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We have reaffirmed our Neutral recommendation on Hologic (HOLX - Analyst Report) with a target price of $21.00.

The company’s third quarter 2012 adjusted earnings of 35 cents per share were ahead of the Zacks Consensus Estimate by a penny, though revenues of $470.2 million were short of the consensus estimate. The reported quarter was challenging for Hologic with economic uncertainties in Europe, slower sales cycles and increasing pricing pressure. Apart from margin erosion on European sales, revenues were impacted by more than $4 million because of these headwinds.

Breast Health is the biggest segment of the company which contributed 45% of revenues during the reported quarter. Within this segment, sales of Dimensions continued to gain traction and represented 71% of digital mammography revenues and 60% of units. Although product revenues in the third quarter had slowed with shift in orders from 2D systems to the 3D tomosynthesis systems, the number of 3D systems in the domestic backlog increased 76% sequentially. Besides, tomosynthesis upgrades represented approximately 25% of total tomosynthesis unit sales in the third quarter.

Based on installations made till the third quarter, the company has achieved 45% of its goal to place 500–700 3D systems (and targeting 60% at the end of fiscal 2012) in the US within the first two years of approval. Moreover, we are encouraged to note that the company has already achieved the 60% target after taking into account units in backlog (that will be shipped in the fourth quarter). We believe that a favorable reimbursement decision for tomosynthesis, likely next year, should further drive growth. Moreover, clinical results from some key studies are expected to be published by the end of 2012.

Meanwhile, Hologic’s Diagnostics business is expected to strengthen with the acquisition of Gen-Probe. This franchise recorded 10% growth with three-fourth coming from core diagnostics businesses, primarily ThinPrep pap test and the balance coming from molecular diagnostics products. We are also encouraged to note that the launch of the Cervista HTA system has been well received in the US market, with 30 units in the domestic market already installed, resulting in positive customer feedback.

We are encouraged by Hologic’s focus on the international market that contributed 27% of its revenues during the reported quarter, up from 25% in the prior quarter. Revenues from this region increased 21% or 25% after considering unfavorable currency. Despite the persistent economic uncertainties in Europe, Hologic has been building its international infrastructure and fortifying management resources, particularly in the emerging markets of China, Latin America, the Middle East and Eastern Europe.

Recently, Hologic receivedan unfavorable ruling in a patent infringement suit with Smith & Nephew (SNN - Snapshot Report). The suit involved the sale of MyoSure tissue removal device, which was included in Hologic’s portfolio with the acquisition of Interlace Medical.

Our neutral recommendation is backed by a Zacks #3 Rank (‘Hold’) in the short term.

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