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Hologic, Inc. (NASDAQ:HOLX)

F1Q 2014 Earnings Conference Call

February 3, 2014 17:00 ET

Executives

Deborah Gordon - Vice President, Investor Relations

Stephen MacMillan - President and Chief Executive Officer

Glenn Muir - Chief Financial Officer and Executive Vice President, Finance & Administration

Analysts

Tycho Peterson - JPMorgan

Anthony Petrone - Jefferies Group

David Lewis - Morgan Stanley

Rich Newitter - Leerink Partners

Bill Quirk - Jefferies

Brian Weinstein - William Blair

Isaac Ro - Goldman Sachs

Jayson Bedford - Raymond James

Jon Block - Stifel

Vijay Kumar - ISI Group

Doug Schenkel - Cowen and Company

Bill Bonello - Craig-Hallum

Operator

Good afternoon, and welcome to the Hologic Incorporated First Quarter Fiscal 2014 Earnings Conference Call. My name is Matt and I am your operator for today’s call. This conference is being recorded and all lines have been placed on mute.

I would now like to introduce Deborah Gordon, Vice President, Investor Relations to begin the call.

Deborah Gordon

Thank you, Matt. Good afternoon and thank you for joining us for Hologic’s first quarter fiscal 2014 earnings call. The replay of this call will be archived on our website through Friday, February 21 and a copy of our press release discussing our first quarter results, as well as our second quarter and fiscal 2014 guidance, is available in the Overview section of the Investor Relations section of our website. Also in that section is the 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 actual results to be materially different from any future results implied by such statements. Such factors include those referenced in our Safe Harbor statement and our first quarter 2014 earnings release and in the company’s filings with the SEC. 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 the release. Please note, today’s call will consist of opening remarks from management followed by a Q&A session. Please feel free to go back into queue and if time permits, we will be more than happy to take your follow-up questions at that time.

With that, I would now like to turn the call over to Stephen MacMillan, President and Chief Executive Officer.

Stephen MacMillan

Thank you, Deb and thank you all for joining us today. I am pleased to be here this evening for my first Hologic earnings call. Before turning to our quarterly results, I would like to briefly highlight my initial experiences and outline an early roadmap for our future. In my first two months, I have been meeting with many of our team members to acquaint myself with the business and better understand the opportunities that lie ahead as well as the near-term challenges we face. My initial observations are simple. Like many businesses, we have our share of challenges, but most importantly, we have a great set of businesses and people. It is now time to reorient ourselves from an acquisition led model to one focused on organic growth via a stepped up operational focus and a clear commitment to paying down our debt.

I joined the company because of its unparalleled portfolio of assets. As the dynamics of healthcare continue to evolve, the sweet spot will be products and technologies that improve patient care, make delivery of care more efficient and reduce healthcare costs. We have tremendous opportunities as our market-leading technologies are aligned with these important industry trends. While so much emphasis in our healthcare system is placed on treatment, we believe there is a huge opportunity to improve care and reduce costs through better diagnosis and we can play a role here. As an example, our 3D tomo franchise can dramatically improve cancer detection rates while also significantly reducing the need for unnecessary callbacks, a true win for patients and the healthcare system.

As you know, prior to my joining the company, a strategic review process was already underway. I have become involved in that process, building on a lot of the work that has been done. We expect to wrap up that process during the current quarter. And although not entirely complete, our expectation at this time is that there will be no major changes to our corporate structure though we may pursue some select smaller divestitures. I am energized by my initial look from the inside, which has reaffirmed my belief that we have great products with compelling prospects and that our diversified business model provides a strong foundation for success. We will now focus on building and optimizing these assets to drive value creation.

I have also found a committed and passionate employee base that is working resolutely to deliver our critical products and services to our customers and their patients. And I look forward to leading these talented individuals to make the changes that will enable us to accelerate growth. An organization derived success from its team’s singular and acute focus on achieving clearly defined goals. And let me now be clear about our goals. One, return to growth and two pay down debt.

Now for a little more color. Our first priority is to return this company to sustainable top and bottom line organic growth. How are we going to do this? A simple three pronged strategy. First, accelerate growth of the core drivers in each of our key franchises. Second, slow the declines of the businesses facing headwinds. And third, expand our key franchises outside of the U.S. In terms of the growth drivers, we are going to focus on our three major businesses: Diagnostics, Breast Health and Surgical. We have key platforms in each of these businesses that are in the early stages of a sustainable growth period that we can build on.

In Diagnostics, we have a terrific instrument platform in PANTHER that we can better leverage over time, especially with further menu expansion. In Breast Health, 3D tomo should be a significant growth driver as we do a better job executing on this sizable opportunity by making sure the clinical story is more broadly understood. Simply put, no woman who knows the facts would want anything but 3D tomo for her mammogram. And in our GYN Surgical business, we have a growth driver in MyoSure which we can supplement with new products that will allow us to better leverage our sales force. Together, these three drivers create a unique and powerful force within the company that we can – we believe we can really deliver overall sales and income growth.

As we drive these products in the U.S., we also have significant untapped opportunities abroad. Currently our international business represents only a quarter of our total sales. We will be dialing up the focus outside the U.S. to expand our breakthrough technologies around the world. There has been much talk about the near-term headwinds we faced including interval expansion in cervical cancer screening NovaSure pressures and our efforts to broaden reimbursement for tomo. Despite this, the opportunities provided by our core businesses should help us offset these pressures in the coming quarters as we seek to return to growth. We must also compare the company for growth by ensuring the right people are in the right positions to win with proper infrastructure in place to support them.

