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Hologic, Inc. (NASDAQ:HOLX)

F4Q09 (Qtr. End 09/26/09) Earnings Call

November 09, 2009 17:00 p.m. ET

Executives

Deborah Gordon - VP of IR

Jack Cumming - Chairman

Rob Cascella - CEO

Glenn Muir - EVP and CFO

Tony Kingsley - Head, Surgical Group

Howard Duran - Head, Diagnostics Group

Analysts

Tycho Peterson - JPMorgan

David Lewis - Morgan Stanley

Josh Jennings - Jeffries & Company

Amit Bhalla - Citi

Jayson Bedford - Raymond James

Isaac Ro - Leerink Swann

Amit Hazan - Oppenheimer & Company

Jonathan Block - SunTrust Robinson Humphrey

Operator

Ladies and gentlemen, good day and welcome to the Hologic incorporated fourth quarter and fiscal year 2009 earnings conference call. My name is [Dalia] and I will be your operator for today's call. Today's call is being recorded. All lines have been placed on mute. I would now like to introduce Deborah Gordon, Vice President of Investor Relations. Ms. Gordon, your line is open, please go ahead.

Deborah Gordon

Thank you very much. Good afternoon and thank you for joining us for Hologic's fourth quarter and fiscal 2009 earnings conference call. I encourage everyone to visit Hologic's Investor Relations page of our website in order to view the PowerPoint presentation related to the comment that Glenn Muir Hologic's Chief Financial Officer will be making in his opening remarks. The replay of this conference call will be archived on our website. Please also note that a copy of the press release discussing our fourth quarter and full year results as well as our first quarter and fiscal year 2010 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 details 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 or GAAP. A reconciliation of these non-GAAP financial measures to the related GAAP financial measures can be found in Hologic's fourth quarter 2009 earnings release including the financial tables in the release.

Please note that today's conference call will consist of approximately 30 to 40 minutes of opening remarks from management followed by a thirty-minute question-and-answer session. We therefore ask each participant to please limit his or her questions to just one with one follow-up as necessary.

Before I turn the call over to Jack Cumming and Rob Cascella, I would like to remind you of a few investor conferences Hologic management will be participating in this month and next. Glenn Muir and Rob Cascella will be presenting at the Citigroup's Small-to-Mid Cap Conference in New York City on November 19, at 9:10, Eastern Standard Time.

Hologic management will be presenting at our Annual Investor Meeting on December 1 at 8 A.M. central time at RSNA in Chicago, and Jack Cumming will be presenting at the NASDAQ OMX Conference in London on December 1 at 11:15 A.M. London time. All of these presentations will be webcast. The details of which may be found on the IR section of our website.

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

Jack Cumming

Well, thank you very much Deb and good afternoon everybody. Thanks for attending our fourth quarter, fiscal 2009 conference call. And as Deb said joining on the call today is Rob Cascella our newly appointed CEO; Glenn Muir our Executive VP and CFO; Tony Kingsley, head of our Surgical Group and Howard Duran head of our Diagnostics Group and all of us of course will be available during the question-and-answer session.

I'd like to begin this call by speaking to our announcement today about Rob's appointment to CEO. I will then turn the call over to Rob to review our business performance in the recently completed quarter and fiscal year. And finally Glenn will discuss our fiscal '09 results and our guidance for the first quarter and full year of fiscal 2010. We will then open up the call for Q&A.

And as Deb stated, we are going to conclude this call in about an hour out of respect for everybody's time and it may run over a little bit depending, we are going to try to give 30 minutes for Q&A. So depending on when we finish our part we will then go right away into the rest.

First let me start by saying it's a distinct pleasure to announce Rob Cascella's promotion to Chief Executive Officer. And as many of you know, Rob has done an exceptional job as our president and COO since 2003. All of us on the company's Board of Directors believe Rob's depth of experience and proven leadership are key elements that Hologic enjoy continued success for many years to come.

Having served as CEO since 2001 I've had the great fortune to work alongside Rob since he joined the company. And I'm absolutely certain; Hologic will be very well searched under his leadership. Rob's promotion follows the succession plan that we've had in place for quiet sometime. And the timing of the appointment shortly following the start of our new fiscal year as a perfect opportunity for him to take the helm as CEO.

As many of you know, in his role as President and COO, Rob has been an active part of the executive team in setting the strategic direction for the company while also being responsible for the running of the day-to-day business. As a result the transition to Rob's leadership will be seamless.

In my continuing role as Chairman, I'm excited by the opportunity to focus my energies on business development with special emphasis on expanding our international footprint which is a major strategic growth initiative for Hologic for the coming years.

Selfishly speaking, this shift in roles allows me to do what I am most passionate about, working hand-in-hand with our sales team and distribution partners, to promote our best-of-breed market leading technologies, helping drive growth through acquisitions and joint ventures, and playing a more active role with customers and local governments, to find solutions to meet local market needs, to deliver quality healthcare to underserved women on a worldwide basis.

I know I speak on behalf of not only myself, but the rest of the Board of Directors and the management team of Hologic, when I say Rob's strong management abilities and extensive expertise give us great confidence, he's the perfect fit for this role. And at this point, allow me to congratulate Rob and welcome him to his new position.

