Hologic Inc (HOLX) 2018 Q3 法說會逐字稿

Good afternoon, and welcome to the Hologic, Inc. Third Quarter Fiscal 2018 Earnings Conference Call. My name is Jessica, and I am your operator for today's call. Today's conference call is being recorded. (Operator Instructions)

I would now like to introduce Mike Watts, Vice President, Investor Relations and Corporate Communications, to begin the call.

Thank you, Jessica. Good afternoon, and thanks for joining us for Hologic's Third Quarter Fiscal 2018 Earnings Call. With me today are Steve MacMillan, the company's Chairman, President and Chief Executive Officer; and Bob McMahon, our Chief Financial Officer. We're also joined by our new CFO, Karleen Oberton. Karleen was formerly our Chief Accounting Officer and we just announced that she's replacing Bob this week. Steve and Bob both have some prepared remarks, then we'll have a question-and-answer session.

Our third 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. Finally, a replay of this call will be archived for 30 days.

Before we begin, I'd like to inform you that certain statements we make during this call will be forward-looking. These statements involve known and unknown risks and uncertainties that may cause actual results to differ materially from those expressed or implied. Such factors include those referenced in the safe harbor statement that's included in our earnings release and in our filings with the SEC.

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

Finally, any percentage changes that we discuss will be on a year-over-year basis, and revenue growth rates will be expressed in constant currency, unless otherwise noted.

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

Thank you, Mike, and good afternoon, everyone. We're pleased to discuss Hologic's financial results for the third quarter of fiscal 2018. We posted strong results overall with both total revenue and earnings per share finishing above our guidance ranges. Breast Health outperformed. Our core international franchises continued to grow at a robust pace, and our molecular diagnostics franchise accelerated from last quarter. In addition, both our surgical and Medical Aesthetics divisions, which had struggled recently, showed solid sequential improvement, in line with our expectations. And just today, we closed a tuck-in acquisition that will further strengthen and expand our Breast Health franchise. We'll discuss that more in a moment. But first, let me provide an overview of our top line results.

In the third quarter, revenue of $824 million grew 2.2% on a reported basis or 1.1% in constant currency. Although we're not satisfied with this growth rate, we believe we are making encouraging progress in several areas of the company. Before we discuss that progress, let me point out that, like many others, we had a tailwind from the weaker dollar compared to the prior year period. This benefit, however, was less than we forecast 3 months ago since the dollar has strengthened since then. In addition, please note that we have now annualized the effects of the Cynosure acquisition and the blood screening divestiture, both of which occurred in the second quarter of last year.

Now let's get into the details. Breast Health, our biggest business, led the way in the third quarter as U.S. revenue accelerated while international sales remained strong. Diagnostics improved from a soft second quarter with upside from the divested blood screening business. Surgical was basically flat on a global basis, and, as we predicted, is showing steady improvement over the last 3 quarters. Cynosure also finished in line with our expectations, declining compared to a tough comp in the prior year period but increasing sequentially.

In terms of geography, our legacy international franchises again demonstrated robust growth in the third quarter. Excluding Cynosure, OUS revenue increased 14.5%. This performance was once again led by Breast Health, but our other businesses also contributed strong growth, reflecting the significant broad-based improvements we have made in talent and capabilities in recent years. Including OUS sales of Cynosure products, which declined in the period, total international sales were $207.2 million, an increase of 5.5%.

On the subject of international and in response to recent news, let me mention that while China represents only about 3.5% of our total sales, several of our products are included on the expanded list of potential Chinese tariffs. So while we do not think these potential tariffs would have a significant impact on the company, we are keeping a close eye on the situation.

In the United States, total revenue of $616.8 million was basically flat in the third quarter, down 30 basis points. Underpinning this, however, we saw positive momentum in our legacy franchises as growth rates improved sequentially in Breast Health, Diagnostics and Surgical. Cynosure sales declined materially compared to the tough comp in the prior year period, as expected, but increased on a sequential basis, reflecting a strengthening commercial organization in the United States.

Now let me provide some detail on our divisional revenue results in the third quarter. As mentioned, Breast Health outperformed again in the period. Global Breast Health sales totaled $307.9 million, a robust increase of 7.4%. International continued to lead the way with sales growth of just over 20% for the fourth consecutive quarter despite annualizing the first of our 2 European distributor acquisitions. In addition, the much larger U.S. breast business strengthened in the quarter and posted growth of 4.4%, a testament to our team, the strategies they have put in place and solid commercial execution.

Within Breast Health, sales of imaging products increased 6.5% globally, our best growth rate since the second quarter of 2016. We continued to gain market share behind our clinically differentiated Genius 3D mammography systems and have bolstered growth by revitalizing our R&D pipeline and introducing new products. These include our 3Dimensions and 3D Performance systems and our Affirm prone biopsy system, all of which are performing well.

At the same time, sales of interventional products continued the recent hot streak, increasing 12.4% globally. With this third consecutive quarter of double-digit growth, interventional is emerging as another important growth platform. New products played a role here as well, especially our revolutionary new Brevera biopsy system, which improves biopsy workflow and the patient experience.

Our Breast Health business gets even stronger with the acquisition of Faxitron, which we announced today. Before I discuss the details, I'd like to take this opportunity to publicly welcome nearly 70 Faxitron employees to Hologic. This transaction broadens our product portfolio and expands the role we play in the clinical continuum of care for breast cancer patients. Faxitron's market-leading product, which spans from digital specimen radiography to breast lesion localization to sentinel lymph node biopsy solutions, are sold via a strong distribution channel that focuses on breast surgeons and pathologists. So Faxitron will complement our strengths in the mammography suite and enable us to play a larger role in breast-conserving surgery, an adjacent growth market.

