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Hologic (NASDAQ:HOLX)

Q1 2013 Earnings Call

February 04, 2013 5:00 pm ET

Executives

Deborah R. Gordon - Vice President of Investor Relations

Robert A. Cascella - Chief Executive Officer, President and Director

Glenn P. Muir - Chief Financial Officer, Executive Vice President of Finance & Administration and Director

Peter K. Soltani - Senior Vice President and General Manager of Breast Health Line of Business

Analysts

Tycho W. Peterson - JP Morgan Chase & Co, Research Division

Isaac Ro - Goldman Sachs Group Inc., Research Division

David R. Lewis - Morgan Stanley, Research Division

Jayson T. Bedford - Raymond James & Associates, Inc., Research Division

Brandon Henry - RBC Capital Markets, LLC, Research Division

Brian Weinstein - William Blair & Company L.L.C., Research Division

Doug Schenkel - Cowen and Company, LLC, Research Division

Vijay Kumar - ISI Group Inc., Research Division

Richard Newitter - Leerink Swann LLC, Research Division

William R. Quirk - Piper Jaffray Companies, Research Division

Operator

Good afternoon, ladies and gentlemen, and welcome to the Hologic Inc. First Quarter Fiscal 2013 Earnings Conference Call. My name is Kelsey, 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 conference. Please go ahead, Ms. Gordon.

Deborah R. Gordon

Thank you, Kelsey. Good afternoon, and thank you for joining us for Hologic's First Quarter Fiscal 2013 Earnings Call. The replay of this call will be archived on our website through Friday, February 22, and a copy of our press release discussing our first quarter results as well as our second quarter and fiscal 2013 guidance is available in the Overview section of the Investor Relations section of our website. Also in that section is a PowerPoint presentation related to the comments that will be made during today's opening remarks.

Before we begin, I would like to inform you that certain statements made by Hologic during the course of this call may constitute forward-looking statements. These statements involve known and unknown risks and uncertainties that may cause the actual results to be materially different from any future results implied by such statements. Such factors include those referenced in our Safe Harbor statement in our first quarter earnings release and in the company's filings with the Securities and Exchange Commission.

Also during this call, we will be discussing certain financial measures not prepared in accordance with Generally Accepted Accounting Principles, or GAAP. A reconciliation of these non-GAAP financial measures to the related GAAP financial measures can also be found in our first quarter earnings release, including the financial tables in that release.

Please note, today's call will consist of opening remarks from management followed by a 30-minute question-and-answer session. So we do ask that you please limit your question to just one and, as the time permits, we'll be more than happy to take your questions at that time.

I would now like to turn the call over to Rob Cascella, President and Chief Executive Officer.

Robert A. Cascella

Thanks, Deb. Good afternoon and thank you for dialing in to Hologic's first quarter call. Joining me on today's call are Glenn Muir, our Executive Vice President and CFO; and Peter Soltani, our Senior Vice President and General Manager of Breast Health.

Today, we have a full agenda and a lot of things to comment on. I'd like to first start up by summarizing our first quarter performance; discuss the recent publication of the Oslo study and its implications on reimbursement; review the market adoption of our 3D tomo product; update you on the progress we're making in the integration of Gen-Probe, including recently announced organizational changes; discuss the sale of LIFECODES; review key products in our diagnostic franchise, including an update on the PANTHER rollout; and provide a brief review of some of the other key businesses. I'll then turn the call over to Glenn who will discuss financial results and provide an update on our guidance. We'll then open the call up for Q&A.

So about the quarter, we believe we're off to a solid start for '13. We grew our adjusted revenues by 36.4% to $644.6 million, which was at the high end of our guidance range. Our 3 largest business units, Diagnostic, Breast Health and Surgical, all experienced year-over-year growth.

Adjusted earnings-per-share were up 11% from a year ago to $0.38, which was $0.01 higher than our guidance. Importantly, these results were achieved despite continuing macroeconomic headwinds, as well as challenges posed by Hurricane Sandy, which we estimate impacted our total revenue by about $5 million during the quarter.

We made great progress integrating Gen-Probe, which allowed us to accelerate planned organizational changes. We had a very, very successful RSNA with stronger customer interest in tomo, and we subsequently saw key clinical studies published, most notably the Oslo study.

Finally, we received FDA approval for our APTIMA HPV genotyping test and later received FDA clearance of our APTIMA Trichomonas test to run on PANTHER. In addition, we received approval for our contrast-enhanced digital mammography which we intend to release later this year.

A little bit more detail about Oslo. Shortly after the close of the quarter, we achieved a significant milestone with the publishing of the Oslo tomosynthesis screening trial in the journal Radiology.

Oslo is the first large-scale, with nearly 13,000 patients on an interim reporting basis, prospective breast cancer screening study investigating the use of tomo in combination with conventional 2D digital mammography and comparing it to 2D digital alone. Researchers at Oslo University Hospital led by Dr. Per Skaane found that the use of tomo in combination with 2D resulted in a statistically significant increase in cancer detection. This is compelling in that not only did the overall detection of cancers increased 27%, but the study found a 40% increase in the detection of invasive cancers otherwise missed in 2D. These are exactly the type of cancers that we need to detect and treat early. Additionally, there was no increase in the detection of DCIS, which are exactly the type of cancers you would be concerned about over-diagnosing.

These outstanding improvements in cancer detection were achieved while also reducing false positives by 15%. Remarkable because 2D recall rates in Oslo are already extremely low.

The study also demonstrated the use of 3D tomosynthesis improved cancer detection across all types of breast from dense to fatty. In summary, the Oslo study demonstrates that tomo overcomes the limitations of 2D mammography by improving invasive cancer detection while simultaneously reducing false positives and overdiagnosis. These are terrific results. And really, quite frankly, we couldn't be more pleased.

