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Intrinsic Value is all-important and is the only logical way to evaluate the relative attractiveness of investments and businesses.
Good afternoon, and welcome to the Hologic Incorporated Second Quarter Fiscal 2018 Earnings Conference Call. My name is James, and I'm your operator for today's call. Today's conference is being recorded. All lines have been placed on mute.
I'd now like to introduce Mike Watts, Vice President, Investor Relations and Corporate Communications, to begin the call.
Thank you, James. Good afternoon, and thanks for joining us for Hologic second quarter fiscal 2018 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 today, then we'll have a question-and-answer session.
Our second quarter press release is available now on the Investors section of our newly redesigned 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 for 30 days.
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 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 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 to GAAP can be found in our earnings release. Finally, any percentage changes that we discuss will be on a year-over-year basis, and revenue growth rates will be expressed in constant currency unless otherwise noted.
Now, I'd like to turn the call over to Steve MacMillan, Hologic CEO.
Thank you, Mike, and good afternoon, everyone. We appreciate you joining us to discuss Hologic's financial results for the second quarter of fiscal 2018.
Our results were solid overall. Total revenue finished above our guidance range, and earnings per share met our expectations. On the other hand, we are writing down the value of Cynosure and lowering our annual revenue guidance based mainly on a reset of expectations for that business, which we'll discuss more in a moment.
As a quick overview of our second quarter results, revenue of $789.3 million grew 10.3% on a reported basis, or 8.3% in constant currency. Excluding the impact of the Cynosure acquisition and the blood screening divestiture, both of which occurred in the second quarter of last year, revenue increased 4.8%, or 2.6% in constant currency. This was in line with the assumptions underpinning our last guidance.
In terms of geography, our international business again demonstrated robust growth in the second quarter. International revenue exceeded $200 million for the first time and increased 28%, helped by the contribution of Cynosure. Even excluding Cynosure and blood, international sales increased 15.1%, with broad based strength across our various divisions and regions.
In the United States, revenue of $588.5 million increased 3.3%, again primarily due to the acquisition of Cynosure. Excluding Cynosure and blood, U.S. revenue was basically flat.
In terms of divisional performance, our Breast and Skeletal businesses performed well in the second quarter. Diagnostics sales were a little soft as anticipated as we believe fewer women had regular checkups in January and February due to weather and the severe flu season. Surgical sales declined again in the quarter, as expected, although we are seeing early signs of improvement.
As for Cynosure, the business is stronger today than at any point since we bought it. But at the same time, it's now clear that given the almost complete rebuild we've had to do with the U.S. sales force, we will not meet our original expectations for the business. As a result, we booked a significant write-down this quarter and are resetting our short-term revenue expectations, while maintaining the firm belief that Cynosure 2.0 will be a consistent growth engine for the future.
Given these moving pieces, in my remarks today I'll try to put our divisional revenue result in the context of how we see the company from a strategic perspective. If we go back to 2014 and 2015, the dramatic turnaround that our team executed relied mainly on better domestic commercial execution. We knew we had clinically differentiated products and succeeded in driving their market shares to very high levels in the United States.
More recently, we began layering in contributions from new products that were emerging from our revitalized R&D pipeline. And last year, our efforts to build strong international foundations began to bear fruit. Also last year, we divested our blood screening business and acquired Cynosure to shift our portfolio toward higher growth markets.
As we survey the company today, we are very pleased with the positioning of our Breast Health business as well as our international growth prospects. We have successfully managed through fears of a cliff in 3D placements, and have transformed our international business from a start-up to a vibrant growth engine.
Given these successes and all the good things that we see happening in Cynosure and Surgical, we are confident that these businesses are also improving in similar ways. Cynosure and Surgical are classic examples of what some of you heard me say, that sometimes the underlying capabilities of an organization are better than the numbers reflect. Said differently, it's common that, during transitions, the numbers will lag the foundational progress that's being made, and that's what we believe is happening at Cynosure and Surgical today.
One reason I'm confident of this is the organizational change we made in December when we eliminated the position of Chief Operating Officer. This was a major shift in how we run the company. The executives who lead our primary businesses and regions now report directly to me, which brings me closer to our end markets and the sales teams that I value so highly.
In addition, we have formed an expanded global leadership team to promote greater alignment and faster decision-making across our organization. I'm energized by this new structure because it enables me to drive an even greater urgency for organic and inorganic growth, and it's helping the entire organization return to a level of activity and speed of decision-making that characterize the early days of our turnaround.
With that introduction, now let me focus on the four areas I mentioned before: Breast Health, Cynosure, Surgical and international. Breast Health, our largest business, outperformed again in the second quarter. Global Breast Health sales totaled $300.1 million, a solid increase of 4.9% compared to the prior year period.