From a financial perspective, acquiring Faxitron is consistent with our capital deployment goals. It's a great tuck-in acquisition that leverages our expertise in the breast health channel while providing attractive growth and return on invested capital. We are seeing increased business development activity across our divisions and hope that acquisitions like Faxitron will become a more regular part of our story in coming quarters. Faxitron also reinforces a theme that we discussed on our last call that our Breast Health division is much more than mammography machines today. We have built a diversified, increasingly global business around the core of our Genius 3D platform. And increasingly, growth is coming from new products, software and service, even as capital placements in the mature U.S. market level out. In fact, domestic 3D gantries represented only about 20% of global breast health sales this quarter as our sales force gets better and better at understanding customers' needs and selling our full portfolio. The energy and excitement in our Breast Health division has never been stronger than it is today based on a clinically differentiated core of mammography systems, multiple new products built around this core and now a complementary tuck-in acquisition.

Before we move on, let me mention that we are also pleased with the favorable initial ruling issued by the International Trade Commission in our patent infringement complaint against Fuji. The judge recommended an exclusion order that prevents the importation of infringing Fuji products into the United States and a cease and desist order that prevents the further sale of those products here. We look forward to a final ruling by the ITC in November.

Moving on to Diagnostics. Revenue of $294.3 million grew 2.3%. The growth driver here continues to be molecular, where global sales of $154.5 million grew 6.3% and also accelerated sequentially. Internationally, molecular grew in the mid-teens, marking the eighth time in the last 9 quarters we have achieved double-digit growth and reflecting a steady cadence of new product introductions into global markets. In the U.S., where we already enjoy high market shares in our key assay categories, molecular still grew at a healthy mid-single-digit rate, improving from a tough second quarter that we believe was negatively affected by a bad flu season.

Our Aptima women's health assays on the Panther system remain the primary growth drivers in dollar terms, but we're also seeing nice adoption of our virology menu at a variety of labs. Although the base remains small, sales of our quantitative HIV, HCV and HPV tests more than doubled again versus the prior year period. And we are optimistic that the Global Access Initiative we announced last week will lead to further growth of viral testing in resource-limited countries.

Elsewhere in Diagnostics, cytology and perinatal sales of $121.1 million declined 1.8%. Cytology growth remains challenged in the United States due to our high market shares and longer cervical cancer testing intervals, but a solid quarter internationally enabled global cytology sales to finish roughly flat. On the other hand, sales of our fetal fibronectin test declined, dragging down this subsegment.

Finally, on Diagnostics, revenue related to our divested blood screening business totaled $18.6 million. Although this represented a decline of 2.1%, it was roughly double what we forecast. Nonetheless, we have now annualized the financial impact of the blood screening divestiture and expect a significant reduction in quarterly blood screening revenue going forward.

Now let's cover our GYN Surgical division. Consistent with our expectations, global revenues of $107.7 million increased fractionally after posting 2 disappointing quarters of declines. Underpinning this, we are encouraged to see signs of stabilization in NovaSure. As we discussed on our last call, our new leadership team is changing the culture of the surgical sales force, investing more in the endometrial ablation category and emphasizing the benefits of our product relative to competitors. As a result, while NovaSure sales declined 7.6% on a global basis, this rate of decline was much less than in recent quarters. At the same time, MyoSure continues to perform well with growth of 9.6% in the quarter. As our surgical team continues to execute better, we do expect the total business to return to better growth in the fourth quarter.

Before we leave Surgical, let me mention that we're very gratified by our victory in the patent infringement lawsuit we initiated against Minerva. As you probably know, last week, a jury awarded us $4.8 million in damages for Minerva's infringement of 2 of our NovaSure patents. As the legal process continues to play out, we intend to seek a permanent injunction prohibiting Minerva from selling the infringing device in the United States.

Now let's discuss Medical Aesthetics, which posted sales of $91.7 million, down 18% versus the large comp in the prior year period. Coming off a disappointing reset last quarter, we believe these results represent a step in the right direction. While we still have a lot of work to do at Cynosure, we are encouraged that revenue finished in line with expectations in the third quarter and increased sequentially.

Aesthetics markets remained healthy, and our revamped domestic sales force is settling in and gaining confidence. This helps us strengthen relationships with customers and also gives us strategic flexibility. For example, we recently signed an agreement with Porter Instrument, a business unit of Parker-Hannifin Corporation, to distribute their Nitronox nitrous oxide system, which physicians are increasingly using to reduce pain and anxiety during aesthetic procedures. In addition, we have agreed to distribute another El. En. laser in the United States, this one for hair removal. These deals show how we can supplement organic innovation with small transactions that capitalize on our commercial strength, scale and stability with the ultimate goal of building sustainable, competitive advantage in a fragmented industry.

We are beginning to see other signs of progress in the changes our new leadership team is implementing at Cynosure. For example, our new TempSure radio frequency platform is off to a good start. Encouragingly, most TempSure systems are being purchased by customers who are new to Cynosure, broadening our customer base and opening up long-term opportunities for additional placements and upgrades.

SculpSure also posted solid growth sequentially, above what we would have anticipated from normal seasonality as our efforts to strengthen this brand in the underpenetrated, noninvasive fat-reduction market are beginning to pay off. For example, SculpSure ratings on RealSelf, an influential website for the aesthetics industry, have increased dramatically and are now better than our primary competitors. Patient interest and referrals have increased significantly based on our DTC efforts and better post-sales support, and customers are noticing.

And finally, in another sign that the health of the business is improving, recurring revenue from customer service and disposables increased to almost 10% in the quarter and represented more than 1/4 of total sales, this despite the decline in overall Cynosure sales. So while we are still very much in prove-it mode with Cynosure, we are learning how to win the right way in aesthetics and forecast that Cynosure will become a consistent growth engine, starting next quarter, as the prior year comps normalize.