From a reimbursement perspective, on our last earnings call we indicated we were waiting for publication of key studies. With those now published, we are preparing to execute the next stage of our reimbursement strategy. There are 3 components to our reimbursement efforts. The first is we continue to work with professional societies to secure a permanent CPT code, which is a fairly long process. We're also initiating discussions with CMS to secure an alternate code, which is potentially a more near- and midterm process. In addition, we're engaging with private payors directly to establish payment in the absence of a formal code. We're hopeful we can confirm a meeting with CMS this quarter, and believe we are on track to achieve our goal of establishing reimbursement by the end of calendar 2013.

I want to talk a little bit about our tomo adoption. We had what we believe to be a very successful RSNA in November that again highlighted our 3D tomo as the leading technology in breast imaging. Tomo was the subject of 15 clinical presentations in over 50 workshops. We were very pleased with customer interest at RSNA, which contributed to a 10% sequential increase in our backlog during the quarter. It remains too early to measure the full commercial impact of the Oslo study, so soon after its publication. But we are already seeing a significant increase in interest as compared to levels experienced in 2012. We are optimistic Oslo will help drive demand.

We believe all of these is very exciting, but the reality is we are still extremely early in the adoption cycle of tomo, and at this point, we are seeing the 2D digital mammography market as being saturated. So as we have explained in the past, there may be quarters where the decline in the rate of 2D sales outpaces the uptake of 3D tomo, simply for reasons of budget approval requirements, longer sales cycles and, obviously, the lack of reimbursement.

The very positive news is the market is moving away from 2D and more and more customers are realizing they will need 3D in order to provide their patients with the best available technology and to remain competitive within their local communities. We continue to feel strongly that once reimbursement is secured, we will be well-positioned to realize the benefits of increased tomo adoption.

All this said, we remain on track with original estimates and continue to expect that we will at least double our U.S. installed base of 3D tomosynthesis systems this year despite these challenges.

Now I'd like to discuss some of the other business units, and I'll start with Diagnostic. First, an update on the success of our ongoing integration of Gen-Probe, which we closed on August 1 of last year. The integration is proceeding extremely well. We are on track to exceed our target of $40 million in cost synergies in the first year and $75 million within 3 years. As we said earlier, we believe that these targets were very conservative.

As we announced in January, our strong integration progress has enabled us to accelerate the timing of a number of planned strategic organizational changes. Based upon our progress, the timeline for Carl Hull to retire from his role as General Manager of Diagnostics was expedited. The reasons for acceleration of this timing are all related to positive factors and the achievement of key internal integration milestones including: a complete sales force training and integration program; our facility relocation plans progressing superbly at this point; the completion of organizational restructuring and customer hand-offs; and finally, the approval of PANTHER, HPV genotyping and Trich coming sooner than expected.

Having surpassed these critical milestones, the senior management team, including Carl, are confident that now is the right time to move forward with the planned management transition in the Diagnostics segment. As we announced, Carl will remain a consultant to Hologic through mid-August and this transition period. We can't thank him enough for his contributions to the organization, and he leaves the segment well-positioned to drive growth over the long term.

Finally, we have a deep bench of talent at Hologic and the legacy Gen-Probe organization. We are excited to offer our team opportunities to assume greater levels of responsibility within the company. We are confident we have the right team in place to help take our Diagnostics segment to the next level and continue to create value for our stakeholders.

Now just a bit about LIFECODES. In early January, we announced an agreement to sell our LIFECODES business to Immucor. Glenn will give you more the details of that, but the sale of LIFECODES allows us to focus on the areas of our Diagnostics franchise that are better aligned with our strong presence in women's health and in infectious disease. We are pleased to have found a strong partner for the LIFECODES asset and look forward to closing this transaction during the fiscal second quarter. While we are always evaluating our portfolio of assets and how best to maximize their value for our shareholders, our guidance for the current year does not assume disposition of any additional business lines.

Now for a brief update on ThinPrep. We continue to see the same underlying trends we have previously discussed; a modest decline in U.S. volumes related to interval expansion, which is always expected; and a solid double-digit growth internationally, especially in China. Were it not for the effects of Hurricane Sandy, we believe our worldwide ThinPrep business would have grown in the low-single-digits, consistent with our previously communicated expectations.

Overall, our women's health Molecular Diagnostics franchise delivered strong growth of 12% on a year-over-year basis in Q1. This is primarily comprised of APTIMA Combo 2, which continued its strong market leadership position in CT/GC testing and grew mid-to-high single digits year-over-year after adjusting for the impact of Sandy. Our HPV franchise which continues to perform well, posting strong growth of 27% on a year-over-year basis. Both Cervista and APTIMA HPV posted solid growth in the quarter, each with double-digit year-over-year increases. Overall, our HPV franchise remains on track to exceed 20% growth through the year, just as it did in the first quarter.

The PANTHER launch continues to proceed quite well and is also according to plan. Our initial focus has been on upgrading existing DTS customers to PANTHER systems. We are now shifting our emphasis to new PANTHER placements. As we move into this phase of our launch, we expect to see benefits from incremental CT/GC volumes and, over time, increase in our AUPs.

As we indicated last summer, we expect to place 1,000 PANTHERs by the end of fiscal '15. The recent clearance of APTIMA Trich on PANTHER in the U.S. makes it even more attractive to mid-tier labs, especially those looking to offer some differentiation in the form of test menu.

We will next look to offer HPV and HPV genotyping as part of the PANTHER menu and expect those to be released by the end of calendar 2013. I want to reiterate, the PANTHER remains the premium automated solution for mid-tier labs and is fundamental to our socket strategy. As menu expands on the system, we believe we provide powerful efficiencies and revenue benefits to our lab partners. Operationally, we're pleased we posted solid results in Diagnostics despite the revenue headwinds encountered in the quarter.

Now just a bit about our GYN Surgical business. Surgical grew a healthy 11% on a year-over-year basis after adjusting for the discontinuance of Adiana. On a geographic basis, Europe was quite strong in the quarter, growing in the midteens on year-over-year. MyoSure was once again the driver, with sales more than doubling year-over-year and posting double-digit growth on a sequential basis as well.

