Hologic 3QFY17 Financial Results Conference Call Prepared Remarks FINAL: 8/2/17 Note: May Change Slightly When Delivered Mike Watts VP, Investor Relations & Corporate Communications Thank you,. Good afternoon and thanks for joining us for Hologic s third quarter fiscal 2017 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 third 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 this call will be archived on our website through August 25. Before we begin, I would like to inform you that certain statements we make during this call will be forward-looking. These statements involve known and 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 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 to GAAP financial measures can be found in our earnings release. Finally, unless otherwise noted, all percentage changes we discuss will be on a year-over-year basis, and revenue growth rates will be expressed in constant currency. 1
Now I d like to turn the call over to Steve MacMillan, Hologic s CEO. Steve MacMillan Chairman, President & CEO Thank you Mike, and good afternoon everyone. We re pleased to discuss Hologic s performance in the third quarter of fiscal 2017. We posted solid results overall, and delivered on our near-term financial commitments. Revenue exceeded our guidance, and non-gaap earnings per share finished at the high end of our forecast. Our molecular diagnostics and international businesses continued to emerge as strong growth drivers, and our recently acquired Cynosure business performed in-line with our quarterly expectations. From a longer-term perspective, our quarterly results reflect positively on our efforts to revitalize and reshape our business portfolio. If you could have listened to our strategic planning discussions back in 2015, when our domestic breast health business was driving tremendous growth, we knew that we needed molecular and international to accelerate when breast inevitably slowed. And that is exactly what has happened, as we upgraded leadership and made the necessary investments. This quarter, in fact, both businesses posted double-digit growth, results that would have seemed unlikely even a year ago. But while we were working to establish new growth drivers in molecular and international, we also were ramping up R&D in all our divisions to ensure that we could generate sustainable, organic growth for years to come. Several of the new products that resulted like the Affirm Prone biopsy system and Myosure Reach are making increasing contributions to growth. This quarter, for example, sales of new products exceeded $40 million globally, although obviously this is not all incremental. And other new products are emerging, some of which we ll discuss today. But before doing that, let s provide a brief overview of our third-quarter results. Reported revenue of $806.1 million grew 12.4% on a reported basis, or 13.1% in constant currency. Margins were solid, based on continued price discipline and solid expense control, which led to non- GAAP earnings per share of $0.50. EPS declined by 2.0% compared to the prior year period, a small amount considering the comp included a full quarter s contribution from our divested blood screening business. So we are doing an effective job of filling that earnings hole with gains in our base business, as well as Cynosure. 2
If you were to back out blood screening and Cynosure, core revenues grew 2.4% on a reported basis, or 3.1% in constant currency. Similarly, core EPS would have increased 11.9% if you excluded blood and Cynosure, so we continue to show good leverage up and down the income statement. So while it was a solid quarter overall, we plan to do better. At Cynosure, our efforts to stabilize and strengthen the domestic sales force are underway under new leadership, and our R&D remains highly productive. And in Breast Health, we are excited about new claims for our Genius 3D mammograms, new insurance coverage, and new products that we re launching now, which we will discuss for the first time today. With that introduction, now we d like to discuss some third quarter revenue highlights, focusing on molecular diagnostics, international, Cynosure and Breast Health. Then I ll hand the call over to Bob to cover other revenues, expenses, and our updated guidance. First, growth in the third quarter was led by molecular diagnostics, where global sales of $144.1 million increased a very healthy 10.3%. The story here is very similar to prior quarters. In the United States, where sales grew at a high-single-digit rate, our commercial team is doing an excellent job of crossselling our full product portfolio, increasing market share and utilization of our fully automated Panther system, and expanding the market by driving compliance with testing guidelines. In addition, this quarter we gained FDA clearance for our Aptima assay to detect Herpes Simplex Virus 1 and 2. While the molecular herpes market is not huge, our new test is an important addition to the Panther women s health menu, and a nice incentive for new customers to try out the system. Outside the US, where molecular sales grew more than 20 percent for the fourth time in five quarters, we continue to see the benefits of new leadership, healthy Panther placements, and multiple new product introductions, including our viral load assays. And we recently received a CE mark for our new Panther Fusion system, which provides lab customers new capabilities and enables them to further consolidate testing on our platform. We still have a lot of work ahead of us, but we are on our way to building an international molecular business that rivals the leadership position we have established domestically. Beyond molecular diagnostics, we are very pleased with the continued growth and positive evolution of our international business as a whole. More than a year ago, we said this business felt like a start-up, and told you that building the foundations for sustainable growth would take some time. But we laid that groundwork in a very deliberate way, starting with new leadership. Now, for the second consecutive quarter, international sales grew low double-digits, excluding blood screening and Cynosure. While we are still early in the game, we are clearly putting points on the board and are encouraged by our progress. 3