Before we leave Cynosure, let me say that just yesterday, we received the FDA letter regarding MonaLisa Touch, which represents less than 10% of Cynosure sales. We are still analyzing the FDA-specific concerns but acknowledge that this may create some market uncertainty around MLT in the short term. Having said that, we obviously agree that these products need to be marketed appropriately. Given our strength in women's health, the studies we have already done for MLT and our efforts to demonstrate the clinical value of all of our products, we believe we can be a leader here over the long term, especially relative to competitors that may not have our compliance and regulatory capabilities.

I want to be very clear here. We believe a higher level of scrutiny from regulatory authorities will benefit us over time since we share the same goals as FDA, clinically strong products that improve lives and are marketed responsibly. We are all about supporting technology with science and clinical evidence, so we welcome the more level playing field that this action signals.

To wrap up the revenue discussion briefly, Skeletal Health revenues of $22.5 million grew 2.1% due to strong international sales and continued solid adoption of our bone density systems, which are used both for osteoporosis screening and human performance management.

So to wrap up, our financial results were strong in the third quarter with both revenue and EPS exceeding our guidance. While Breast Health and international led the way from a growth perspective, we are also pleased with the progress we are making in Surgical and in Cynosure. And we are excited about today's acquisition of Faxitron to boost our breast business.

Before I hand the call over to Bob, let me take this opportunity to thank him for 4 outstanding years as our CFO. As we announced separately today, Bob will be leaving the company to join Agilent. Since coming to Hologic in 2014, Bob has played a key role in our success. He's been a terrific leader in the organization and a great partner to me. He helped our businesses return to growth, which, in turn, enabled us to improve our cash flows and strengthen our balance sheet by paying off debt. And he built strong relationships with many of you on this call.

While we're sorry to see Bob leave, we are also excited to promote Karleen Oberton, our Chief Accounting Officer, to replace him. A 12-year Hologic veteran, Karleen has a deep knowledge of our businesses, our markets and our people. She was already a member of our global leadership team and has long been a valued partner for our divisions as well as an expert on financial planning and accounting matters. She is ideally qualified to both continue and expand the financial progress we have made, and Mike and I look forward to introducing her to many of you soon.

Now I'll turn the call over to Bob.

Thanks, Steve, and good afternoon, everyone. Before I begin, let me just thank you, Steve, our Board of Directors and the entire Hologic team for the honor and privilege of working with you over the last 4 years. I'm immensely proud of what we've achieved, not just from a financial perspective, but also in terms of building a sustainable growth business and making a huge difference for women's health. I will miss many things about Hologic, but I leave optimistic about the company's future and confident that Karleen will take the finance team and the organization to even greater heights. I also look forward to staying in touch with many of the investors and analysts on this call in my new role.

Now let's get to our third quarter results. In my remarks today, I'm going to walk through our income statement, touch on a few other key financial metrics then finish with our updated financial guidance for 2018. 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 posted strong results in the third quarter that exceeded both our revenue and EPS guidance. Breast Health and international drove our growth, while Cynosure and Surgical improved sequentially as well. This top line performance, combined with solid expense control, a lower effective tax rate and our share repurchase program, enabled us to post non-GAAP earnings per share of $0.58, 16% higher than a year ago.

Moving down the P&L. Gross margin of 62.6% decreased 50 basis points compared to the prior year. This was primarily due to product and geographic mix as our international sales carry a lower gross margin percentage than sales in the United States. Total operating expenses of $279 million were up 1.5% as we balanced our efforts to drive leverage within the operating expense line with our desire to increase funding for key growth initiatives as well as to protect our intellectual property through legal activities. Operating margin of 28.8% was down 20 basis points compared to a year ago, primarily due to the effect of geographic mix on gross margins.

Now to round out the discussion of the income statement. Net margins of 19.3% increased 130 basis points compared to a year ago due mainly to a lower effective tax rate. We also took advantage of volatility in our share price to opportunistically repurchase our common stock in the third quarter. Specifically, we bought back 2.2 million shares for a total of $80.8 million. In addition, we're pleased to announce that the board has approved a new $500 million share repurchase authorization to replace our old plan.

So as I mentioned previously, all these activities led to non-GAAP earnings per share of $0.58 in the third quarter, an increase of 16% compared to the prior year. So even as the international grows more rapidly than our U.S. business, we continue to increase EPS at a rate well above sales.

Before we talk about our updated guidance, I'll quickly touch on a few other key financial metrics. Our leverage ratio, net debt over EBITDA, currently stands at 2.6x, and we remain comfortable around this level, recognizing that it could fluctuate a little based on the timing of transactions like Faxitron. One reason we are comfortable with our debt level is we continue to generate strong cash flow. This quarter, free cash flow was $209 million, and we have generated $472 million of free cash year-to-date when you exclude the nonrecurring tax recapture payments associated with retiring our convertible notes. Our strong cash flow and the revamping of our debt structure provide us with plenty of capacity to continue to pursue small tuck-in acquisitions like Faxitron while also acting opportunistically on our $500 million share repurchase authorization. Finally, adjusted EBITDA of $261.7 million increased slightly compared to the prior year.

Now let's turn to our updated non-GAAP financial guidance for the full year and fourth quarter, beginning with our full year revenue guidance. We are increasing our full year guidance due to our strong performance in the third quarter. We now expect reported revenue of $3.205 billion to $3.22 billion in fiscal 2018, representing reported growth of 4.8% to 5.3%. Based on recent exchange rates, this equates to constant currency growth of between 3.9% and 4.4%, higher than our guidance from last quarter. With only 1 quarter remaining in our fiscal year, this annual guidance implies revenues of $800 million to $815 million in the fourth quarter. Compared to the prior year period, this reflects revenue ranging from a decline of 0.4% to growth of 1.5% on a reported basis or growth of 0.1% to 1.9% in constant currency terms. Underlying this forecast, we are incorporating recent FX rates as the dollar has strengthened since we last guided. We now expect currency to be a headwind in the fourth quarter and into '19 as well.

