Hologic, Inc. (NASDAQ:HOLX)
Q2 2016 Earnings Conference Call
April 27, 2016 04:30 PM ET
Mike Watts - VP, IR, Corporate Communications
Steve MacMillan - Chairman, President, CEO
Bob McMahon - CFO
Isaac Ro - Goldman Sachs
Jonathan Groberg - UBS
Tycho Peterson - JPMorgan
Jack Meehan - Barclays
Doug Schenkel - Cowen and Company
Bill Quirk - Piper Jaffray
Vijay Kumar - Evercore ISI
Brian Weinstein - William Blair
Raj Denhoy - Jefferies Investments
Scott Wang - with Morgan Stanley
Derik de Bruin - Bank of America
Rich Newitter - Leerink Partners
Jon Block - Stifel
Jason Bedford - Raymond James
Mark Massaro - Canaccord Genuity
Good afternoon and welcome to the Hologic, Inc., Second Quarter Fiscal 2016 Earnings Conference Call. My name is [Rene] and I am your operator for today's call. Today's conference call is being recorded. All lines have been placed on mute.
I would now like to introduce Mike Watts, Vice President, Investor Relations and Corporate Communications, to begin the call.
Thank you, Rene. Good afternoon and thanks for joining us for Hologic's second quarter fiscal 2016 earnings call. With me today are Steve MacMillan, the Company's Chairman, President and Chief Executive Officer; and Bob McMahon, our Chief Financial Officer. Steve and Bob both have some prepared remarks; then we'll have a question-and-answer session.
Our second quarter press release is available now on the Investors section of our website, we also will post our prepared remarks to our website shortly after we deliver them. Finally, a replay of the call will be archived on our website through May 27.
Before we begin, I'd like to inform you that certain statements we make during this call will be forward-looking. These statements involve known as well as unknown risks and uncertainties that may cause actual results to differ materially from those expressed or implied. Such factors include those referenced in the Safe Harbor statement that's included in our earnings release and in our filings with the SEC. Also during this call, we will be discussing certain non-GAAP financial measures, a reconciliation from GAAP can be found in our earnings release.
Now, I would like to turn the call over to Steve MacMillan, Hologic's CEO.
Thank you, Mike, and good afternoon everyone. We are very pleased to discuss Hologic's financial results for the second quarter of fiscal 2016. We posted very good results overall, highlighted by 14.6% growth in non-GAAP earnings per share. The strength of our business model was evident on three levels in the quarter. First, our U.S. businesses grew revenue at a low double digit rate continuing a recent pattern of outstanding commercial execution.
Second, we again improved both gross and operating margins while making significant investments in our future and third we entered a new phase of our capital allocation strategy by repurchasing our common stock while continuing to pay down our convertible notes. Together, these strategic actions drove EPS growth more than double the rate of sales.
More specifically, domestic revenue increased 10.6% in the quarter, led by strong performances by our breast health and surgical businesses. International sales were lower mainly due to expected declines in blood screening and the discontinued products we discussed in our initial guidance.
But international breast health showed signs of stabilization which I’ll discuss in a moment. Globally, total revenues grew 5.8% on a reported basis or 6.3% in constant currency terms and if we would exclude the headwind from discontinued products second quarter revenue would have increased more than 7% in constant currency.
Non-GAAP gross margin was 65.8% in the quarter, a significant improvement of 240 basis points compared to the prior year period. We reinvested much of this incremental profitability for future growth and will continue to do so in the future. But still increased non-GAAP operating margin to 33.9% in the quarter, 40 basis points higher than last year.
At the same time our strong cash flows enabled us to be opportunistic in buying back our common as well as our convertible debt to continue improving our capital structure into enhanced future earnings power. Bob will cover the details in a moment, but net income represented a very robust 19.6% of sales and grew 14.1% while non-GAAP EPS totaled $0.47 up 14.6% compared to the prior year.
With that introduction and overview out of the way, I’d like to cover five subjects in my comments today. The first two have been topical over the last quarter, our domestic and international breast health businesses and obviously these franchisees will continue to be important to our future as well. But as we write new chapters in the Hologic story, but this course is broadening as we build on our successes and add new strategic tools. With that in mind, today I’d like to highlight our surgical business, gross margin improvement opportunities and the research and development pipeline. Hopefully this discussion will provide a little incremental color into the multiple levers we can pull to generate sustainable revenue and earnings growth overtime.
Let’s start with our domestic breast health business which grew a very solid 11.2% based on continued adoption of our Genius 3D mammography. Genius placements were strong, increasing both sequentially and year-over-year and we saw a good increase in service revenue as well. We continue to gain market share and our investments in customer marketing are enabling us to do that while maintaining stable price amidst fierce competition. As a result, domestic imaging sales grew at a healthy mid teens rate.
We believe we still have runway ahead of us as our 3D Systems are only about a third penetrated into our own installed base, and roughly 20% into the market as a whole. We remain confident in the long term opportunity as customer interest and orders inhouse remain high and as clinical evidence continues to mount on the benefits of Hologics exams for patients and physicians, specifically a longitudinal study published in February in the peer-reviewed JAMA Oncology showed that the benefits of our Genius exams [Indiscernible] and improved cancer detection can be sustained and even improved overtime with consecutive years.
In addition, a separate study published just yesterday in JAMA showed that these benefits hold true for women with both Dense and Nondense Breasts. Further bolstering the case for widespread adoption.
Now let’s turn to our international breast health business which generated a lot of attention last quarter. While we still have a significant amount of work to do here, we did signs of stabilization in the second quarter and are optimistic that we will see further signs of progress and predictability in the quarters ahead.
While revenue declined by low single digits on a constant currency basis in the second quarter, it’s important to note that last year’s results benefitted from sales of products that he had since discontinued. If we back out this headwind international breast health sales would have increased at a mid single digit rate in constant currency, a materially better performance than a decline we saw last quarter.