The U.S. business was essentially flat compared to the prior year period while international sales grew a robust 27.6%, marking our third consecutive quarter with growth over 20%. This performance reflects the tremendous progress we have made in building a sustainable growth engine through both organic and inorganic means, including the acquisitions of two of our European distributors.
As I mentioned, we are pleased with the strategic positioning of our Breast Health business. Today, Hologic is much more than a company that sells mammography capital. Instead, we have built a diversified, increasingly global Breast Health business around the core of our Genius 3D mammography systems. And increasingly, growth is coming from new products, software and service even as capital placements in the mature U.S. market level out. In fact, domestic 3D gantries represented only about one-fourth of total Breast Health sales this quarter.
We continue to feel great about ongoing market share strength in mammography, fueled in part by new products. For example, we are seeing good adoption of our new 3D Performance mammography system, which enables us to convert lower volume customers cost effectively. And late in the second quarter, we received full FDA approvals for our new 3Dimensions platform, the world's most technologically advanced 3D mammography system.
Of note, the new and improved hardware and software of 3Dimensions, which enable higher resolution images and increase patient comfort, are backwards compatible with most of the Genius systems we have sold over the last several years. So, we can further smooth the boom and bust cycles of the past by driving upgrades to the several thousand Hologic 3D systems in the field, while continuing to replace thousands of remaining 2D gantries with new Genius systems.
We are also pleased with the progress we've made with our interventional breast business. As we have introduced new products that enable us to participate more broadly in the clinical continuum of care and as our sales force has sold our portfolio more effectively, interventional has emerged as an additional growth platform for the company.
In the second quarter, sales of interventional breast products increased 10.3%, based in part on solid U.S. uptake of our new Brevera breast biopsy system, which improves biopsy workflow and the patient experience. In addition, sales of our new Affirm prone biopsy system continue to grow.
Now, let's turn to Cynosure, our Medical Aesthetics business. Cynosure sales were $85.5 million in the second quarter, an increase of 11.5% compared to pro forma results in the prior year period, when Cynosure was an independent company for most of the quarter. On a sequential basis, Cynosure sales declined versus our first quarter results, reflecting the seasonality that we discussed in our last call.
As I mentioned upfront, we are very disappointed in the write-down related to our acquisition of Cynosure. While we remain optimistic about the market and our growth prospects, it is clear now one year after closing the transaction that we will not achieve the revenue goals contemplated in our deal model. As many of you know, we had an unusual amount of churn in the U.S. sales force, both pre and post close, which was highly disruptive to the business and clearly set us back.
As we sit here today, roughly two-thirds of the domestic sales force is new in the last year, with many having been hired just in the last 60 to 90 days, as we needed to get managers in place before adding new reps. In many respects, delivering the results we have over the last two quarters, with only a partial sales organization, actually gives us more confidence that as the team comes up to speed we will see much brighter days ahead. I spent time with this team a couple of weeks ago, and the spirit, commitment and talent have me excited about where we're headed despite where we've been.
Nonetheless, to acknowledge our much lower starting point, we are resetting revenue expectations for Cynosure today. We believe this will give us a more realistic set of targets against which we can hopefully outperform and, at the same time, reduce the outsized focus on a single franchise that represented only 11% of sales in the second quarter.
We firmly believe Cynosure is on the right track, just like we knew that Kevin Thornal would get international on the right track when we sent him to Europe in early 2016. We know we have to prove it. But Kevin and his new management team are settling in at Cynosure, and their confidence is building.
Let me discuss a few of the positive developments that underpin our confidence. First, we have significantly increased the size and, more importantly, the quality of our domestic sales force compared to a few quarters ago. Our new leaders are now acting as talent magnets for positions at all levels, and attracting top talent from leading companies. And while most of our new reps will need six to nine months to get fully up to speed, they are already winning business, which is an encouraging sign.
For example, a new sales leader played a central role as we won a significant new SculpSure contract with LightRx. LightRx is one of the nation's largest medical aesthetics providers, and conducted an extensive analysis of competing non-invasive fat products before choosing to expand its use of SculpSure. While revenue will play out over time, the agreement represents an important confidence booster for potential SculpSure customers and even our own reps.
Momentum is also building for SculpSure in other areas. Patient ratings on RealSelf, which is an influential website for the aesthetics industry, have increased dramatically and are now on par with our primary competitor. Patient interest and referrals have increased significantly based on our DTC efforts, and customers are noticing.
The final reason we are encouraged about Cynosure's prospect is the strong launch of TempSure Envi, our new radiofrequency platform that minimizes facial fine lines and wrinkles, tightens skin through soft tissue coagulation, and improves the appearance of cellulite. TempSure got off to a good start even with a sales force that was operating at far less than full strength in the quarter. As our sales force matures, we believe that TempSure will be an important growth driver, especially if we roll out new applications in women's health and general surgery. We also expect TempSure will become a great example of how to win the right way in Medical Aesthetics. We will do this by creating long-term value for our customers and by leveraging our scale, stability and strength to gain sustainable competitive advantage in a fragmented industry.