We are pleased with the reception of the limited release of our recent additions to MyoSure line, which is MyoSure Light and MyoSure XL. These offerings broaden the types of uterine pathology we can treat, which ultimately expands the market.

Overall, NovaSure sales were essentially flat on a sequential and year-over-year basis. NovaSure remains the market leader in endometrial oblation. However, high deductibles and lower-cost non-GA alternatives have created some obstacles for this product line. Looking ahead, we see growth in NovaSure coming from OUS opportunities in untapped markets, as well as increasing adoption in newer markets for us like China.

We are pleased with the performance in growth trajectory of our Surgical business. With NovaSure stabilized, we see strong growth being fueled by the broader adoption of MyoSure.

In summary, our fiscal year is off to a solid start. And with the substantial progress we have made ahead of schedule with the integration of Gen-Probe, the publication of the Oslo study and the recent FDA approvals and clearances of several products, we are poised to continue delivering strong results. Our new product cycles in tomo and PANTHER have tremendous promise and give us further confidence in our long-term growth outlook.

With that, I'd like to turn the call over to Glenn Muir.

Glenn P. Muir

Thank you, Rob. First quarter non-GAAP consolidated revenues increased to $644 million and include a net adjustment of $13.3 million, primarily related to our collaboration agreement with Novartis, reflecting the cash that was received for our share of product Novartis shipped to end-use customers in the quarter.

As we discussed in detail on last quarter's earnings call, we believe adjusting revenues provides a more meaningful measure of our true sales in the quarter since if not for the purchase accounting adjustments, we would have recognized revenue on these cash receipts during the quarter. This treatment is consistent with our historical practice. Foreign currency had a negligible impact on consolidated revenues.

And to provide a bit more color on an apples-to-apples basis, pro forma revenue growth was 3% when adjusted to include Gen-Probe for the full quarter of last year and to exclude discontinued businesses such as LIFECODES and Adiana in both quarters. In addition, we estimate that without the impact of Hurricane Sandy, revenues would have grown an additional 75 basis points.

Turning to our operating segments, our Diagnostics revenues represented 49% of total company revenues this quarter, increasing $165 million or 107%. On a pro-forma basis, including Gen-Probe revenues from a year ago and excluding revenues from our discontinued businesses, the Diagnostics segment revenues increased low-single-digits in the current quarter. This was another good quarter for our Diagnostics segment as revenue growth was ahead of the guidance we shared on last quarter's call. Specifically, we forecasted that total Diagnostic revenues would double as compared to legacy Diagnostic revenues in the first quarter of last year. Our legacy Diagnostics business was driven by strong Molecular Diagnostics performance and the continued strength of our ThinPrep franchise in international markets. Legacy Molecular Diagnostics products revenue grew double-digit, driven by our HPV product lines which posted double-digit revenue and 20%-plus volume increases worldwide.

Our ThinPrep business posted strong results in international markets with volume and AFP increases, driving its high single-digit revenue growth. Importantly, this growth offset the mid-single digit decline we saw in the U.S. of which 1/2, we believe, was due to canceled visits related to Hurricane Sandy.

Turning to the highlights from Gen-Probe's primary product lines, we saw its solid results from clinical diagnostic products which were up 9% from Gen-Probe's reported results a year ago. Separately, blood screening revenues declined slightly due to the timing of instrument sales to Novartis as assay revenues were up. Our APTIMA STD products remain the largest contributor to clinical Diagnostics, led by APTIMA Combo 2 for CT/GC, with increasing contributions from newer portfolio additions to Trichomonas and the HPV. The trends we saw in the first quarter from these primary business lines were positive and support our long-term expectations of the Gen-Probe business lines.

Our Breast Health revenues increased $5.5 million or 2.5% and represented 3 -- 34% of total sales. Total segment revenue growth was driven by an increase in service revenues, partially offset by a 2% decrease in product revenue. As Rob discussed, the modest decline in mammography product revenues reflects the ongoing mix shift to our Dimensions product lines from our legacy Selenia. Even though 3D tomo system revenues were up 72%, it wasn't enough to offset the 29% decline in 2D-only system sales. This is to be expected as the market shifts to 3D, especially here in the United States.

Our Dimensions product line represented 75% of worldwide digital mammography product revenues and 62% of units sold this quarter and were significantly higher than 1 year ago. First quarter sales benefited from the strong 3D tomo backlog at the beginning of the quarter, and ordered growth during the period drove a 10% increase in backlog at quarter end, both in units and dollars. Worldwide 3D upgrade units increased 32% year-over-year and 14% sequentially, representing almost 25% of 3D tomo unit sales and 10% of tomo revenues. We are very pleased with the growth and increasing adoption of our Dimensions product lines, including our 3D tomo offering, which remain on track with our expectations.

Our GYN Surgical segment reported a $2.4 million or a 3% increase in revenues, driven by triple-digit growth in sales of MyoSure. Excluding Adiana revenues in both periods, GYN Surgical sales increased $7 million or 10%. International sales of NovaSure increased 6%, while domestic declined slightly. Overall, we are quite pleased with the double-digit pro forma revenue growth in the Surgical business.

And finally, our international business achieved positive growth. We experienced mid- to high single-digit growth in each of our Breast Health, Surgical and Skeletal business segments and triple-digit growth within Diagnostics. Diagnostics' growth was driven primarily by the inclusion of the Gen-Probe products over last year, most notably blood screening and APTIMA, and to a lesser extent by 20% growth in Legacy Diagnostics which I discussed a few minutes ago.

Now for a brief review of some of the first quarter non-GAAP performance and the rest of the P&L. If we look at gross margins, they were 62.5% which was flat with the prior year and up 30 basis points sequentially and within our guidance range. Breast Health and Diagnostics posted lower margins year-over-year while GYN Surgical posted another quarter of sharp improvement, up 450 basis points to over 80% due to the favorable mix shift from Adiana to our MyoSure products. Total diagnostic gross margins did decline 550 basis points. This is primarily due to higher international sales and, to a lesser degree, from the contribution of Gen-Probe since close.

