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Hologic Inc. (NASDAQ:HOLX)

F4Q08 Earnings Call

November 11, 2008 5:00 pm ET

Executives

Deborah R. Gordon - Vice President, Investor Relations

Jack Cumming - Chairman and Chief Executive Officer

Robert A. Cascella - President and Chief Operating Officer

Glenn P. Muir - Chief Financial Officer, Executive VP

Tony Kingsley - Senior VP and General Manger, Surgical Group

Howard Doran - Senior VP and General Manager, Diagnostics Group

Analysts

Jayson Bedford - Raymond James & Associates

Tycho Peterson – JP Morgan

David Lewis – Morgan Stanley

Amit Bhalla – Citigroup

Amit Hazan – Oppenheimer

Eric Lo – Merrill Lynch

Isaac Ro - Leerink Swann

Operator

Welcome to the Hologic Incorporated fourth quarter and fiscal year 2008 earnings conference call. My name is Miranda and I’m your operator for today’s conference. (Operator Instructions) I would now like to introduce Deborah Gordon, Vice President, Investor Relations to begin the call.

Deborah R. Gordon

Good afternoon and thank you for joining us for Hologic’s fourth quarter and fiscal year 2008 earnings conference call. I encourage everyone to visit Hologic’s Investor Relations page of our website in order to view the power point presentation related to the comments that Glenn Muir, Hologic’s Chief Financial Officer will be making in his opening remarks.

The replay of this conference call will be archived at our website. Please also note that a copy of the press release discussing our fourth quarter and fiscal year 2008 results as well as our first quarter and fiscal year 2009 guidance is available in the Investor Relations section of our website under the heading Financial Results.

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

Also, during this call, we will be discussing certain financial measures not prepared in accordance with generally accepted accounting principles for GAAP. A reconciliation of these non-GAAP financial measures to the related GAAP financial measures can be found in Hologic’s fourth quarter 2008 earnings release including the financial tables and the release.

Please note that the length of today’s conference call is set at 1 hour, and will consist of 30 minutes of opening remarks from management followed by a 30-minute question-and-answer session. We therefore ask each participant to limit his or her questions to just one with one followup as necessary.

I would now like to turn the call over to Mr. Jack Cumming, Chairman and CEO.

Jack Cumming

Good afternoon everyone and thanks for attending our fourth quarter fiscal 2008 conference call. Joining me today will be Rob Cascella our President and COO and Glenn Muir our Executive VP and CFO. Also joining us today is Tony Kingsley, Senior VP and General Manger of our Surgical Group and Howard Doran, Senior VP and General Manager of our Diagnostics Group who will both be available during the question-and-answer session.

We are very pleased, of course, to share with you our fourth quarter and fiscal year financial results for the period ended September 27, 2008. Our agenda for today’s call is as follows: I will discuss where Hologic is today, provide information on our results for fiscal ’08, and very briefly discuss our outlook for fiscal 2009. Glenn will then detail the financial results and provide guidance for the first quarter and fiscal ’09. I will return to talk about our segment results and outlook and provide an operational update. We will then open up the call for questions. As Deb stated, we plan to complete this call in an hour out of respect for everyone’s time.

First of all, Hologic posted record fourth quarter fiscal ’08 revenues of $442.5 million, an increase of 118% over the fourth quarter of 2007, which did surpass our guidance of $438 to $439 million. Non-GAAP EPS for the fourth quarter of ’08 were $0.30 in line with our guidance and compared to non-GAAP EPS of $0.30 for the same period last year. Full year revenues of $1.67 billion rose 127% while non-GAAP EPS rose 24% to $1.18 versus $0.95 last year, and also met our initial guidance from a year ago.

While we are pleased with today’s results, we acknowledge this year has been very difficult, and we also realize that the decline in our stock price has profoundly affected many of our shareholders as it has our associates who are also shareholders. Furthermore, we recognize the coming fiscal year will be an important transitional year for Hologic.

In fiscal 2009, we have several challenges including the ongoing integration of two substantial acquisitions, three major product PMA filings awaiting clearance by the FDA, the completion of a major manufacturing facility in Costa Rico, and all within a fragile global economic environment. We are confident we have the management depth and experience necessary to effectively address these issues and will come out well positioned for 2010.

Let me remind everyone we were in a comparable situation several years ago when Hologic underwent a similar transformation. We started off as a one-product bone densitometry company for the detection of osteoporosis and undertook an aggressive strategy to diversify. In a period of a few years, we transformed Hologic by acquiring the LORAD Mammography business from Trex Medical, the CAD technology from R2, and the biopsy line from Suros.

Hologic transformed itself into a focused women’s healthcare company driven by sales of mammography products and became the market leader with a 55% to 60% share of the US digital mammography market, and a leader in the emerging international market.

Fiscal 2008 was clearly another transformational year for Hologic with the strategic acquisitions of Cytyc and Third Wave which further broadened our women’s healthcare portfolio of businesses with the beneficiaries of Cytyc’s well-formed marketing and distribution infrastructure and strategically important ThinPrep and NovaSure franchises, and Third Wave’s exciting molecular diagnostics new pipeline, all of which allow us to compete in a significantly larger market.

Now this brings us to fiscal 2009, a transitional year. First and foremost, we remain focused on completing the integration of both companies and receiving FDA approval of three next generation technologies, Tomosynthesis/3-D breast imaging, Adiana the permanent contraception, and CerVista HPV testing. We are also continuing to strengthen our infrastructure through efforts such as moving surgical manufacturing to a newly constructed lower cost facility in Costa Rico.

Taking these factors into account, we are projecting fiscal 2009 revenue growth of approximately 10% to a range of $1.825 to $1.850 billion in guiding to non-GAAP EPS of $1.22 to $1.24 net of $0.12 for Third Wave dilution.