Now let's shift over to Surgical which posted sales of $99.4 million in the second quarter, a decline of 3.2%. MyoSure had a good quarter, posting growth of 12.3% and surpassing quarterly NovaSure sales for the first time. But NovaSure sales declined by 16.3%. As we said in our last call, we expected Surgical to be down in the second quarter. But recent ordering patterns continue to support improving trends in the back half of the year as new leadership makes a difference, comps get easier, and our revamped sales and marketing efforts take hold.
MyoSure and NovaSure remain the leading brands in their categories by far, and our commercial efforts are designed to emphasize their many advantages. We believe that educating customers about the many advantages of NovaSure has helped market share trends stabilize. For example, you might have seen recently a new peer reviewed publication that highlighted better outcomes for NovaSure patients than with a new competing procedure. In addition, a recent survey of more than 700 OB-GYNs showed that 57% of physicians who try that new product had discontinued their use of it and returned to another ablation device. Of these, 87% of doctors return to NovaSure, the clear market leader.
As we discussed last quarter, we are also taking steps to boost growth in what has been a declining endometrial ablation category. For example, we are partnering with actor and director, Aisha Tyler on a direct-to-patient campaign called We Hate Heavy Periods, to help overcome the stigma associated with discussing menstrual health. We are working to ensure that the one in five women who experienced abnormal uterine bleeding know that reliable, minimally invasive treatments are available, and that they don't have to suffer in silence.
Before I turn the call over to Bob, let me touch briefly on another nice success story, the growth of our international businesses. Even excluding Medical Aesthetics and blood screening, OUS sales increased a robust 15.1% this quarter, our fifth straight quarter of double-digit growth. And if you include contributions from Cynosure which we have now integrated into Hologic's regional management structure, OUS revenue cracked $200 million for the first time in the second quarter.
To put this in perspective, international is now larger than our domestic breast imaging, molecular diagnostics and cytology franchises. So we've made really nice progress compared to what was basically a start up just a few years ago. And importantly, our performance in the second quarter was driven by broad based strength across divisions and countries, which gives us confidence that international growth is sustainable over the long term.
So to wrap up, our financial results were solid in the second quarter. Revenue exceeded our guidance and EPS was in line with expectations. We are pleased with the second quarter performance of our largest division Breast Health, as well as the progress we are making internationally. And while we are disappointed with the reset on Cynosure, many signs emerged that show we're on the right track there and in Surgical as well.
Now I will hand the call over to Bob.
Thank you, Steve, and good afternoon, everyone. Today in my remarks I'm going to highlight some of our other divisional sales drivers, walk through our second quarter income statement, touch on a few other key financial metrics, and then I'll finish with our updated financial guidance for 2018. Unless otherwise noted, my remarks will focus on non-GAAP results, and percent changes will be on a year-over-year basis in constant currency. Steve already highlighted our Breast Health, Surgical and Cynosure businesses, so I'll start my discussion with Diagnostics.
Global Diagnostics sales of $279.7 million decreased 7.6% in constant currency. Removing the impact of our divested blood screening business, diagnostics sales grew 1.8% against the toughest comp of the year for the core business. As we alluded to on our last call, we believe U.S. diagnostics result in January and February were affected by severe weather and a terrible flu season that reduced well-woman visits. As evidence of this, our Diagnostic sales per day declined in January and February compared to prior year periods, but rebounded nicely in March.
Diagnostics growth was once again led by molecular diagnostics, where global sales of $150.7 million increased 4.4%. In the United States, where we enjoy very high market shares in our key assay categories, molecular sales grew 2.5%. International molecular diagnostics grew a healthy 15% based on strength across our Aptima women's health test as well as in products.
Moving on to cytology and perinatal. Global revenues of $117.7 million declined 1.4%. We are the undisputed market leader in cytology with our ThinPrep liquid Pap test and are proud of the role that more than 650 million pap tests since introduction have played in dramatically reducing deaths from cervical cancer.
Our product advantages and customer relationships have enabled us to gain significant market share over the last several years. But as a reminder, it's harder to drive incremental gains from these high levels and we continue to face headwinds from longer cervical cancer screening intervals in the United States. Rounding out Diagnostics, blood screening revenues were $11.3 million in the quarter, higher than expected as we continue to fulfill our obligations to Grifols following the divestiture of the business.
To wrap up the revenue discussion, Skeletal Health, a division that doesn't get much attention due to its small size, posted revenues of $24.6 million, an increase of almost 10% in constant currency. Growth was evenly distributed between DEXA products and services where interest is increasing and body composition testing for human performance and our new fluoroscopy system.