Before I turn the call over to Rob to review Hologic's 2009 operational performance, I would sincerely like to thank Hologic associates worldwide for the honor and privilege of representing them as CEO of Hologic for almost a decade. It is their passion, their commitment, their tireless efforts to truly make a difference in this world that has not only motivated me, but has humbled me knowing how much they have given up themselves. And finally, a special thanks to Dr. Jay Stein and David Ellenbogen our co-founders for giving me the opportunity to serve in this role.

And Rob, let me turn this over to you and wish you obviously the very best.

Rob Cascella

Well, thanks very much, Jack. I'm truly honored to take over as CEO of this wonderful company. My sincere thanks to you and the rest of the board for the opportunity.

I'd like to now turn to a review of our results. I'm pleased to report once again, our quarterly revenues and earnings exceeded our guidance. As stated in our press release, Q4 '09 revenues totaled $403 million, a 9% decrease from the fourth quarter of fiscal 2008 and sensibly flat to Q3 of '09. This compares to our guidance of $390 to $400 million.

The high performance was due to the strength in our GYN Surgical and diagnostic businesses, as well as our growth in our recurring revenue stream from service. Again, offset by the continued yet, anticipated softness in our digital mammography capital equipment business.

Consistent with our report to you last quarter, we felt the economy had little impact on our consumables businesses. When factoring in our recurring revenue stream from service, these combined sales represented approximately 75% of our Q4 revenues.

For the fourth quarter of fiscal 2009, our non-GAAP earnings per diluted share were $0.28 beating our guidance of $0.25 to $0.27. This compares to our non-GAAP EPS of $0.30 for the same period last year, and flat to our EPS last quarter.

For the full year of fiscal 2009, our revenues totaled $1.637 billion versus $1.674 billion from '08, a decrease of 2%, and exceeded our guidance of $16.25, and $16.35 billion. While non-GAAP earnings per diluted share were $1.17 as compared to $1.18 last year, and at the top end of our guidance range of $1.15 to $1.17.

I would now like to take a minute to briefly provide the fourth quarter revenue overview by segment. Breast Health revenues were $174.8 million down 21% from $221 million for the fourth quarter last year. This decrease was primarily due to reduced digital mammography revenues as we are still feeling the effects of hospital budget constraints, coupled with the success we enjoyed from the lower end configurations of Selenia as we now offer, which allows us to compete in different geographic markets. This overall reduction was tempered by strong growth in Selenia related service revenues as we continue to grow our install base and to a lesser extent by growth in our breast biopsy products.

Diagnostic revenues totaled $138.7 million, an increase of 4% compared to $133.7 million for the same period in fiscal '08. We were very pleased with our global ThinPrep sales this quarter holding fairly steady from last quarter and up year-over-year. Imager adoption continued to increase in the US as measured by a higher percentage of ThinPrep tests imaged particularly by our two largest lab customers.

Consistent with the prior quarter outside the US, sales within European and Asia markets were solid. Our new Cervista test also contributed modestly to the revenues in the fourth quarter and we are extremely pleased with the roll-out of this product and the level of penetration to-date.

GYN Surgical revenues totaled $67.3 million, an increase of 13% compared to $59.7 million for Q4 of '08, solidly ahead of expectations and up sequentially, chiefly due to NovaSure procedure volume. Adoption of the NovaSure system as an office-based procedure continues to remain a focus and we are pleased with the growth and the percentage of our business for monthly standing orders.

Our new Adiana system for permanent contraception contributed modestly to the quarter as we methodically roll-out our global sales strategy.

Skeletal Health revenues totaled $22 million compared to $28.1 for the same period in '08s, a decline of 22% and down $1 million sequentially. Sales of our osteoporosis assessment systems were again affected by the weakness in capital spending worldwide as expected.

Let me now turn to a brief review of our accomplishments of '09. On last year's fourth quarter call we fully anticipated '09 would be a transitional year. Little did we know how much transition we would face as we ultimately navigated along with our peers, the worse economic crisis in current memory. Given the substantial headwinds Hologic faced, I'm particularly pleased with our achievements over the year.

First, in this difficult year Hologic persevered and in the face of a 2% decline in annual revenues, we aggressively reduced expenses and preserved our earnings thereby reporting non-GAAP net income on par with last year and delivering at or above our earnings guidance for three out of four quarters.

Second, we continue to diversify our business away from economically sensitive capital equipment and towards consumables and recurring revenues which now comprise approximately 75% of our revenues and command higher gross margins, thus helping to further insulate our earnings power this past year.

Third, we generated substantial cash, approximately $500 million in free cash flow, specifically even as sales declined our free cash flow increased over 70% over last year.

Fourth, we maintained and in many cases grew our leadership position in women's health. Despite the softer market, we recently exceeded 5,000 total shipments of Selenia systems, making us the clear worldwide leader in digital mammography. Our share of the endometrial ablation market is estimated at 65% to 70% with continued adoption of the NovaSure procedure both in the hospital setting and as an office based procedure. Our share of the US Pap market remains steady at 70% even in the face of competition and our revenues outside the US increased nicely.

Fifth, Cytyc and Third Wave are substantially, fully integrated into the fabric of Hologic and have contributed substantially to the growth in our product portfolio.

And, six, we have made substantial progress on building out our international infrastructure particularly in key markets. Specifically, in mid-October we formally announced the opening of our Asia Pacific regional office where we plan to conduct sales and service training, product support and other key functions. We are very pleased to be driving the availability of improved healthcare for women globally.