A fresh perspective on the company is helping us determine how best to drive focus and accountability throughout the company to better drive growth across our products. While working to return to growth, we will continue using our strong cash flows to pay down debt. Those of you familiar with my management style will recall that I do not like carrying sizable debt, so we will be focused on reducing our debt balance which is consistent with the plans we have recently presented.

Now turning to a discussion of the core, our results came in slightly ahead of guidance with revenues of $612 million and EPS of $0.34. While our results were ahead of guidance, we are not pleased to be reporting year-over-year revenue and earnings declines. We have work to do to return to organic growth. Fortunately, our key growth franchises made progress during the quarter. Although Diagnostics declined overall in the quarter, our molecular business posted some encouraging results, especially in the key U.S. market that bode well for the future and point to the many opportunities ahead of us in this business. The initial uptake by Quest has been very successful as increasing volume of our assays drove strong performance for the Aptima product line.

As mentioned earlier, PANTHER is proving to be one of our brightest long-term opportunities. We installed our highest number of systems to-date in the U.S. during Q1 with a substantial portion resulting from competitive conversions for new accounts. We remain well on our way to achieving our stated goal of installing 1,000 PANTHERs by the end of fiscal 2015.

A quick reflection for you here. My initial feeling is that we are in the early innings of beginning to realize the full potential of the Gen-Probe acquisition by combining very strong technical and scientific platforms with a more aggressive and commercially-focused selling team. I have to tell you that while much attention is focused on the assays in this space, we believe we have a significant breakthrough on the instrumentation front with PANTHER, which delivers very real and meaningful workflow improvements, a key benefit for our lab customers. In our cytology and perinatal business, we continue to face headwinds in our ThinPrep franchise as we work hard to find ways to mitigate its impact on our overall diagnostics segment. Clearly, one such opportunity is to further penetrate international markets and grow our presence there.

In Breast Health, we are making good progress in the marketplace. Despite the challenging environment for capital equipment, we were able to grow our overall U.S. Breast Health business 6% in the quarter. We delivered strong growth in 3D tomo, which we expect will continue for some time as we are in the relatively early stages of this product cycle. As most of you know by now, there is remarkable and growing body of clinical evidence that supports our efforts to establish 3D tomo as the standard of care in mammography screening, which we expect will only strengthen with additional publications this year and beyond.

With regard to reimbursement, we know it is an area where investors have been awaiting more visibility. At this time, we cannot commit to a timeframe in which we will achieve widespread reimbursement, although we continue to pursue parallel paths with both CMS and private payers. However, I want to be clear. This should not stand in the way of our commercialization efforts. The fact is 3D tomo makes sense economically and has strong clinical efficacy that should drive us adoption regardless of reimbursement coverage. We remain on pace to reach our fiscal year stated goal of shipping over 500 3D dimension systems in the U.S.

In our Surgical business, MyoSure once again delivered strong double-digit growth. This business unit is an area, where I believe we could also benefit from providing our sales force with additional products to sell and we will be looking to ramp our innovation efforts in this division. While encouraged by what I have seen thus far, we clearly have work to do to return to sustainable top and bottom line growth. Our market-leading products are helping improve healthcare and we will build upon the strong foundation to approve our operational and financial positioning and create value for shareholders.

Before turning the call over to Glenn who will discuss our financials in greater detail and review guidance, we would like to note at the beginning of this quarter, we have taken a more streamlined approach to how we present our financial results and guidance. You may notice this as you review our press release and supplementary presentation. These changes are simply part of our effort to provide a clear and concise view of our business with each quarterly update and also I would say to really be consistent.

With that, I will now turn the call over to Glenn.

Glenn Muir

Thank you, Steve. Unless otherwise noted, all of my commentary regarding changes will be on a year-over-year basis. First quarter revenues were $612 million, a decrease of 3% compared to reported revenues of $631 million and 5% compared to non-GAAP revenues of $644 million, which reflect the addition of $13.3 million primarily related to a purchase accounting adjustment recorded in the prior year. Q1 revenues last year also included $12.6 million from LIFECODES, a business we divested in March 2013.

Diagnostics revenues declined 6.6% to $286 million on a reported basis and 10.5% on a non-GAAP basis when factoring in the $13.3 million adjustment primarily related to purchase accounting. As expected, the decrease is primarily attributable to the absence of sales from the divested LIFECODES business as well as declines in our ThinPrep and blood screening businesses, which were consistent with the fiscal 2014 headwinds we described on our last earnings call.

As I mentioned last quarter, we will no longer refer to Legacy Hologic or Gen-Probe results, now that we are a path to one year anniversary of the acquisitions closed. However, in order to provide more visibility into our diagnostics business, we will begin discussing results in three categories: molecular, cytology and perinatal and blood screening. First, cytology and perinatal revenues declined 11% in Q1, which was in line with the expectations we have set forth last quarter largely attributable to the anticipated volume declines in our ThinPrep business as a result of expanded screening intervals in the U.S. as well as lower average selling prices internationally. Blood screening revenues declined 14% on a non-GAAP basis. The decrease was driven largely by an expected decline in assay sales related to higher than usual West Nile virus orders in the first quarter of the prior year.

And in molecular, our non-GAAP revenues decreased 8%. However, on an apples-to-apples basis, when excluding the $12.6 million of LIFECODES revenues last year, the existing molecular business increased 3% during Q1. The increase was driven by double-digit growth from our Aptima women’s health products, which include CT/GC, HPV, and Trichomonas. A significant portion of this growth was attributable to the strong uptake at Quest as Steve discussed. We also saw growth outside of Quest driven by Aptima HPV and growth in cancer-related assay revenues. In molecular, we are in the early stages of seeing some success, especially in the U.S. due to an increase in account closures and competitive wins.