Now moving down the P&L. Gross margins of 62.7% declined 120 basis points compared to the prior year. This was due primarily to geographic mix, as our international sales carry a lower gross margin percentage than sales in the U.S. Gross margin was also negatively affected by the sales mix specifically they divestiture of the blood screening business and sales of lower margin Cynosure products.
Total operating expenses of $266.9 million increased 19.7% in the second quarter, mainly due to the inclusion of the Cynosure costs. If you were to back out Cynosure operating expenses, our base business declined in a low-single digit rate reflecting the very deliberate efforts to control costs and drive operating leverage. Our operating margin of 28.9% declined 380 basis points due to product and geographic mix, as well as the divestiture of our blood screening business and the addition of Cynosure.
And finally, net margins of 18.7% decreased 120 basis points as the negative mix factors I discussed previously were partially offset by improvements in our non-GAAP effective tax rate mainly as a result of U.S. tax reform. All of this led to non-GAAP earnings per share of $0.53, an increase of 6% compared to the prior year. As a reminder, the prior year period still included the month of regular revenue and profit from blood screening prior to the divestiture.
Now before we move on to guidance, I'll quickly touch on a few other key financial metrics. During the second quarter, we took advantage of volatility in our share price to opportunistically repurchase our common stock. Specifically, we bought back 2.8 million shares for a total of $106.5 million. This left just under $200 million remaining on our current share repurchase authorization at the end of the quarter. In addition, while this activity technically fell outside of our second quarter I'm pleased to announce that as of last week, we are officially free and clear of our convertible debt. Retiring this highly dilutive debt provides us with a much stronger balance sheet and reduces variability in our diluted share count.
At the end of the second quarter, our leverage ratio net debt over EBITDA stood at 2.7 times, a comfortable level for us. And finally, adjusted EBITDA of $248.2 million in the second quarter declined 3% compared to the prior year as improvements in our base business were offset by the divestiture of blood screening.
Now I'd like to shift gears and discuss our non-GAAP financial guidance for the full year and the third quarter. In conjunction with our re-evaluation of the Cynosure business, we are resetting expectations for near-term revenue in Medical Aesthetics, and this is the primary factor driving a reduction in our 2018 revenue guidance.
As Steve discussed, we remain confident that Cynosure is on the right track, and we see several tangible signs that the business is improving. However, it's clear now that this improvement is taking longer than expected so we wanted to establish a more realistic set of baseline assumptions for Cynosure that we can hopefully beat rather than chasing a number and fueling controversy in the stock every quarter.
More specifically, although we expect to see sequential improvement in Cynosure revenue in the third quarter, we don't believe the business will return to year-over-year growth until the fourth quarter of this year. As a result, we expect Cynosure's full year revenues in our fiscal 2018 to be down materially versus the $390 million the company posted on a pro forma basis in the prior four fiscal quarters from October of 2016 to September of 2017.
If we look at the rest of Hologic, our revenue forecasts haven't changed much in aggregate since our last guidance. As a result, we now expect full year revenue to range from $3.18 billion to $3.21 billion with reported growth rates between 4.0% and 4.9%. Based on recent exchange rates, this translates to constant currency growth of 2.7% to 3.7%, and organic growth in the low-single digit range.
As a reminder, we are defining organic revenue to exclude blood screening for the full year and Medical Aesthetics for the first two quarters of fiscal 2018. And as we discussed last quarter, organic revenue growth also adjusts for fewer selling days in 2018 and non-recurring royalty revenue in our Diagnostics business.
Despite the change in our revenue guidance, we feel confident in our ability to control expenses, as well as the multiple ways we can drive leverage within the P&L. As a result, we remain committed to our previously communicated earnings per share guidance range of $2.22 to $2.27, which represents reported growth of between 9.4% and 11.8%.
In addition, we expect that cash flows will remain strong. We continue to forecast the free cash flows this year in the mid-$600 million range, excluding the non-recurring tax recapture payments associated with retiring our convertible notes. This updated full year guidance is based on diluted shares outstanding of roughly 280 million for the full year, and an effective tax rate of approximately 23%.
Now, let's turn to guidance for the third quarter of fiscal 2018. We expect revenue of between $795 million and $810 million, which reflects a decline of 2.8% to a decline of 1% on a constant currency basis. On a reported basis, our guidance reflects revenue ranging from a decline of 1.4% to growth of 0.5%.
On the bottom line, we expect EPS of $0.55 to $0.57 in the quarter, which implies growth rates of between 10% and 14%. As you update your estimates, we would again encourage you to model around the middle of our guidance ranges as we have incorporated both upsides and downsides into our forecast.
Before we open the call for questions, I'd like to conclude by saying that we posted solid results in our fiscal second quarter led by our Breast Health business and our International franchises. These businesses are well-positioned to drive future growth given the strategies we have in place, and we enjoy durable leadership positions in many other product categories as well. The tremendous progress we have made across multiple fronts since 2014 has enabled us to retire all the convertible debt we inherited, completing a major financial initiative and resulting in a much stronger balance sheet.
