quarters, or has there been any change to, call it, end-user demand out in the field in certain countries? Thanks, guys.

Sure, Jon. I think this is more an internal execution issue of us dealing with our dealers versus the market, per se. Having said that, we were hopeful to get some bigger orders in some of the emerging markets this year, and we are probably just backing off that. We're making some progress in Brazil and places like that that we are probably being a little more cautious about as we go in. But it is much more our own execution and, frankly, again, it is a small part of our business that we know has great potential and we will realize it. But it is more that, I think, than anything external or macro that we would really point to. It could be macro, but we are not going to look to say it is that. I think the opportunity is still there.

Vijay Kumar, Evercore ISI.

Thanks for squeezing me in. So maybe one on breast imaging and I'm sorry to sort of pick on this, but the dealer issues that you are having in international, what gives us the confidence or visibility that this is a short-term issue? And it looks like the US growth slowed down sequentially. So I'm just wondering if you can give us some color on what happened US versus OUS.

Yes. Two pieces. I think, first off, the US, we continue to feel really, really good. I mean, obviously, the growth rates, Vijay, which you pointed out, will be slowing down as we are going against some monster comps, especially when we come into the second half of this year. But, really, already from here on, we are now going in against much tougher comps from here. We are still growing the business, but we are not going to be putting 20% growth rates up on top of strong growth rates from a year ago.

The outside of the US, I look at this, folks, just like every other issue we face since we came to the company. We are not the perfectly well-oiled machine. I think we were making a little bit of progress, haven't made the progress that I would like to see, and it is just a matter of better execution, which is something we know how to do. And it just requires a little greater focus than probably what I was providing.

Great. And then, one follow-up on diagnostics. Clearly, this was a monster diagnostic quarter. And it is US business. You grew high singles. It feels like you are clearly gaining share. Can you provide some color on what is going on and how sustainable is the share gain? Because when you look at sort of the Aptima franchise, those are some pretty big product lines and pretty mature. So I am just wondering why this business is so strong and what is going on. Thank you.

Yes, Vijay, I think it has been the hidden piece and back to a focus on execution where we have clearly been a little more focused in the US. But our team has been continuing to place Panthers, continuing to speak to the benefits that our products bring. And, obviously, you know us well enough to know we are not one of these out there trumpeting, gee, we are number one. We beat this person. We got this competitive win. But, quietly, we are really proud of what we have done on the HPV franchise in the US. And combined with psychology, combined with the co-testing message, combined with Panther placements, they are all -- no one thing is magic, but when you systematically pile them up, it provides a very nice outlook and has us feel pretty good. This strength is going to continue.

Derik de Bruin, Bank of America.

A lot of the questions have been asked, but let me just do a couple here. So can you talk a little bit about the contribution to services for the breast health business? I know it is going to be more of an impact on the business going forward as some of those systems that you placed earlier now start -- people have to start paying for service contracts. Can we think about instrument placements versus services and how it goes in the mix?

Yes. I think we feel pretty good. Obviously, the service revenue in the quarter was not as strong as the overall product revenue, but that will be a great kicker as, basically, every system for the most part in the second year is when those will kick in. And we will say this. We are seeing a higher attach rate on the 3D service revenue contracts than we did on 2D. So, a), it is a little bit higher. So I think it is sort of one of those pieces that will kick in and we feel very good about for the future. And the team is doing a better job of actually selling service contracts today, probably in a tougher environment than we ever have.

Yes. Just one other thing, Derik, just to kind of give you a little more color on that. While our total service -- when you looked at it for the total company -- only grew roughly 2%, when you actually peel the onion back and look at the biggest component of that, which is our domestic US mammography business, that grew in the mid-single digits, which is consistent with what we have been talking about as that business, with that high attach rate, higher ASP relative to the service contracts on the lower ASP 2D. So we continue to feel good about that business.

Just a little clarification for me on this. So why was the 2D attachment rate on services so low historically? (multiple speakers)

It wasn't low. It was extremely high, and we are going from an extremely high level to actually an even extremely higher level. It was well into the 80s%, and we are doing even better than that.

Yes. We are at 85%-plus.

Yes.

Mark Massaro, Canaccord Genuity.

Congrats on the good quarter. I wanted to ask, you acknowledge that you have seen some bundling from some of the competition in breast health, and meanwhile you've also stated that you gained share. I wondering if you could just talk about the dynamics internationally. Is the bundling occurring more frequently internationally than it is in the US, and can you just help us understand some of the pressures you saw internationally in context of gaining market share?

Sure. I think it is less bundling internationally than it still -- the stage of development internationally. We have not done nearly as good a job of selling the benefits of 3D. Just from a government affairs standpoint, from a marketing standpoint, a lot of what we have going in the US, we are doing a great job of.

Internationally, because we are through dealers, we have not worked with them closely enough to really segment the market. We were starting -- obviously, there was a lot of opportunities for 2D. We need to do that. But we have had so much focus on 3D, and I don't think we have just done as good a job of fully marketing it through.

So that is a part of the whole issue of consolidating the international business under Eric. We have kind of -- I set it up when I first got here to have Eric really focus on the US, Claus focus internationally. It probably led to two silos, more than sharing the learning across the geographies. And, frankly, I feel like it has done a great job overall, but we have probably left a little bit on the table as it is related to our international development.

So now, Eric is on the case. Here we go.

Maybe a little outside the box here, but would you consider identifying countries in Europe where you could go direct in the breast health side in particular?

We are looking at it everywhere as to what is really the best model, and that will be something, I think, you can expect us to report back on over time. I would tell you, there is a lot more complexity to it all in that, candidly, in a number of geographies, we had given the marketing authorizations to the dealers. So the dealers actually own the marketing authorizations, which is not something you would typically expect of a company this size. But it is one of these, as you go into the onion and peel it back a little more, there is more work to be done, which is why we just think it is going to take us a little bit longer. I kind of view it as it will be a great thing to have in the out years when things slow down in the US. We probably are not getting there as fast as I would like to, but we will probably end up getting there at a time that will be ultimately actually pretty well timed for the total Company.

Jason Bedford, Raymond James.

I will ask two questions that will require one word answers, so we can keep it within an hour here.

All right, Jason.

So what was the installed base of Genius at the end of the quarter? And then, what are the -- what is your latest thoughts on gross margin expectations for 2016? Thanks.

Higher and higher. Yes, we are not going to give you --

Any better words than that, Steve?

You asked for one word answers, Jason. As a reminder, we are only going to give the placement numbers on an annual basis rather than getting into quarterly pieces, but we were very pleased with the additional placements of, certainly, the Genius systems and, frankly, Panthers as well, looking at our diagnostics business.

And then, gross margin, I think we are basically guiding to -- we think there is 100 basis points of improvement year over year and feeling very encouraged by that opportunity.

Thank you. That is all the time we have for questions today. This now concludes Hologic's first-quarter fiscal 2016 earnings call. Have a good evening.