Hologic's (Nasdaq:HOLX) difficult midlife crisis continues. With its core cervical cancer screening business struggling in response to new recommended testing intervals and the 3D tomo mammography business slow to ramp up, Hologic is a distressing mix of sluggish organic growth and a debt-laden balance sheet. While some investors seemed encouraged by the company's move to bring back its former CEO, there's a lot of work to be done to carve out an attractive growth path for this company.
A Sluggish Fiscal Q3, With Realistic Guidance
It has been a little while now since Hologic has reported a strong organic growth quarter, and this quarter continued that trend. Although results were in line with the company's prior announcement, guidance is going down again, albeit to a level that doesn't appear to shock the market.
Revenue rose 33% as reported this quarter, but organic growth was only on the order of 2%. Diagnostics led the way in terms of absolute revenue and reported growth, with 87% reported growth. Underlying performance was more modest, as ThinPrep sales declined 6% while core Gen-Probe sales were up 6% on an adjusted basis. Breast health sales rose 9% as tomo sales doubled, while GYN Surg revenue increased 1% (adjusted) and skeletal revenue increased 2%.
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There weren't many surprises on margins, but nor was there much improvement. Gross margin ticked up about a half-point, with reported operating income up 36% and the operating margin up about 80bp.
In light of the slow ramp of 3D tomo, the sluggishness in GYN Surg, and the declines in ThinPrep, management adjusted guidance lower for the next quarter. Revenue is going down about 4% relative to prior expectations, with EPS guidance down about 17%.
Meet The New Boss, Same As The Old Boss
Prior to this earnings release, Hologic announced that it was making a change in the CEO position. Whatever the “personal reasons” that led now-former CEO Robert Cascella to step down, the board brought back former CEO Jack Cumming for the same role.
This is a good example of a mixed blessing. Mr. Cumming has come in with guns blazing, talking about a comprehensive business/portfolio review and clearly looking to explore ways of increasing the company's capital returns to shareholders (dividends and buybacks). But let's not forget that Hologic made a series of questionable deals during Cumming's former tenure, including Third Wave (which the company largely failed to develop to its potential) and Cytyc.
It's also not obvious to me what Mr. Cumming can do to affect significant near-term improvements in the business. The GYN Surgical business could likely be sold to a company like Johnson & Johnson (NYSE:JNJ), Boston Scientific (NYSE: BSX), Cooper (NYSE:COO), Covidien (NYSE:COV), or Bard (NYSE: BCR), but I doubt it would bring in even $1 billion. Likewise, the company probably could find a buyer for the skeletal health business, but it's not going to make much of a difference.
So what else can be done? I can't imagine the company giving up on the growth opportunities in breast health, with the 3D tomo ramp still in its early days. Whether or not this market can live up to bullish hopes of a $4 billion-plus opportunity, and whether or not GE (NYSE:GE) and Siemens (NYSE:SI) ultimately close the gap with Hologic, this is a business worth continuing to try to grow (and the 23% sequential increase in Hologic's tomo backlog was a positive).
Likewise, it would be exceptionally bold to see the company do something major with the diagnostics business. The company's non-exclusive deal with Quest (NYSE:DGX) should help build up the Aptima assay line and I wouldn't rule out the possibility that Hologic could be a player in hepatitis C testing down the line. Still, rivals like Qiagen (Nasdaq: QGEN), Becton Dickinson (NYSE:BDX), and Roche (Nasdaq: RHHBY) won't give them any breathing room.
The Bottom Line
This could be the bottom for Hologic. The 3D tomo business has yet to really ramp up and the company is going through a tough transition with its ThinPrep business. Even so, it's hard to go above 5% or 6% for long-term revenue growth outside of a real sign that 3D tomo acceptance is growing in the market. That leads to a roughly $22 fair value today, but I definitely acknowledge that there's an opportunity for this company to do better and for the numbers to head higher as (or if) ThinPrep stabilizes, Gen-Probe continues to grow, and 3D tomo takes off.
Disclosure – At the time of writing, the author owned shares of Roche