And finally, we brought the following new products to commercialization in '09. Cervista High Risk and 16/18, Adiana and Eviva to both the US and international markets. Our MammoSite multi-lumen to the US market and a ThinPrep integrated imager to markets outs the US. Of note, these new products also represent key additions to our disposable product lines which help to support an attractive long-term recurring revenue stream.

Turning now to review a few of our key new product developments. I'm happy to report considerable positive momentum among physicians and labs for Cervista, High Risk and 16/18. We are making solid progress and enjoying many successes in penetrating labs and signing up new customers. Although sales of Cervista were moderate in '09, we believe we're laying a strong foundation for more meaningful revenues in fiscal 2010.

In the quarter as you know, we introduced Adiana to the OB/GYN community and we are seeing solid success in registering doctors for training. During this limited launch period, we have gained very valuable information about the product and our training program which we are now incorporating into a broader launch plan. Limiting the release has allowed us to want to increase our confidence and the competitiveness for the product and the ability of our experienced sales force to train and sell to physicians and, two, build sufficient inventories in Costa Rica to support the expected demand.

In August, we gained approval for our MammoSite multi-lumen device used in accelerated partial breast radiation for breast cancer therapy. The advantages of this kind of therapy includes the targeted delivery of radiation while minimizing exposure to healthy tissue. The multi-lumen product is a more competitive device as compared to our single-lumen offering as a result of its ability to treat a wider range of cases. We began a limited market launch of the product in October and anticipate full commercial launch by the end of this quarter.

Finally, our ThinPrep integrated imager system received CE marking approval in late September. The integrated imager represents the latest innovation in cervical cancer screening by combining proven ThinPrep imaging technology and slide review into a single convenient standalone device. Clearly, the international market has been a source of considerable growth for ThinPrep, as it converts to liquid cytology and the integrated imager is expected to accelerate the adoption of our ThinPrep technology.

As to tomosynthesis, the plan as we described last quarter has not changed. We are in continual discussions with the FDA and are preparing a broad range of clinical trials over the next year.

Let me pause and remind you of the upcoming Radiological Society of North America RSNA annual meeting, which serves as an important showcase for our breast and skeletal imaging technologies. The meeting is November 29, through December 4 and we will be hosting our annual analyst present on the morning of Tuesday, December 1. RSNA draws radiologists, technologists and hospital administrators from around the world and this year we will continue to market our tomosynthesis system to international customers. And we will be featuring our new 2D Selenia Dimension system to US customers. We would also expect a meeting to provide us with a bit more clarity about the outlooks for future hospital capital spending. In short we once again expect this year's RSNA to be an important and productive meeting.

So in summary, we are pleased with Hologic's fourth quarter and fiscal 2009 performance especially in the context of a difficult global economic environment. Our increasingly diversified revenue base and focus on profitability enabled to us meet or exceed the guidance we have previously provided.

We continue to generate very strong cash flows and to reduce our term loan balance both of which are key focuses advantage. We also continue to bring new products to market and to work on a new pipeline of new technologies to strongly position us for this year as well as the long-term.

With that let me turn the call over to Glenn to provide the fourth quarter financial details and detailed guidance for fiscal 2010.

Glenn Muir

Thank you, Rob. I would like to now expand on the financial results for the quarter. Rob highlighted our fourth quarter revenue performance by segment. Our mix of domestic and international product sales continued to be approximately 80% and 20%. Foreign currency translation had a modest impact on a reported revenue growth, 1% year-over-year, primarily within the diagnostics and surgical segments as most of these international sales are dominated in local currency.

Turning to the rest of the P&L our gross margins on a non-GAAP basis was 61.5%, down slightly from the third quarter and up versus 60.9% last year. This he can excludes $39 million of amortization of intangibles and is within our guidance range of 61 to 62%. The year-over-year improvement in gross margins was due primarily to product mix, favoring higher margin disposable products.

On a GAAP basis gross margins were 51.3% versus the 52% we guided to. We maintained the cost savings initiatives we put in place at the beginning of the year and this continued to result in a favorable outcome. Our operating expenses on a non-GAAP basis of a $117.4 million primarily excluding amortization of intangibles of approximately $12.9 million came in below our third quarter non-GAAP expenses and also below our guidance of $122 million to $126 million.

Further, when compared to last year, our fourth quarter operating expenses excluding the amortization of intangibles decreased approximately $9.1 million. Absent the acquisition related in other charges pre-tax earnings this quarter were a $114.1 million. Using our annual effective tack rate of 35% non-GAAP net income was $72.4 million versus non-GAAP net income of $77.2 million last year, a decrease of 6.2%.

We reported fully diluted non-GAAP EPS this quarter of $0.28 versus $0.30 a year ago, which was ahead of our guidance of $0.25 to $0.25. This adjusted EPS includes the operations of Third Wave which equates to a $0.2 per share after-tax loss also in line with our expectations.

While our overall revenues for fiscal 2009 were slightly below last year, we did exceed guidance for the year and remain encouraged by growth in our diagnostic and GYN Surgical segment as well as the overall service related revenues we generate.

For the year, disposables and service represented 72% of our revenues in capital equipment represented 28%. This is up from 62% and 38% respectively last year. For the full fiscal year 2009 our gross margin on a non-GAAP basis were 62.2%, up from 61.7% in fiscal '08. This excludes $154 million of amortization of intangibles and is within our guidance range of 61.5% to 62.5%.