Let me affirm our intention is to provide guidance that is both realistic and achievable. In arriving at this guidance range, we have assumed; first, no US revenues from products awaiting FDA approval; secondly, foreign currency rates consistent with current levels; third, a continuation of the tight credit markets we are currently experiencing; and fourth, our view that the economy which is under considerable pressure will experience further slow-downs which will translate into some softening in demand for our products. Glenn will provide more details about our guidance in his formal remarks.

During 2009, we will implement strategies to support our revenue goals and as necessary to quickly adjust our cost structure to align with our earnings projections. Given the limited visibility in the current economic climate, as change has been dramatic, we believe it is prudent to provide a conservative range for our guidance; however, conservative, we believe our disposable line of products will be more resilient to such economic concerns and that our digital mammography systems will garner more available capital spending dollars as customers attempt to maximize returns and preserve their market presence with women who drive healthcare spending decisions for their families.

As fiscal 2009 progresses and as the picture hopefully improves over the course of the fiscal year, we will update our guidance and narrow the range as appropriate.

Now, let me turn the call over to Glenn.

Glenn P. Muir

I’d like to now expand on the financial results of the quarter. As Deb stated, these financial results are also detailed in a power point presentation accessed on the IR page of our corporate website at www.hologic.com. My presentation today includes certain non-GAAP financial measures and a reconciliation of these measures to their most directly comparable GAAP counterparts as set forth in the same power point presentation as well as in the press release that was issued after the market closed today.

Fourth quarter revenues of $442.5 million increased 118% from last year’s fourth quarter. Revenues increased 3% from the third fiscal quarter of 2008 or June quarter led by the inclusion of Third Wave for 9 weeks. Without Third Wave for a moment, total revenues this quarter were up 12% year-over-year on a pro forma basis including the historical Cytyc businesses.

We reported fully diluted non-GAAP EPS this quarter adjusted for acquisition cost of $0.30 versus $0.30 a year ago, which was in line with our guidance on our last earnings call. This EPS figure includes Third Wave which incurred an adjusted pre-tax loss of $13 million comprised in an operating loss of $5 million and interest expense of $8 million, which equates to $0.03 per share after tax loss, also in line with our expectations. Absent Third Wave dilution, our earnings would have achieved a record high.

Our no. 1 revenue driver continues to be sales of our Selenia portfolio product and related services. In this quarter we sold a record 452 digital mammography systems eclipsing our guidance of 434 systems. As Jack will discuss later, this includes the shipment of our first Tomosynthesis or 3-D systems, which are called Selenia Dimensions to international customers. This quarter, our full field digital mammography revenues increased 16.2% to $119.3 million, and our service revenues in our Breast Health segment alone increased 8.1% to a record $37.5 million. Selenia was not alone in driving revenue as sales in each of our four recording segments this quarter increased over Q3 or June quarter this year and also Q4 of fiscal 2007.

Included in our GAAP results are charges related to the acquisition of Cytyc in October 2007 and Third Wave in July 2008. These fourth quarter charges total $231.6 million primarily for three items, the write-off of acquired R&D, the amortization of intangible assets, and the write-off of inventory to fair market value.

Fourth quarter consolidated gross margins adjusted for the acquisition related charges were 61% versus 48% last year and just under the 62% we were expecting. The shortfall from our estimate was due chiefly to two factors; one, geographic mix due to the increase in Selenia sold internationally; and two, unabsorbed overhead at our new Costa Rico manufacturing facility. The benefits of our strategic diversification efforts are evident in the significant increasing gross margins compared to last year.

Our operating expenses absent the acquisition related charges were $126.6 million or 28.6% of revenues and in line with our previous guidance. Included in these operating expenses was $9.8 million for Third Wave. Our operating expenses for our continuing businesses were $116.8 million, almost $8 million less than Q3. The decrease in operating expenses is directly related to our efforts to streamline our businesses and leverage our combined resources. The combination of higher gross margin dollars and lower operating expenses are what contributed to the better than expected operating income results.

Offsetting some of the improvement in operating income were three items; first, an increase in interest expense of approximately $1 million versus expectations due to a slight uptake in LIBOR rates; two, the faster pay-down of a portion of the term loan which resulted in an acceleration of the deferred financing cost amortized through interest expense this quarter; and three, an approximate $1 million foreign currency loss due to the strengthening of the dollar. Even with these negative impacts, non-GAAP pre-tax income this quarter was $122.2 million compared to $51.6 million last year and ahead of our guidance of $120 million.

Absent the aforementioned acquisition related charges, pre-tax earnings this quarter would be $122.2 million, and using our effective tax rate of 36.8%, non-GAAP net income would be $77.2 million versus non-GAAP net income of $32.9 million last year, an increase of 135%. This equates to non-GAAP EPS of $0.30 based on a fully diluted share count of 259 million shares.

Turning to fiscal 2008, full year revenues grew 127% to $1.674 billion from $738.4 million and met our guidance. Excluding revenues from Cytyc and Third Wave, both acquired in 2008, organic growth was 27% over fiscal 2007. Full year non-GAAP diluted earnings per share increased 24% to $1.18 versus $0.95 and met our guidance. The full year gross margin excluding acquisition related charges of 61.7% improved significantly from 48.1% last year, and again, speaks to the strategic value of our two recent acquisitions.

The 2008 non-GAAP operating expenses totaled $484.9 million and were below our guidance of $500 to $510 million. The fiscal 2008 non-GAAP operating margin of 32.7% compares favorably to 22.1% in fiscal 2007.

For our Selenia product line, bookings and shipments reached record highs. Our product backlog remained relatively flat as we have successfully worked our backlog down to a level where we are comfortable we are able to meet current customer demands. The total dollar backlog of all our products was $360.4 million at the end of September.

Turning to the balance sheet, on July 17th in connection with acquisition of Third Wave, we borrowed $540 million consistent of a senior secured tranche A term loan to the amount of $400 million at an interest rate of LIBOR plus 2.5 and a tranche B in the amount of $140 million at an interest rate of LIBOR plus 3.25. At the end of September, we had already repaid $75 million of the term loan leaving a balance of $465 million. Given our strong cash flow, we still expect to pay this new term loan off within the 2-1/2 year period we originally guided to.