Also from a divisional perspective, let me remind you that in last year's fourth quarter, Diagnostics benefited from roughly $9.5 million in royalty payments that will not recur this year. Also in Diagnostics, as Steve mentioned, we expect blood screening to decline to a little more than half of the third quarter level. We forecast that Surgical growth will improve in the fourth quarter, while Cynosure will grow year-over-year but decline on a sequential basis due to normal seasonality and the potential near-term impact of the FDA letter on MonaLisa Touch.

Now let's move on to our revised EPS forecast. We are tightening our non-GAAP EPS guidance for the full year to a range of $2.24 to $2.26 or roughly $2.25, which implies reported growth of about 10.8% despite absorbing the incremental FX headwind I discussed. So we are growing our non-GAAP earnings at a double-digit rate despite having a material EPS contribution from blood screening in the prior year. This earnings guidance is based on recent foreign exchange rates, a full year tax rate of about 23% and diluted shares outstanding of approximately 278 million to 279 million for the full year. Our full year EPS guidance translates to non-GAAP earnings per share range for the fourth quarter of $0.58 to $0.60 or roughly $0.59, which would represent an increase of about 18% on a reported basis. As you update your estimates, we would again encourage you to model around these midpoints as we've incorporated both upsides and downsides into our forecast.

Before opening the call for questions, let me summarize by saying we exceeded our revenue and EPS commitments in the third quarter. Our results highlight the progress we've made and the opportunities ahead of us for both Breast Health and international. At the same time, we're encouraged by the progress we're making in Surgical and at Cynosure and remain bullish that these efforts will begin to pay off with better growth for these divisions starting in the fourth quarter.

With that, I will ask the operator to open up the call for questions. (Operator Instructions)

Operator, we are ready for the first question.

(Operator Instructions) And we'll go now to Doug Schenkel with Cowen.

I'll just ask the 2 of them, and then I'll listen to your answers, both are on molecular diagnostics. So first, you've recently launched a number of new molecular diagnostic assays, including, but not limited to, virology. In your prepared remarks, you talked about strong virology growth while acknowledging it was off of a small base. Do you expect these assays to have an impact on system placements and overall molecular revenue growth in a more meaningful, broader way in fiscal '19? And then the second question is really on the pricing environment for U.S. molecular products. I'm wondering if pricing erosion has accelerated as you renew reagent rental contracts. And related to that, your contract with a large reference lab has now passed the 5-year mark. I'm wondering if you could provide an update on where you are in renewing that contract. So I guess that was actually 3 questions instead of 2. Sorry about that.

I was going to say, Doug, that was very clever the way you -- 2 questions, and it was clearly 3. And let's -- we will try to take them all. I think in terms of the molecular diagnostics piece, we are seeing continued growth in Panther placements, driven both by our sales activities, but the enhanced menu is definitely helping on that. And so again, I think it's all incrementally strengthening that will pay off and continue. We expect continued Panther placements into 2019. We're pricing a little bit more of an uptick in some of our international Panther placements in the last couple of quarters, which we think also bodes well to continue that growth going forward. In terms of pricing pressures, nothing significantly different in the quarter, pretty flattish. And the final piece in terms of discussions about any particular contracts, as we've said in the past, we're not going to comment on any specific customer negotiations. But we'll share more of that as we go into next year's guidance and everything else that will be factored in.

We'll now take our next question from Vijay Kumar with Evercore ISI.

So maybe I'll start the first one, and...

Just when you thought, Vijay, that we hit you with all the news we could in the last few days.

(inaudible) It's certainly been a lot to digest. And maybe I'll start with the management transition here. Bob, congrats on the move. But I'm just curious because, just from a Hologic perspective, a lot of us who've looked at the story for a number of years, we thought the business was on its path to being a sustainable top line grower. I'm just curious on the timing and maybe some -- if you could provide some background on the transition, I think that would be helpful.

Yes. Thanks, Vijay. And what I would say is in many ways, I'm very sad to leave Hologic. I couldn't be more proud of what we've accomplished and of the talented team that we have here in place, and quite honestly, the opportunities the business has ahead of it. My experience here was a big stepping stone in kind of my professional career that actually gave me the opportunity to have the opportunity at Agilent, which is a more global company, slightly bigger. And what I would say is I leave knowing that the company is in better shape than certainly when I got here, and I leave it in very capable hands with Karleen. I know she will be a great partner to Steve and the rest of the leadership team here and will continue the great work that we've been doing.

We'll now take our next question from Isaac Ro with Goldman Sachs.

Congrats to Bob. But just maybe on the Faxitron acquisition, can you just give us a little bit of detail on the nature of the business? And in particular, just curious about the impact it will have to gross margins. I took a quick look at the website, and it seems like there's a combination of equipment and disposables. So just interested in sort of the profitability contribution that business will have at the gross margin level.

Yes. Isaac, it's Bob. This business generated roughly $27 million in its last fiscal year, so it's not going to have a material impact on the total company. We do believe that there's opportunities to improve gross margins over time, obviously leveraging the scale that we have. They're slightly lower than where we are today, but we do see that, that has an opportunity to improve. As we think about the business, probably not going to have any impact in '18 and will be EPS neutral in '19 but then accretive thereafter.

We'll take our next question from Bill Quirk with Piper Jaffray.

Great. Congrats to both Bob as well as Karleen. Let's see here, staying on Faxitron for a second, if I may, I guess just a couple of follow-up questions off of Isaac's. So I guess tell us how quickly can you get the Breast Health team trained in on the product line? And then U.S., OUS revenues split. And then lastly, looks like we probably should have about $4.5 million dialed in for the fourth quarter.