This improvement was primarily due to product mix favoring our higher margin disposable products. Our operating expenses on a non-GAAP basis of $482.1 million declined compared with last year's expenses and were also below our guidance.

In addition, (inaudible) operating expenses at Third Wave, which we acquired in July of last year, the net decline in operating expenses this year was $34 million. This is due to the cost savings initiative we implemented in the beginning of the year. (Inaudible) the acquisition-related charges, pre-tax earnings for the year were $464.2 million, using our effective tax rate of 35% non-GAAP net income was $301.7 million versus non-GAAP net income of $294.7 million last year, an increase of 2.4%.

We reported fully diluted non-GAAP full-year EPS of $1.17 versus $1.18 a year ago, which is at the high-end of our guidance of $1.15 to $1.19. This adjusted EPS includes the operation of Third Wave which equates to an $0.11 per share after-tax loss compared to a $0.03 per share after-tax loss in fiscal '08: Our total dollar backlog for all products was $323 million at the end of September. Down slightly from $334 million at the end of June.

We ended the year on a positive note. We ended the year on a positive note as backlog in our Breast Health segment increased to its highest level in three quarters. And this quarter we booked the highest number of Selenia digital mammography systems for the year.

Turning to the balance sheet, during the fourth quarter we repaid $96 million on our $540 million term loan which was borrowed on July 17 of last year in connection with our acquisition of Third Wave. Thus we have repaid a total of $366 million of the term loan leasing a balance of $174 million at the end of the September quarter.

As of today our balance has been further reduced by another $24 million to $150 million. Our strong cash flows will enable us to pay off this loan within the 2.5 years we originally guided to. We generated in excess of $140 million of free cash flow in the fourth quarter of fiscal '09, comprised of approximately $152 million of cash flows from operations, less Capital expenditures of $12 million.

Moving on to guidance, I will first discuss fiscal year 2010 and then cover the first quarter. Note that our fiscal 2010 guidance reflects a continued decline in our hospital capital equipment business as we have chosen a fairly cautious view as we enter the new fiscal year. During this past quarter, we saw a pick up in Selenia digital mammography orders and while the orders are for lower priced configurations as a result of our various product offerings, these trends suggest an improvement over the steep declines of the past year.

However, given the trends is leaning toward lower ends configurations in the near term and with limited visibility prior to RSNA., we are guiding to lower mammography revenues in fiscal 2010 compared to fiscal 2009. At the same time mammography-related capital equipment only represented 23% of our total revenues for this recently completed fiscal year. So for fiscal 2010 which ends next September 25, we are introducing total revenue guidance of $1.625 billion to $1.65 billion. This guidance reflects our current expectations that, number one, Breast Health revenues stabilize at our current quarterly run rate reflecting continued softness in capital spending.

Number two, diagnostics and GYN Surgical revenues grow modestly due to, first, new sales of Cervista and Adiana, bearing in mind these new products are starting from a small base and will therefore move the needle only slightly particularly in the first half of 2010 and increasing, as the year advances. Second, increased imager adoption. Third, higher international sales and, fourth, more widespread use of the NovaSure system.

Number three, we are expecting service revenues to increase primarily related to our growing install base of Selenia digital mammography systems. And, number four, as stated in the press release this guidance reflects a reduction of approximately $21 million in annual revenues year-over-year due to our decision to discontinue certain products as we detailed in our earnings release.

And, lastly, for tomosynthesis, we continue to expect only international sales in 2010. We are looking for full year gross margins of approximately 62% to 63% on a non-GAAP basis. We are expecting operating expenses in the range of $490 million to $500 million up approximately 2% to 4% from fiscal '09 and excluding the amortization of intangibles.

We are expecting interest expense based on current LIBOR rates to be approximately $123 million and as a result of our adopting APB 14-1 for the accounting for convertible debt in fiscal 2010. The 1123 million does include non-cash interest expense of approximately $71 million which we have excluded from our non-GAAP adjusted guidance. Our effective tax rate absent impairment charges is expected to increase from 35% to 36% which by itself will have a $0.02 effect on EPS. We are expecting non-GAAP adjusted EPS of $1.15 to $1.19 per share compared to $1.17 in fiscal '09.

Next, our guidance for the first quarter. For the first quarter of 2010 ending this December 26, we are expecting revenues in the range of $400 million to $405 million. Our revenue estimates are driven by three primary factors. First, flat to slightly down Breast Health and skeletal revenues compared to Q4 '09 as the capital equipment sales into the hospital setting continue to be constrained which affects our Selenia and digital mammography systems, our biopsy tables and our skeletal diagnostic equipment.

Second, continued growth in our diagnostics and GYN Surgical segments as well as recently launched Cervista HPV and Adiana permanent sterilization products. And third, the afore mentioned reduction in revenues from discontinued products of approximate $2.6 million in the quarter. We expect gross margins of approximately 61% to 62% on a non-GAAP basis. We are expecting operating expenses to rise slightly on a sequential basis to $130 to $133 million, or 32% to 33% of revenue, primarily as a result of increased costs relating to trade shows and programs in the first quarter of each fiscal year, such as our national sales meeting in October and RSNA in December, as well as increased sales and marketing costs related to our recently approved products.

We expect interest expense to be approximately $33 million in Q1 including approximately $17 million of non-cash interest expense as the result of our adopting APB 14-1. Our effective tax rate is expected to be 36% and we expect non-GAAP earnings per share, excluding the amortization of intangibles of approximately 24% to 26% per diluted share.