As always, business improvement starts with people and our Chief Operating Officer, Eric Compton has made several important organizational changes internationally in recent months. We moved one of our key U.S. breast health leaders to Europe and he is now in charge of building stronger, mutually productive relationships with our dealer network. Towards that end we had signed several new, performance based contracts with our top dealers. In addition, we have hired a new European Head of Service, which we have identified as a critical role to support our dealers and direct customers. We also have brought our new leaders of marketing, molecular diagnostics, surgical and regulatory, so the team is coming together nicely.
Now let me turn to those three new topics surgical, gross margins and R&D. Lets cover surgical first. Global sales were $90.9 million in the quarter and grew 15.9% in constant currency. Surgical has exemplified the tremendous commercial turnaround that has occurred at Hologic with the second quarter representing the fifth consecutive quarter of double digit growth in the United States.
It wasn’t too long ago that Surgical was viewed as a non-strategic asset that should be divested. Today, however, surgical is a vibrant business with strong profitability and cash flow plus good growth potential and I couldn’t be proud of the team who has made it happen. Their formula for success has been straightforward. Stabilization of our NovaSure franchise which was declining at a high single digit rate only a couple of years ago, combined with excellent growth from our MyoSure products for [Uterine] and fibroid removal.
We remain enthusiastic about the potential for MyoSure as we seek to expand the addressable market and replace older treatments. And now with the market withdrawal of our competitor to NovaSure we have an opportunity to drive material growth for that product as well. We believe that NovaSure sales benefitted from the competitive recall by a few million dollars in the quarter and we are investing in marketing and physician outreach programs to ensure this continues for the balance of the year.
The second topic I want to cover is our ability to improve gross margins. A year ago, we weren’t overly bullish in this regard, but our operations team deserves a tremendous amount of credit for improving upon already strong profitability. To highlight what we’ve been able to achieve in the second quarter, non-GAAP cost of goods sold for our products was lower, in absolute terms than it was in the prior year period, despite an increase in sales. This is far bigger than a mix shift story. It is reflecting tremendous work by our teams. To make this possible, new leadership is instituted productivity improvement targets for each of our plants and local managers have responded with scores of specific projects. We are closing our Bedford facility, our former corporate headquarters and moving the skeletal manufacturing that was done there to a contract manufacturer. And as we have discussed previously we are doing a much better job of leveraging our corporate purchasing power across the business.
The third area I want to discuss is our research and development pipeline and it’s important to begin with a bit of context. The unfortunate truth is that our R&D pipeline was weak, reflecting years of a growth by acquisition mindset. Too often R&D spending was viewed as a plug in the income statement. The amount that was left over while attempting to meet short term financial goals.
To reverse this mentality we have been adding talent and rebuilding processes across the company to make R&D a driver of sustainable growth again. Although this process is far from complete, we are beginning to see the fruits of our labor. In diagnostics for example, we now have a robust menu of molecular assays available on Panther in Europe spanning women’s health as well as virology.
Recently we have secured CE-marks for new tests for HIV-1, Hepatitis-C, Hepatitis-B and a sexually transmitted disease called Mycoplasma genitalium. In the United States we are already the leader in women’s health. We have filed the pre market approval application for our HIV viral load asset. And the PMA for our hepatitis C Assay is scheduled to be submitted late this calendar year.
Finally, our Panther fusion platform which will provide customers the flexibility to perform PCR testing in a single unit dose format is on track to be introduced internationally next year. In surgical we are now in the process of launching a line extension called MyoSure, Reach.
MyoSure, Reach increases clinical utility by providing surgeons the access to polyps and fibroids in more areas of the uterus. And we believe that will play an important role in extending our leadership position in the field.
Finally in breast health we are excited about two new biopsy products that will further build on our positions as the innovative leader in the market. Our new 3D enabled Affirm prone biopsy system was introduced in Europe in March and is being launched domestically now. Affirm represents the first real innovation in the biopsy space in roughly 20 years and leverages our growing installed base of Genius systems by enabling physicians to perform a more accurate biopsy using 3D technology.
To further enhance our biopsy business, we expect to launch an entirely new biopsy tool in Brevera next year. Brevera has break through potential as it allows real time analysis of the biopsy sample, thereby vastly improving the patient experience. Stay tuned for more information on this.
Before I turn the call over to Bob, let me conclude by saying that we are pleased with our second quarter financial results which in some ways opened a new chapter in the Hologic story. As in recent quarters, our commercial teams generated robust growth in the United States. At the same time, we generated operating leverage through productivity improvements while simultaneously investing for the future. And we boosted our bottom line performance by opportunistically deploying capital. All-in-all a solid well rounded performance.
Now I will hand the call over to Bob.
Thank you, Steve, and good afternoon, everyone. In my remarks today, I am going to highlight our other divisional sales drivers and some key financial metrics and then wrap up with our updated financial guidance for 2016.
Unless otherwise noted, my remarks will focus on non-GAAP results and percentage changes will be on a year-over-year basis. Overall, we had a strong second quarter, with double digit growth in the U.S. in addition three of our four businesses demonstrated global growth in the quarter.
Steve already discussed breast health and surgical, so I will focus on diagnostics and skeletal. Diagnostics our largest business reported sales of $304.4 million in the second quarter, growing 3.2% in constant currency terms. We are pleased to report another positive quarter in our cytology and perinatal business which generated $116.1 million in sales growing 3.5% in constant currency.
U.S. sales grew mid single digits which was by far our highest growth in several years, even with lingering headwinds from path interval expansions.
Turning to molecular diagnostics we posted sales of $126.1 million up 5.8% in constant currency. Domestic sales increased at a faster rate as our fully automated Panther system continues to accumulate new placements and competitive wins.