We generated $329 million of free cash flow in fiscal 2008 comprised of $407 million from cash flow from operations less capital expenditures of $78 million. This was an increase of 148% over our free cash flow of $130 million in fiscal 2007.

I would now like to provide detail on our guidance for fiscal 2009, which ends September 26, 2009.

For the first quarter of fiscal 2009, which ends on December 27th, we are expecting revenues in the range of $441 to $443 million remaining level with our record Q4 results. Although we are seeing solid progress across our business segment, we believe we will experience a typical fiscal first quarter levelling when compared to our fourth quarter. We expect non-GAAP earnings per share excluding the amortization of intangibles of approximately $0.29 to $0.30 per diluted share. This includes the results of Third Wave, which are dilutive to adjusted EPS by $0.04.

Our earnings guidance takes into account the following key P&L considerations. First, gross margins on a non-GAAP basis are expected to hold steady with the just ended fourth quarter at 61%. This excludes approximately $36 million of amortisation of intangibles, which on a GAAP basis would result in gross margins of 53% to 54%. Second, total operating expenses on a GAAP basis are expected to rise sequentially to $149 million to $151 million including amortization of intangibles of approximately $13 million. Non-GAAP operating expenses would then be $136 million to $138 million or 31% of revenue. The incremental increase compared to the prior quarter related to the inclusion of Third Wave for a full quarter as levered cost associated with RSNA, our largest trade show, and outdoor national sales meeting, both of which fall in the current first quarter. Third, based on current LIBOR rates and our quarterly reduction of our debt balance, we would expect interest expense to remain at approximately $20 million. Lastly, this quarter, our effective tax rate will benefit from the retroactive application of the recent reinstatement of the Federal R&D Credit. This will provide us with a one-time pickup in our tax provision and will result in our effective tax rate decreasing to approximately 33%.

Next, our outlook for fiscal 2009. As far as consolidated revenues, we are targeting total revenues of $1.825 billion to $1.850 billion which represent growth of approximately 10% over fiscal 2008 and non-GAAP EPS of $1.22 to $1.24 per share. These results include the dilutive effect of Third Wave as was expected. Absent, the operating loss and increased interest expense for the year attributable to Third Wave, our non-GAAP EPS guidance would have been $0.12 higher or $1.34 to $1.36 per share. This would have resulted in 14% to 15% adjusted EPS growth in FY’09. While we would prefer to grow earnings in excess of revenue growth year in and year out, as Jack discussed earlier, fiscal 2009 is a year of transition for Hologic clouded by uncertainty tied to the global economy and the timing of the FDA approvals. Our intention therefore is to be conservative by providing guidance that is both realistic and achievable.

The rationale supporting our guidance is as follows: One, our revenue guidance does not assume any US sales of the three products currently awaiting FDA PMA approval - Tomosynthesis, CerVista HPV, and Adiana. When approved, we are confident these products will each be significant drivers to our future revenue and earnings growth. While we continue to believe all three will get approved this fiscal year, we acknowledge from experience that it is difficult to accurately predict FDA approval. As such, we think it is prudent to remove any domestic contribution from these products. As approvals are obtained, we will update our guidance accordingly. However, our revenue guidance does assume a minimal amount of revenues from sales of Selenia Dimensions, CerVista HPV, and Adiana to overseas markets.

It is important to note that certain expenses are being incurred in advance of approval, expenses such as ramping up manufacturing at our new facility in Costa Rica and preparing launch programs for the three products currently with the FDA for approval. Our guidance therefore reflects the impact to earnings growth resulting from these upfront costs. It is necessary for us to invest now in order to ensure each product is launched properly upon approval. Upon approval, we expect these revenue contributions will begin to offset the related pre-market and launch costs.

Secondly, our revenue guidance is further broken out amongst our four reporting segments as follows. In Breast Health, we are forecasting revenue growth of approximately 5% over fiscal 2008 due principally to an increase in service contracts and related parts especially in connection with the previously sold Selenia units and an increase in Suros breast biopsy tool. In Diagnostics, we are forecasting revenue growth of approximately 15% to 16% over fiscal 2008 primarily due to international ThinPrep, imager, and prenatal product growth, plus the inclusion of a full year of Third Wave revenues. Third Wave revenues due however exclude any US sales of the HPV test pending approval as I previously noted. In GYN Surgical, we are forecasting revenue growth of approximately 17% to 18% over fiscal 2008 primarily attributable to continued growth of NovaSure in the US market. In Skeletal Health, we are forecasting flat revenues with fiscal 2008.

It is important also to say a word again on the economy and its influence on our fiscal 2009 revenue guidance. Although we still have not seen a slowdown in our business, we should not expect to be immune particularly given the capital equipment nature of approximately one-half of our business and the recent strengthening in the US dollar. As such, the lower band of our revenue range does reflect the potential for some softening in our businesses due to the current global economic challenges of tight credit, recessionary conditions, and a strengthening dollar.

Switching to gross margins, we are looking for full year gross margins in the range of 61% to 62% on a non-GAAP basis. This guidance excludes approximately $143 million of GAAP charges related to the amortization of intangibles, which would lower the gross margins on a GAAP basis by 8 points. Gross margins are expected to remain flat at fiscal 2008 largely due to the two factors mentioned earlier - one, a mixed shift, and two, unabsorbed overhead in our Costa Rico facility. We will see gross margin improvements on sales of our three products currently awaiting FDA approval are fully ramped up and the manufacturing and start-up costs at the new Costa Rico facility are absorbed.

And for operating expenses, we are expecting to be in the range of $552 million to $562 million, up approximately 13% to 14% from fiscal 2008, and excluding $53 million of expected amortization of intangibles. Expense growth exceeds projected sales growth due principally to the recognition of various pre-launch costs for Tomosynthesis, HPV, and Adiana without a commensurate offset of revenues. A portion of this spending is expected to be on R&D so that we can continue to keep our pipeline full of innovative and differentiated technology. While we always spend carefully, given the present uncertainty of the economic environment we’re keeping a watchful eye on all elements of our spending and have already identified cost saving strategies. We also will further reduce our expenses if the economy should materially worsen. We will be prudent in these efforts however to ensure we do not inhibit any of our strategies to grow our topline.