In fiscal 2010, we expect to generate over $500 million of free cash flow and to pay-off our term loan. Capital expenditures have never been a big part of our business and we are expecting CapEx of close to $60 million and depreciation of approximately $75 million for the year.

In summary, although optimistic about our market share position, strength of product offerings and the new products being launched, our guidance is essentially flat with the year just ended, reflecting our uneasiness with the strength of the economy and a cautious stance as we begin the New Year with limited visibility.

With that, let me now turn the call back to Rob.

Rob Cascella

Thank you, Glenn. In summary, we're very pleased with the performance of Hologic's management team and our associates during a very difficult economic time. We effectively managed our business by continuing to market and sell the highest quality products and by always putting our customers first. Over this next year, our mission will be to maintain our number one position in women's health through innovative product development, aggressive marketing and exceptional customer service.

This now concludes our opening remarks. Jack, Glenn, Tony, Howard and I will be happy to answer any of your questions. In order to allow for as many investors as possible to ask questions, I remind you please observe Deb Gordon's earlier request that you limit your questions to one, with one follow-up question if necessary. With that, operator, please open up the call lines.

Question-and-Answer Session

Operator

(Operator Instructions). Our first question comes from JPMorgan's Tycho Peterson.

Tycho Peterson - JPMorgan

Yeah, good afternoon. Wondering, and congrats, Rob, on the promotion. I was wondering if you can comment a little bit on just some of the early marketing message around Cervista and talk a little bit about with the two sales teams, lab sales and physician office. What message is being delivered to the sales force? And then to the extent you're starting to see interest in 16/18 genotyping and competitively how you're positioned against some of the accounts that are coming up.

Rob Cascella

Sure. Howard why don't you take that

Howard Doran

Hey Tycho, thanks for the question. We're very pleased on how we finish the year certainly as it pertains to Cervista high-risk, and as you know, the sales teams have been integrated now for the better part of nine months since FDA approval and they're working very hard to go out and sign as many customers up as possible.

As we've discussed before, the revenue has a slightly trailing effect. It takes a couple of months to get the contracts signed, get the validations completed before you start actually reporting out live patient's results.

So, I think a real good way to think about our business is, what is the value of the accounts that we've gotten to that point at the close of this year? And if you think about the contracts we've closed, the people that we validated and those that are actually giving out live results today, we would anticipate that we have somewhere in the mid single-digit market share at this point. And if you think back to where we were prior to FDA approval, it was well under 1%. So, we're very pleased with that initial progress that we've made.

In regards to your question about 16 and 18, that's really a differentiator. As the labs industry itself continues to become more competitive, it really comes down to labs being able to go out and offer things that others don't and what we have really found is, one of the reasons that customers are very interested in bringing Cervista HR in, is so they can package 16/18 out to the customers and more further differentiate themselves from their competition as well.

So, we are very pleased that that is important to them. It's not real material when it comes to revenue, but it is a differentiator for them in the marketplace and it just makes the Cervista story that much more compelling.

Tycho Peterson - JPMorgan

And just one last one on that front. Type 45 seems to be, there's some noise in the market about that. Can you comment if you are hearing from customers about that being an issue. That you don't have that in the product, or?

Howard Doran

Actually we've not heard it at all. What Third Wave did is sat down with key opinion leaders, NCI, etcetera, and strategize on what was the best approach for genotyping the future. I don't think you have to look any further than ASCCP guidelines, they recommended 16 and 18. That's the path they followed because the KOL said it was the right one, NCI said it was the right one and ASCCP has already adopted it. So, we think we picked the right too.

Operator

Next up, we have David Lewis with Morgan Stanley.

David Lewis - Morgan Stanley

Two quick questions here, mostly on guidance. The first one is, Glenn, just looking at next year, you made some commentary as did Rob about box placements and revenue-per-box sort of continuing that trend downward. If you look by our model, revenue for box is relatively firm. So, do you still expect kind of revenue per box to be down next year and maybe you could talk to us about gross margins for the Selenia business as you move down market. Do you still believe you can hold the gross margins relatively flattish by lowering cost on lower revenue per box or has that dynamic changed?

Glenn Muir

David, let me start with that one and if we think about Q4 for a moment, the quarter just ended and the Breast Health results. What I tried to articulate was, we expect to be stable for the rest of the year at that level; which includes at the end of the day, a reduction in overall Selenia digital mammography sales.

If we think back to last year, the first quarter of '09 that was a big Selenia number for us. So, just stable at today's rates will bring us under the '09 when we think about 2010 guidance.

So, the answer is, yes. We are expecting a decline in Selenia digital mammo unit and the revenue from them to a certain extent as we changed the configuration and the product mix to more of our value and Encore items. So, as we move more to the value and the Encore placement, I think the gross margins will compress a little bit as well.

David Lewis - Morgan Stanley

And then just looking at SG&A for a second here, Glenn, very good job constraining SG&A spending here this year, but heading into next year, given the continuing push on HPV as well as increasing push on Adiana, where are you taking from the SG&A line to fund those new programs?

Rob Cascella

I'll try to answer that David. We've had a range of discretionary programs that will become much more highly selective about in terms of being able to fund or invest in and where much of the growth in marketing will come from or the funding for that will be cutting out programs that we thought were either of a very high risk and low probabilities of pay back and so on and so forth. So there are still levels within our operating expense structure that are discretionary in nature, that cover some of the other business lines that won't be using such dollars. So, we can funds the growth drivers within the company.