Moving on to Breast Health, revenues increased 3% to $226 million driven primarily by solid growth in 3D tomo system sales and continued growth in service revenues from our growing installed base of digital mammography systems. Breast biopsy sales were up as well. Partially offsetting these increases was the expected overall decline of 2D system sales as customers shift to 3D. We continue to see good momentum in the U.S. for 3D tomo driven by positive clinical results, decreasing payment from private payers and competitive wins.

Now, turning to GYN Surgical, strong double-digit growth in MyoSure was offset by an expected decline in NovaSure resulting in revenues of $79 million, which were down 2.5%. We are making progress toward reaching the point, where continued MyoSure growth coupled with international NovaSure expansion should drive overall growth in the surgical segment.

I will now review first quarter non-GAAP performance for the rest of the P&L. Gross margins were 63.2%, up 70 basis points and above our guidance range of 61.5% to 62%. Favorable product mix in our capital business related to higher 3D sales combined with higher service margins drove the improvement in the quarter. This increase in gross margins while encouraging is expected to return to the guidance range we provided for the year of 61.5% to 62% as our product mix fluctuates and we begin to increase certain manufacturing and service costs.

Operating expenses of $196 million declined $2 million or 1% representing 32% of sales and coming in at the lower end of our guidance range despite revenues exceeding guidance. Operating expenses this quarter included $5.4 million for the medical device tax, which we did not incur in the year ago period. Our estimated annual tax rate is now 34.5%, 50 basis points above our guidance as certain international deductions may not be realizable. Despite this slightly higher rate, we were able to achieve earnings per share of $0.34, $0.03 higher than the guidance range we issued last quarter.

Now, turning to the balance sheet, we finished the quarter with $449 million in cash, down $272 million year-over-year and down $381 million sequentially. We continue to generate very strong cash flow, which we used to pay down debt consistent with our ongoing efforts to reduce our total debt obligation. In October, we voluntarily prepaid $100 million on our term loan B and in December we have redeemed a full $405 million of debt related to our convertible notes. We generated $180 million in operating cash flow during the quarter, which puts us on track to achieve our previously stated goal of generating $500 million to $525 million in fiscal 2014. We ended the quarter with total debt obligations of $4.4 billion resulting in a net debt to EBITDA ratio of 4.5 times.

Our return on invested capital on a trailing 12-month basis was 8.2% compared to 8.3% in fiscal 2013. For definitions and calculations of operating cash flow and ROIC, please refer to our supplementary PowerPoint presentation. And with regard to capital allocation as Steve stated deleveraging will be a primary focus as we work toward our target of a net debt to EBITDA ratio of 2.5 times by the end of fiscal 2017. Last quarter we announced our Board authorized a $250 million three year stock repurchase program. This plan remains in place. However, we did not repurchase any shares during the quarter.

Now to review our non-GAAP guidance for our fiscal 2014 Q2 and our full year, as a reminder our guidance is fully detailed in the supplementary PowerPoint presentations and assumes currency rates consistent with the average during Q1 of ’14. It does not assume any share repurchases or divestitures. For the second quarter of fiscal 2014, we expect revenues in the range of $605 million to $615 million representing a year-over-year decline of 1% to 2% and essentially flat with the previous year on a pro forma basis excluding LIFECODES revenues of $10.6 million.

Even though we are anticipating the headwinds we discussed at the outset of the year such as ThinPrep and NovaSure, we are beginning to see a nice uptick in sales of 3D tomo and our Aptima women’s health assays. We expect EPS in the range of $0.32 to $0.34. For the fiscal year we are reaffirming our revenue guidance range of $2.425 billion to $2.475 billion and raising the low end of our EPS guidance range to $1.34 to $1.38 from the guidance we provided last quarter of $1.32 to $1.38 primarily due to our strong earnings performance in the first quarter and slightly offset by an increase in our tax rate at 34.5%.

In summary, our first quarter results set us on solid footing to achieve our fiscal year guidance. We are encouraged with the growing customer demand for our 3D tomo systems and Aptima women’s health assays. Our first priority is to execute on the organic growth strategies Steve articulated. We will remain focused on utilizing our strong cash flows to further deleverage the balance sheet.

And with that I will turn the call back to Steve.

Stephen MacMillan

Thanks Glenn and before we take questions, I just want to reiterate how excited I am to be here at Hologic. While there is no denying we face some near-term challenges, looking beyond them I see a bright future. We have unique platforms and products that will continue to deliver cutting edge solutions that answer the unmet needs of diverse markets. I am confident we are implementing the right strategies to create shareholder value and position Hologic for growth and success. In the months ahead we look forward to updating you on our progress and providing additional details on our vision for our future.

And with that operator please open the call up to questions.

Question-and-Answer Session

Operator

(Operator Instructions) At this time we will take a question from Tycho Peterson with JPMorgan. Please go ahead.

Tycho Peterson - JPMorgan

Hi, thanks for taking my question. You guys in the slides kind of removed some of the segment highlights and so just wondering if you can touch on margins for the segments, if there is anything in any of the divisions that was off trend from the prior couple of quarters. And then as a follow-up, Steve you talked a little about returning to organic growth and your predecessors have talked about return to organic growth in fiscal 2015, so I am just wondering if you are comfortable with the timelines that were previously laid out?

Stephen MacMillan

Sure, I will let Glenn handle the margins and I will…

Glenn Muir

Yes, Tycho let me start with the gross margins if I could. We won’t be breaking out that level of detail going forward for the segments on the individual gross margins, but I will say we had a very nice quarter for gross margins in Q1, a little bit better than 63% and it is because we saw its strength on the Breast Health side. We’re getting nice average on prices, nice product mix to the 3D tomo systems and we’re seeing very nice service margin as the service group that we have is very profitable especially in light of kind of a delay in some hiring that we have had on the service side. But we won’t be able to provide that in the same level of detail as in the past, Tycho.