Despite an increase in mammography gross margins driven by the shift away from Selenia 2D towards our higher-priced, more profitable Dimensions line, overall Breast Health margins decreased 100 basis points. The margin decrease was in our biopsy line and was primarily caused by the transition of product from our Indianapolis facility, which is being closed to Costa Rica and Massachusetts.

Our operating expenses increased $46.9 million or 31% to $198.3 million, representing 31% of sales compared to 32% last year. This performance was in line with our guidance range. Our net income increased $11.7 million or 13% to $101.8 million. And this quarter EPS was $0.38, $0.01 higher than our guidance of $0.37.

Our non-GAAP EPS this quarter included a benefit of a $0.01 related to the legislative changes associated with the reinstatement of the federal research tax credit. On January 2, legislation was passed to retroactively extend the federal research tax credit for 2 years. We will record this cumulative adjustment in our GAAP results in our second fiscal quarter of 2013. For non-GAAP purposes, we apply this 32% tax rate beginning in our first fiscal quarter.

As of December 29, our cash and equivalents totaled $721 million, up $154 million from the end of fiscal 2012, reflecting another quarter of focused working capital management and solid operational results, both of which contributed to strong free cash flow generation. We continue to focus on improving our cash collection and day sales outstanding. This quarter alone marked an improvement of 4 days, which we were very pleased with, especially given current economic challenges that often result in delayed payments.

One item to note that added positively to our cash inflow this quarter was a $60 million cash receipt from K-V Pharmaceutical in full satisfaction and discharge of our claim. The gain of approximately $54 million, net of related costs, was recorded in our GAAP statement of operations. However, we excluded both the gain and cash inflow from our non-GAAP results and free cash flow guidance for the year. This is consistent with our treatment of all the prior payments received from K-V.

Our total debt obligations stand at $5 billion, resulting in a ratio of total debt to EBITDA of approximately 4.5, down from 5.1 in September. We remain committed to reducing this ratio to 2.5 by the end of fiscal 2015. Debt reduction will be funded by a strong operating free cash flow, which we continue to expect will be approximately $600 million this fiscal year. As a reminder, our initial focus for debt paydown during fiscal '13 is on the $775 million tranche of our convertible notes that are expected to be put to the company in December, as well as $65 million in scheduled principal payments for tranche A and B of our term loans. This obviously requires a substantial amount of cash, so we plan to build our cash balance through fiscal '13 and into fiscal '14 and to focus on starting to pay down the remaining $3.5 billion in debt we borrowed to fund the Gen-Probe acquisition.

In addition, consistent with prior years, our second quarter will include a higher cash outflows as compared to our first quarter as a result of the timing of tax payments, which we expect to approximate $95 million in Q2 as compared to less than $10 million in Q1. In addition, we will have higher interest payments as a result of the semiannual due dates on our $1 billion unsecured note payable.

Another transaction that will add positively to our GAAP cash inflows during our second quarter is our expected sale of our LIFECODES business to Immucor, as Rob discussed. We expect $85 million in cash at closing, subject to certain adjustments. As we did with the payment received from K-V, we have excluded this cash inflow from the anticipated $600 million and annual non-GAAP free cash flow guidance we provided and is therefore incremental.

Our guidance expectations are fully detailed in our Q1 '13 earnings release and our supplementary PowerPoint presentation, both of which are posted on our IR website. Note, our guidance is on a non-GAAP basis and reflects current operations, including revenues from approved and cleared products and recently acquired businesses. It also contemplates the expected sale of LIFECODES during our second quarter. All comparisons are provided on a year-over-year basis.

For Q2 '13 ending on March 30, we expect revenues of $635 million to $640 million, representing year-over-year growth of 35% and 36%. And on a pro-forma basis, excluding the discontinued businesses, growth of approximately 4%. This guidance excludes an expected purchase accounting reduction of $5.2 million related to our Novartis collaboration. Our guidance assumes currency rates consistent with Q1, the continued ramp-up of new products, including the Dimensions, PANTHER and MyoSure systems, and an overall strengthening in each of our operating segments. These increases are partially offset by a reduction in revenues related to our Adiana product, which generated approximately $4.5 million in revenues last year in Q2 and our LIFECODES business, which generated almost $11 million in revenues last year in Q2.

This guidance on a pro-forma basis reflects our expectations that Diagnostics revenues will grow in the low- to mid-single digits, and our Breast Health and GYN Surgical will grow in the mid-single digits. Continuing, we expect our gross margins of approximately 62.5% to 63% and operating expenses at $205 million to $210 million or approximately 32% to 33% of revenues, primarily due to the inclusion of Gen-Probe's operating results and, to a lesser extent, a general ramp-up in anticipation of increasing revenues. In addition, Q2 '12 operating expenses include approximately -- I'm sorry, Q2 '13 operating expenses include approximately $8 million in additional G&A expense related to the medical device excise tax that went into effect on January 1.

Interest expense of approximately $56 million and an effective tax rate of 32%, with approximately 271 million diluted shares outstanding for the quarter. All of these results in EPS of approximately $0.33 to $0.34. The medical device excise tax was expected to be $0.02 dilutive to EPS, partially offset by the federal research tax credit which is expected to add $0.01.

For fiscal 2013, which ends on September 28, we are reaffirming our non-GAAP revenue guidance of $2.61 billion to $2.64 billion. This represents an increase of 30% to 31% over fiscal 2012 revenues of $2.01 billion. This guidance excludes an expected purchase accounting reduction of $22 million related to our Novartis collaboration. In addition, it reflects an increase in revenues related to our acquisition of Gen-Probe resulting in our expectation that Diagnostics revenues will increase in the mid-single digits on a pro-forma basis, excluding LIFECODES, over fiscal 2012. Our guidance also reflects our expectations of high single-digit growth coming from our Breast Health and GYN Surgical segments.