In addition, utilization in sales of our assays for Trichomonas, HPV chlamydia, gonorrhoea continue to grow. Internationally, we had another solid quarter of Panther placements. This keeps us optimistic about our future growth potential in Europe, where we now have a full menu of women’s health and viral load assays as Steve mentioned.
In blood screening, worldwide revenue of $62.2 million decreased 2.4% in constant currency as expected. While there were some geography shifts as our partner Grifols balanced inventory, the overall decline was mainly due to stronger ordering in the prior year period to support the rollout of our business with the Japanese Red Cross.
We do continue to see however trends towards lower blood utilization worldwide and therefore anticipate that quarterly blood screening sales will settle in the mid $50 million range as the market and customer usage patterns mature.
In skeletal health, we had $22.2 million in global sales, a decline of 8.2% in constant currency. Domestically, sales increased at a low single digit rate, but international sales were negatively affected by distributor ordering patterns. Because this business is so small, it is not uncommon to see these kinds of fluctuations and we do expect that skeletal will be a solid contributor to growth overtime.
Now let me switch gears and discuss operating expenses in the second quarter. Total expenses of $221.2 million increased 12.9% mainly as a result of our continued investment in breast health and diagnostic marketing programs along with the timing of R&D program which we foreshadowed last quarter.
This increase in spending which will continue into the second half of the year is planned and deliberate, and the key component of our strategy to generate long term sustainable growth. Two factors contribute to our willingness to support these incremental investments, first and most importantly we see good returns on the specific projects we are pursuing. For example, our investments in consumer marketing for Genius are enabling us to gain market share while maintaining stable price in the face of new competition.
Second, we already have an industry leading operating margin and have shown that we can and will increase this margin overtime, but our goal is not to drive operating margin to unprecedented levels for our industry, instead we want to steadily improve them while also investing in appropriately in DCF positive projects for long term growth.
At the same time, our goal is to allocate capital to enhance shareholder returns and during the second quarter, we accelerated our efforts in this regard. For the last few years our primary use of excess cash has been to pay down debt and our long standing goal of reduction net debt to 2.5 times EBITDA by the end of 2017 remains in effect.
As evidence of this, we spent $311.4 million in the second quarter to repurchase convertible notes with the principle value of $226.6 million. While our convertible debt totaled over $1.3 billion in principal less than 12 months ago, it is now down to $793.3 million a reduction of more than $0.5 billion. And given the continuing strength of our cash flows we are in a position to supplement debt reduction with opportunistic repurchases of our common stock.
Specifically in the second quarter, we brought back 4.3 million shares of our stock for $148.8 million. While stock buy backs have always been part of our long term plan, market weakness in the second quarter enabled us to pounce a little earlier than expected.
These strategic actions enabled us to sequentially reduce our share count in the second quarter, the first time in a long while that our diluted share count declined. In fact, diluted shares outstanding or 288 million were basically flat compared to the prior year period no longer diluting EPS growth, specially non-GAAP EPS increased 14.6% about 2.5 times the rate of sales.
Let me just emphasize that our debt reduction and buy back activities will not prohibit us from seeking other opportunities for tuck in acquisitions. Our business development teams are settling in and while no transactions are eminent, we are actively evaluating opportunities across our businesses.
Before I move on to guidance, let me cover a few other financial metrics from the second quarter. Improvements made to our balance sheet contributed to a total debt outstanding of $3.4 billion a decrease of 534.1 million compared to a year ago and net debt of 3.1 billion.
Our leverage ratio net debt over EBITDA now stands at 3.1 times. In the second quarter, adjusted EBITDA was $253.8 million up 6.4% compared to the prior year period. In addition, our trailing 12-month EBTIDA surpassed $1 billion this quarter, a nice milestone for the company.
Our ability to generate strong profits while lowering debt has again allowed us to increase return on invested capital. As our second fiscal quarter, ROIC was 11.7% on a trailing 12-month basis, a 170 basis point improvement over the prior year.
Finally let’s turn to our updated non-GAAP financial guidance for the full year and third quarter. Starting with the full year, we are raising the low end of our revenue guidance by $10 million to reflect the solid performance in the first half of the year. We now expect reported revenue of $2.81 billion to $2.83 billion in fiscal 2016 representing reported growth of 3.9% to 4.6%.
Based on recent exchange rates, this equates to constant currency growth of between 4.6% and 5.4%. Compared to our last guidance, there are a few puts and takes related to revenue. On the positive side, the market withdrawal of a competing surgical product should provide a tailwind to NovaSure and the dollar has weakened slightly.
The currency benefit for us is less than you might expect however since much of the dollar weakening has been relative to Japanese Yen and other currencies where we have minimal exposure. In terms of headwinds we are more cautious on near term blood screening revenue given macro trends in the market and we do risk our international forecast slight
I should also mention we have made the voluntary decision to stop selling CF InPlex our test for cystic fibrosis due to manufacturing quality issues at a key component supplier that recently resulted in a recall. This will represent a headwind of several million dollars to our U.S. molecular diagnostics revenue in the second half of the year but shouldn’t have much effect on margins.
In terms of earnings for the full year we now expect EPS of between $1.89 and $1.91 which translates to reported growth between 13.2% and 14.4% or constant currency growth of 14.6% to 15.8% this is based on the effective tax rate of approximately 33% and diluted shares outstanding of roughly $292 million for the full year.
As we work through your models you will see that our increased EPS guidance implies a healthy expansion of already industry leading operating margins while accommodating increased investment, specifically we intend to continue investing behind our Genius campaign in breast health and cervical cancer co-testing and diagnostics.
We will aggressively fund the commercial activities to launch important new products such as our Affirm prone biopsy system and capitalize on the competitive investment environment surrounding NovaSure.
