Artivion, Inc.
Q4 2008 Earnings Call Transcript

Published: 19 Feb 2009

[Operator:]

Good morning ladies and gentlemen and welcome to the CryoLife Fourth Quarter and Year End 2008 Financial Conference Call. (Operator Instructions) It is now my pleasure to introduce your host Mr. Steven Anderson, President and Chief Executive Officer of CryoLife. Thank you. Sir, you may begin.

[Steven Anderson:]

Good morning everyone, this is Steve Anderson, CryoLife’s Chairman and CEO. I would like to welcome you to CryoLife’s Year End 2008 Conference Call. This morning I am joined by Ashley Lee, the company’s CFO, Executive VP and COO, as well as Dr. William Northrup, the company’s VP of Medical Relations and Education. Today we are augmenting our presentation with slides. You may access the slides by logging on to the website and then clicking on the Investor Relations heading, then under that heading click on to web casts and presentations and you will then be able to see the slides. This morning we reported a record revenues and earnings for fiscal year 2008. Our revenues were $105.1 million as compared to $94.8 million for the same period last year, an increase of 11% year-to-year. 2008 was the best cardiac year for the company since 2001. This represents the 8th consecutive quarter of profitability for the company. The agenda for today’s call is as follows

[Ashley Lee:]

Thank you, Steve. To comply with the Safe Harbor requirements of the Private Securities Litigation Reform Act of 1995, I would like to make the following statement

[William Northrup III:]

Thank you, Ashley. I would like to begin with an update on the CryoValve SG. As disclosed previously this week by the company, the FDA has cleared a new claim for the CryoValve SG pulmonary human heart valve. All references in this presentation to CryoValve SG refer to the pulmonary valve only. The new labeling claim relates to reducing a component of the immune response and recipients of the CryoValve SG whose pulmonary valve is replaced during a Ross procedure or during reconstruction for a congenital heart defect. For those not familiar with the technology, CryoValve SG pulmonary human heart valve is processed with the company’s proprietary SynerGraft technology, which is designed to preserve the integrity of the support structures of the valve while removing the donor cells and cellular remnants that stimulate antibody production. In the same way that protective antibodies are formed after exposure to various vaccines, similar destructive antibodies are typically formed after transplantation of foreign tissue or organs and from mismatched blood transfusions. Any level of any pre-transplant antibodies induces the risk of rejecting future tissue and organ transplantations and patient mortality. In addition, high and prolonged antibody levels may prevent or delay transplantation until a suitable cross match compatible donor is identified. Three slides from our FDA submission supporting this claim will be used to illustrate the significance of this new claim. In the first data slide we can see the typical development and persistence of what are called panel reactive antibodies, or PRA, in response to the surgical implantation of an allograft heart valve. Time and years is shown on the horizontal axis on the bottom and percent is shown on the vertical axis on the left hand side. The intensity of the antibody response over time is shown in the upper graph with a greater than 50% intensity of the PRA test by one year remaining above 25% intensity up to six years after surgery. A negative response would be considered 10% or lower. As can be seen from the lower graph, 75% of these patients with allograph transplants developed these antibodies and kept them for up to six years. In the next slide we see a similar comparison of the intensity of the response for the two specific classes of antibodies measured by the PRA test; with time and months on the horizontal axis on the bottom and percent reactivity on the vertical axis on the left hand side. In this case we are comparing the standard CryoValve with the CryoValve SG, where it can easily be seen that for both classes of antibodies the standard CryoValve induces the typical antibody response at or above the 50% level by three months, while the CryoValve SG barely reaches the 10% level of reactivity, below which is considered negative and is unsustained, as demonstrated by the rapid return below this threshold level before eight months. Finally, in the next slide we can see a side-by-side bar graph comparison of the percentage of patients developing Class I and II antibodies following implantation of a standard processed allograft heart valve in four different studies on the left and the CryoValve SG in three different studies on the right. Percentage of patients with antibodies is on the vertical axis on the left hand side. Clearly, a much lower percentage of the CryoValve SG patients formed antibodies than the standard CryoValve patients. Based on this data, all evidence regarding the CryoValve SG pulmonary human heart valve indicates

[Steven Anderson:]