Stephen MacMillan

And Tycho on the growth front clearly our plan would be to generate some level of growth in 2015. This part of me says at the highest level 2014 is about stopping the declines, 2015 shoring up that base. But I feel pretty good that I think even as the course of 2014 plays out, we will hopefully show less of declines and even flatten this business out certainly before the year is out and be able to start to get towards growth for next year. And it’s really driven by my confidence in especially the U.S. Molecular Diagnostics business and our U.S. Breast Health businesses. And by the way those two and frankly to drove in even that the surgical business that will grow, just the U.S. for those three businesses accounts for about 70% of our revenue. And I think all three of those can show sequential improvements through the year, sequentially obviously they were down in this quarter for two out of three Breast Health was up but basically the diagnostics business should be less down towards moving towards positive, the surgical business should be moving towards positive, Breast Health of anything will probably accelerate a little bit through the year. And I think really hopefully have us accelerating through this year and setting the platform for growth next year.

Tycho Peterson - JPMorgan

Thank you.

Stephen MacMillan

Great. Thank you.

Operator

At this time we’ll take our next question which will be from Anthony Petrone with Jefferies Group.

Anthony Petrone - Jefferies Group

Thanks and welcome, Steve. Maybe just a little bit more on your statement on sort of the slowing the declines in some of these businesses, they’ve been facing some headwinds pretty consistently here, some of them are certainly secular, you mentioned that the shift in ThinPrep testing and also some of your customers in diagnostics have been talking pretty steadily about utilization and pricing declines. So may be a little bit more on actually how you sort of reverse some of the trends we’ve been seeing pretty consistently for the past year or so and then just a follow-up on capital structure comments that you had?

Stephen MacMillan

Sure. Let me start on the trends and first and foremost it’s going to be about driving growth and accelerating further growth on the growth franchises. The second part was to your jack point of slowing the decline; I think we’ve got several things here. One is just sales force execution and by the way I’m talking about slowing these on the margin probably but things like even NovaSure or ThinPrep making sure that our reps aren’t just accepting the macro headwinds and make the extra call. Let’s still remind people why our products are superior to those in the competitive set and still try to get those extra sales. I think sometimes it could become a self-fulfilling prophecy when you got all the headwinds you just sort of throw up your hands.

And I think by just shining it brighter light and a greater focus and remaining people that the way we grow is really a combination of not losing as much on one side so you’re just replenishing the other side. It’s a bit of accelerating the positives but trying to do what you can to hold on fight off the declines a little bit. Having said that let’s be clear. The ThinPrep, NovaSure, those are still legitimate headwinds, those will continue to decline, but if we can even slow the rate of decline from minus 10% to minus 9% or minus 8% on the margin those will be improvements and then eventually frankly I hate to say but anniversary-ing will start to help us a little bit as we go certainly into 2015 and beyond.

Anthony Petrone - Jefferies Group

That’s helpful. And just on the capital structure, can you maybe walk through the strategy there for net pay downs in terms of prioritization. Should we expect pay downs on the higher interest portions of the cap structure or are there restrictive covenants that require your initial pay downs to be allocated toward the term loans?

Glenn Muir

Yes, Anthony, let me talk a little bit there. When we look at the pieces of the debt for a moment between the term loan A and B and then the senior note and then the convertible, we really have three pieces. The senior note, we don’t have an ability until 2015 to do anything with that and that is the highest interest rate. Our focus today is to try to lower the term loan B, because that’s the highest interest remaining of what’s left. The convert actually has a small coupon today. So that’s where our focus is. The B is also variable at the moment. So it would be the priority as we generate cash and pay down debt.

Operator

At this time, we will take a question from David Lewis with Morgan Stanley.

David Lewis - Morgan Stanley

Good afternoon.

Stephen MacMillan

Hey, David.

David Lewis - Morgan Stanley

Steve, how are you?

Stephen MacMillan

Great.

David Lewis - Morgan Stanley

I wanted to come back to something you focused on the call here. Your return to growth was clearly the message on the call, but you also mentioned the need to invest in areas like the o-U.S. to drive that growth. So I do think a question that many holders have is can you return to growth without a return to increased spending? So does the EPS guidance give you the flexibility you need to accelerate growth and if it does, can you help us understand how you reallocate some of that spending to focus on the areas you think are best suited to accelerate that growth?

Stephen MacMillan

Sure. I think to be clear the current EPS guidance does give us that latitude. And we are already talking within the team as I see some pockets of strength as to some additional investments we could make even this year whether it’s sales or frankly R&D projects to kind of self-fund some additional growth and still deliver on the EPS line and really start to set ourselves up for the future. So I think overall as you well know, we have got a pretty good operating margin and we are going to have to increase I think some spending in R&D and probably sales force expansions, but I think we can find that money internally so that we don’t have the depressed margin to do it. As you also well know and I probably articulated, some of that is not going to affect our business in the next few quarters, but 2015 and beyond hopefully they start to at least see some of it. Internationally, the opportunities here are enormous. And I will tell you I saw some pockets – we saw some pockets of growth internationally that the total numbers kind of mask, but our core business is an example in Europe. All three franchises showed some reasonable and very good growth in Europe. So at a time when I think a lot of companies are challenged in Europe, I think we have got opportunities there and it will by shining a brighter light really allow us to invest further, but again without really seeing margin decline.