Yes. Bill, this is Bob. We're probably not going to give you the international OUS split right now. What I would say is it's -- although I would say the majority of the revenue is in the U.S. As we think about it, they do have a strong distribution channel already. So what we're going to be able to do is leverage that as well as then bring our, what I'll call, discipline to it and improve. So we bring a channel. We bring some expertise, and that actually expands our offerings within the radiology and then the breast biopsy suite. So we think about it as an adjacency that they already have a strong -- they have a leading position in the products that they provide. I think we'll be able to utilize our resources and expertise to actually grow that business even beyond what they were able to do.

We'll go now to Brian Weinstein with William Blair.

(Operator Instructions).

So, Steve, I'll throw one out there, see how you react to it. So you talked about not being satisfied with 1.1% growth this quarter. I'm just curious what do you think is a satisfying level of growth for the company at this point given the makeup of the businesses. Longer term, how do you think about where you want to be there on growth? 1.1%, clearly not where you want to be. Q4, maybe more in that 4% range. But how do you think about what is satisfying here?

Yes. Clearly, given the nature of the businesses, Brian, we want to be in the mid-single-digit business. And I think, obviously, our goal is to get back there. As you well know, we've got a couple of large businesses that are going to be below that, and then it's getting the rest to be going above it. So I think as we transition into next year, and certainly, we're going to avoid giving 2019 guidance at this point in time, but certainly want to be accelerating as we come out of the year.

Got it. And then for follow-up, you talked about the recurring revenues within Cyno. And the customer service and disposables piece there, I think you said was up 10% and more than 25% of total sales. Can you talk specifically how you're doing that at this point and any other kind of targets that you would have for where you think that, that should be in the near term?

Yes. The simple goal is we're starting to see some very nice uptick in the PAC key revenue, so still not enormous, but it's moving very nicely in the directions as the SculpSure machines that are out there are starting to get more usage. And so I think it's all part of the broader play of getting our marketing efforts, driving people in to get SculpSure treatments, getting PAC keys going. And certainly, over time, as we've talked about, new products that will bring more of a disposable element, in addition to just a pure capital sale. We think, over time, that's going to become a much bigger part of the business, but that's going to be a multiyear journey, certainly.

We'll now take a question from Tycho Peterson with JPMorgan.

Congrats to Bob. I look forward to working with him at Agilent. Maybe just starting out on Cyno. I want to understand the range of outcomes here for MonaLisa. I know it's only 10% of Cyno sales, but it looks like the FDA only really had kind of 2 requests in their letter. So can you talk about maybe time lines to get back to them and how you see this playing out?

Sure. You know what? Our time line will be get back to them within the 30-day window that they've requested. And let me give you a much bigger-picture perspective on this as to why I think this is going to be a huge net positive for us over time. And this quarter, does it put a little damper on things? We'll see, may very well be. But over time, this is going to be very good. And, Tycho, I think you were around long enough to know my early days at Stryker, when the DOJ and Chris Christie came in and looked at the orthopedic industry practices, and I will tell you, I remember standing in front of my first sales meeting as CEO at Stryker, where people thought I had my head in the sand because a lot of our competitors were pursuing sales practices that we were not going to go down that path. And at the end of the day, when the DOJ came and looked into the orthopedic industry, and while it was painful to go through that, if you remember, the 5 major companies were looked at. And early on, Stryker was losing market share when I took over. When we got a level playing field and the regulations got clear and the scrutiny got better, in a level playing field, the best teams with the best products are going to win. And when Chris Christie settled that, and you may recall, the other 4 companies all got fined and all got deferred prosecution agreements and Stryker did not. And that started, for the next 10 years, Stryker gaining market share. And that's exactly what we think will happen in this industry. So frankly, having a little scrutiny, while it can be a little bit of short-term pain, we absolutely welcome it because I believe it will allow the cream to rise to the top. And that's fully where we expect to be. We are investing in the clinical trials. We're investing in the right people. We're building the right teams and really think it'll play well to us over time.

We'll go to our next question from Jonathan Block with Stifel.

Two probably relatively quick questions. So the first one, Bob, maybe for you. Looks like constant currency came up by roughly 100 bps or $30 million. Fair to say, is that approximately half attributable to blood screening and maybe the remaining Breast Health? I'm just curious on how you guys are viewing the upside guidance today versus 3 months ago, and then I've got a follow-up.

Yes. I think you're thinking about it the right way, Jon.

Okay. And then, Steve, maybe this one for you. It sounds like both Surgical and Medical Aesthetics are set to return to growth I believe you said starting next quarter. You're adding some products to the bag in Medical Aesthetics. Can you talk about a rough growth profile that you expect these divisions to recapture? And I just ask that because at one point, these were both hyper-growth assets. They have fallen on hard times. It seems like you've got them back on track. So maybe you can talk about what you should expect -- what we should expect near term and then maybe longer term.

Sure. I think -- let's take the Surgical, which, by the way, if you recall, 4.5 years ago, Surgical was a declining business, and then it got into some good, solid, mid-single digit growth, became hyper growth, frankly, when we had a competitive withdrawal in the category. I think that inflated it. The longer-term growth rate for those categories, if you play it out, endometrial ablation is probably a flattish category, truthfully. And then fibroid removal is probably a high singles, so the blended average of our Surgical business is probably a mid-singles. And we ought to be every bit, as you know, we expect ourselves to grow faster than the categories we compete in. So I think Surgical getting back into the mid-singles is where we feel good. We'd love it to be even better than that. And I think you'll see in the U.S., certainly in this coming quarter, it will be a return to growth. We returned globally to growth, or call it, flattish this quarter. The U.S. has been sequentially getting stronger each of the last few quarters, but it still declined less. We don't want to be talking about declining less, so I feel fully confident that team will return us to growth. And then we look at Medical Aesthetics. We do believe we're on the verge of starting to turn that business into a market to better-than-market grower at what is probably right around the 10%-ish number. So we're not going to be satisfied unless we're going for double-digit growth on that as we come out of the year.