One reason we are feeling good about international is the breadth of our performance. In recent quarters, molecular diagnostics and surgical led the charge, but this quarter, every business except Skeletal posted solid growth. In particular, I want to highlight the progress made in international Breast Health. As a reminder, in all four quarters of our fiscal 2016, that business declined. In the first quarter of this year, it was flat, then it grew at a mid-single-digit rate in Q2. This quarter, international breast health grew in the low-teens, reflecting our efforts to optimize channel strategies and strengthen our commercial capabilities. The third area I d like to discuss is Cynosure. Our view of Cynosure continues to be very optimistic over the long-term, though still cautious in the near-term. Cynosure posted revenue of $110 million in its first full quarter as part of Hologic. This was much higher than in the second quarter sequentially, and in line with our quarterly guidance. There was a lot to like about Cynosure s performance in the quarter. First, we are pleased with sales of skin-related products, especially PicoSure. Second, overall international sales grew significantly compared to the prior year. Third, sales of consumables increased at a low-teens rate, driven by dramatic growth in SculpSure PAC keys, which illustrates the value that our product is providing in the field. And fourth, we made important progress in new product development. But at the same time, it s clear that we can improve Cynosure s commercial execution in the United States, just as we did at the larger Hologic three years ago. As we discussed last quarter, there has been a considerable amount of disruption in the US sales force, and newly hired reps are still getting up to speed. To tackle this challenge, we have named Kevin Thornal as division president of Cynosure. I ve personally known Kevin, who engineered the remarkable turnaround in our European Breast Health business over the last year or so, since our time together at Stryker. He is a strong, commercially focused leader who we re confident will have Cynosure growing again in 2018. Kevin replaces Michael Davin, who will be retiring on September 1. Michael built Cynosure into the world s leading medical aesthetics company, and we thank him for remaining with Hologic during the integration process to share his expertise and knowledge. Longer term, we remain enthusiastic about the value of the aesthetics market, as well as Cynosure s ability to lead it. Nothing has changed in terms of the positive market backdrop. With the changes we are making, we are now in an excellent position to capitalize on these tailwinds, with a broad portfolio of differentiated products, the commercial expertise and backing of Hologic in areas like direct-toconsumer advertising, and a robust R&D pipeline. 4
As evidence of this last point, we received FDA clearance ahead of schedule this quarter to use Sculpsure, our non-invasive body contouring product, to treat the back and thighs. In addition, we have filed for regulatory clearance to use Sculpsure in what s called the submental area, under the chin. This is a significant market opportunity that should boost growth in 2018, as we believe our laser technology provides an advantage over the competition. And finally, we have filed for clearance of an innovative, new radiofrequency platform, which over time will have applications in aesthetic, women s health and surgical markets. Now we d like to turn to our fourth subject, Breast Health. In the third quarter, global Breast Health sales of $283.7 million increased a modest 0.9% in constant currency. The US business declined 1.7%, while international sales increased 13.0%. In the United States, incremental placements of 3D gantries declined, like in recent quarters, as the time required to close deals has increased due to market and competitive dynamics. But at the same time, 3D units increased sequentially, booking trends remain solid, our backlog is healthy, we still have roughly half of our installed base to upgrade, and we remain a net market share gainer. In addition, other drivers of growth continue to emerge within Breast Health. For example, service revenue again benefited from an expanding installed base in the United States, delivering more than $100 million in sales. Revenue from our interventional products also increased nicely, as we are doing a better job of selling our full portfolio. Finally, sales of our new Affirm prone biopsy system continued to build. In addition to these positive trends, several other factors give us confidence that our domestic Breast Health business will grow in 2018. First, this quarter we earned important new labeling indications that will broaden our competitive advantage. Our sales representatives can now say that Genius mammograms are the only mammograms clinically proven to detect 20 to 65 percent more invasive breast cancers than 2D alone, with an average increase of 41 percent. In addition, only Genius mammograms are FDA-approved as superior to 2D mammography for routine screening of the nearly 50 percent of women who have dense breasts. This is meaningful because more than 30 states now have laws requiring women to be notified of their breast density. Second, we made significant progress on reimbursement during the third quarter. Approximately 85% of American women in our target patient population now have incremental insurance coverage for 3D, which we believe will solidify even broader market adoption over time. And third, we expect sales of new products to continue to build as we move into 2018. Revenue from our Affirm Prone System is healthy, and we expect to launch Brevera, our innovative new biopsy system, 5