We also expect to make some key hirers in our international business which typically comes in with initial sign in cost for relocation and the like. And we are pursuing some entirely new R&D initiatives such as developing a blood screening test for the Zika virus while also seeking out opportunities to accelerate R&D timelines for existing initiatives for example by increasing the breadth of outside support.
Not all of these investments are permanent in nature, but we do expect them to push operating expenses upward in the second half of the year. At the same time however, our capital deployment activities are effectively offsetting the impact of the strategic investments on the bottom line.
Now turning to guidance for the third quarter of fiscal 2016, we expect revenues of $695 million to $705 million. Compared to the prior year period, this range reflects a reported growth of 0.2% to 1.6% or 0.6% to 2% on a constant currency basis. As a reminder, these lower growth rates are due to a much tougher comparable in the prior year period when revenue jumped almost $40 million on a sequential basis.
In terms of the bottom line, we forecast diluted non-GAAP earnings per share of $0.47 to $0.48 in the third quarter. This represent continued strong growth of 9.3% to 11.6% on a reported basis was 10.1 to 12.4 in constant currency terms.
Our full year guidance obviously implies the sequential step up in the fourth quarter revenue. This is due to normal sequential business momentum that we expect contributions from new product launches and the timing of some royalty revenue that is expected later this year.
Before opening up the call for questions, I would like to reiterate that our view on the second quarter is one of a good multi level execution. Revenue grew at a solid rate based on continued outperformance domestically and stabilization outside the United States. We improved already strong operating margins while accommodating increased investment in key growth drivers.
In our capital deployment activities helped to pay for these investments at the EPS line while setting the stage for leveraged growth over the long term. Now that we are half way through our fiscal year we are optimistic about our full year forecast. We are anticipating solid, mid single digit revenue growth in line with our original expectations as strength in the U.S. offsets the weakness we have seen internationally.
We forecast solid expansion of operating margins while simultaneously investing for the future. And we expect the acceleration of our capital redeployment activities to allow us to leverage operating gains all the way down to EPS which should grow at a mid teens rate.
With that, I will ask the operator to open up the call for questions. Please limit your questions to one plus or related follow up and return to the queue. Operator we are ready for the first question.
Thank you. [Operator Instructions] And our first question comes from Isaac Ro with Goldman Sachs.
Good afternoon, guys. Thank you.
Hey, Steve. I wanted to start with the outlook in the ex-U.S. business and specifically understand kind of what's embedded in your outlook for this quarter. You obviously made some changes to the team there as you pointed out. I'm curious if you talk a little about how the changes in the team will justifies with just the operating environment and just that we understand the guidance little better?
Yes. I would say, still very conservative near term, because we started the signal about this time last year. The deeper we dug into international, international for context is really much more of a start-up than a turnaround. We've got our three franchises across the geographies and so what Eric is really doing in part of what specific data, the changes we need to really build out a team not just get a team that was in place operating differently, and so Eric is really going out.
We're already recruiting and bringing in different people, different leaders, but it’s going to take that – that's going to more a 2017, 2018 event, I think, and really we're thinking about international as drivers in especially frankly 2018, 2019, 2020 and not as focused on the near term. So I think the near term is pretty cautious and conservative. But it will be coming through right when we need it.
Got it. That's helpful. May be second question would be on [Indiscernible], just curious if you could update us on what you've learned about the nature of the products like here in terms of the pace and magnitude of adoption. You've given us some color for last couple of quarter, but curious on update there, especially if you put in context with the [Indiscernible] study earlier this week and then just what you're seeing in terms of how effectively your customers are able to get reinvestment and all that. Just an update on how that's going.
Sure. I think if you go back two years and I described at the time we probably saw a building a freight train, clearly I think the combination of better reimbursement and especially our consumer marketing efforts and our sales efforts really dramatically accelerated that. And instead of a freight train, it definitely look for like an aeroplane I think taking off.
And you saw that especially as you know in our third quarter last year when you starting really positing this 20% growth numbers. I think what we see is we still feel very good about the order trends and about frankly the biggest piece I think we're incredibly excited about is the way we're holding pricing. And the demand still looks very good, having said that we're going against obviously now as we go into this third quarter, we're going against the huge comps and therefore again as we try to signal of last year that the absolute growth rate will probably be slower here for the U.S. breast health business, as certainly as we into the coming quarters, but I think still feeling really good, that there is a lot of runway ahead and I think when we talk to investors I think people often think there's going to be a peak in that huge trough. I think we're seeing it is probably would be much more of a Plato, whereas we hit a peak, but there is still a lot of runway that should have us last for quite a while here.
Hey, Isaac, this is Bob. Just a follow-up on what Steve is saying. The numbers where we expected them to be and what I would say is also in terms of the placements where we're not going to get specific number, it was up sequentially as we expected and also up versus prior year. So we feel continued good about our continued adoption in driving that business.
Thank you. Our next question comes from Jonathan Groberg with UBS.
Hey. Thanks for taking the question. Congratulations on a solid quarter and hitting on all these important themes. I guess there is two questions from me both on the molecular diagnostics front. One, can you maybe talk about [Indiscernible] kind of what you're seeing and some of the key test there both in the U.S. and internationally, I think you specifically mentioned you'd had some pretty uptake on the menu and panther in Europe.
And then two, if you just clarify Bob on the cystic fibrosis test that you're exiting, are you exiting or is it just a recaller, because of the recaller you are now exiting that business and was that a few million dollars on an annual basis, was that kind of be the headwind? Thanks.
Yes. Actually it’s going to be a few, we are exiting it. I'll take your second question first [gap audio] we are exiting it permanently and it will be a few million just in the second half of the year, so it would be larger than that on an annual basis. It’s roughly a $10 million annual number, annual product. So we'll absorb that.