We'll go to our next questioner who is Richard Newitter with Leerink Partners.

This is Jaime Morgan on for Rich. A quick question, just to kind of follow up on the Medical Aesthetics business. Where are you guys in terms of the sales organization? I know you said reps are in the midst of getting -- settling in and gaining confidence, so just looking for an update on the hiring progress and any sort of commentary you can kind of give around what we should be expecting for total rep headcount and the rep productivity and kind of the cadence of increases there.

Sure, Jaime. I'd say for the first time, we're probably at about a normal level since over a year ago. So we've got a couple of openings here and there, but it's now kind of in that standard range where you've always got a few openings and a little bit. And I think it's really the first time that we've been at that level. Now we still have people coming up to speed because the average tenure of many of the reps are still pretty junior in a lot of cases, but I think we feel really good about the progress we've made. And I think the part that's very encouraging is a lot of our legacy team, the folks who've been here, they are just not going to cover off the ball. So we have people really, really putting up very strong growth rates while they've been offset by some of the vacancies and everything else. So I think as we come into the fourth quarter, starting to feel better and better. Are we operating 100% effectiveness yet? No. But do we have most of the positions filled with good people? Yes.

Okay. That's helpful. And then just one quick follow-up on the TempSure product. I think you've indicated in the past that you guys are looking into expanded indications in both surgical and women's health. I was wondering kind of if you could give us an update on your progress on either of those indications and potentially how much of this could expand your market opportunity with this product.

Sure. I think what we continue to be excited about is TempSure is probably one of the first, what I'd call, real platform technologies that we have gotten into. And we basically have a surgical offshoot of that product that should be coming next year, so very excited by the initial sales of TempSure. And then we have stuff coming behind it as we'll go into next year.

Yes. Jaime, we just launched the women's health product literally in the last several weeks.

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

Congrats again, Bob, on the move. Steve, just want to think about Cynosure and into the fourth quarter there. Three different things kind of going on here. You've got traditional seasonality in the core Cynosure business. You've got improving momentum, as you talked about on this call, and you've got some MonaLisa headwind. But if you think of that business down quarter-over-quarter, could you just walk us through sort of the 3 components? How should we be thinking about sort of fourth quarter down sequentially in light of the sort of 3 interlocking dynamics going on?

Yes. I think, David, the way I think about it is July and August, typically, in this industry are pretty light, so you do have a clear step-down. I think our hope would be that the improved sales force and everything else could almost offset that, but you've also got the international component of that, which will also be a little softer. And candidly, MonaLisa is probably a slight little curveball. I think what it will probably do is put a pause on potentially some sales here in the short term, and that might be the difference between, deep down, wanting to actually see it go up in the quarter or not, but I think just being cautious while we're still getting out from -- getting this business back on track. I would assume that that's probably a slight more of a headwind this quarter that will play out well over the long term for us.

Okay. And, Steve, just 2 small quick ones to kind of follow-up. First is MonaLisa from a data perspective. There were a couple of studies ongoing for MonaLisa. I think one was suspended last year. I'm not sure where the other one is. But where are you on the clinical data front on MonaLisa? And then you mentioned Fuji in your prepared remarks. I wonder, any thoughts on sort of expectations for 3D Performance in the low end of the market to the extent that they are, in some way, [enjoined?]

Sure. Another magical ability to get 3 questions into 2, David. On the Fuji piece, I think we feel good that competitively, frankly, even without the legal win, our teams are being very aggressive and we continue to get a lot of wins. Certainly, they were going incredibly deep on pricing. And does that create some opportunities for us? Frankly, there were some of the accounts that we're just not going to go that low, so it may allow us to pick up some additional business in that arena here as we go forward. And there's -- the first one that's really mentioned, Breast Health. There's a lot of momentum in our Breast Health business right now that we really like what's going on there.

Steve, can I add just something on that? David, to that point, the 2 newest gantries that we launched just recently, the 3Dimensions and 3D Performance which is at the lower end represented roughly 50% of all the 3D gantries that we launched or that we sold in the quarter, and we still continue to have a very high capture rate of new opportunities. So when we look at the U.S., we believe that when we look at new placements, we're still getting an excess of 8 out of every 10 of those. And so feel very good, to Steve's point, around the competitive nature. And really not [beyond by price,] but it's the clinical benefits and the features that these products provide. And I think that that's what's been a hallmark of that team and will continue to do so, and why I think we feel very good about what they're doing as they expand their offering beyond just gantries.

And to the other question on MonaLisa, we're actually fairly deep in discussions with the FDA about deeper studies for MonaLisa Touch, things that we haven't discussed exactly but very deep into discussions. And frankly, it's why we extended the partnership. As we announced, I think, on the last quarterly call, we see this being a great product over time, but we have that more modest expectations because we have been limited, as you know, in terms of where we've been selling it. And we've wanted to generate additional clinical data for the product to strengthen the claim structure around it, so we're actually -- been deep in discussions with them on that.

We'll now take a question from Jack Meehan with Barclays.

Steve and Bob, I was hoping you could give us some color on operating margins as we look into 2019. And what are some of the puts and takes that we should be thinking about heading into the new year?

Yes. Jack, I think we want to be careful not to get into 2019 guidance. But I think at a high level, you know what, gross margin is probably not going to move dramatically because if the international business continues to grow at a lower gross margin, probably not going to be seeing the huge wins that we had in the previous years. They're also -- depending on what happens with the tariffs, that could be a slight headwind to gross margin that we would seek to try to make up as much as we can, but -- dealing with that . And I think we'll get a little bit of OpEx leverage. So whereas -- that, as we grow, that's got to be the ability to start to drive a little bit more operating margin expansion.