David Lewis - Morgan Stanley

Okay, thanks Steve. Very helpful. And then next question just on gross margins, I think you talked about that gross margin trend fading across the quarters. I guess maybe give us a little more detail about that, it was a stronger GM that you saw in the year ago period, but it’s just not clear to me why that GM would fade so dramatically throughout the balance of the year given the strength here and considering the growth was so depressed here in the first quarter, you still had a very strong GM number. Help us understand specifically what drives that depression throughout the quarters?

Glenn Muir

Sure, David. So the gross margin percentage in Q1 was a bit more than 63%, which is the highest that we have posted in sometime. And it’s fair to say it is not one item, it’s a whole host of things that kind of clicked and found a place for us during the quarter. Some of it was a very nice product mix to the Breast Health side, an increase in service without any increase in service cost, so an enormous amount of gross margins from that. We were heavily weighted to the U.S. this quarter more so than other quarters. We are actually a little bit lower on the international side. So we have better price in the U.S. We did have some manufacturing variances that were positive. We had very good absorption, because our inventory was up for the quarter. I know it sounds like a laundry list, but it really is. We did have a slowdown in hiring and expenses in Q1. These are the things I expect not to fully reverse, but even out for the remainder of the year. So at this point in the year after only one quarter, we would be more comfortable with the current guidance that we have already provided the 61.5% to the 62%.

Stephen MacMillan

And David, I would add an overall comment too. I think one of the things I want to make sure we do is we establish our new reputation here is be very credible as we are going forward and not over celebrate something and having us think we are at a new level because obviously I think we have gotten into the – trying to point out the real positives in a quarter and neglecting some of the others. And I think we have heard from all of you credibility is key. You know that’s a very important mantra of mine. So I think this quarter was unusually good, we would love to celebrate. Hopefully, you know we are going to be working hard to improve upon even the guidance, but don’t want to get ahead ourselves at this stage in time.

Operator

At this time we will take the question from Rich Newitter with Leerink Partners. Please go ahead.

Rich Newitter - Leerink Partners

Hi, thanks for taking the questions and welcome to Hologic Steve.

Stephen MacMillan

Thank you, Rich.

Rich Newitter - Leerink Partners

Maybe I can just start with a little bit bigger picture. I appreciate and thank you for giving us the comments on 2015 and that there is likely a return to growth in store in that time period. Can you maybe give us a sense especially in light of the fact that you don’t see any dramatic strategic shifts in the businesses right now or restructuring of the businesses, what’s the long-term growth potential is of the assets you have in place?

Stephen MacMillan

You know what, I want to careful at this stage getting into long-term projections. I feel good, but I have got to get my sea legs a little bit further and I want to be careful not to get too far ahead of ourselves. Sorry about that.

Rich Newitter - Leerink Partners

That’s okay, that’s fair.

Stephen MacMillan

Our long-term right now is made out of starting to execute better quarter-over-quarter while we sorted out. But I do feel like franchises we are in should be nice growth drivers.

Rich Newitter - Leerink Partners

Okay. And just going back to your comment on reallocation of investment, specifically with respect to sales – I think you said reinvigorating the sales force and some of the businesses that you are seeing secular challenges, how do you view that, are there incentive structures you will put in place, what specific initiatives can we expect from the next few quarters?

Stephen MacMillan

Sure. Some of it’s as simple as really looking at the call calendars and making sure that while we are driving growth on one franchise we are not completely neglecting the others. It is setting up the quarters and frankly I think team has already done a pretty good job here of making sure that the sales reps quotas include multiple product lines aren’t just totals. So it’s just driving down to that kind of level of detail making sure we have got the right people in the right focus areas. And then the second part will be probably particularly outside the U.S. starting to look at where are there pockets that we might expand our sales organizations.

Operator

At this time we’ll take the question from Bill Quirk at Jefferies. Please go ahead.

Bill Quirk - Jefferies

Great, thanks, good afternoon. Steve first question and I realize it’s a bit of tricky one, but given the importance of Gen-Probe in your future plans, here is one of the three-pronged growth strategies, as well as just kind of considering the overall level of change that the organization has been through over the past year, can you talk a little bit about the morale of the organization and just help us think a little bit about retention there too? Thank you.

Stephen MacMillan

Bill, it’s a great question. I will answer to you exactly what I told our Board last week. I think when I arrived here there were a number of people, dare I say with one foot out the door. And I think with my arrival a whole bunch of them kind of stopped that foot out the door, stopped making phone calls out and are very intrigued. But some are – many and especially I think frankly out in San Diego are still waiting to believe. But they want to believe they have invested their heart and souls and that so many people at the grassroots level of this company have spent their lives really helping build it up and want this company to fulfill its rightful potential.

And I think we really have a lot of them reengaged, reenergized as we are going forward. So we are not quite where I want to be as I told our Board I am not sure lot of these people are ready to run into the burning building behind me, but I think will be there here in the coming months. I am very encouraged by what I am seeing. But we do have work to do. You don’t go through that the amount of leadership turmoil that we went through both at the top of Hologic and also frankly at the Gen-Probe facility in San Diego in a 12 months period without having a meaningful and significant impact on morale. So – but I think we have bottomed and are on the way up now. But – and I do think that’s going to be a big driver of performance in the future. When you have people with one foot out the door 5 0’clock rolls around they are ready to head home. When they believe what they’re working in they’re giving you that extra effort, they’re making that extra sales call, they’re working that extra project and product development and that’s where we need to be.

Bill Quirk - Jefferies

Understood. And then just as a follow-up for Glenn, certainly good to hear about the overall Aptima performance; obviously understand that Quest had a hand to play there, can you speak a little bit too, I don’t know if organic is the right term to use here but kind of what the Aptima franchise look like without the benefit of Quest?