And then in terms of the test, I think we feel really good about the continued uptake of both the full menu in the U.S. and starting to see some encouraging signs on the update of the menu in Europe, but again we wanted to be very careful, making sure we're not declaring victory until we start to string together a number of quarters. But I think we're starting to see some better panther placement. We have a new leader of molecular business in Europe who actually came later last year and so he starting to get his traction and driving its. So I think feeling pretty good about where that business should be going.
And I think we continue feel good about gaining share here in U.S. as well and across the major assets that we have. We start breaking up and track all the things. We're seeing growth, nice growth really across each of the asset.
Could you just maybe comment on annual consumable run rate, is it increasing in panther, where we are in terms of the annual utilization?
We spoke Jonathan, we mentioned 170,000 on a worldwide basis last quarter and its actually increased from there, this year. And the U.S. being higher than that in terms of the average sell for panther. And I think I give you the highest level how we're feeling about the diagnostics business right now.
We're incredibly [Indiscernible] with what's [Indiscernible] is going, remember that was a really ugly situation just couple of years ago that business is now clearly flattens to modest growth, molecular is looking good and blood screening is probably a little bit behind, you know blood screening and that's the one we don't control the commercial channel on. We're seeing probably greater inventory reductions, certainly than what we expect in start of the year and we're absorbing it based on the strength in the parts of the business.
Our next question comes from Tycho Peterson with JPMorgan.
Hey. Bob wondering if you can maybe comment on gross margins, you guys were about 150 basis points of what we've been modeling. Just wondering how much of this is function of mix versus maybe some of the operational improvements and what should we expect for our gross margins going forward?
Yes. So we're not going to give a specific target on gross margin going forward, Tycho, but what I would say is, it is an element of geography mix, product mix and productivity. Actually geography mix is the smallest component of that, roughly about 25% of that improvement was due to geography. And the rest being the product and productivity and what I would say it is probably equally split between those two.
And we feel good about our continued improvement there with the initiatives that Steve talked about across all of the functions of our business, our operations team are really executing well and identifying opportunities to continue to improve efficiencies and obviously as our sales growth drives more units to the factory that also helps us well.
Okay. Then question for Steve. I know you get a lot of questions on managing kind of the tomo cliff. And just wondering with the pipeline components you've laid out today plus the service business, which you guys continue to highlight do you feel like you've got enough of a line of sight that that's going to be kind of a smooth transition. And if not can you maybe just touch on capital deployment. I mean you talked more about buybacks today, but how do you view the opportunity set? And then do you need to rely on tuck-ins to effectively manage the tomo cliff when that comes?
Sure, Tycho. First I'm going to try to dissuade you from using the cliff because we've been working very hard to make sure that it won't be a cliff, and I'd say that in all seriousness. We've been very focused on what happened with the 2D curve and everything else and by thinking about how we extend out and do some line extensions and other things that's been a huge part of our focus to be able to have more of a plateau or very soft decline in that segment of the business at some point in time as suppose to real cliff. I think it’s part of what we have coming things in biopsy and frankly people [entities] running that business for us. It’s a longer track record being about to put even some singles and double on the board in addition to just the every home or every five or eight year home run that we've tended to have in this business.
So I would tell you I'm feeling incrementally better every time Bob and I and Eric Compton are down meeting with that business on what's happening in their pipeline and we'll talk more and more about that certainly in the coming quarters and years. But I think we're feeling better about being able to mitigate that.
To the other piece, I just want to jump even though your question on margin to Bob, because I was very adamant early on when I came was probably not expecting much margin expansion. This has been one of the very positive surprises to me. And I think the big piece that I want to be clear on is, we're going to use a lot of this gross margin expansion to continue to invest into the business which leads to the second part of your follow-up question there, which is as we go forth we are certainly spending more on R&D, more in marketing and it will allow to do tuck-in acquisitions based on the cash generation.
And so I think we're really opening up a new leg in the store, where we got more levers available to us than we did two years ago. Two years ago we were so hamstrung with the debt and the converts and everything else. We didn't have really an ability to potentially manage, because as we all know we're going to see some ups and downs in the rate of sales growth. We're going to continue to grow. We're going to have some periods that will be a little bit slower while we wait for the next new products to come through. I think we're feeling better and better that we're going to be able to deliver very strong earnings growth consistently and in the periods when we are growing faster we’ll probably reinvest a little bit more in the periods that are slower, we may not have quite the accelerated investments in that type. So hopefully that starts to give a little more of a longer term view of what we are thinking about.
Thank you. Our next question comes from Jack Meehan with Barclays
Hi, thanks good afternoon. I just wanted to ask kind of little bit more granularity on the blood screening business and what you are seeing the market today and I think I caught a mid $50 million number you referenced. Just, what is the trajectory of that business look like over the next maybe three to six quarters?
I think it’s going to be slightly down. I think if we look Jack at the global market, let’s take it by U.S. The U.S. clearly hospitals are getting better and better at managing their inventory at minimally invasive surgery at being able to limit their use of blood. So I think we are forecasting that the U.S. is a slight decliner. This quarter, our U.S. business was actually up fairly significantly in blood that was more an inventory correction, but I think the way we are thinking about it is this is a low single digit decliner. Internationally, I think we see the business very slight grower, but globally I think because of the declines in the U.S. we think about blood screening as a flattish to slightly down business. And that’s -- you go back to the headwinds we had as a company facing us a years ago it was blood, it was NovaSure, it is MyoSure. I’m sorry; it was blood, NovaSure and ThinPrep. The two that we control the commercial channel feel great about changing the long term trajectory. I don’t think we are quite as ready to declare a change in the trajectory of blood screening.
Then I think the other thing that’s important to note Jack there is this is a macro trend, we are not [losing gap] contracts, we have not lost any contracts. We are the market leader so as the market goes, so goes our business and I think that’s important to say that we continue to feel good about continuing to secure the contracts that we have and this is more a utilization factor as opposed to loosing contracts to competitors.