We remain confident that Cynosure is headed in the right direction, but are deeply disappointed in the write-down this quarter as well as the reduction in our full year revenue guidance. The revenue growth rates implied in the back half of the year are clearly not what we aspire to, although it's worth emphasizing that we are maintaining our guidance for EPS growth this year and remain a strong generator of cash as well.
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.
Thank you. And we'll take our first question today from Doug Schenkel with Cowen.
Hey, guys. Good afternoon. We appreciate all the helpful details on Cynosure. But of course, like others, I want to dig in a bit deeper. Last quarter, it sounded like you felt like you were making pretty solid progress with the sales force and that you were seemingly on track. We definitely got that sense as well at our conference when we had the fireside chat with you intra-quarter. So, could you provide a bit more detail on what changed for Cynosure, certainly, over the past quarter and, to some extent, over the last few months? And related to that, is the guidance reduction entirely due to Cynosure sales force changes or is there something broader here? For instance, are there some market dynamics in play that maybe you didn't appreciate fully even a few weeks ago?
Yeah, Doug. It is not market dynamics. It is very much – we feel like we're making good progress with the sales team. But at the end of the day, we were expecting a huge ramp in the second half of the year. And I think as we budgeted and everything else and really went back and looked through our mid-year forecast, I think it's unrealistic in terms of what we were expecting for the second half of the year. But feeling – there is no difference in how we feel from the time we were at your conference to now, other than the ramp going forward. But I think at the end of the day, we delivered in the quarter, frankly, within the range about what I thought we would. But I think the ramp that we had implied in the second half of the year was just way, way beyond what we're going to get to.
Yeah. I guess that's kind of the crux of the question, right? I mean, not to be difficult here, but I'm sure you appreciate that, that one thing that you're talking about as being the one thing that changed is kind of the most important thing that's changed. So, what did you see happen in the quarter that you didn't appreciate even a few weeks ago?
Nothing happened in the quarter that we didn't appreciate a few weeks ago, other than really thinking more about the true trajectory going forth. We just delivered $91 million, frankly, in the first fiscal quarter, call it, $85 million and change this quarter, which is frankly very consistent with the seasonal declines you see. Feel good about where we're going. But again, our original guidance for the year implied a much, much stronger ramp, especially in that second half of the year. But I think the team is settling in very, very well. I was just with the sales force a few weeks ago. I think the true churn that occurred in the sales force was just far bigger than we ever imagined, but do feel very good about the leadership and the people we have in place now.
Yeah, Doug, I think, in addition to that, as the teams were settling in, I think we've learned a lot more around the ramp.
Yeah.
And so, we were expecting a much more significant ramp. And as the teams have come in, in this last quarter, I think we've got a better understanding and a better handle on that. And hopefully, we've put ourselves in a situation where we can get into a situation where we can beat and raise, and are looking at this as a conservative number as opposed to chasing the number.
Yeah. Yeah, Doug, just to add one more point. This was only Kevin Thornal's second quarter of actually running the business. And I know it seems like forever, trust me he's a very large shareholder in this company and myself. And where we are, it seems like forever in terms of what we're doing in terms of the turnaround here. But at the end of the day, even as Kevin has gotten in and gotten a lot deeper into the business, much better handle on where that trajectory is going.
Next we'll hear from Jack Meehan with Barclays.
Thanks. Good afternoon. So in Diagnostics, how much do you think the Easter flu weather impacted the quarter? And can you talk about the competitive environment with some of the new products whether you think those are starting to resonate?
Yeah. Jack, hey. This is Bob. I'll answer the first part of your question in terms of the impact. Quite honestly, it's really hard to know. But what we can say is based on some data that we have that well-woman visits in January and February declined at high-single digit rates in the U.S. versus year ago. So we do think it had a decent impact on our business and we saw in March where it actually rebounded and improved a bit.
And on the new products, I think we're getting some nice progress on those in the uptake. And so far they're still small relative to the overall size of our STI platform, but we're seeing nice feedback certainly from Fusion as well as some of the new products, the Virals and some of the other new products that we have globally.
Great.
We've always said that those are – yeah, I'm sorry. We've always said those are primarily going to be a growth driver in 2019.
Got it. And then a two parter on Breast Health. International, great results. Maybe just talk about what the drivers were there. And then in the U.S., recent MQSA data month-to-month, but just talk about some of the recent placement trends? Thanks.
Sure. International, I think, we are thrilled with the progress we're making. And I'd also remind everybody since we have Kevin Thornal running our Cynosure business, he's the one we sent in Europe a couple of years ago and it was a train wreck. And he totally put all the foundational elements into place that are paying off today for international business. Country by country, we are winning more tenders. Our dealers are more engaged. We also did pick up our dealer in Germany as well as Spain and are winning more accounts since those are now owned by us than they used to win – winning more tenders than what they did when they were standalone dealers. So, just feeling great about the foundational progress that has been built over there.