Stephen MacMillan

Organic is the right phrase, Quest is organic, so but no – I’m sorry that’s me being a wise guy. I’ll hand it over to Glenn.

Glenn Muir

Yes that was my answer too. Yes, Bill that’s a tough one. We really can’t comment and try to pull out what Quest contributed, but we’re very happy with the uptake I mean we talked about last quarter that Quest had ordered and had installed a large number of their new TIGRIS systems in the summer time. So this was the first quarter we begun to see some real benefit from Quest. The real pickup is on the Aptima CT/GC side. I think some of the new Aptima assays like Trichomonas more of a new test. We’ll be yet to see going forward as will be HPV. So there is a lot of ground for us to pickup with Quest. So we’re very happy with their initial push for the product, get into those TIGRIS is up and running.

Bill Quirk - Jefferies

But it is broader than Quest as well.

Glenn Muir

No doubt.

Stephen MacMillan

In terms of the growth.

Operator

Moving forward you’ll hear from Brian Weinstein with William Blair. Please go ahead.

Brian Weinstein - William Blair

Hi, thanks for taking the questions and good afternoon. Stephen, I was hoping to push you just a little bit more on the o-U.S. situation. It’s obviously only 25% or so of revenues. It’s been an area that people have talked about investments here for a while, and Gen-Probe has been an asset, that’s been notoriously underrepresented outside the U.S. So I’m just curious if you can be a little bit more specific on things you can do, are there specific products that you’re going to highlight o-U.S., are there specific territories, and can you give us an update on the Far East and China and what’s going on there? Thanks.

Stephen MacMillan

Sure. Great question. I think it does get down to a granular focus on how we start to build it by franchise and by country and it’s understanding the reimbursement environments in each of the major countries and what we can do to influence that. So if I would articulate a strategy here, this is clearly going to take time, but it does start with market access, do we have the right reimbursement for the right product lines in the right countries? And if you really dial it down I would tell you, I just don’t think we’ve been very focused there, we may have talked about it in the past but the results and there I’d say even the internal reports and Glenn and I had a lot of good discussions about it. The internal reporting system within the company to me is not been as focused on even looking at the international business within the months and within the quarters and I’m a big believer that what you measure allows you to ask the questions and drive it. So now to go one level further down in granularity, if I look the molecular diagnostics business, clearly as you mentioned it’s ballpark, it’s about 15% of our revenue is outside the U.S. There is no reason to be that low I mean that’s obviously from more of the Gen-Probe base, where the cytology piece of our business is probably more like 30% plus outside the U.S.

If we think about the Breast Imaging business generally still probably three quarters of it is in the U.S. and then the GYN Surg business frankly is about almost 90% is in the U.S. So right now we’re literally going through – if you take Europe as an example country-by-country, franchise-by-franchise, okay. If we look at France what is the opportunity in France, well maybe there is a big opportunity for call it the surgical business whatever where that’s the kind of granularity we’re starting to talk about. And as I mentioned earlier I think we’ve got a very good leader of our European business who is bringing that kind of discipline and focus to the organization.

The – you mentioned Middle East and some of the other areas I think we’ve been a little more scattershot of capital sales on the Breast Imaging side where we’ve had some very nice business over time, but frankly pretty up and down. And I think part of what we’re going through this quarter and by some of the international numbers look weaker was we’re going against some big sales in both Latin America, the Middle East and even the CIS last year in this quarter. So starting to drive if we get the surgical business and the molecular businesses involved in those countries as well, it will give us more of a stable growth pattern. China, to be quite candid, we have got some work to do. We have done an acquisition there many of you know, the TCT acquisition a few years back, probably not one of our most shining moments. We are in the midst of doing some work and making some leadership evolutions there, where I think that will – it’s certainly been a drag to the last few quarters and will probably continue to be a drag in the short-term while we get that turned around and hopefully see better growth out of Europe and other areas to offset it while we get that shored up.

If I look at Japan, Japan is a tiny part of our business relative to traditional norms. So again, huge opportunity, I think it’s now really started to drill down and these opportunities will be much more programmatically probably 2016 and beyond want to certainly start to get going on them in 2015, but as you start to think about really penetrating some of these businesses, it’s much more the longer term play than the next few quarters.

Brian Weinstein - William Blair

Thank you very much.

Operator

At this time, we will go to Isaac Ro with Goldman Sachs.

Isaac Ro - Goldman Sachs

Good afternoon guys. Thanks for taking the question.

Stephen MacMillan

Sure Isaac.

Isaac Ro - Goldman Sachs

Hi, Steve. I just want to ask one on the overall volume environment, we have seen obviously some pretty good results not only from you guys, but other companies across MedTech and actually Abbott Labs (ph) this quarter. So I am wondering if you thought you saw any pull forward in volume in the calendar fourth quarter and trying to get a sense as a result what you guys are assuming for seasonality on a sequential basis as we move into first calendar quarter?

Stephen MacMillan

Sure. I don’t think we saw lot of pull forward from our customers be in the quarter. Typically, we do see a little bit of a downtick based on our set of businesses in the calendar first quarter, which is why our revenue guidance for this quarter kind of brackets roughly. Typically, we go down our revenue guidance actually has us probably flat sequentially, which maybe modest improvement in terms of growth rates or lack of declines, but I don’t think we really saw lot of pull forward from the quarter. Glenn, do you have anything to add there?

Glenn Muir

No. I think that sums up, Steve. We haven’t seen any pull-through in Q1 December and we don’t have a lot of seasonality built into our business anymore now that we have especially on a consolidated basis. When we look at the surgical business, we always have the reset of insurance deductibles that hit us in the March quarter, but that’s offset by other parts on the molecular side, the diagnostic side.