Regarding stock option charges, included above are approximately $28 million of FAS 123R stock compensation charges. We have not backed them out of our guidance, but we will indicate what they are quarterly and will disclose them in the press release as we currently do.

For interest expense, we would expect interest expense based on current LIBOR rates to decrease slightly year-over-year to approximately $78 million which is composed of our convertible debt plus the current term loan. The slight decrease in interest expense reflects our plans to pay down the term loan by approximately $50 million per quarter, offset by the higher LIBOR rate than in the prior year. Note that a 100-basis point swing in LIBOR impact earnings approximately a penny per share.

Our effective tax rate for the year is expected to be 35.25%. In Q1 we are expecting the lower tax rate of 33% related to the reinstatement of the Federal R&D Credit and in quarters 2 through 4 we’re expecting 36%. We’re expecting shares outstanding to increase slightly during the year to 251 million to reflect stock option activity. And regarding Third Wave, we are expecting the transaction to be approximately $0.12 dilutive in fiscal 2009 as compared to our original guidance or at $0.10 dilutive impact to non-GAAP EPS. The difference from our original guidance is that we have chosen to conservatively remove US HPV sales from our forecast until PMA approval.

In fiscal 2009, we will remain strongly cash flow positive and we will not require any financing to fund our operations. We expect to generate a minimum of $75 million of free cash flow a quarter and to pay down approximately $50 million of the term loan per quarter with the balance allocated to bolstering our cash balances. Capital expenditures have never been a big part of our businesses and we are expecting CapEx of $70 million and depreciation also of approximately $70 million.

Thank you very much for your time. I will now turn the call back over to Jack.

Jack Cumming

Now, I would like to provide more insight into our four reporting segments. First of all, Breast Health, revenue has increased 35% to $861 million, up from $639 in ’07, and that of course is fuelled by sales of digital mammography and the addition of two new product lines relative to last year which are MammoSite and MammoPad breast cushions, and Breast Health represented 50% of fourth quarter sales which has been consistent with the recent trend. The fourth quarter full field digital mammography revenues reached $119.3 million, which is up 16% over last year. Before discussing Selenia unit sales, please note that this is the last quarter we will report the unit number as a standalone matrix. Going forward we will provide an overall revenue figure generated from our entire digital mammography product line. In addition to competitive reasons we are implementing this change largely because our Selenia systems have become a full product line with increasingly more diverse features and functionality, peripheral configuration alternatives, and geographic pricing variations, all causing unit numbers to be more confusing than helpful with respect to interpreting performance.

In addition, as we discussed in the past, simple mathematical ASP calculations are not an indication of pricing trends as they are impacted by the system’s alternatives just mentioned which tend to be more driven by product mix, configuration mix, and market mix. All these elements are far more prevalent as we expand our product offerings to be tailored to specific market needs and our geographic reach extends beyond traditional offshore markets. As an added note, the MQSA data which has in the past been a good proxy for system placements in the US will become less and less relevant going forward because the database does not capture the placements for upgrades nor does it account for international placements which will become a growing percentage of our business.

With that said, this quarter we sold 552 digital mammography systems which was above our guidance of 434, and this included several shipments of our Tomosynthesis system called Selenia Dimensions to international customers. We began the international rollout last quarter with the installations occurring at the latter part of the quarter. We are extremely pleased with the progress in bringing sites online and imaging patients. In fact I just returned from a grand opening overseas with a facility that is imaging over 20 patients a day. Going forward, we believe the US market at less than 45% penetration today, but there will be continued growth in domestic sales of Selenia fuelled by practices expanding to market consolidation and the progression of distributive mammography screening models throughout rural America. We also believe international markets at less than 25% penetration represent a significant opportunity for growth as both public and private sector support of the technology becomes more widespread, and finally we’re confident with the growing installed base, we’re continuing to build up our foundation for future replacement sales and the transition to 3D mammography.

In our Diagnostic segment which includes ThinPrep, Full Term, and Third Wave, revenues increased 6% to $133.7 million from the June quarter. International sales of ThinPrep disposables, domestic and international unit replacements, and the addition of Third Wave revenues of $5.9 million accounted for the growth. Diagnostic revenues represented 30% of total quarter sales. We’re very pleased with the progress we’ve made this quarter integrating Third Wave into Hologic. A tremendous opportunity exists for Third Wave products to add value to our sales and marketing channels. Over the past quarter we trained the entire Diagnostic laboratory sales team on Third Wave products and expanded the team to over 50 sales people. We believe our team now is a necessary expertise to support a full launch of CerVista once it is FDA approved which is expected in the first half of calendar 2009.

More immediately, we have exciting opportunity to kick off CerVista’s formal entry into the European market by presenting the topline FDA clinical trial data at the internationally recognized Eurogin Conference in Nice, France on November 14th and 15th in two short podium presentations, the first being our PMA for 16/18 genotyping on Friday and the second being our summary of PMA covering ASCUS reflex and high-risk screening on Saturday. We plan to talk more about the data at the Eurogin. However, it is important to note that the data coming out of Eurogin will be in the form of summarized highlights and not the complete data set. We believe that this data will prove the clinical utility of CerVista for high-risk HPV testing. We plan to formally launch CerVista internationally in the early calendar 2009 and will discuss those plans further subsequent to the Eurogin meeting, and you should expect a press release from us next Monday morning to cover the specifics of the presentations. The combination of the substantial global ThinPrep franchise with the Third Wave HPV test provides us with potent synergies that will pave the way for increased sales and profit in this segment and for gaining in these markets. We believe we can gain share and we believe the global market for HPV testing is approximately $800 million.