David Lewis - Morgan Stanley

And Rob just lastly and I'll jump back in queue. The earliest you think we'll get an update in terms of your progressing time limit, the FDA on tomosynthesis. Can you just update us on timing there? Thank you.

Rob Cascella

Sure, we really don't have a specific time. Right now we're in the process of multiple clinical trials working with the FDA to certainly sort out protocols and the like and it would be a bit of an injustice if what we tried to do is literally throw a dart at the wall in order to pick a time that we can give you meaningful information.

Operator

We'll move on now to Josh Jennings with Jeffries & Company.

Josh Jennings - Jeffries & Company

Guess my first question here is just on your outlook for hospital spending, capital equipment spending specifically and Jack mentioned on your last earnings call that he expected a very, very slow recovery in his hospital budget in the US. It looks like you've seen a little bit of an improvement in this last quarter. Just wondering if you can comment on how you're looking at calendar Q4 here in here into 2010 and the US side and also what you guys are seeing internationally, specifically in Europe in terms of capital equipment spending and then your expectations there? Is it really just a downtick to lower cost units or are you actually expecting numbers of systems to be down as well?

Rob Cascella

We've really covered the range. As Glenn indicated, we had a good fiscal fourth quarter. But not thinking that one quarter is a trend, it's a little too early in fiscal Q1 for us to make a strong determination, primarily because much of the buying pattern starts after RSNA. So we have a little bit of a blind spot to really get good market intelligence at this point.

I would say that if we look both domestic and international, we see more activity occurring. Whether or not that activity ends up in order closure, is yet to be determined and, yes, depending on the market we are bracketing it with different product configurations so that the late adopters, those laggards that are just buying digital today, are really after our low end systems. So we will see some configuration there in as a result of that.

Having said that, we're also at a point where we have an aging install base of customers that are now looking to replace. So, we think that we may have somewhat of a mixed blending where our very high-end Dimension's 2D product. So, the reason for the guidance was really one of giving us a little bit more time to have visibility into the future, to get an understanding of really where we think these markets are headed.

Josh Jennings - Jeffries & Company

And if I can just follow it up with just a question on your international growth opportunity, looking back at when you guys at acquired Cytyc and some of the synergies that you were expecting internationally and looking at US international sales mix, it's still around 80-20. When do you expect that to pick up for one, and where do you expect that mix to be at the end of 2010, 2011, and then also just how that'll impact gross margins going forward?

Glenn Muir

If we look at what we've done internationally we are now putting the infrastructure in place in different parts of the world so that we can really define a growth strategy that allows to us support growth through better sales training, better service training.

Up to this point we've been really dealer-based and we will remain dealer-based for a good part of our sales but we are building an infrastructure around those dealers to support them. With respect to what happens with ASPs, certainly depending on where we are selling around the world ASPs will be impacted and that's across all of our product lines, not certainly limited to imaging. But that mix effectively is compensated for to a certain extent by the fact that if we are selling through dealers then there we don't certainly have the same operating expense infrastructure requirements that we would under a direct sales model.

So when we look at international, we look at international from a growth perspective. How that changes with respect to mix between domestic and international has a lot to do with what happens with our domestic business of course. So if our domestic business continues to be weak, then we would expect a percentage point swing in the percentage of our business that is done offshore. That is not the intent today. I think looking at it from a true dollar perspective is where we are focused on versus even the percentage mix between domestic and international.

Operator

Now we'll move on to Amit Bhalla with Citi.

Amit Bhalla - Citi

Hi, I wanted to start on the Breast Health business, two questions there. Glenn or Rob, can you talk to us about what your assumptions are for fiscal 2010 and how much of that, how much of your numbers are predicated on the replacement market picking up. And then secondly on Tomo and the international market can you comment on the adoption there and how long sites are taking to get up and running.

Rob Cascella

When we put our plan together for 2010 we anticipated there would be a reduction in digital mammography sales and that reduction was probably somewhere in the area of 10% to 15% at the higher end of our range. If we look at the lower end of our range we are contemplating a more significant reduction than that upper limit.

Let's say it's as high as 20% or more. The reason for that is just the unknowing of whether or not we will see an uptick in the US market which is really going to drive further sales or will the US market remain flat to down and also be exacerbated by lower ASPs based on these configuration changes that we talked about.

Going forward, the, I think that we see tomosynthesis is being a product for international markets that will take a long time for adoption to occur. International has been typically slower than the US market. Each country needs to verify and validate. There's a separate regulatory process that needs to be affected. So although we are selling successfully tomosynthesis, we are not looking for that to be a revenue driver in 2010.

Amit Bhalla - Citi

Rob, just to clarify the first set of comments were you were talking about the Breast Health reduction of to 10% to 15% the high-end or 20 the low end. You're just talking about Selenia revenue there? What exactly are you talking about there?

Rob Cascella

That's really a combination of units and dollars. So units will be down by a certain percentage and that unit reduction will be increased by an overall lower ASPs as we move to the lower end of the market with our on core and value systems.

Amit Bhalla - Citi

Sure. The question on Tomo international was just about how long sites are taking to get up and running. My follow up on Adiana was you mentioned a number of doctors have signed up for training. Can you tell us what percentage of those doctors are already using NovaSure? Thanks.