around the end of our fiscal year, so our interventional portfolio is well-positioned for long-term growth. Finally, I wanted to share for the first time that we are in the process of launching our first two new mammography systems since 2011. These new products will enable us to further segment the market and extend our competitive leadership position. Our new 3D Performance system, which has been launched globally, provides the superb image quality that customers have come to expect from Hologic, but with workflow capabilities and throughput that are geared toward smaller, lower-volume customers. In addition, at the high end of the market, the best just got better. Our new 3Dimensions system delivers the industry s fastest, highest-resolution breast tomosynthesis exam, plus a wealth of additional improvements. These include a better patient experience using the SmartCurve breast stabilization system, superior image clarity from our fastest and highest-resolution detector, and faster, better 2-D images from improved software and machine learning algorithms. The 3Dimensions system has been launched overseas, where customers are giving it positive reviews, and we expect to introduce it domestically in the coming quarters. So behind the scenes, our R&D team in Breast Health has been highly productive, and we look forward to these products adding to growth in coming quarters. Before I turn the call over to Bob, let me summarize by saying that we are pleased to have met our financial obligations in the third quarter. We expect molecular diagnostics and international to be increasingly important growth drivers in our portfolio, and have lots of new product innovation on the way to improve growth at both Cynosure and in Breast Health, so we believe we are well-positioned for the future. Now I will turn the call over to Bob. Bob McMahon CFO Thank you Steve, and good afternoon everyone. In my remarks today, I m going to highlight some of our other divisional sales drivers, walk through our third-quarter income statement, touch on a few other key financial metrics, then finish with our updated financial guidance for 2017. Unless otherwise noted, my remarks will focus on non-gaap results, and percentage changes will be on a year-over-year basis. 6
As Steve mentioned, we posted solid results in our third quarter. Molecular diagnostics and international performed well, and are emerging as new growth drivers within our portfolio, consistent with our strategic plan. This is an important development, as our domestic molecular business and our international franchises combined to represent nearly 40% of revenue this quarter. And we have initiatives in place to improve growth at Cynosure and in Breast Health, based on both better commercial execution and productive R&D. With that introduction, I ll begin with Diagnostics, our largest division, where revenue of $284.1 million decreased 7.4% due to the divestiture of our blood screening business. Although we closed this transaction last quarter, we do have an ongoing agreement with Grifols for raw material and instrument supply, which yielded $19 million of very low-margin revenue in the quarter. This was higher than expected, and much more than we anticipate in the fourth quarter as well. Excluding blood screening, diagnostics revenue grew a solid 5.4% in the quarter. Since Steve already covered molecular, I ll mention that Cytology and Perinatal sales of $121 million were essentially flat in the quarter versus a tough comp from last year. In our GYN Surgical business, revenues of $106.5 million grew a solid 5.2%. Myosure continues to lead the charge, with global sales growth of 20.8% in the quarter. Novasure sales declined 5% as we ve lapped the benefit of a competitive withdrawal. Specifically, it s worth noting that the third quarter a year ago was a huge one for Novasure, as sales grew by nearly 15%, making for the toughest comp of the year for the division as a whole. To wrap up the revenue discussion, skeletal health revenues of $21.8 million declined 5%, although we are encouraged by interest in our bone density products, especially for body composition testing in the US, and expect this business to improve in the fourth quarter. Moving down the P&L, gross margins of 63.1% decreased 260 basis points compared to the prior year, mainly due to product and geographic sales mix, the divestiture of our blood screening business, and a full quarter of sales from Cynosure products, which carry a lower gross margin. Total operating expenses of $274.9 million increased 19.9%, primarily due to the inclusion of Cynosure expenses for the full quarter. But if you back these out, we demonstrated good operating leverage, with total expenses declining by 4.2%. As a result, operating margin was 29% in the quarter. This was 480 basis points lower than a year ago due to product and geographic sales mix and the blood screening divestiture. However, our profit 7