Regarding the MQSA data, I'd remind everybody, there's always little variations. And particularly there was a change in methodology that occurred in April where the FDA is now basically having the ACR, certify the machines. We think that may have resulted in more volatility than usual on the most recent number.
Having said that, we feel great about what we are doing in the Breast Health business. And I'm so proud of our team. The market shares we continue to garner, particularly in the United States on 3D, is well beyond, I think, what anybody, ourselves included, could've imagined a couple of years ago in a very competitive market. What our teams are doing there, and not only driving additional gantries and winning so many competitive customers over to us, but then building out that product line. Our interventional business being built out, the service business, the software, and if you see, again, that whole cliff that everybody was so concerned about a couple of years ago under Pete Valenti and our team in the U.S., they have really, really started to change that curve and feel very good about both what they've done and where we're headed.
Next, we'll hear from Vijay Kumar with Evercore ISI.
Hey, guys. Thanks for taking my question. Steve, if I had to maybe draw an analogy, it's been an interesting season so far. One of – your peer company from your former life, they took their numbers and the stock actually went-up because the feeling was it was clear when you went for it. And I think what some of the hoarders are questioning is especially looking at quarter stock is in the aftermarket, has the guidance been reset? Like, what's the comfort level that this has been now reset and we won't have any more disappointments going forward?
Sure, Vijay. It's a great question. Glad you asked it. We feel very good. We don't like the reset. And candidly, we have a lot of debate of do we go as low as we do? We wanted it to be a clearing event. We wanted to get the numbers down as painful as it is. We know there's been a huge overhang and there's been such an obsession with Cynosure. And I would tell you, as I sit here today I have two very mixed feelings. One is I am disappointed because we never like to do this to have to write down and take guidance down. On the other hand I much more confident in our outlook of where we're going. And I fundamentally believe business by business, we have every business getting stronger and going on the right track. So it's – and I know that's a weird juxtaposition of emotions. But as I sit here – I know having been with the Cynosure sales team, that market is still a great market. We are increasingly getting the team together. And I don't think people fully understood even though we've talked about it, the gaping holes we had in that sales team. So now as I'm starting to see people getting the wins together. really feeling very good. And my – frankly, I think our hope was this would be the clearing event to try to get the obsession around Cynosure monthly number, quarterly numbers behind us to where we're not going to be missing and we're going to get into a good place going forward.
No, understood. And maybe, Bob, one on the guidance. The EPS, I'm kind of having a hard time getting to the range. Is there something below the line maybe on the tax rate for the year which went down, which maybe perhaps – and explain such as given the guidance cut on the top line and what we saw from a margin front in the Q?
No. The tax rate is pretty consistent across the quarters. What we have said is, we were taking some investment – the opportunity to make some investment as a result of the tax rate reduction earlier in the year, and we're actually managing some of the rate or the take down through OpEx reductions. So we're not making – we've made some investments. We were planning to make more. We're actually probably scaling some of that back to ensure that we've got the strong foundation, because we didn't deliver all of the EPS earnings potential as a result of the tax rate reduction to the bottom line when we first gave guidance.
Isaac Ro with Goldman Sachs has our next question.
Good afternoon, guys. Thanks.
Hey, Isaac.
On Cynosure – hey. Could you tell us when we might be able to expect meaningful new product launches? And the reason I asked is SculpSure got a 510(k) clearance in 2015, and 2016 was a good year for Cynosure so clearly that product cycle has an immediate and significant impact. So you said that the business might need some refreshing in the portfolio. It would be helpful to know kind of when we might expect that.
Yeah. I think TempSure just launched in this last quarter. So I think part of what gives us increasing confidence of where we're headed is the TempSure launch is off to a very nice start. And it will have additional applications that will be coming over time, so it may not have the incredible spike. SculpSure was probably an unusually large huge uptick. But I think the fundamental strength of TempSure feel really, really good about where that's going. And the initial sell-in, frankly we're very, very pleased with.
Okay, thanks. And just a follow-up on capital allocation. Obviously, this is one of the more significant transactions under your tenure and it's been obviously a little disappointing to start. So how has that informed your appetite for future deals? I think in prior quarters you've said that you're still interested looking at bolt-ons. But I'm wondering if maybe it makes sense to pump the brakes a little bit more until you put up a couple good quarters here or if this really sort of unaffected to your view on future M&A? Thanks.
Isaac, obviously, we're incredibly disappointed. And therefore it does affect how we think about it going forward. But really, what it comes down to is we now want to be really focused as we'd like to be on true tuck-ins that supplement our existing businesses. So, that's where we're very focused, much smaller deal size than obviously Cynosure. That was an unusual opportunity. But at the end of the day, we're very focused now really by division. That added a new division to us. Now, all of our focus is within the existing divisions.