Tony Kingsley

Yeah, it's Tony. I would say a very high percentage of them. We have not targeted them because they use NovaSure, but those are procedurally-oriented physicians and tend to be good (inaudible). So I'd say there is a very high overlap.

Amit Bhalla - Citi

Are you talking about like 80% or so or can you give us a range?

Tony Kingsley

I don't know for a fact but I suspect it's that high.

Amit Bhalla - Citi

Okay.

Operator

Next in our queue we have Jayson Bedford with Raymond James.

Jayson Bedford - Raymond James

Just a couple questions. Just on the gross margin line, in the fourth quarter it was a little weaker than we thought. It looked like both the diagnostic and surgical segment margins were lower both sequentially and then quite a bit lower from last year and I'm wondering,there could be some non-cash noise in there but is pricing impacting the margin line at all?

Glenn Muir

No. Jayson, on the gross margin line it is not price, especially as it relates to the disposable products. It has more to do with the cost of the some of the manufacturing, especially the new products. The operation down in Costa Rica we're trying to get it up and running especially for the Adiana product. So, it's on the cost side of initial, I would say start and ramp up cost. It's not on, not on the pricing side.

Jayson Bedford - Raymond James

Okay. And then, Glenn, it looks like that the implied guidance for gross margin kind of ramps up throughout the year. Is that indicative of Costa Rica coming online?

Glenn Muir

A couple of things, it is, yes, Costa Rica coming online. Also a greater percent of our revenues moving to the disposable products. I mean as we think about 2010, we are guiding to lower capital equipment sales and those are the products with the lower gross margin.

Now if our sales dropped too low we have some unabsorbed overhead of course that we now have to cover on the digital mammography side but for a moment the whole shift in mix so the disposals will throughout the year, give us a slightly higher gross margin and approach a 53% level by the ends of the fiscal year.

Jayson Bedford - Raymond James

Okay, great. Just a quickie. There's been reports out there that GE has taken some market share. Have you seen any of that and does your data I guess indicate that you've held digital mammography share? Thanks.

Glenn Muir

Yes, we are pretty confident that although there is a lot of selling activity in the market. Based on certain market data it appears that we have either held steady or have gained market share so I have no other comment other than what we are seeing in the market is probably different than what you are hearing at this point.

Rob Cascella

Jayson, that MQSA data can be a little bit confusing at times especially on a monthly basis. So we tend to look at the NEMA analysis that's provided by all the manufacturers. And if you look at that quarterly we are continuing to hold our 60% plus market share here in the US.

Operator

Moving on now to Isaac Ro with Leerink Swann.

Isaac Ro - Leerink Swann

I was wondering if you could comment a bit on the changes in the reimbursement landscape both medical imaging as well as across your consumables portfolio. Any changes there as we head into calendar 2010 that we think might impact your business?

Rob Cascella

We felt pretty good about our review of 2010 rates across the board. In fact had some improvement or have held steady. So we are not looking for anything negative in terms of reimbursement impacting any of the businesses at this point in comparison to 2009.

Isaac Ro - Leerink Swann

Great. Just secondly, putting aside for a minute the unique capabilities on 16 and 18 that Cervista has, was wondering if you can comment a little bit on what you think will be required to offer? Either from a bundling and or automation perspective to start gaining some share on some of the bigger labs and I think in the automation side you guys had pointed in the past to sort of amid 2010 availability for full automation. I was just wondering if that's still on track and what else you thin you might need to do it and gain some share.

Ron Cascella

We are not changing where we believe our automation will hit the marketplace. We are still confident in that. I think the other thing that's really important to mention is that we've had many customers come up to Massachusetts under non-disclosure agreements to take a look at what we are working on and I think besides the fact that we are on track what's even more exciting is their reaction to what they see when we share with them the platform. I don't think bundling is the right term. I think what customers like is they like buying the stuff from fewer organizations and when you can go into a lab that you've got to be strong, long lasting relationship on- cytology and you can add another line of business with them and work together through the same service and application specialist channel. It's just a lot easier to do business. And so I would not look at it from a bundling perspective from a cost of acquisition or purchase, I would look at it that it's much easier to do business with someone who provides the complete solution from cytology all the way through HPV screening. So I think if you use bundling under that context I think it makes a lot of sense. We are very excited again about the instrumentation and we think it will allow us certainly to get into larger volume labs as we start to unfold through 2010. HPV screening.

Operator

Now we will hear from Oppenheimer & Company's, Amit Hazan

Amit Hazan - Oppenheimer & Company

My first question is on Pap and HPV, I'm wondering if you can comment on US Pap market and whether volume has been steady there and just generally as you've been rolling out HPV, what you've been doing in terms of marketing and how you've been going about marketing, being that the guidance says that you should do Pap plus HPV only once every three years.

Glenn Muir

Sure. Let me start with the last question first in regards to, our physician sales force, what we've been doing is we've been slowly deploying that group in markets where we actually have Cervista high risk available. So in those markets we are absolutely outtalking about the advantages of code testing with Pap plus HPV in women over 30. We are out every day talking about the merits of the ASCCP guidelines and giving recommendations for proper screening of women through the various products that we offer to the OB/GYN. And that's only in about 20% of our sales team is doing that today.