Thank you, Dr. Northrup. On January 19, the company celebrated its 25th anniversary. Since the inception we have processed tissues from over 100,000 donors. We think this is an industry record. Over the past 25 years we have shipped about 160,000 allografts’ for use in reconstructive procedures. During this time CryoLife has become the world leader from the preservation of allograft heart valves and allograft vascular conduits. We are developing a 25th anniversary booklet that reflects on the doctors and their patients who have benefited from the use of implanted cryo preserved heart and vascular tissues as well as BioGlue. If you are interested in receiving a copy of the 25th anniversary booklet, you should log on to the CryoLife website and fill out the order form that you will find on the home page. During the last conference call I told you that we had received a lengthy list of questions from our European notified body regarding the BioDisc nucleopulposis replacement device and its CE Mark submission. We are finalizing our response to their questions and anticipate submitting our updated application by the end of March. Also during the last conference call we commented on the preclinical animal testing that was being conducted to evaluate the tropic solution organ transport solution. At that time we indicated that we had not been able to achieve the results we were seeking using a porcine model and would be changing the testing to a canine model. Since the last call we have completed our feasibility animal testing of the organ transport solution. After reviewing all of the testing data, we have been unable to duplicate some of the results the inventors had reported earlier. Specifically, our research has shown that the industry standard UW solution, which served as the control for our testing, performed better than we anticipated. This in turn provided less opportunity for the tropic solutions transport solution to show significant improvement in kidney transplant outcomes. Therefore, we do not expect any significant future expenditure to develop this technology. The 2009 forecasts given to you earlier do not include any revenues for this product. Since receiving FDA clearance for the sinograph process CryoValve SG pulmonary heart valve in ‘087, there have been over 380 of these valves shipped for implant through out the US. They have been used for both right ventricular outflow tract reconstruction and in the Ross procedure. As Dr. Northrup mentioned, the SynerGraft process valves are performing well in patients and the reduction of the induced PRA levels is a significant patient benefit. The SynerGraft process heart valves carry a premium fee of about $3.500 over list. You will recollect that for the past several years we have been developing and testing BioFoam surgical matrix an expanding version of BioGlue surgical adhesive. BioFoam includes and expansion agent that increases the volume of the delivered product three to four times that of BioGlue. We have always believed that this product could have a wide spectrum of clinical uses ranging from sealing organs during surgical procedures to sealing wounds from trauma. We have worked with the Department of Defense since 2005 in the development of this product. In fact, over the past four years we have received about $3.5 million from the Department of Defense for the development of BioFoam. At the end of December ’08 we submitted an application to our European notified body for the approval of BioFoam as an agent for the sealing of organs. We expect to hear back on the status of this submission within the next month or two. When we ultimately receive CE approval, we will initiate a three center 45 patient study that will have up to a six month follow up. We anticipate the commercial launch of BioFoam will begin in Europe after the first 15 patients have been enrolled and they have completed their 30-day follow up. CryoLife management held an initial meeting with the FDA regarding BioFoam in August of ’08 to discuss our proposed clinical study. Our IDE submission was sent to the FDA in November of ’08 and conditional approval of the IDE was received in December of ’08. Our amended IDE submission will be submitted to the FDA sometime prior to the end of March. The indication for the clinical trial is for the control of bleeding during liver surgery. We will initially conduct a feasibility clinical study of approximately 20 patients, 10 receiving BioFoam and 10 receiving conventional treatment and these patients will be followed for six months. A pivotal clinical trial would be initiated thereafter. We anticipate that it will take about two years to complete both of these studies. That concluded my comments and now we will open up the call for questions.

[Operator:]

(Operator Instructions) Your first question comes from Raymond Myers with Emerging Growth Equities.

[Raymond Myers:]

My first question is it looks like the operating expenses were lower than you had guided in the third quarter and perhaps R&D was down related to the tropic solutions. But SG&A was down as well. Could you help us understand what caused that and how we should expect that to fall in Q1 and beyond?

[Ashley Lee:]

If you look at the fourth quarter, Ray, a lot of the short fall in the SG&A expenses were related to lower revenue. You know, we had less commission expense and other expense associated with pushing the product out the door, so that was partially the reason there. We also had an adjustment related to our product liability reserves in the fourth quarter of this year. Also, with the continued strengthening of the dollar, when we translated our expenses associated with International operations back to US dollars, those came back a little bit lower than we had anticipated also. So, if you go into 2009 we have guided SG&A expenses, I believe, to be between $50 and $52 million. I think that really kind of speaks for itself as to where we expect to be in 2009.

[Raymond Myers:]

How much product liability reserve adjustment was in the quarter?

[Ashley Lee:]

About $500,000.00 and all of that will be detailed in our 10-K, which we expect to file probably by the end of the day tomorrow.

[Raymond Myers:]

Okay great, we will certainly look for that. It looked like cardiac revenue was down in the quarter. I know an awful lot of that is just due to the economy, it can’t be helped, but how is that looking going into the first quarter? Are you seeing any turn around there? It was unusually low.