And the other piece I would say is, I'm much more closely driving the inorganic, the business development propositions by having the division presidents reporting directly to me, and feel very good that we're both making go and no-go decisions faster in the process. And I do think – I hope to see some small little things that will be coming forth over the course of the year, but clearly on a very different scale.
Next, we'll hear from Bill Quirk with Piper Jaffray.
Great. Thanks. Good afternoon, everybody.
Hey, Bill.
Hey, Bill.
So, I guess I think I know the answer to this first question, but I'm going to throw it out there anyway, Steve. It sounds like – did I hear it correctly that you finished hiring out or building out, I should say, the sales team for Cynosure, so all those seats are filled and now it's kind of a bit of a waiting game to get them up the curve?
Yeah. It's not fully built out, but I'd say we're 90-ish percent there now. And it is. And I would say it's – while it's – I'd probably say it's less about waiting for them to get up to speed. We're training them in a different ways much more aggressively. We're seeing some of them starting to hit the ground running and getting their sales far faster than what we might have usually expected. And that's what gives us a good outlook. I think coming back really to an earlier question two of we haven't wanted to take debt by a thousand cuts. We wanted to survey the situation long enough, have Kevin in this role. He's been reporting directly to me now for the last four months. I think we have a very good handle on where the business is going, what's going on, and figured, okay, let's just take it down and then we build from here.
Understood. And then just, I guess, kind of thinking a little longer term, Steve, about the business with new products like TempSure as well as the ongoing competitive dynamic. Once we kind of get through the period of getting these guys up and running, trained, productive, how should we be thinking about the longer term kind of pace of the segment? Should we be thinking about this as double-digit type of revenue growth once we get beyond this interim period here?
Absolutely. That's how we're thinking about it, Bill. This is still the fastest-growing market of any market we compete in. And as you know, with us, every market we compete in, we play to do very well and grow faster than the markets. And I fully believe we will be there in the exact same place over time.
This is a product-driven, relationship-driven, sales force-driven business, just as our other businesses. We've had a little bit of an extra learning curve in this particular one. But there is nothing in it that says we can't compete and do exceptionally well. We also see it still – despite obviously a major competitor in Allergan, the rest of the business is still very – the rest of the industry is still very fragmented. And we see big opportunity still over time that will also be an area for tuck-ins and things like that once we have the sales force well established. And that's exactly where we're going to be focused.
Our next question comes from Tycho Peterson with JPMorgan.
Hey, Steve. Can you talk more about the strategy to get GYN Surg growing again, other than easy comps and new leadership? And on the competitive front, you did – publication has been asked if you retracted, so I'm just wondering whether you're willing to comment on that at all as well.
Yeah. I'm very, very happy that you asked that question. It will not be retracted. We feel very good about the underlying way that that study was done. So, feel really, really good about that.
And you said other than easy comps and leadership, I'll go with the second one. Other than leadership, well, leadership is what it's about. And this is another one that we replaced the President, the VP of Sales, three of the four regional leaders and more than half of the managers, all in the last nine months, and feel really, really good about where that business and those leaders are going from a competitive standpoint. You see, MyoSure started to pick back up this quarter. We're watching the underlying trends and feeling good that that business has come down.
We said back in January at your conference, I said, hey, we're going to be in for a few rougher quarters. If you look, our first quarter was down, call it, 8%; this quarter, down 5-ish. I think we may still not – we'll likely still be down a touch maybe this quarter. And I think by the time we exit the year, exactly as we said at your conference in January, I think we'll be back to growth and moving in that right trajectory. But as I acknowledge, I think we fell asleep at the switch a little bit too long. We were slow making leadership changes in that division, and our teams are fighting back now.
Okay. And then, a follow-up on Cyno, for Bob maybe. Was the entire guidance cut from Cyno? You said it was primarily Cyno, so I just want to make sure there's not something else that's changing in the assumptions. And then, does the write-down have implications on the level of reinvestment you're willing to make on that business around DTC and other areas?
Yeah. I'll take the second question first. The answer on that is no, it doesn't affect the level of investment. The write-off is really a reflection of, hey, we've got a much lower base than it was originally contemplated in our model and it's going to take us longer, but we're still expecting growth in that business and we'll invest behind that.
In regards to the takedown, the majority of it – vast majority of it was Cynosure. We took that down multiple tens of millions of dollars, as you can expect or as you can imagine, relative to the forecast that we had built in. There are some small changes relative to probably Diagnostics with the not getting back, the January and February, but those are small.
I would add one other thing on the piece with NovaSure. I think not only the clinical results that have come out and were published, but also some of the survey, I think we've given our sales organization more tools to be able to be much more competitive in the marketplace. So, it's not only new leadership, it's also new tools to actually get out there and provide. And then with NovaSure ADVANCED that's been out, really driving that as well.