For gross margins, we are increasing our guidance to approximately 63%, the high end of our previous guidance. The key drivers of future margin improvement are expected revenue increases and the addition of the higher-margin Gen-Probe Molecular Diagnostics products.

In addition, we are slightly increasing our operating expense guidance by $10 million to now $785 million to $810 million, which is approximately 30% to 31% of revenue. This reflects, in part, having LIFECODE-related expenses in the quarter which were not anticipated and, in addition, the acceleration and increase in certain marketing and product launch programs in response to recent regulatory approvals and clinical data releases. We continue to expect to incur an additional $25 million of G&A expenses in FY '13 related to the medical device excise tax. Our interest expense will be approximately $220 million, and our diluted shares outstanding will be 272 million.

We are updating our guidance for our annual effective tax rate and EPS as a result of the reinstated research tax credit. We expect the credit to positively impact our effective tax rate, and therefore, we now estimate that our effective tax rate will be approximately 32%, an improvement of 2 percentage points from the guidance of 34% we provided on November 12. And we now expect adjusted EPS of $1.58 to $1.60. This is $0.02 higher than previous guidance due to the income tax benefit, which is partially offset by a slight increase in operating expenses. As a reminder, this EPS guidance includes the impact of the medical device excise tax which we expect to be $0.06 dilutive.

In closing, we are pleased overall with our financial and operating results during the first quarter and look forward to continued progress over the balance of fiscal 2013. The organization responded well to the challenge of driving continuous growth across our business segments while officially executing our integration plans.

As we continue to execute operationally, we also will remain focused on further strengthening our balance sheet. As we've demonstrated in the first quarter, we are taking steps necessary to improve working capital and free cash flow while paying down debt.

And with that, let me turn the call back to Rob.

Robert A. Cascella

Many thanks, Glenn. Well, we believe that there were several important accomplishments in the quarter, and we attribute all of those to truly the breadth and value of our diverse family of products and, obviously, the dedication of our associates. Although the environment remains challenging for all companies in our field, we are more confident than ever that Hologic has the right strategy, product portfolio and leadership to continue growing this company, strengthening our balance sheet and building shareholder value.

I want to thank you all for participating on this call, and we'll now open the call up for questioning. So thank you, operator.

Question-and-Answer Session

Operator

[Operator Instructions] Our first question will come from Tycho Peterson with JPMorgan.

Tycho W. Peterson - JP Morgan Chase & Co, Research Division

Yes, you had called out a couple of things, Sandy and the ongoing kind of headwinds from the end of film to digital transitions. Can you just talk more specifically about the outlook for Breast Health though? Where are we in the cycle and what are some of the underlying trends in particular for the 2D business?

Robert A. Cascella

Yes, well, I think the good news, as we indicated, is that the market seems to be rapidly gravitating towards 3D. What that does in the short term is put certainly some headwinds on the 2D business relative to the normal replacement cycle. I think customers are waiting to buy 3D. And I think that things like the Oslo study are giving them the kind of ammunition that they need to go get budget approvals. And I also believe that the further we penetrate into that market, the competitive dynamic that's being created by the broader adoption of tomo is causing more and more customers to buy the products. So what we're seeing is that as we talked about, even last quarter, there may be some lumpiness in this early period of the rollout of this new piece of capital equipment. But all of the indicators appear very, very positive. And as a matter of fact, we, in our last call, said that we would nearly double the installed base in this fiscal year and we are saying today that we will, at a minimum, double our installed base of tomo products in the U.S. because we feel much more confident about the rollout of the product.

Tycho W. Peterson - JP Morgan Chase & Co, Research Division

And then maybe just a quick follow-up. Can you talk about service dynamics there? Obviously, you're installing or upgrading the installed base. How do we think about the service business? Does that begin to slow once you move past the bolus of upgrades?

Robert A. Cascella

I think what happens with services, as long as the installed base continues to grow, the service revenue continues to grow as well. I think that you may see, and as we have said in the past, a slowing in the growth percent as more and more tomo units are installed because in fact, the tomo units will carry a 1-year warranty and the existing Selenias that are being decommissioned would come off of service contract. But that's actually the kind of trend that we would want to see, right? We would have a significant spike in equipment revenue and a tapering of the growth in services as a result of that.

Operator

Moving onto Isaac Ro with Goldman Sachs.

Isaac Ro - Goldman Sachs Group Inc., Research Division

Just the first one, if you could maybe touch again with a little more color on the dynamic that you saw in the quarter, with customers holding off on tomo. Is that the way you quantify -- just as you look at conversations with your customers, some of the bigger ones that have bigger capital budgets, do you get a sense that there are sort of earmarks being held out over the next 12 to 18 months if clarity on reimbursement plays out?

Peter K. Soltani

So Isaac, this is Peter. So I think you have a number of questions there. So just a couple of observations. Again, as was noted earlier, our backlog of 3D product did increase quarter-over-quarter. So when you see just the -- and certainly the continuation of the general positive trends, certainly with the sort of the clinical data that was presented in RSNA along with Oslo. That's probably accelerated people not wanting to purchase 2D and, in fact, sort of deferring their decision until they can submit for additional budget dollars to go right to tomo. So all of those dynamics are a little bit complicated. But certainly, it's the kind of thing that we would expect to see. I think you had another question towards the end there, if you'd like to repeat that?

Isaac Ro - Goldman Sachs Group Inc., Research Division

Sure. Just wondering if you'll offer any color commentary on -- especially with your larger customers, you said to which some of those customers have earmarked dollars if and when they have more clarity on reimbursement. Just trying to get a sense of how your visibility compares now than maybe then prior to Oslo?