In fiscal 2009, our outlook for the Diagnostic group is fairly level domestic ThinPrep sales complimented by positive growth in the international ThinPrep market as this segment is still underpenetrated relative to the US. The ThinPrep franchise will continue to be a source of significant cash flows. We expect revenues from Full Term, our pre-term labor diagnostic to grow double digits as our sales force continues to raise awareness about the availability of this important diagnostic tool used in confirming small size or pre-term labour. Our gross outlook also includes a gradual ramp up in international CerVista sales.

In our GYN Surgical segment, NovaSure sales rose a stronger than expected 6% or $59.7 million from $56.3 million last quarter. These results are a solid indication the changes implemented in Q2 to focus on in-the-office sales are working. Additionally, we’ve successfully reduced inventory levels at the customer site and believe that product in the channel is now largely normalized. As a result this is driving a higher level of monthly standing orders as evidenced by our increased backlog especially in the office-based markets. In fact, we continue to see significant increases in our GYN segment since the end of the second quarter when the program was first launched. GYN Surgical revenues constituted approximately 14% of total in fourth quarter sales. For the near future we expect we continued growth in this segment. We believe we’ve repositioned our sales model to support higher product utilization, and with the refocus on longer-term customer commitments and increasing backlog, we’ve mitigated our exposure to monthly selling dynamics.

In our skeletal health segment, which includes osteoporosis assessment and many C-arm product lines, revenues increased 10% from last year to $28.1 million due to an increase in systems sold across both categories. Sales also by the way rose 4% sequentially. Skeletal health sales comprised approximately 6% of fourth quarter sales, and this segment is expected to be fairly flat throughout fiscal 2009 as these product lines continue to be impacted by uncertainty regarding possible reimbursement changes.

I’d now like to spend a few minutes to discuss our three products that are currently awaiting approval at the FDA, our Selenia Dimensions Tomosynthesis, our CerVista HPV molecular diagnostic test, and our Adiana system. We really do not expect much news from the FDA between now and receiving approval. Naturally, the ability to accurately predict approvals is difficult which is why we have decided to take a conservative approach as Glenn talked about and remove all US revenues from our FY09 guidance and to provide you with only our core product growth. Specific to Tomosynthesis, as we disclosed in our press release, we have complied with the FDA’s July 30th request for more information and are hopeful of approval within the first half of calendar 2009. We’ve received calls from a number of analysts who have heard rumors the FDA will be conducting a panel meeting in February 2009. As a matter of record, we have not been contacted by the FDA regarding appearing before a panel meeting. However, if it is held and we are invited, we will certainly be prepared. If and when anything does change or we receive material information from the FDA, we will certainly communicate it to you at that time. In the interim, we do not plan to provide any future updates regarding the PMA process.

To close out on this topic of the Tomosynthesis PMA approval, I want to make it abundantly clear so there is absolutely no confusion or misinterpretation of our position. We fully believe the information we have provided to the FDA answers the questions they asked us to address, and we remain optimistic about receiving approval, and we are very excited about the growth opportunity it provides. Additionally, we remain hopeful of approval of our CerVista HPV test and the Adiana system will also occur during the first half of calendar 2009.

In conclusion, let me try to summarize by saying for the fourth quarter, revenues and earnings met our expectations. We posted another record of Selenias sold and posted international sales of our first Tomosynthesis systems, all which point to us increasing our market share and installed base. We also experienced continued recovery in NovaSure and stable performance in our ThinPrep franchise. Our gross margins improved and operating expenses came in below plan. As we march forward into fiscal ‘09, our most important objective is financial execution. We are all committed to delivering on the guidance we have provided you today.

With that, Glen, Rob, Tony, Howard, and I would be happy to take your questions, and before opening up our call for the Q&A session, in order to allow as many analysts as possible to ask questions, please observe Deb Gordon's earlier request that you limit your questions to one with a followup question as necessary, and with that Miranda if you would take over and get the Q&A portion moving along.

Question-and-Answer-Session

Operator

The question and answer session will be conducted electronically and will last for 30 minutes. (Operator Instructions) Our first question comes from Jason Bedford with Raymond James.

Jayson Bedford - Raymond James & Associates

First, just so that I'm clear, when you receive approval for any of the three products, would you expect the products to be immediately accretive to the bottomline, meaning if there’s a forward spend necessary in that quarter and subsequent quarters, the marketing spend will not exceed the revenue you will get from those products?

Rob Cascella

There will be some incremental investment that will be necessary in order to roll out any of these products, and it will be by way of marketing program and any of the other promotional aspects of it. If it is in fact dilutive upon its initial release, we believe that it would be within that quarter or the near quarter following that it would be accretive. We don’t believe that the dilution would be long term, but we also believe that we will experience up to a quarter of dilution from the release of the new product.

Jayson Bedford - Raymond James & Associates

Surgery, if I heard you correctly, will have 17% to 18% growth next year. What gives you confidence in that acceleration?

Tony Kingsley

I think there are really three reasons. The first is that we observed that the endometrial ablation market is large and continues to be underserved. I think what we’ve gained a lot of confidence in in the last 6 to 12 months is the clinical argument that NovaSure should be a procedure that’s used earlier and more frequently for women with menorrhagia relative to medical management. We think we’re winning that battle with physicians. The second is we’re continuing to invest in patient outreach, with both things we are doing at the physician office level to provide outreach and education but also separate targeted and significant investments on the internet to convert people who are searching for solutions, and I think the third is the clinical data continues to be encouraging. Recently there was a paper presented done by the Mayo, so that’s from a reputable institution done independently that among other things specifically identified the use of RF energy, which as you know from the NovaSure procedure, it is a positive predictor of amenorrhea, so we just think you will see a bunch of different fronts things that are very encouraging.

Operator

Our next question comes from Tycho Peterson with JP Morgan.

Tycho Peterson – JP Morgan

Could you comment a little bit on the instrument development timelines for Third Wave, and how we should think about that with relationship to the Cervista launch?