Most of the activity obviously since launch has been on the laboratory side. We have talked on the last couple of quarters actually the last three quarters year-over-year a little softness in volumes. We actually saw it tick back up this quarter. So although we had reported that for the last few quarters, we actually were very pleased with this past quarter's performance and we are starting to see an uptick. So, I don't think any more deterioration in the economy has affected any volumes, and nor do I see anything major happening on expansion of interval or through competition at this point.

Amit Hazan - Oppenheimer & Company

And so just a follow-up to that and I'll ask my second question as well, would be, are you thinking about that for the next year? Is the Pap volume going to change at all based on HPV testing? And then the second question unrelated is about backlog. It's been declining now for a couple of quarters including this quarter sequentially, I mean. And I'm wondering, since you talked about an uptick in orders in the Breast Health side, if you can just give us a little bit of color on what's been going on with the backlog you're reporting and why it's declining? Thanks.

Howard Doran

Yes, on the Pap market for next year again, if you go back to the last year, what we've really been saying is that we really thought the economy was having the biggest change involved in volumes, not competition and not expansion of integral. If we really foresee that continuing for the near future, there's no real evidence that real strong changes in behavioral patterns are occurring at the OB/GYN based on code testing, and I would say for 2010 we have an unchanged viewpoint on the material impact of that strategy.

Glenn Muir

Let me talk about the backlog real quickly because the backlog becomes important more so in the Breast Health and the capital equipment side of the business and it does on the disposables especially when it relates to contracts that could go out 12 months, and involves standing orders. So, that really has nothing to do with current business but just a timing of when we sign those contracts. And I think that's what happened this quarter because the fact is on the Breast Health side, our backlog and the number of Selenia orders in fact went up.

So that was a positive, even though the total backlog went down which was driven more on the disposable side, but had nothing to do with losing contracts at all, but merely the timing of re-signing new contracts.

So, I think we're caught in the relevance of that backlog number for a moment. It does have more relevance on the Breast Health and capital equipment side which was in fact strong in Q4. But that is a consolidated company-wide backlog number.

Operator

Let's go to Sameer Harish with Needham & Company.

Sameer Harish - Needham & Company

Really a question on Adiana, we've been talking to physicians and found a high degree of interest in offering more options in permanent sterilization, largely to give patients what they are asking for and with such a large consumer component, when do you think you'd be in a position to engage some sort of direct-to-consumer program? And do you think this would be, tied to physician training? Do you think you would engage it regionally or around sort of more on a national scale as you get more penetration?

Tony Kingsley

I think we have a lot of work ahead of us and frankly a lot of opportunity addressing the physician targets. So, I think that will clearly be our focus as we go through the rest of this fiscal year. We haven't thought it makes sense for us to do something significant on the DTC front until we're comfortable. We have the right cohort of physicians.

Sameer Harish - Needham & Company

In terms of guidance, do you expect the physician training to be the catalyst for near-term growth or do you expect more growth once you can move into that direct-to-consumer phase?

Tony Kingsley

I think the answer is, yes. We expect physician training to be a catalyst for significant short-term growth.

Operator

Our final question for today comes from SunTrust Robinson Humphrey's, Jonathan Block.

Jonathan Block - SunTrust Robinson Humphrey

Just a couple of quick ones. Glenn, I think the first one for you, Third Wave I believe you mentioned was about $0.02 dilutive in the quarter. So, when we think about FY '10 when do you think that turns the corner and should be accretive to EPS?

Glenn Muir

Our original expectation was for Third Wave to be accretive in fiscal 2010. It's unlikely at this point it'll hit for the full year accretive on a quarterly basis. We would hope by the end of the year it would. And then part of the issue has to do with a couple of the products that were previously sold under ASRs that had been discontinued because of the change in the regulations that we will not be continuing. So there was a fairly significant revenue drop with those products that will have to be made up on the Cervista HPV side. So, it's going to be towards the end of the fiscal year, Jonathan, and it's doubtful it will be accretive for the full fiscal year, unless HPV really takes off beyond our current guidance for the year.

Jonathan Block - SunTrust Robinson Humphrey

And then, Tony I believe this one's for you. Just on the NovaSure front, can you tell us you mentioned about continued progress in office. What percent of the procedures for NovaSure are done in the office and then, what does that tell us about how you're going to attack the market for Adiana. In other words, where are your sales guys going to hunt first if you would?

Tony Kingsley

Yeah, but we are north of 15% in our procedures in office. We continue to make steady progress. We obviously like that business to continue to grow quickly, but we continue to be very focused on moving physicians in office and think we are continuing to have success there. As relates to Adiana, we do believe that Adiana is very well suited to the office and we actually think that in some sense, Adiana may help us move physicians to the office on NovaSure as well.

Operator

Ms. Gordon, I will turn the call back over to you.

Rob Cascella

Sure, why don't I just close out that? Well look folks; while the broader environment is full of concern so it's obviously, we believe that we're positioned to respond to whatever the challenge. Our operational performance has improved considerably as we have successfully integrated two major acquisitions over the past two years. Our financial position is unparalleled due to our high level of cash flow which we think is very positive and our portfolio of market leading products is very diverse. We think we are technologically superior to our competitors and we have highly relevant products from a clinical perspective.

In addition to that, we think we have a group of people, our associates that are all very dedicated to the mission that we're on. So, we are poised for success over the long-term. With that, I'll thank you and wish you all a good evening.

Operator

Again, that concludes today's conference call. Thanks for your participation.

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