profile remains among the best in the medical technology industry, and we have nice opportunities to boost operating leverage going forward. To round out the discussion of the income statement, net margins of 18% decreased 220 basis points compared to a year ago, as negative mix was partially offset by a lower effective tax rate. All this led to non-gaap earnings per share of $0.50, at the high end of our guidance range. Despite the divestiture of the very profitable blood screening business, EPS declined by only a penny, so we are doing a good job of filling the earnings hole with growth in our base business and Cynosure. Specifically, Cynosure contributed $0.02 to EPS this quarter, so we have already achieved the accretion goal we established when we announced the deal. If you back this out, along with a penny from blood, non-gaap EPS in our base business grew by 11.9%, much faster than sales. Before we talk about our updated guidance, I ll quickly touch on a few other key financial metrics, beginning with the balance sheet. Total debt decreased $201 million compared to the prior year. Of note, we repurchased $200 million in principal of our convertible notes for $269.1 million, reducing their future dilutive impact. Our leverage ratio, net debt over EBITDA, currently stands at 2.6 times, and we remain comfortable around this level. One reason we are comfortable with our debt load is that we continue to generate strong cash flow. This quarter, free cash flow was $180.1 million on a normalized basis, excluding the large tax payment we made related to the gain on the sale of the blood screening business. So combined with our revolver, we have plenty of capacity to continue pursuing small tuck-in acquisitions and eliminate our remaining convertible debt when the notes become callable in fiscal 2018. Finally, adjusted EBITDA of $260.7 million decreased slightly compared to the prior year, as improvements in our base business were offset by the divestiture of blood screening. Now let s turn to our updated non-gaap financial guidance for the full year and fourth quarter, beginning with our full-year revenue guidance. We are reducing our full-year guidance mainly due to expectations for lower Cynosure sales in our fiscal fourth quarter. While we have made good progress in stabilizing and strengthening the US sales force, we know it will take these reps some time to get up to speed and for our other commercial initiatives to kick in. In addition, the overall medical aesthetics market experiences a seasonal slow-down over the 8
summer months. So, our guidance implies a significant decrease in Cynosure revenues compared to the prior year, when sales were roughly $106 million. All in, we now expect reported revenue of $3.04 to $3.055 billion in fiscal 2017, representing reported growth of 7.3% to 7.8%. Based on recent exchange rates, this equates to high-single-digit constant currency growth of between 7.9% and 8.4%. If you were to back out Cynosure and blood screening, we continue to expect solid, mid-single-digit growth in our core franchises. With only one quarter remaining in our fiscal year, this annual guidance implies revenues of $785 to $800 million in the fourth quarter. Compared to the prior year period, this range reflects revenue growth of 8.0% to 10.1% on a reported basis, or 8.3% to 10.3% in constant currency terms. For modeling purposes, let me remind you of two things that will affect our fourth quarter results. First, as we discussed when we initially gave guidance for the year, we have one less selling day in the quarter versus the prior year. We estimate this will depress our growth rates by 70 to 80 basis points or so. But at the same time, we are due a multimillion-dollar royalty payment from one of our diagnostics partners, which will boost our molecular line. Now let s move on to our revised EPS forecast. We are slightly raising the midpoint of our non-gaap EPS guidance for the full year to a range of $2.00 to $2.02, which implies reported growth between 2% and 3.1%, and constant currency growth between 3.0% and 4.1%. So we are growing non-gaap earnings for the year despite losing a net $0.22 per share from blood screening. Please note that while we will continue to see blood screening revenue throughout the year as we fulfill our contractual obligations to Grifols, these sales will be much smaller than in recent quarters, and have essentially zero impact on EPS. This earnings guidance is based on recent foreign exchange rates, a full-year tax rate of 30.5%, and diluted shares outstanding of approximately 288 million for the full year. This full-year guidance translates to non-gaap earnings per share of $0.48 to $0.50 in the fourth quarter. This represents a decrease of (3.8%) to (7.7%) on a reported basis, and (3.4%) to (7.2%) in constant currency, due primarily to the divestiture of our blood screening business, partially offset by the acquisition of Cynosure. As you update your forecasts, we would again encourage you to model around the midpoint of our guidance ranges, as we ve incorporated both upsides and downsides into our forecast. 9
Before opening the call for questions, let me summarize by saying that we delivered on our revenue and EPS commitments in the third quarter. Our results highlight the progress we have made in building vibrant molecular diagnostic and international businesses over the last couple of years. At the same time, we re-energized our R&D efforts in breast health, and are strengthening our commercial capabilities in medical aesthetics. We remain bullish that these efforts will pay off as we move into 2018. With that, I will ask the operator to open up the call for questions. Please limit your questions to one plus a related follow-up, then return to the queue. Operator, we are ready for the first question. 10