Howard Doran

We are continuing to work on some development aspects for a fully automated instrumentation that would actually make sample accessioning directly from the ThinPrep Pap test vial. We are moving ahead with that project. We are encouraged by the results. We would anticipate a submission post approval in the US of Cerrvista to the FDA, and we believe we’ll be within that timeframe.

Tycho Peterson – JP Morgan

In your conversations with labs, the interest ahead of having instrument launch, can you just talk as to how integral that’s going to be in terms of driving the consumable demand?

Howard Doran

In the conversations that we’ve had, certainly there’s been a lot of interest over the last handful of months to have discussions in regards to potential conversions to the Cervista test, and we think that many of the customers today actually still have limited upfront automation. There is still a lot of manual processing within the market place. We think that we have some efficiencies that will make that easier for certain accounts, and there are other methods for backend automation that are being implemented by many customers today that we think will be appropriate in the short to medium term until we have the other device into the marketplace, so we think that the solution that we will have post FDA approval will meet the market demand, and the feedback from other laboratories have been favorable that we will have the right solution for them. We think it will be operational efficiencies. We think we will have lower Q&S rates which are real hard saving dollars to the account, the ability to do in the future 16 and 18 genotyping, and the fact that you burn less controls, we believe we will have a very economic favorable solution when it comes to cost per billable as opposed to cost per test, and that’s a much different calculation when you’re burning less controls. It becomes less costly for the customer to run the assay, so we think there are a lot of things that play into this. Instrumentation is just one, and we think we have a good stance across the board.

Tycho Peterson – JP Morgan

Can you provide an update on configuration trends and pricing and some of the things that you addressed last quarter?

Rob Cascella

I think, Tycho, what we saw in the quarter was certainly an ongoing shift to more international units, and we certainly had a pretty diverse mix relative to Selenia assays we manufactured as well as our standard Selenias, so when we look at the dollars, what in fact we realized in the quarter was a very similar movement in terms of mix, but again, I think the product mix itself has shifted between the lower priced categories as well as some offshore products.

Operator

Our next question comes from David Lewis with Morgan Stanley.

David Lewis – Morgan Stanley

On backlog, given the slight decline in total dollar backlog sequentially, maybe you can talk about customer fulfillment initiatives and the effect that had on backlog, and then linking that into this dynamic of trying to be conservative about this year, Jack, maybe walk us through the type of scenarios and analytical work you did to get comfortable with economic weakness that you’re not currently seeing.

Jack Cumming

I’ll talk about the economic part of it. I think if we read every economic report that’s out, we’d have to first ask were those the same economists who didn’t predict this, which was 90% of the economists out there. The reality is that what did is we did an in-field survey twice in the last thirty days on a global basis with the heads of the radiology departments, mammography departments, in the hospital themselves, on the purchasing side. We surveyed governments because in the international market, so much of product is tied to tenders. Obviously anecdotally you can find softness in a number of places, but we really haven’t seen a formal trend that has developed. We’ve had very good feedback in the US, but I guess the question is has the worst really the US from an economic standpoint, what is going to be the depth of this economic crisis because the news gets worse every day. So, on a today basis, we were conservative. I tried to point out the areas that we’ve looked at certainly which would be where is the dollar today versus other currencies, the tightening of the credit market which will affect hospitals and their ability to buy and certainly will affect governments and their ability to buy, and that’s kind of the way we came about it. Firsthand research we felt was the only way to do this, and consequently, I think that we’ve got a pretty good handle on it, and we’ve set up a good system now on a global basis that we’re receiving this information in real time literally on a daily basis.

David Lewis – Morgan Stanley

But all that information you received, Jack, from these two surveys in the last 30 days is still not seeing it and then yet, you still cut numbers by some percentage factor.

Jack Cumming

We would have our heads in the sand if we did not believe that when you look at the economic indicators that are followed today. The one that I have talked about and I talked in the last call about was the economic indicator for unemployment. Unemployment is the one that I feel is going to hurt more than anything else businesses in America and especially healthcare because hospitals as you well know, David, end up with more slow play and more no pay, and that comes down to really tightening their budgets up. The credit markets have really tightened on hospitals today even those that have had reasonably good credit. Everyone is under a lot of stress including the hedge funds about how much cash are they going to need and is more cash going to be available, so we certainly have got to take that into consideration when we formulate these plans, and that’s we did.

David Lewis – Morgan Stanley

On leverage, could you just comment on the specific plans next year that can be used to drive better leverage in the business and maybe comment on the impact that FX had as a percentage of growth on the topline versus that 10% and any EPS impact that currency on an adjusted dollar basis?

Glenn Muir

Let me tackle the leverage first of all. I think there are a couple of pieces to leverage, one is on the gross margin line as we move forward, and as we’ve talked about the biggest driver for us in improving our gross margins will in fact be an acceleration of the revenue side of things. I mean we do have a fairly fixed cost structure when it comes to manufacturing. We will require an acceleration in revenue to get a lot of leverage on the manufacturing side. I don’t believe, and I think it’s evident in our guidance that there is a lot of leverage on the margin side in FY09. I believe that will happen in 2010 as we begin to get traction from the three new PMA products. That’s one side of it. The other side of leverage is on operating expenses, and I think as we’ve tried to indicate and illustrate today, we are seeing continued improvement and even decreased in our overall operating expenses. We do expect to be able to make some continued improvement from a leverage or percent of revenue standpoint as we look at FY09, and I think that’s where we’ll see a little bit of the benefit.