Got it. That’s helpful. And then just one on Panther, the incremental Panthers that you are placing in the field now, I’m just curious what’s the mix of the customers look like, is it existing customers adding capacity, is it new customers, how much of a driver has been year up, any additional detail will be great. Thanks.
Yes it’s a bit of both in terms of existing and newer and to some degree it’s starting to go [Indiscernible] slightly smaller accounts. We’ve penetrated most of the large ones and part of this is we look at our menu of the future and what we have coming we realize if we can get a few more Panthers placed even in midsize accounts, hospital labs other reference labs that’s going to benefit us as well. And frankly, Panther has got a pretty good footprint for OUS, but we’re never really put the resources behind it and so we are starting to place a few more internationally especially in Europe right now.
Thank you. Our next question comes from Doug Schenkel with Cowen and Company.
Hi, good afternoon. This is actually Chris on for Doug today. Thanks for taking the question.
Bob, can you help us walk through the bridge for the EPS guidance. Our math suggests that just the share count reduction relative to the prior guidance should get you about $0.03 of benefit increase EPS by $0.02 at the midpoint. And this was despite AP this quarter. I guess the question is, are you changing any other operating investment or assumptions that would impact EPS growth?
So your math is very similar to our math. We calculate that the change in share count calculates about $0.03. We’ve raised the midpoint $0.02 and we talked about the increased investment that we plan to make and are going to be delivered about making in both R&D and marketing in the second half of the year. And that’s essentially the math that you should be able to walk through. We are expecting higher operating expenses in the second half as a result of the benefits that we are seeing in those to generate long term sustainable growth both in R&D and marketing. And so we are taking some of that benefit and reinvesting into the business.
Yes Chris to add to that is if you think about it we grew EPS about 14ish percent last year at the high end of the range this year it’s going to be another 14 on top of 14. There’s a point at which you don’t want to go too far because we are thinking about this over the long haul.
Great. That's helpful. And hopefully I'm right on this but can you talk about the OUS cytology perinatal growth. It appears OUS growth for that business slowed on a sequential basis. Is this right, and what was the cause of this?
Hey you are exactly right. I think we saw a little bit of inventory correction in China, primarily and I think we probably with some distributor changes and everything else there is a little more inventory probably in the channel there than what we had fully grasped. So I think it’s a underlying consumption. It looks good, and I think we may have another quarter or so with a little bit of adjustment here and then probably be as Eric has dug in deeper and deeper we are getting better granularity, better visibility and I think it’s more of a an inventory contraction issue.
Thank you. Our next question comes from Bill Quirk with Piper Jaffray
Great. Thanks. First question is timing around the Zika virus assay. I know you guys have one in development. I know one of your competitors has introduced it in the southern part of the country, but just kind of thinking about timing around that rollout and then I guess a second part of that question is, is the testing strategy here has been a little different than what we've seen historically, where it looks like we are doing region-by-region testing rather than the whole country. So I would love to hear your comments on those two? Thanks.
Sure, Bill. On the first part, we’ve been working very aggressively with both CDC and FDA on the topic and we should have a blood screening product via IND for use here in the coming months by early summer certainly by the peak mosquito, in time for mosquito season. We don’t yet know exactly how the market is going to play out. We’ve been through this script before with dengue and West Nile and not being quite sure clearly it does look like there is rationality to this and we are prepared with the various centers to be ready and responsive to what is needed to be done. And our primary focus initially is on blood screening. We are also and as part of the additional investment in the second half also looking on the diagnostic side of it as well that would be further out time wise.
Got it. And then just a real quick follow up. The PMA that was filed on HIV viral load, I'm assuming that happened during the quarter, can you give us any incremental color there?
It will be; excuse me…
And then about -- just about a 12 month turnaround time on that, guys?
Yes -- so HIV has been filed in recent months and for a PMA we typically assume about a year.
Perfect. Thank you.
Thank you. The next question comes from Vijay Kumar with Evercore ISI.
Why don’t [Indiscernible] Boston Scientific headline today by the way.
Thank you, Steve. I'll make sure I have a better one for you guys. Just maybe turning to -- this is the guidance. And when you look at the 3Q to 4Q sort of ramp, can you just explain to me, Steve or Bob your comfort on sort of the -- it just seems to be 3Q to 4Q it seems to be slightly higher than sort of the QoQ ramp?
Yes hi Vijay, this is Bob. Obviously the sequential spike is greater when you are modeling at the top of the guidance range, so I would suggest that you model kind of to the midpoint. But it’s driven by our confidence in sequential growth of 3D, that’s a big piece of it as well as the other businesses. So the impact of our new product launch is such as the Affirm biopsy which had been built into our plan. The -- some of the growth in the NovaSure business as you recall that would be strong there and then we also have some royalty revenue that shows up in our molecular diagnostics business in the fourth quarter again which we had anticipated this year.
Great. And maybe one last big picture question for Steve on cap deployment. I saw that you guys took out the convert in the queue. I'm just curious at what point do you feel, Steve, comfortable on maybe deploying capital for M&A versus lowering the debt load?
Yes we are ready and willing to spend there on M&A and actually we did make an acquisition of our own stock in the quarter. That was actually a pretty good acquisition that we made and we are feeling pretty good about that. The teams are definitely looking and where Bob and Eric and I are now reviewing on a more regular basis ideas. We also just looked and so we will not let it get in the way. Ultimately I look forward to the day that we have no converts left on the balance sheet, but I would suspect we will be doing some acquisitions along the way while we continue to clean those up. So, still in the way at this point in time still focusing the division on what we call bite size, things that supplement the existing businesses and we are very willing and ready to go, but I would say as Bob said in his script nothing eminent wouldn’t even necessarily expect any, anything much in this fiscal year necessarily. So we thought mop up some share as well that the market gave us a nice opportunity.