Jon Block with Stifel has our next question.
Great. Thanks, guys. Good afternoon.
Hey, Jon.
Hey, Steve. I'll ask two quick ones. First, just on the gross margins. The gross margins were a bit below what we were looking for specific to fiscal 2Q. And so, Bob, maybe if you can talk about, was that specific to one division versus another? And then, how should we think about gross margins going forward? And then, I just got a quick follow-up.
Yeah. So, there wasn't any one-time discrete event in there. It was really a result of probably two things, geographic mix with our international business really driving that and then product mix within the divisions. I would expect that to be flat to slightly improving over the rest of the year. As Surgical comes back to growth, that's a very highly – a very accretive gross margin business. And then, actually as the U.S. business and Cynosure, that also has a much better gross margin than overall Cynosure as a whole. So, we do think that that will help – kind of help with gross margin going forward, and we've obviously got our continued productivity model programs as well.
Okay. Great. And then, I think I've got this number right, but the 15.1% international growth, call it, ex Cyno and blood, can you approximate what the organic growth was, sort of if you exclude some of the recent distributor tuck-ins, if you can quantify that? Thanks, guys.
Yeah. This is Bob. That was still roughly double-digit total.
Thank you. Next, we hear from Derik De Bruin with Bank of America.
Hi. Good afternoon.
Hey, Derik.
Yes. So, a question or two. So, I appreciate the fact that when you revamped the European sales force, you sent Kevin over there and you were able to turn it around. But when I look at that, it's because I think Hologic certainly has very good technology, very differentiated products and certainly there is a medical need for those products. So – and the same thing in Surgical, I can certainly understand how the sales force coming in, a new management coming in is going to do that. That isn't really the case with Cynosure. I mean, there's not a lot of medical need for it. There is – the publications around it are a little bit choppy in terms of what it is. It's like – so, my question is, it's like, where the same playbooks work given that you're trying to go into a market which is a little bit fuzzier than what you're normally going after?
Yeah. Fair question, Derik. I look at it slightly different. While the medical need is traditionally defined might not be as big, there is huge demand. And the people who want these procedures and the docs providing them, there's a lot more data and the opportunity to drive data. But at the end of the day, this is about great products and great sales people. And that's really what drives this business, and building long-term customer relationships. So, that is not that different than what we can do. And we know, we just got to go prove it. We will.
I mean – and have you seen any traction at all in the OB/GYN market for MonaLisa?
Yes, yes. And again, we think that particularly with additional clinical data over time and our sales force, we're seeing some new customer interest in that product and do feel very good about where that will go over time, and also that that will be the leading edge frankly to help a lot of OB/GYNs get into cash pay, everything else. We always said we didn't do Cynosure for 2017 or 2018, we did it for the long haul. We know patience is thin right now on it, but we're incredibly focused and, frankly, only the coming quarters, what we say now probably isn't going to matter a lot, but I'm very confident we'll be putting those points on the board as we go forward.
Operator, I think we have time for maybe one more question.
Thank you. Our final question will come from Brian Weinstein with William Blair.
Hey, guys. Thanks for taking the questions. And just to follow up a little bit on that last question. There's a lot of talk obviously within Cyno about what's going on in – on the body category, and you mentioned a little bit here on OB/GYN. But there's other parts here, the skin part is well. Can you just talk about where it is that you're really seeing the deficit here relative to what you originally thought? Is it all on that body side? Is it that the OB/GYN's a little bit less or is the skin not coming through kind of where you thought? And can you also address, if you wouldn't mind, what your longer term margin expectations are for the business? I understand – I recognize that you're still thinking longer – double-digit growth in the outyears, but how do you think about the profitability of this business going forward? Thanks.
Sure Brian. The first part is the deficits that we see are less byproduct category than they were the gaping holes where we didn't have sales people on the streets. And again, we keep trying to emphasize, there were a lot of holes in the sales force, we just didn't have people showing up. And therefore every product line was that – we had areas that had virtually very few sales at all. So, it's – the gaps we're looking at are far more by territory than by product line. As we go forth and we're starting to see it, as we're putting people back in those territories, we're seeing SculpSure, we're seeing TempSure, we're seeing Icon. We're seeing all of the categories start to get the lift back up for the things.
Ultimately, profitability over time, we think it's going to take some time. The gross margin will be slightly dilutive to the company here in the nearer term. Long-term, can that be at the company average? We certainly would hope so. Operating margins today are very, very small, so that will be an opportunity over time. I think that'll still take multiple years before that gets to a – an operating margin that is not dilutive to the company.
Thank you. That is all the time we have for questions today. This now concludes Hologic's second quarter fiscal 2018 earnings call. Have a good evening.