With respect to your question on FX for a moment, I just want to remind everybody that when we think about our international sales consolidated, they are less than 20%, so to a certain extent, we don’t have a large exposure, maybe not terribly good, I mean to the extent we don’t have more international sales, but we don’t have as much exposure. The strengthening dollar does impact us though, and it impacts us in a couple of ways. We have two parts of the business. The imaging part, the capital equipment side of the business typically sells overseas in US dollars, so we aren’t directly affected from any kind of translation on equipment sales such as Selenia. On the other hand, since we do sell in dollars and sine we do have a dealer network, it does make it a little bit harder for our dealers, and to continue to gain market share, we may have to make certain accommodations over time to those dealers. We haven’t had to do that yet, but it certainly would be something we would consider in the future, so I think from that part of the business there is not any direct affect. The overseas operations that we have form a natural hedge to some of the expenses that we have overseas. On the diagnostics side of the business, the other half of the 20% for a moment, we do sell in the local currently, so there is a bit of translation exposure, and in fact, if we look at our FY09 guidance, we have reflected that in the range that we’ve given, the current rates as we see them today, so if the dollar strengthened even more, I’d think that yes there would be lower revenues from translation. If the dollar weakened, I think we’d get a little bit of a benefit, so it’s somewhat of an unknown, but for us, it really is not a big number today.

David Lewis – Morgan Stanley

Glenn, was it 100 BPS of growth you think and two pennies at the bottom, something in that range, or less?

Glenn Muir

For Q4?

David Lewis – Morgan Stanley

No, for fiscal ’09. As you think about your outlook, do you think currency affected you by more than 100 basis points of growth on the top and more than 2 cents on the bottom?

Glenn Muir

Yes, probably.

Operator

Our next question comes from Amit Bhalla with Citi.

Amit Bhalla – Citigroup

In terms of the OUS business, can you talk about what your assumptions are for OUS sales for the three new products, and in this current quarter, what portion of the 114 units were Tomo units in the quarter?

Jack Cumming

Do you mean what percent they were of the total Selenia units?

Amit Bhalla – Citigroup

I was calculating about 114 Selenia systems or units in the quarter that were sold overseas. I’m just trying to get a sense if there was Tomo units in that number or if there was a separate number for Tomo.

Jack Cumming

As a matter of fact, I’m glad you asked that Amit because I needed to correct myself because earlier in my talk I said 542 instead of 452, so that means Rob will have to make up that extra 100 this quarter somehow. Rob, do you want to go ahead? It was like about a 75:25 split talking about international and…

Robert A. Cascella

The first question that you had was what kinds of international volume in our plans and the projections for ’09, and there again we took a relatively conservative view on Tomosynthesis, and the reason being on that was simply it’s primarily going to be in the European market. We don’t think there’s an opportunity at least in the first year for the rest of the world or Asia-Pacific, and we also believe that with the strengthening dollar that that product will be challenged, but we also do believe that we will have some near term successes as we did in this past quarter, so we’re relatively conservative. With respect to both Adiana and Cervista, there are challenges relative to reimbursement, product registration, some of the issues that we discussed earlier, so they are relatively low levels of international sales for those products as well.

Jack Cumming

To answer one of the questions you did ask when you said is our dimensions in our international number, and the answer is, yes, it is.

Amit Bhalla – Citigroup

Can you quantify that for this current quarter, and my followup question would be in fiscal ’09 for the breast business that’s growing 5%, Glenn talked about just service contracts and an increase in Suros as the drivers for growth, should we read from that that you were looking at the US to the Selenia business flattening out? What are the assumptions for Selenia as well as the other portions of the breast business?

Jack Cumming

When you look at the numbers, we took the position that we’re not going to give out units, nor will we give out units on Tomosynthesis, but your point is very well taken, and that is that there will be in growth in certain areas of our breast health segment. We are forecasting flattening on digital mammography until such time as we in fact introduce Tomosynthesis. We are looking at primary market growth happening in the US market for that over this year following its launch. There will be growth outside the US, but again, I think that what we’ve attempted to do is take into consideration that that growth may be impaired somewhat by us being less competitive with the product as a result of currency exchange.

Amit Bhalla – Citigroup

Did Glenn say that backlog in terms of units was flat for Selenia this quarter?

Jack Cumming

We did say that we had a very strong order quarter for Selenia, and in fact we did, and we’re relatively backlog neutral for the product, so if the question is why aren’t you showing growth and reflecting that trend, again I think that what we’ve tried to project in all of what we’ve talked about today was a level of conservatism because of really the unknown, and I think we’ve taken a position that rather than put forth numbers that in fact may be later impacted by an unfavorable in the global economy or an exchange, we took the position that we would be conservative relative to those business lines.

Operator

Our next question comes from Amit Hazan with Oppenheimer

Amit Hazan – Oppenheimer

If we think about your unit orders for digital mammo directly, do you expect that worldwide unit orders next year will be up and then will US orders be up next year?

Jack Cumming

Yes, in both areas.

Amit Hazan – Oppenheimer

The second question I have is on the Costa Rica facility. If you can help us out and kind of walk us through how quickly that is going to reach capacity or what is the trend towards reaching capacity, and then how should we think about that relative to gross margin and generally what your gross margin thoughts are long term beyond 2009?

Jack Cumming

We’ve just completed the transfer of the NovaSure line. We’re tooling up on the Adiana line, and obviously we won’t really start seeing meaningful volume out of Adiana until such time as it gets FDA approval because its primary market focus will be the US market. So there’s certainly a lot of effort that is going in with the additions of people that are being trained to build the product and indirectly who are being trained to manage the building of the product, so until such time as we’re probably through the half of the year, we are not going to see our absorption stabilize there as a result of a lot of both direct and indirect labor being in a training and learning mode and in fact the release of incremental volume to that factory. Once it is up and running, it’s a world-class facility that has substantial capabilities for growth. Our intent would be to move more products there and reap the benefits of a low-cost manufacturing operation. It’s just going to take some time.

Amit Hazan – Oppenheimer

What would be your goals for long-term gross margins, if you could just generally comment?

Jack Cumming

Just in general, or for the products that are being built in Costa Rica?

Amit Hazan – Oppenheimer

In general, but I’m thinking kind of to the extent that it helps you with that, but generally speaking, working margins on your business.