Okay. Your next question comes from Brian Weinstein with William Blair.
Hey guys thanks for taking the question. Seeing, if we can get maybe a little bit more granular on Genius. If we use the airplane analogy, when do you guys think that you will level off at 35,000 feet in other words, I mean is it -- do you think you have -- through sometime through 2017. Do you think it's a longer ramp than that, anything that you can help us triangulate on, on when you hit that plateau?
Sure. It probably is 17 at some point in 17 and we have thought originally it would have been 18 or beyond I think the success and the faster climb. We are getting to 35,000 feet faster probably a good year faster than I would have imagined, but I think we’ll definitely be able to stay up there for a while.
Okay, and then…
I think we are starting to think 17 is probably it.
Okay, that’s helpful. Thank you and then on the repurchases, can you remind me do you have anything in your covenants that restrict the repurchase amounts that you have. And what your current authorization is for share repurchases? Thanks.
Yes hey Brian this is Bob. We have currently an authorization for 250 so we roughly have about 100 million at the end of the quarter. There is nothing significant in our covenants that would prohibit anything of that size and nature.
Thank you. Our next question comes from Raj Denhoy with Jefferies Investments.
Hi, good afternoon.
I wonder if I could explore this idea of you guys plateauing a bit in tomo. The guidance you gave for the third quarter as well as the fourth quarter sort of implies that that's happening, right? And when we think about 2017 though, is the growth that you've implied for the back half of the year which is something in the 2% to 3% range really what we should think about for the business until you get to this next product cycle whether it's in diagnostic or otherwise. Is that how we should think about the business over the next 12 to 18 months or so?
Sure, Ray. I think first up we are not quite plateaud yet. We are still implying some growth in the final couple of quarters but definitely much slower growth. And I do think we are preparing for 2017 it’s going to be slower top line growth than where we’ve been over the last four or five six quarters. I think just being pragmatic about it. And as part of the investments we are making today so that we know we can set ourselves up to continue to deliver frankly very healthy EPS growth even in what might be a slightly lower top line growth environment.
But is something in that sort of 3ish percent range the way we should think about 2017 for you guys from a revenue growth standpoint?
We are just not ready to get into pre announcing 2017 guidance at this point, but it certainly going to be lower than where it was, probably not a horrible number to use at this point in time.
Thank you. Our next question comes from [David Luis] with Morgan Stanley.
Hi guys it’s actually Scott in for David. Steve and Bob, I think guidance for this year implies comp adjusted stability into third quarter versus second quarter, and then kind of a sharp acceleration into the fourth quarter. Can you just give us an idea of what's driving that effect?
Yes hey Scott, we -- in the fourth quarter we talked about continued growth in 3D sequentially. We also have the benefit, the continued benefit of some tailwinds around our NovaSure business with the competitive market withdrawal. And we have some royalty income that shows up in the fourth quarter as well as the new products, products like the Affirm prone biopsy cable that show up more in the fourth quarter than they do in the third quarter.
Understood. And just a follow up I guess on the GYN surgical part on NovaSure, can you -- I think you so mentioned in your commentary earlier that the impact from the competitive recall was about $1 million to $2 million. Can you seize the opportunity from here? And do you expect kind of pro rata share going forward or a higher share going forward? Thank you.
We will always expect a higher share. We don’t have a completely great handle on exactly what that number would be going forward, but I can tell you we are just with our surgical team this week and they are having a lot of success, doing tremendous job on both NovaSure and MyoSure. It’s clearly been one of the more positive upsides to the business. Again, if you look over the last two years where surgical was and where it’s going we are feeling really good about the trajectory.
But that is -- that is one of the areas we are making incremental operating investments in to capture that, and so that’s part of the second half in investments as well as the 3D Genius campaign and they are contesting in the marketing side on the diagnostics business.
Thank you. Our next question comes from Derik de Bruin with Bank of America.
Derik de Bruin
Hi, good afternoon, how are you?
Derik de Bruin
So in HPV, one of your competitors mentioned they've seen some share gains in the U.S. on their primary testing assay. Can you sort of comment on that. I mean, I obviously, your gains in cytology would suggest that your co-testing isn't suffering from this. So could you just talk about -- first of all I guess certainly share gains in the cytology market. And then just on the primary testing situation.
Yes I think we are feeling pretty good about I mean ultimately the science on -- the science as well as many, probably some of the best. I think the science is very much on our side on co-testing and we feel very good about what we are seeing both on the cytology side and frankly on our HPV side. So, I don’t -- we certainly don’t see us loosing share on HPV.
No I would say both on HPV and ThinPrep Derik in the quarter grew above market.
Derik de Bruin
Great, that's helpful. And just one quick follow-up. I guess when you look at where you are in Panther placements versus the total addressable market, I mean how far would you say has Panther penetrated?
Fifth or sixth [indiscernible] Derik in the U.S.
Derik de Bruin
In U.S. Great.
In our earlier inning in U.S. And then [Indiscernible] we got to build the capabilities outside the U.S.
Thank you. Our next question comes from Rich Newitter with Leerink Partners
Hi, thanks for taking the questions.
Hi, how are you? Just wanted to make sure that I had the buckets right for the moving parts on your constant currency guidance, and what went up and what's kind of good and what's bad -- or incrementally good and incrementally bad. So it sounds like the blood screen reduced outlook is call it, maybe $10 million in the back half. It's a bad guy. You didn't have FX, which is a good guy. If you could quantify that on some level or quantify each of these buckets that would be great.