Isaac Ro - Goldman Sachs

That’s helpful. And then just a follow-up on the comment you made on potential select divestitures, just wondering if you had an updated view on what kind of criteria you will place on those decisions? That will be helpful in framing your thoughts there. Thank you.

Stephen MacMillan

Sure. At the end of the day, we are obviously focusing on what we can do to grow our business. The three big franchises for the most part have very good growth drivers. There maybe some products in some of those areas that we might think may not necessarily be growth drivers that we may look at, very much on the smaller side of things.

Operator

At this time, we will move forward and take a question from Jayson Bedford of Raymond James.

Jayson Bedford - Raymond James

Good evening. Thanks for taking the questions. Just wanted to circle back to gross margin and the strength in the quarter, you hinted that Breast Health was strong. Just wondering did you see a bigger impact from upgrades meaning those folks going from as I mentioned 2D to as I mentioned 3D and wondering if that had a positive impact on gross margin in the quarter?

Stephen MacMillan

No, that actually wasn’t it, Jayson. It was just more 3D in total. It wasn’t the upgrades. I mean, those are potentially opportunities that continue to be out there. When we think about 3D sales, there is still – the upgrade portion is still between 20% and 30%. There really wasn’t a shift to the upgrade, but every quarter, you are correct, we continue to sell 2D dimensions into the U.S. market and those all could be upgraded at some point in the future.

Jayson Bedford - Raymond James

Okay. And just as a quick follow-up, what’s left in terms of converting your business with Quest?

Stephen MacMillan

Well, the TIGRIS units are in place at Quest today and it’s a matter of them adopting all the molecular assays. So the first to adopt was on the CT/GC side. We are expecting ramp ups over time of both Trichomonas as they move to NAT testing for Trich and then also on the HPV side. I – we will also say that the arrangement with Quest does expand hopefully our use of ThinPrep as well. They were a company that used both ThinPrep and SurePath. So we would have the expectation of some increases on the ThinPrep as well, so we are early on in all those pieces right now Jason.

Jayson Bedford - Raymond James

Okay, thank you.

Operator

At this time, we will take the question from Jon Block with Stifel.

Jon Block - Stifel

Great. Thanks and good afternoon. Maybe the first one just to focus on G&A for a second, it looks like it was a big increase in G&A and maybe if you can just be a little bit more specific where that went in the quarter, was that towards building some of the long-term international infrastructure Steve that you referenced or was it geared more towards augmenting the sales force with some domestic opportunities? Thanks.

Stephen MacMillan

It was less around the long-term than I would clearly like to say. Glenn do…

Glenn Muir

No, Jonathan it’s kind of no to those questions. The G&A went up because number one we have the med device tax year-over-year in there, but also in the December quarter we are heavily weighted with our SG&A expenses and all our national tradeshows. So this Q1 is our expensive quarter in total. In addition, those expenses include a number of stock options and equity type expenses. We had some leadership changes those thing don’t come cheap, so some of that is included in the G&A as well.

Stephen MacMillan

Well, good. That was Glenn’s right way of saying that the hiring of me drove our SG&A up a little bit, but we are going to make up for that, don’t worry.

Glenn Muir

Steve, please don’t mind, but I meant it to be high value though, however, you did take that right, Jonathan.

Jon Block - Stifel

Absolutely, understood. And then maybe this is a follow-up, Steve you have mentioned I think referred to some additional offerings in the GYN segment and is that something you can see in internal R&D or are there opportunities sort of in the more immediate term from possible call tuck-in acquisitions? Thanks.

Stephen MacMillan

Sure. I think it will be a bit of both, clearly I think just by starting to talk again and not just talk and people are seeing it as really focusing on organic growth. We have got that group as an example. One that was feeling like a little bit of redheaded stepchild I think in a big company for a bit being reenergized, I love that business it’s one I am comfortable with. And to me it’s all about constant innovation, upgrades to your existing products and starting to talk with that team about that. And also giving them license to say hey, folks this maybe one where if you find a small product line tuck-in acquisition. Even something with $10 million or $15 million for that business would be very meaningful that then we can grow those things over time. So I think empowering them to start to look both internally and externally is the focal point. So again, nothing that’s going affect the trajectory next quarter, but that mindset I think really will start to pay dividends here and hopefully 2015 and beyond.

Jon Block - Stifel

Great, thank you.

Operator

At this time, we will move to Vijay Kumar with ISI Group.

Vijay Kumar - ISI Group

Thanks guys. So maybe my first question for Steve, I just wanted to ask you about, has there been any major surprises either for the upside or the downside since you are down the role of CEO, what’s been – what’s sort of – what’s been the focus for you as you can sort of get your arms around the business?

Stephen MacMillan

Sure. I think the upside is probably that our sales teams and some of our sales leaders, there has probably been a few more changes there over the last year or two to the positive. I frankly thought the organization might be slightly sleepier given the market share positions, but I think there is actually some very good strength there which gives me the latitude as we do some shifting around the organization the priorities to I think really help drive it forward. I think that, so yes hopefully that answered it.

Vijay Kumar - ISI Group

Got it. And maybe one for Glenn, would you be willing to comment what proportion of your GYN Surgical businesses might show right now and what was the decline in 2D mammography business? Thanks.