Jack Cumming

There are many elements of our gross margin, but if we look at all of the pieces of the gross margin puzzle, first being Tomosynthesis which is a high-content software product which should theoretically have a very strong gross margin. Secondly, we have a low-cost manufacturing operation for all of our GYN surgical products which should provide a margin benefit to us, and as our interventional breast volume continues to grow, we’ll have better utilization and growth out of that factory as well, so the long-term expectations barring issues of competitive price pressures, we being forced to manage pricing as s result of strengthening dollar, all would be very positive. So we’re very encouraged that in a market where generally we see margins declining, we feel that our margins will improve over time, and they have.

Operator

Our next question comes from Eric Lo with Merrill Lynch.

Eric Lo – Merrill Lynch

My first question is on Selenia. You mentioned that OUS mix is becoming a bigger part of the overall mix for the products. Can you comment on what it is right now and where do you think it can go within 12 months?

Jack Cumming

Around 25% right now, and we believe that that will increase to probably a bit north of 30% over the balance of this year.

Eric Lo – Merrill Lynch

On the US market specifically, the market itself is about 44% penetrated. Can you help us understand what the penetration is in the high volume and mid volume and low volume centers and what the size of each of those markets might be and what do you think the opportunities are for placements over the next year, and do you think centers within each of these different markets have a specific price point that is acceptable, and what do you think that price point is?

Jack Cumming

There’s a lot in that question, and let me see if I can answer it. Clearly, when you look at the US market, of the 8000 or 9000 sites that are available, it is doubtful that 9000 sites are going to convert to digital mammography. As we’ve always said we believe that there’ll be ongoing consolidation. Through this current year, as consolidation is occurring, what we’re going to find in that market is that it will be low-level buyers. It will be those who are making decisions on a choice of either not converting to digital or finding the lowest cost alternative to converting to digital and may in fact be a CR user at some point in the future. That’s one element of the target buying group today, and we are offering products that can in fact compete at that level. In addition to that through consolidation, we are going to see some of our consolidator type buyers buying a lot of small practices and wanting to standardize across that market with a standard type Selenia at more traditional pricing, so if you look at specifics, we’re talking about a product that ranges somewhere between $180,000 to $250,000 depending on what profile of buyer we’re considering. If you looked at the number of accounts that is relevant to that, I think what we’re findings is that the market is going to become segmented, and it is going to be the high-end market which is going to be in a replacement mode over this year where they are replacing their units, their older competitive units, their older Hologic units, and will continue to buy Selenia or Selenia Dimensions, and then the remaining portion of the market is the lower tier, and that lower tier will be split up between those practices that are still attempting to go standalone which will be the ultra low end or those that have become acquisition targets or consolidated and they will go back to the mid-tier market because in fact they are being acquired by the very people that are now standard Selenia users.

Eric Lo – Merrill Lynch

Last question is on NovaSure. Can you comment on what the in-office penetration is right now and have you guys seen physicians becoming more focused on in-office procedures trying to drive incremental income for their practices?

Tony Kingsley

We have continued to see growth in the office business. It is now I think approaching 14%, so it continues to grow on a quarter on quarter basis, and we are continuing to see, I guess I would say, increasing enthusiasm about office-based physicians among other reasons when you talked about which is some of the economic incentives, so we are comfortable that we are both seeing growth in offices that we have already opened where we are working with people to expand their volume and also continuing to use existing happy NovaSure users from the hospitals and into the office.

Operator

We’ll take our next question from Isaac Ro with Leerink Swann.

Isaac Ro - Leerink Swann

On Tomo, what feedback on pricing can you share with us from Europe, and are you charging the listed price, and if so, do you think that pricing will hold in US?

Jack Cumming

To try to be clear, on international, we sell through dealers, so there is a dealer discount that is applied to the sale of a Tomo unit, so if you assume for a moment that a standard Tomo unit in the US might sell for $500,000, and I’m just throwing out a number, there is going to be roughly a 20% discount off of that for the dealer, so today when we look at a full configured Tomo system, we are obviously going to be below the US pricing threshold, but in fact the prices that we have established for Tomo on those sales that have been executed on an international basis have all held without erosion. Now, it’s very early on, but the pricing expectation has been fulfilled, which I think is an important aspect of the product, meaning that the prices that we had earlier suggested, and let’s assume that a fully loaded Tomo with a workstation is going to sell for somewhere in the area of $450,000 to $500,000 on a US basis that that price modifies for a dealer transfer have held with the dealers and the end-customers that have purchased it thus far.

Issac Ro - Leerink Swann

For Cervista, about the data, should we expect to see some head-to-head results versus Invader?

Tony Kingsley

I don’t think so at all. I think the summary data that we are going to provide is going to certainly validate the credibility of the technology, and it will be very summary data, but again I think it will certainly demonstrate the creditability our specific testing. To just to answer that further, the clinical data that is being presented is being presented as compared to the old trial and that is effectively the former HPV test.

Operator

Ladies and gentlemen, that is all the time we have for questions today. At this time, I’ll turn the conference back over to Jack Cumming for any additional or closing remarks.

Jack Cumming

In times of economic stress, it is important to go back to the basics. Our conservative financial practices have positioned us with a strong balance sheet to withstand these turbulent conditions, and we remain focused on executing our business strategies to further advance our position as a market leader in women’s healthcare. Our investors, you, can be confident we are closely following the impact of the global slowdown on the industry sectors we serve and are taking steps to manage or mitigate the potential effects on our business. In closing, for fiscal 2009 and beyond, I remain confident in Hologic’s strength and in our ability to execute our long-term strategy and deliver on our commitments. We have an excellent product portfolio and R&D pipeline which will serve as our gateway for future growth.

Going forward, we expect great things. I look forward to keeping you informed of our progress, and as in the past, I would like to take a moment to sincerely thank Hologic team members worldwide for their continued dedication and hard work, and together we are one. We look forward to speaking with everyone again in early February to discuss first quarter results, and I would like to end by wishing everyone a very happy, healthy and peaceful New Year, and maybe we will give peace a chance this time. Thank you.

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Source: Hologic Inc., F4Q08 (Qtr End 09/27/08) Earnings Call Transcript
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