Robert A. Cascella

Yes, I think what Peter's indication was of a backlog increase and more interest from an orders activity perspective is a strong indicator for us. I believe, and I think we believe very strongly, that this product is moving forward from a growth perspective with or without reimbursement. However, the broader adoption of this product, a year down the road or 2 years down the road is certainly going to be highly dependent on that. But we're not seeing any indication today nor have we backed away from the numbers that we gave earlier on about the amount of increase to our installed base because of the momentum that we see being developed in the market. It just simply takes longer to buy a tomo unit than it does to buy a 2D Digital Mammography unit for the reasons that we gave. It's a higher dollar amount, there is no reimbursement. So people are buying for budget dollars that we see happening as is evidenced by the fact that we have a 10% growth on our backlog.

Isaac Ro - Goldman Sachs Group Inc., Research Division

Great. And if I could just ask one follow-up on the Diagnostics side of business. Can you maybe comment on the pricing and market share environment, especially for HPV and CT/NG? Just wondering, what you guys are seeing for pricing on both products and how you feel about market share?

Robert A. Cascella

Yes, I think on CT/GC, we have not seen an erosion in pricing. And in fact, we have not lost customers. We believe that our market share is stable. We're still market leaders by a substantial margin here in the United States. I think on the new accounts that we see for HPV, it's a much more competitive market. And I think that because it's incremental business for us, it is at a lower price than some of our earlier HPV wins, but it is business that we did not have in the past. So we're certainly not going to enjoy the days of $18 or $20 a test, and I think that the pricing is much, much lower than that. But as I said, we came from a relatively small installed base and market share to now grow into over 20% and those incremental customers had a lower AUP.

Operator

We're going to move next to David Lewis with Morgan Stanley.

David R. Lewis - Morgan Stanley, Research Division

Just 2 quick questions here. Rob, obviously, you've got a few questions here on the breast business. It sounds like the inflection for tomo may be happening sort of earlier, the enthusiasm is happening earlier which is sort of pressuring the 2D business. Now it gives you more confidence in your -- in the tomo business and the backlog, maybe in the back half of the year. But you maintained guidance for breast, so I think the real question I think investors are going to push you on is does this dynamic you're seeing play out here in the first and second quarter increase your visibility as it relates to kind of the breast outlook for the year? Do you feel sort of the same about it, better about it, or incrementally worse about it when you think about the balance of these 2 dynamics?

Robert A. Cascella

We feel better about it. I don't think we're prepared to raise our number other than with the words that I shared in terms of at least doubling versus nearly doubling our installed base. But we feel better about it, we felt much better after RSNA even though the order trend didn't result in revenue that was enough to cover the shortfall in 2D. The backlog activity and the quoting activity that we're seeing is very, very encouraging for the year.

David R. Lewis - Morgan Stanley, Research Division

Great, that is very clear. And just one more follow-up question. As it relates to operating expenses, I think the thought heading into this year was there's significant cushion on operating expenses. You had a release out before the quarter talking about ahead of your plan on operating expenses. So as you think about this reinvestment, how should we sort of think about that? Should we think about it, you're ahead of plans so you're choosing to reinvest, or were there expenses this year that you didn't think you're going to see that you are seeing? Or is this simply some of the product approvals are hitting earlier on the year and you expected them more in the back half of the year?

Robert A. Cascella

Yes, I think it's the latter. We really are very encouraged that we got the product approvals that we did. And then, in fact, they materialized earlier than expectations. So we believe that in order to successfully roll those products out, we are going to pull up some marketing spend as a result of it. So between that and just this hang over on some LIFECODES expenses in this quarter that were not anticipated led to we having to up our OpEx number. And we're talking about $10 million, of course, on a significant number. So we felt that it was probably well justified.

David R. Lewis - Morgan Stanley, Research Division

And Rob, is it safe to say that if you take the timing of the acquisition and now several months in the acquisition, you still feel better about the level of synergies you're going to be able to achieve?

Robert A. Cascella

Yes, absolutely. And I say that without question or without hesitation. It is not now -- we talk about these things happening over a 3-year period of time and we thought that the first tranche was conservative and we still believe that, and we clearly believe that over the 3-year period of time, the $75 million is not at all a challenge.

Operator

Our next question comes from Jayson Bedford with Raymond James.

Jayson T. Bedford - Raymond James & Associates, Inc., Research Division

I apologize if I missed this, but if I just look at the implied first half guidance versus the second half guidance, it implies that a pretty big step-up from first half to second half. Kind of what drives the better growth in the second half?

Robert A. Cascella

Yes, there's a lot of things, Jayson, that we've been talking about that we need to be more specific with you, so it's a very fair question. And that is that all of the things that had to do with both our HPV business and our CT/GC business on PANTHER, particularly, are things that are now being focused on new account closures versus equipment replacements. We believe that generates incremental revenue for us in the mid-tier lab market. In addition, on the Breast Health side, the news about increased backlog, the news about broader adoption of tomo, are certainly outpacing now what -- where we originally thought with respect the customer interest. All of those things were in our plan and are in our plan. So yes, they were -- they are second half loaded, but they are within the expectations that we had when we originally put our budgets together.

Jayson T. Bedford - Raymond James & Associates, Inc., Research Division

Okay. And then just second one for me, the thought of potential distribution synergies, meaning marrying the Gen-Probe portfolio with the larger Hologic sales force always appealed to me. When can you start seeing the benefit or the potential benefit of that marriage?

Robert A. Cascella

I think we're really starting to see it. I mean, you know how lab sales is. It's very time-consuming, it's not transactional, there's a lot of time that goes into education, there's a lot of time that goes into equipment validation assuming that you've won the account. So I mean, it could be anywhere from 60 to 90 days, from an order win or placement before you even start to see dollar one of revenue. So there's a lot of activity that's going on with the combined teams today and driven by both the physician sales team as well as our laboratory sales team. And I think that, again, when we think about the second half, that's when we start seeing -- believing that we start seeing the fruits of a lot of these efforts. And even early on, last quarter, when we suggested to you that we thought we would see a pickup in the CT/G business but it would happen in the second half of the year because of our physician sales team, because of new PANTHER placements and so on and so forth.