Yes. And I was hoping you could just elaborate on your commentary around some of the increased deal activity you're seeing in the space. Does that stand across all of your businesses? And related to that, how does the Faxitron acquisition fit into how you think you can broaden the Breast Health segment over time?

Yes, great question. We are seeing much -- many more deals that I'd say have the profile of a Faxitron. And I think, as you know, we made an organizational change, really, at the end of last calendar year, where we eliminated the Chief Operating Officer. Me, having direct access to the presidents now of the divisions, they're really starting to ramp up the activity. And just our whole corporate team supporting that, it's just a very different outlook. And I think they're starting to see some things, and we're looking at a lot more things in the flow that are, what I'd call, much more the true tuck-ins that supplement our existing businesses. As it relates to Breast Health, we've been looking at the continuum of patient care and how we continue to build out from the strength we have in mammography. And we've been seeing the growth of the breast-conserving surgery area, and it's such an adjacency. It's ripe for us to be able to go in and have a bigger play. We have a very small product in that space today, so we've got the knowledge. We've got the presence, but this will allow us to build out. And that -- these are the kind of tuck-ins that we really want to be doing. And I would say, frankly, in each division right now, we're starting to see some of them, and we've got them coming forth. So I'm not going to say we're going to have one ready to go every quarter or whatever else. It's never that linear or clean, but I can tell you the teams are really starting to surface some good things. And 2 years ago, we just -- and even a year ago, we just weren't bringing many good ideas forth.

We'll now take a question from Raj Denhoy with Jefferies.

Anthony for Raj. Maybe just back to MonaLisa a bit, there's a little bit of revenue mix in there. I'm just wondering expectations into the second half and then maybe a little bit more detail on maybe the contents of the FDA inquiries. I mean, it looks like there were certainly -- there's a focus on marketing practices. But is there a chance that this actually bifurcates, going forward, in favor of Cynosure? That will be my first question. And then just on Breast Health, it looks like there was a patent suit win, specifically against Fuji. So just an update on sort of share shifts within Breast Health and maybe how that particular situation with Fuji plays out. Is that a tailwind as you go forward here in the second half?

Sure. I think on the MonaLisa piece, it's really very early to know how it will play out for the other companies and everything else. We're just going to focus on ourselves. I think we continue to feel good about MonaLisa. We are very willing to invest in the clinical studies. And by the way, none of us are perfect. I'm sure between legacy stuff -- have you slightly over promoted here and there. We'll clean anything like that up, just as I did earlier in my Stryker days, and then we'll move forward. And again, feel really good about the product and our commitment to the clinical expertise. As it relates to Fuji, frankly they haven't been that big of a competitor. Most of what we're competing with day-to-day is really GE and Siemens institutions, and I think we continue to feel really good about the wins we're continuing to get. You don't grow our Breast Health business the way we have been doing now for a number of years post all the concerns about the cliff without continuing to take market share. So I think Fuji, I put in the nuisance category. And they are certainly there, and we hope to have them permanently withdrawn from the products that are infringing our patents. And that will certainly help. But day in, day out, we're also still competing against some very formidable competitors in GE and Siemens, but [we like our] chances.

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

Great. So I'll just see if I can sneak in 3 like Doug. Number one, can you -- how fast was Faxitron growing? And did you bless Quirk's $4.5 million number for Q4? Number two, are you still comfortable with sort of mid-teens growth in the legacy business OUS? And I'm just curious, have you seen a sort of like buying ahead, ahead of the tariffs from -- in China? Just wondering if you've seen any unusual dynamics in the market ahead of that. And yes, I'll probably just leave it there.

Great. Hey, I don't think we're going to necessarily disclose the Faxitron growth rate, but solid. And we kind of ignored those...

It's faster than the current company.

Yes. Accretive to our growth rate. Bill's number was probably slightly high, I would guess, just where we are in the quarter and where they are in terms of -- as we take it over but I think feel good about a full year number. In terms of the base business growth rates, I would not endorse mid-teens international growth for our base business going forward. I think we have had 7 straight quarters of big [stuff], but now we're really starting to get against big comps and especially stacked comps. We still expect our international business, clearly, to be growth accretive. We also picked up, as you know, a couple of distributor acquisitions. So I think that will come -- certainly slow down as we've annualized all of that but continue to feel really good about the growth rate of our international business being accretive to the company. And finally, I don't -- we have not seen any buying in or stocking in from China. I wish our business was bigger for us to realize that kind of an impact in China but I think nothing noticeable at this point.

We'll go now to Mark Massaro with Canaccord Genuity.

Congratulations, Bob. Wanted to start with the international Diagnostics business. Steve, you indicated not to expect mid-teens growth next year. Certainly, you had a significant benefit from currency in the international business. But I guess just broadly or high level, can you speak about the penetration rates and how you think you're competing across Europe and how much growth you see there just from a market share perspective?

Sure, Mark. Let me be clear. My comment to Derik, unless I misunderstood his question, was about our total international business growing at mid-teens. I think we would expect our molecular diagnostics business to continue to be a very healthy grower internationally. And again, not ready to give guidance, but my comment was more about our total business. I think we feel good about what's going on in Europe. We continue to place Panthers. Our team has gotten a lot stronger there at selling, and as the menu builds out, feeling really good about additional opportunities in Europe. And again, even though we're going against very formidable competitors in that part of the world, we're getting some very nice wins and expect that to continue.

Just, Mark, to that point, I mean, we -- when we look at our market shares there, we have a lot of opportunity to gain market share over time in Europe and in Asia as our menus expand.

Got it. And just a two-parter follow-up. The Breast Health gantries, would you say that, that number of placements is roughly stable or maybe flat sequentially? Or are you seeing an uptake there? And then secondly, on annuity per analyzer on Panther, I think you guys were looking for maybe high single-digit growth there. Any update there?