It sounds like you have a little bit better of an outlook in GYN with a competitor off the market. So maybe incrementally better there. And then you also have the new MyoSure product, so that's the third bucket. That's a good guy. And then you said that you had a slightly weaker or more conservative OUS outlook, and I'd love to know just kind of where that factors in -- in magnitude relative to the blood screening which my math is getting to about $10 million incremental weakness.
Yes Rich, we are probably not going to give all that level of detailed …
Cause no matter what we do will be wrong, but…
[Indiscernible] I think your numbers are not that far off. I would say the FX is probably a little smaller than you may estimate for others, because we do have about a little over a third of our international business is actually based in U.S. dollars. The other piece is the CF recall and market withdrawal that we mentioned before which is roughly we mentioned that that’s a $10 million annual business, so think about that as roughly a $5 million headwind in the back half of the year.
Okay. And just the weaker OUS kind of -- or more conservative OUS outlook, is that separate from blood screening, or is that part of that?
Yes, it’s a little different, but it’s not that -- it’s small. You captured the other big pieces.
Thank you. And our next question comes from Jon Block with Stifel.
Great, thanks and good afternoon. Steve, maybe the first one for you, and I get all the airplane analogies but at the end of the day, we are still in a tomo product cycle that's arguably 20% penetrated for the industry. If I look back, that's were sort of film to 2D at this massive inflation, and so I get the tough comps and maybe one in the plateau than the cliff word, but can you just talk to why the 2017 growth plateau in tomo? When again, arguably, when I look back, at least at the last product cycle that's really where you saw the incremental penetration start to take off?
I think if you really look, we had such a positive inflection point in the third quarter last year, we're in that run up for right now. I think we would always rather be a little conservative on potentially preannounce the fundamental realities we're not totally sure. The dynamics are different than they were at that point in time from both competitive set as well as where hospital stand, everything else.
We do think there are probably some upside in private sector insurance that will continue to kick in as it plays out. And I think it’s why we still feel really good about where it’s going. But I think pragmatically we are picturing it as less of this incredible spike and probably just reaching kind of a new level where its continuing to increase slightly for a while and but not the 20% growth rates that we were getting for few quarters in a row.
Got it. Perfect. Then just one more. It’s a little bit more granular, but international molecular, I know it's small, but were the revenues up year over year like the prior two quarters? And then just at a higher level, can you talk about what you are seeing with international molecular? You've got the viral load assays over there. Are you seeing that help sort of gain market share on the heels of some of those approvals? Thanks, guys.
Yes. As a backdrop remember our international molecular business is still frankly weigh too small, so it was roughly flattish in the quarter. We're seeing some growth in Europe and I think that's where we really want to see the growth and probably its taking a little more of an opportunity. Still some fluctuations in some of the other smaller markets around the world, but I think what we expect over time is we're placing – we actually have started to really place some Panthers in Europe. I think we'll see that as Europe probably being the beachhead for building out that international molecular business, that also should start to provide some steadier growth and steadier foundation to the business to build out.
Fundamentally what we lacked in the company as a true foundational business for really any of our franchise that's outside the U.S. We had sales here and there from certain tenders but we haven't had the fundamental strength what you starting each quarter knowing you got a nice book of business that's automatically coming in. Even in the old days, we used to sell the Panthers instead of reagent rentals and things like that. So we are just trying to get a lot more disciplined to get a much healthier business.
Thank you. Our next question comes from Jason Bedford with Raymond James.
Good afternoon and thanks for taking the questions. Wanted to follow-up on the 3D discussion, do you think the lack of widespread private payer coverage is impacting the uptake of 3D? I've noticed that you guys have become more aggressive on the marketing side there.
We don’t think it’s -- we feel pretty good about the uptake. And I think it’s an incremental opportunity. I don’t see we see it, we don’t see it as a real barrier, we see it probably as additional upside.
Okay. And then just to follow up on the international build out, I realized that it's a long term initiative. But when do think, Steve you will have the team in place internationally?
We’ll have most of the team in place by the end of this fiscal year and we’ve got a lot of the key team. We had quietly started to rebuild the team particularly in Europe late last year, that’s when we brought the new molecular diagnostics leader in, the new service leader was hired in the last quarter. Our new breast health person over, so I think we feel pretty good about the team coming together by the end of this fiscal year and some of them are already hitting the ground and getting it. But it’s definitely more of a 17,18,19 as we really get into the longer term planning. And we are really upsizing that team. We don’t want just some quick wins for the sake of wins; we want it to be the enduring business because part of what we got in the last couple of years was the occasional big win but it didn’t necessarily translated the ongoing business.
Operator, I think we have time for one more question.
Thank you. Our next question comes from Mark Massaro with Canaccord Genuity
Hey guys thank you. So you noted that you are closing the Bedford, Mass, facility. Can you comment on timing and cost savings? And related to that, have you been able to realize any benefits related to optimizing your supply chain?
Yes I think starting on the second part, optimizing the supply chain you are clearly seeing it in our gross margin. I think the part that might have gotten missed in my script and it was the part that probably shocked me the most when I was going through the financial for the quarter. Our absolute cost of goods is lower this year than last. So we are producing more product at less absolute money than last and that’s clearly a result of some of the procurement and productivity initiatives that Mike Kelly, our supply chain leaders put in place under Bob McMahon’s guidance and a lot of help from Eric Compton as well. The Bedford facility will be closing later this later, candidly it’s going to have a fairly minimal impact on the true P&L because it’s the least facility and we are stuck with a bunch of lease costs and other stuff in there. But it’s -- we are still just doing a lot of cleaning up through the company and we’ve consistently said we’ve made a lot of progress in the last couple of years and there is still a lot of opportunity ahead to be better on so many fronts.
Thank you. Nice quarter.
Hey well thank you. Thanks a lot, Mark. And I think that wraps it up.
Thank you. That is all the time we have for questions today. This now concludes Hologic's second quarter fiscal 2016 earnings call. Have a good evening.
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