Operator

Glenn Novarro with RBC Capital Markets has the next question.

Brandon Henry - RBC Capital Markets, LLC, Research Division

This is Brandon on for Glenn. First question, can you just discuss what you're seeing with tomo ASPs on a year-over-year basis? Is it pretty stable or is it declining?

Peter K. Soltani

Brandon, it's Peter. Yes, they're fairly stable I would say. We did introduce another platform last year. It's called the Dimensions 5000. So that provides a different slightly lower price point with some defeatured components on it. But ASPs are holding very steady.

Brandon Henry - RBC Capital Markets, LLC, Research Division

Okay. And then second question, I might have missed this, but can you discuss your breast biopsy performance in the quarter and the outlook for the rest of the year?

Peter K. Soltani

The breast biopsy business did extremely well. We continue to maintain very strong, and in fact grow our market share, we're very, very pleased with that business and we do certainly expect that business to continue to grow for the rest of the year.

Operator

[Operator Instructions] We'll move onto Brian Weinstein with William Blair.

Brian Weinstein - William Blair & Company L.L.C., Research Division

Just want to go over gross margin real quickly. Can you just confirm, I think I heard you guys say that Diagnostics was down about 550 basis points. Was that -- did I say that correctly? And can you guys just address kind of what's going on there? I think you said an increasing OUS sales. But can we dig into that a little bit?

Glenn P. Muir

Right, Brian, it's Glenn. That was in the diagnostics area itself. So if we look year-over-year, back to a point in time where it was Hologic-only with Gen-Probe, we're looking at a slightly different product lineup than we had a year ago. With the ThinPrep and the Hologic products, we were already at a slightly higher gross margin than some of the Gen-Probe products. They were in the mid-to-high '60s, we were in the 60%, almost 70% range. So there's a little bit of an effective of combining the historical Gen-Probe into our mix. But I think even more so, it really is an increase on the international side, especially for the things like ThinPrep where we are getting lower pricing.

Brian Weinstein - William Blair & Company L.L.C., Research Division

How much more pricing do you guys get outside the U.S. versus inside the U.S.?

Robert A. Cascella

Yes, I think we're looking at pretty substantial differences, I mean, it's a -- depending on whether it's dealer or direct, would add a different layer. But let's assume it's direct to direct, we're probably 25% lower with respect to OUS pricing. If you layer on dealer sales, there's probably another 10% below that. So and a lot of that depends on the market, right? We're particularly aggressive and succeeding quite well in China, but the pricing in China is much different than the pricing in a market like the U.K., for instance.

Operator

Moving on to Doug Schenkel with Cowen & Company.

Doug Schenkel - Cowen and Company, LLC, Research Division

Do you -- I apologize if I missed this, but was there any update provided on timelines for HPV genotyping and any other menu expansion on PANTHER? And then related to that, and I guess probably just qualitatively, how do you think the -- I know PANTHER is going well but you have a somewhat limited test menu at this point, recognizing how well PANTHER's going, do you actually think you could be doing a lot better now if the menu were expanded? I guess I'd say that because some of the recent checks we've done suggest that while there's a lot of interest in PANTHER, there are at least a handful of folks that are holding back, anticipating an HPV launch later this calendar year.

Robert A. Cascella

Yes, I think, to the first question, the HPV and HPV genotyping were due out at the end of the calendar year, this calendar year. I think it's a fair statement. Obviously, there's a lot of enthusiasm over PANTHER but what PANTHER really brings to bear is a very diverse menu and the capabilities for random sampling. So now, with Trich on it, I think we answered part of that requirement. But clearly, our goal is to get a socket locked in with now a CT/GC and Trich and growing to HPV and to genotyping. What that will probably do this is, on an interim basis, cause us to use our Cervista and HTA. It's kind of a bridging technology until we're ready to convert over to PANTHER. But it is a -- it certainly is both a demand and a requirement from our customers that we are growing menu on that product, and that is our full intention. And by the end of this year, I think we'll fulfill the initial requirement.

Doug Schenkel - Cowen and Company, LLC, Research Division

Okay. And one follow-up, I believe you indicated that your guidance assumes no additional divestitures. It still seems like there's still some non-core assets related to some recent M&A that exist within the broader portfolio? Could you talk about the criteria by which you're using in considering future divestitures, and how likely is it that you might pursue additional spinoffs this year?

Robert A. Cascella

And look, we are currently studying the product portfolios of both Gen-Probe and our own legacy Diagnostic business and really looking at what do we think the future holds for many of those businesses. Clearly, we talked about being in virology so we know that we are investing heavily, and we being in viral load testing. But as we look beyond the next 3 to 5 years, what do we want to be? And is there an oncology play that we should be investing in today, and is PCA3 one opportunity to do so? So to be very specific about it, it's products like that will take a little bit longer for us to really get comfortable with and to research the broader implications of we investing in not just that particular application but in that field in general. So why I said what I did during the call is I don't think we're going to get a point where we're going to be comfortable enough to do anything like that this year. I think what we're doing this year is really studying what we think the opportunities are around each of those businesses.

Operator

Vijay Kumar with ISI Group has the next question.

Vijay Kumar - ISI Group Inc., Research Division

My first one was just a quick housekeeping. So what was the Gen-Probe contribution in the quarter and what's the sort pull-through run rate on the PANTHER?

Robert A. Cascella

Yes, I think what we did on Gen-Probe was give you -- each of the product lines and what their growth was in the quarter. But I don't know if we gave a...

Glenn P. Muir

We don't really carve out Gen-Probe because their product lines have all been simulated into the Diagnostics group. So I don't have a real single number. We tried to back into Gen-Probe's clinical diagnostic products as an example of some of the traction. So I did say that the clinical Diagnostics, so 2/3 of their old business, was up 9% and the other 1/3 is the blood screening.

Brandon Henry - RBC Capital Markets, LLC, Research Division

I think I can back in the numbers on that. So just maybe on the pull-through for PANTHER, I know that you have the Trichomonas assay approved. Can you provide some color?