Yes. So, Mark, on the Breast Health gantries, we were up sequentially, but it's still within the range that we've [packed in,] we have been saying between [250 and 300] per quarter, and it was in that range. For the annuity on the diagnostics Panther system, that continues to increase. That's one of the things that's a real strong growth driver for that business going forward. We saw a nice rebound this quarter, as we expected. And with the additional menu that's coming on, we would expect that opportunity to continue to grow.

We'll now take questions from Vijay Kumar with Evercore ISI.

And I just want to go through the [tough] fourth quarter (inaudible) guidance assumptions. Just Bob, high level, so what is the FX that's baked into that number for Q4? And if I understood all the different numbers, it's about $9.5 million headwind from the Diagnostics royalty roll-off, which is not going to repeat. There are some contribution, let's call it, $3 million to $5 million from Faxitron, and blood is going to be about $8 million to $9 million in Q4. Is that correct, all those numbers I had?

Yes. You're in the ballpark, Vijay. And what I would say is when we think about where we were from last guide, the FX is hurting us by roughly $8 million.

And that's all going to be in Q4, right, that $8 million headwind?

That's the Q4 number. That's correct. We had roughly about $3 million in Q3 relative to when we gave guidance. And that guidance comprehended -- or was impacted roughly by about $8 million in Q4, and we've included that into the latest guidance.

Got you. And blood is coming much better than expected. Right now, obviously, that's been a headwind [to] margins. I mean, if I understood Steve's comments, it looks like maybe very slight margin expansion for '19. Is that sort of -- it looks like maybe the Street is a little aggressive on margins, op margins for '19?

Yes. Again, we're probably not going to get into all the details. I think what Steve was talking about was as we look at our business, the gross margin line is probably not going to see a whole lot of expansion as we look at our international business growing faster, the impact of tariffs as they come to pass. That being said, we do believe that we have the levers necessary to drive operating margin improvement. And we'll give more guidance on the fourth quarter call.

We will now go to Jayson Bedford with Raymond James.

I'll keep it to one and bring the average down. Just a bigger-picture margin question, specifically on the R&D spend. It's trended lower as a percent of sales over the last few years. In the quarter, it was, frankly, lower than it's been in some time. Steve, is there a point in the life cycle of this business where you have to ramp the R&D spend to fund the organic growth profile? Or should we think of 6.5% to 7% of sales as the right level going forward?

Sure. I think it came down a bit, largely because the heavy investment in the virology programs in Diagnostics, which was a huge clinical program, came down. I would not expect that to leverage much more. I think it's kind of -- it's almost like the business development stuff. Now that we're getting -- we've got better people in place and everything else, starting to see some other projects that we can work on. And I think that will be an area of probably less leverage going forward because we don't want to -- we want to make sure we're investing for the future. And it could even tick up ever so slightly probably as we go forward. But again, hopefully, we're able to keep it at that level and invest for the future, grow the top line, grow the R&D budget and good things keep happening.

We'll now go to Tycho Peterson with JPMorgan.

Steve, I want to...

Yes. Sorry you got cut off earlier.

The whole notion of getting back to mid-single-digit growth, and I know you don't want to necessarily comment too much on next year. But really, the question is how much is contingent on new product driving the recovery back to mid-single-digit growth next year?

It will certainly play a role. And again, we'll talk much more on the next call when we give guidance for next year.

Yes. Tycho, I think, to Steve's point, I mean, without speaking to 2019, I mean, one of the things that we talked about and I think it's being shown is the improvement of our R&D pipeline. We launched several new products in the quarter. But when you think about across our product portfolio, the expansion of our R&D, our menu in the Diagnostics business really helping drive growth there, obviously with what we've been able to do on the Breast Health business with the new gantries but also increasingly some additional products [in surround] and then even in the Surgical and the Medical Aesthetics area, where we're doing some nice distribution deals, and then on Surgical, some nice tuck-ins. That is the way I would expect the cadence to continue going forward. Those things continue to be a bigger and more important piece and actually creates vibrancy in our product portfolio, and I would expect you to see that going forward.

And we will take our final question from Dan Leonard with Deutsche Bank.

So I was hoping you could elaborate on the emerging market program you have for your molecular business. I mean, your competitors in molecular actually do quite a bit of business in emerging markets. And so can you talk about how you'd size that opportunity and what you would expect timing would be on when we could can start to see some contribution from those efforts?

Sure. Dan, as you -- as you well said, a lot of our competitors are much more entrenched there. We're in the early stages. And I'd probably put it as it's going to be not significant probably even as we go into '19, but we're putting our foot in the door. We're building the relationships. Obviously, in the announcement last week for the Clinton Health Care -- Health Access Initiative, I think it's going to go a long way to putting us on the map there, but it's probably going to yield bigger benefits in, call it, 2020 and beyond. But I think we feel good about the initial start that we're getting in there, and we finally have the menu and the system in terms of Panthers that we can make a difference there. It will be probably lower price and lower margin as we also try to do good, but overall, feel like that will be a very good place for us to be as well.

I think the other thing it underscores is the strength of our leadership there. I would tell you 2 years ago, this was not something that would have been possible within Hologic. And so our EMEA leadership team, being able to really work with that, in conjunction with our diagnostics partners here in the U.S., just speaks to what Steve has said along a lot and truly believe that leadership makes a difference. And I think that is as much of a symbol as anything else.

I think a very fitting final comment for Bob as he signs off. And again, a huge thanks to Bob, and welcome to Karleen. Many of you will get to know her in the years ahead. We wish Bob all the best as he moves forth. And thank you, everybody, for listening to our call and keep watching as we keep making this company better and better. Thank you.

Thank you. That is all the time we have for questions today. This now concludes Hologic's Third Quarter Fiscal 2018 Earnings Call. Have a good evening.