Glenn Muir

Yes, let me think about how best to answer that, Vijay. We – on the GYN Surgical side in the 10-Q coming out in a couple of days we’ll talk about the MyoSure increase and it will talk about at $5 million increase in MyoSure. So that’s – that’s a nice double-digit growth. When we think about MyoSure itself the 10-Q also talked about a NovaSure decrease of about $7 million. So that’s a slight single, low single digit kind of decline. What we’re looking for is for that to level off in the NovaSure side, we are encouraged on the international side, we have gotten some approvals that we haven’t had in prior years. So we’re at a point we think where the MyoSure growth will begin to overtake any kind of NovaSure decline, we’re pretty close to that. On the 2D I don’t know if we talked about specifics on the 2D decline, but this is what we’ve been waiting for I mean at some point the 2D goes to zero, right, I mean we are expecting everything in the future to be 3D that is the way the market should move, tomo should become the product out there because of how clinically sub-carrier it is today. If we think about dimensions because I know I commented on dimensions before the new product line. Dimensions are about 80% of that total digital mammography product line item.

Operator

At this time, we’ll take a question from Doug Schenkel with Cowen and Company.

Doug Schenkel - Cowen and Company

Hi, good afternoon. One would think pricing has to be under pressure due to broader challenges in the diagnostic and healthcare space and specifically due to the impact of the Quest agreement I guess treating that as organic using the logic you applied in response to an earlier question, could you provide data on pricing volume trends specifically within the diagnostic segment and then also more broadly across the Company?

Glenn Muir

Yes let’s think about that for a moment. I think it’s hard to be general about diagnostics so Doug. And I think we all understand what’s going on with ThinPrep. Here in the U.S. that is volume, volumes have dropped on the ThinPrep side. We’re looking to soften that decline over the next year. So international it is true that ThinPrep, the ASPs have dropped a bit as well, part of that is intentional on our part especially in Asia as we’ve moved more to some dealer type arrangements away from direct for a whole host of reasons.

On the diagnostic side, we do see more lab consolidation; so that is going to have a slight impact on ASPs. I think in general though we are seeing volumes increase as we win more account, more account closures, many of those are competitive but many of the competitive wins do come with a bit lower ASPs at the trend that we would expect to go forward but it is also part of the future strategy as PANTHERs get placed into the field, it really does provide us with that platform for the future I mean and this is really key to what we’re trying to do.

We’re talking about particularly assays today that a lab they only have on or two of our assays that PANTHER goes in they set running CT/NG, next thing they are running as HPV, they don’t yet have Trichomonas, Trichomonas begins to be a bigger part of the market. So this is all trying to place from our perspective as many PANTHERs as we can. And as Steve said this was our best PANTHER placement quarter. I would expect it go up next quarter. We’re seeing very great uptake on PANTHER itself and I think it is an automation that will really set us apart in the market today and I think for the first time we have a full set of assays that we can take advantage of. So hopefully some of that shift as we go forward.

Doug Schenkel - Cowen and Company

So that’s helpful. I guess with that in mind maybe two quick very related follow-ups. The first is given everything you just described Glenn is that part of the explanation for why you would expect the gross margin comes under pressure a bit more moving forward?

Glenn Muir

Well I was really trying to comment on the remainder of FY ‘14 though Doug. And we have to remember for FY ‘14 we’re not guiding to any revenue overall consolidated revenue increase. So I would expect this pretty – this range of 61%, 62%. As we look into FY ‘15 I think it changes. I think there will be the ability for us to drive additional margin both at the gross margin and the operating margin level as our revenues begin to tick up in part because of these new placements of PANTHERs. So I think FY ‘14 is more about it being a flat revenue year than it is anything else.

Stephen MacMillan

We will as we go forward though I would say outside the U.S. as we start to grow that business outside the U.S. that will probably come at some lower margins. So I wouldn’t model lot of margin – gross margin expansion, because we will have, to your point, Doug, there will be some pricing pressure in the U.S. and as we go outside the U.S., there maybe some slightly lower selling prices, but the key will be to growing the top line fast enough to be able to keep the overall margins in good shape.

Operator

At this time, we will take one more question for the day. This will be from Bill Bonello with Craig-Hallum.

Bill Bonello - Craig-Hallum

Hey, great. Thanks a lot for taking my questions. Just a couple of follow-ups on the women’s health business, you talked a lot about the traction that you are getting currently with PANTHER, which sounds positive. I guess my question is you didn’t talk much about sort of the future with the women’s health business and what you are doing to drive sort of increased growth across the installed base or what you will be doing and sort of what you may need to do to remain competitive as other companies, whether it’s Cepheid or Roche sort of continue to introduce new assays and new instruments? And then I have a follow-up on profitability.

Stephen MacMillan

Sure. We are clearly very well invested in pipeline developments on additional women’s health assays, a scenario that obviously is the near and dear to our heart over time and will continue to be a very strong level of core competence. It’s also an area where I tell you when you combine the physician sales force that we have along with the lab sales force, I think it’s an area that really we should continue to be able to drive some good growth despite the competitive position there.

Bill Bonello - Craig-Hallum

Okay. And then just in terms of profitability, is there anything that you can do with the ThinPrep business given that sort of the structural decline in volumes that’s happening and the potential that, that might continue? Is there anything you can do to sort of right-size that business? Do you have any pricing power at all? Just thoughts on how you might make that business more profitable?

Stephen MacMillan

Yes. I would tell you, it’s actually very profitable today and it’s frankly helping spin off a lot of profitability to invest in other parts of the business. Like any businesses in decline, we will always be looking to do we have the right resource allocation and everything else on it, but again, kind of like we said earlier, you want to be careful, you don’t pull resources away from it too much. It’s a remarkably great franchise. And some of the questions we are asking ourselves are, are there other ways we can breathe new life into that ThinPrep vial was an example. So we will certainly be seeking both maximized profit on that, but also figuring out how to either stop the declines or even figure out the ways to turn it back to a growth business over time and on a global basis. Thank you.

Operator

That does conclude the question-and-answer session and this does conclude today’s conference call. Thank you all for your participation. You may now disconnect.

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