Robert A. Cascella

We're not giving units other than to reconfirm that the 1,000-unit target that we had by 2015 is certainly well underway. I mean, I can say with a level of certainty that we are ahead of expectations relative to PF replacements. I think what we're focused on today is now that we think we've fulfilled our DTS replacements, or at least are getting to a point where we're fulfilling the DTS replacement, we're now pointing those sales efforts at new account wins, and we believe that will be a much stronger opportunity for incremental revenues. So I think that from a unit perspective, we seem to be on or ahead of placement plans. I think the difference over the next half of the year will be a much stronger emphasis on new account closures which would result in incremental revenue.

Vijay Kumar - ISI Group Inc., Research Division

And just a quick follow-up on Breast Health, you did mention backlog was up 10%. And can you just comment on maybe the pacing in the quarter? What happened before and after RSNA, maybe after the publication of Oslo?

Peter K. Soltani

Vijay, this is Peter. Yes, I mean, basically what happened is that -- a couple of things. One is that the quote activity increased significantly and many folks who were sort of on the fence waiting for the clinical data to sort of validate the clinical marriage of the technology, they kind of moved off the fence, so we see just an overall pickup and interest in the quote activity and presentations and so forth.

Operator

Rich Newitter with Leerink Swann has the next question.

Richard Newitter - Leerink Swann LLC, Research Division

I just was wondering, just going back to a prior question earlier on Breast Health, as we think about the remainder of the year and the dynamics playing out between kind of the declining 2D and what sounds like a better outlook for your 3D adoption, is it right to assume, basically, that you see the 3D accelerating to a level that should more than offset whatever declines play out in 2D? Or is there still the potential for lumpiness to possibly outweigh the 3D adoption in the back half?

Robert A. Cascella

I think that there is lumpiness in any new capital rollout. What we believe, however, is that 3D placements start to outpace 2D erosion and just by the sheer fact that their ASPs are higher. But what I mean by lumpiness is that I think until we get to a point where there is a broader and thicker backlog on tomosynthesis, I think you're going to see some lumpiness because of the fact that it's a piece of capital equipment and there's a lot of things that go into an account closure. But having said that, the optimism is there relative to we showing an ongoing trajectory and acceleration of a product over the next -- the second half of the year.

Richard Newitter - Leerink Swann LLC, Research Division

Okay, that's helpful. And on your -- your reiteration of your cost synergies in Gen-Probe integration, I'm just curious, is that something -- I think last quarter, you said that your guidance was not fully reflecting the achievement of even those conservative synergy assumptions. Is it correct to assume that current guidance is still not necessarily maybe leaving a little cushion in there and that the incremental OpEx you're calling out is incremental, but again there could be incremental offsets to the extent that you're not fully forecasting the synergies in guidance?

Glenn P. Muir

Rich, it's Glenn. I think if we think about the cost synergies that we identify for Gen-Probe, nothing has changed. We still feel very confident of where we are on achieving well over that $40 million target that we kind of pegged in the first year in $75 million. So yes, we feel good about that, but those expenses and the actions that we took at the beginning of the fiscal year to enable those cost synergies to come through, those changes have been made. So we'll begin seeing those as the year plays out. The OpEx $10 million increase that we identified or upped our guidance for this quarter wasn't related to Gen-Probe or cost synergies. That was really related to other parts of the business other than, I guess, the little LIFECODE piece that we hadn't anticipated. In our thinking about fiscal year '13, we were expecting to close LIFECODES at the very end of the first quarter. So we've got a little bit of a spillover of expenses into Q2 because of that.

Richard Newitter - Leerink Swann LLC, Research Division

Okay. But just to -- am I right in thinking that your prior guidance was not necessarily fully baking in that full benefit of potential cost synergy?

Glenn P. Muir

Yes. No, no, that's correct. I meant to say yes to that. Very clearly, yes.

Operator

We'll now move onto Amit Bhalla with Citi.

Unknown Analyst

This is Nick Nolan [ph] in for Amit. Quick question on the basis in 2D. How do we think of this going forward in the pacing of this? Do we see similar declines over the next few quarters, similar to what we're seeing this quarter? How do we think about that going forward?

Peter K. Soltani

Yes, I mean, it's -- I mean, if you think about things globally from a 2D demand standpoint, I mean, there are certainly parts of the world that are just not ready for 3D and the demand for 2D will continue to stay fairly stable. But I would certainly say that in the mature markets such as North America and Europe, there's certainly going to be downward decreases in 2D. Anybody needing to get 2D, it would certainly be, frankly, an obsolete product. So you kind of have to add the 2 together to get a sense of where things are going to go. But I would certainly say that we're probably see, again, decreases in 2D adoption in the U.S.

Operator

Moving on to Bill Quirk with Piper Jaffray.

William R. Quirk - Piper Jaffray Companies, Research Division

First, I have a couple of questions. In terms of additional assets on PANTHER, obviously this subject has come up a couple of times today. But I guess I'm curious, because you gave us timing for Trich and HPV, how do we think about alternative sample specimens, things like urine, that sort of thing, for chlamydia, gonorrhea as well as Trich?

Robert A. Cascella

Yes, so I think relative to our sample types for PANTHER, and particularly for CT/GC, I think any of the voids that we have, particularly in male urine, I think that will be completed by the end of the year. We're also completing female urine, but we don't feel that's critical, and that will probably be in the middle of the following year. So we think by the end of the year, we will fulfill the critical sample typing for CT/GC and Panther as well as menu fulfillment of HPV as well.

Operator

Ladies and gentlemen, that is all the time that we have today for questions. I'll turn the conference back to our speakers for closing or additional remarks.

Robert A. Cascella

I think that's really all that we have. We really appreciate the questions and the time, and we look forward to reporting to you in the future. Good night, everyone.

Operator

And again, ladies and gentlemen, that does conclude our conference for today. We thank you all for your participation.

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