[Ashley Lee:]

Let me make a comment about the cardiac revenues and especially as compared to vascular revenues. What we have seen in the past is that cardiac surgeons in hospitals have been more willing to keep a supply of valves in their freezers. You know, they need a variety of sizes and because of the critical nature of the surgeries that are involved, they are more willing to carry an inventory of valves as compared to the vascular surgeon. We have seen that in the past, and especially for the pediatric heart valves, I think hospitals have been more than willing to carry a large supply of valves there. On the vascular side, because we typically have the inventory available, vascular surgeons and hospitals typically do not carry as much inventory at their facilities as do the cardiac surgeons. I think that’s why you’re seeing some of the disparity in the fourth quarter in the operating results, where the vascular revenues were up in the fourth quarter year-over-year and the cardiac revenues were down. Now, going forward, as I indicated in my comments, we see no evidence of any decrease in the procedure volumes, because, again, these are critical surgeries. There are very few options for out tissues. We haven’t seen any competitive products come onto the market place, so we think that these purchasing patterns that we’re seeing in the fourth and we’re seeing a little bit in the first quarter, are going to be transient and that at some point the demand is going to return back to the expected levels. As I stated earlier, we’re seeing, I’m not going to speak about individual product lines, but we’re seeing revenue growth in the first quarter. We expect sequential revenue growth. We expect year-over-year revenue growth and I think that our guidance on the top line for the full year speaks for itself.

[Raymond Myers:]

That’s encouraging. I will let others ask questions, thank you.

[Operator:]

Your next question comes from Greg Brash with Sidoti & Company.

[Greg Brash:]

[Inaudible]

[Ashley Lee:]

We can barely hear you; we’re getting a lot of static.

[Greg Brash:]

I’m sorry; I’m on a cell phone. I will try to keep it short. [Inaudible] in the hospitals is it something you expect to correct itself by the second quarter, especially since you’re seeing some growth here now in the first quarter?

[Ashley Lee:]

I think the first part of your question, Greg, and you were breaking up a little bit, but I think it had to do with the cardiac demand and when we expect that to return? I don’t want to go out and say, give you a definitive date. I mean we are starting to see some signs right now, but I think that we’re going to have more color by the end of the first quarter and certainly much more color by the end of the second quarter, we should know more. But again, we expect the business to be up year-over-year in the cardiac business and the vascular business.

[Greg Brash:]

Okay. Have you scaled back on any of your plans to hire sales reps?

[Ashley Lee:]

We have not. In fact, we made the decision late in 2008 where we added ten sales reps and so we’re committed to that and we don’t have any current plans to add any more sales people in ’09.

[Greg Brash:]

I’m just curious if you have any sense of what percent of your cardiac revenues are where the end user is in the pediatric market?

[Ashley Lee:]

It is 60% at least. I mean if you looked at our pulmonary valve business, which is about 40% and then the cardiac patch material which is about 20% of our business.

[Operator:]

Your next question comes from Matt Dolan with Roth Capital Partners.

[Matt Dolan:]

I have a question on this hospital inventory issues. Could you give us a little more color on what you saw throughout the quarter and maybe, if possible, into 2009, now that we are a pretty good way through February, what gives you hope that it really is an inventory issue, that you’re not seeing surgical slow down? The second part, I don’t know if you’ve commented on pricing yet, but I think in your prepared remarks you have seen little push back. I don’t know if I caught that correctly.

[Ashley Lee:]

As far as it relates to cardiac revenues, again, what we mentioned in the prepared comments and then on the comments that I made with Ray a little bit earlier; we feel pretty confident that it’s really purchasing patterns as opposed to anything related to procedure volume. Again, there are few options for these patients. These are critical cardiac procedures. We haven’t seen any new competitive products come out onto the market place and so there is just no evidence to suggest that there has been any decrease in procedure volume whatsoever. So, you know, when we look at purchasing patterns we know that a lot of the hospitals, and especially with the pediatric centers, carry a supply of these valves. Based on what we saw in the macro environment in the fourth quarter, we believe that these procedures were still being performed, but they were being performed out of existing tissue supplied. We saw that through out the fourth quarter into a little bit into the first quarter. We are starting to see some encouraging signs that things are improving, but as to when the purchasing patterns get back to normal levels, I think only time is going to tell. I think that well know more by the end of the first quarter, certainly no more than by the end of the second quarter, but again, we fully expect the demand to come back to expected levels.

[Matt Dolan:]

Okay and on pricing?

[Ashley Lee:]

On pricing we’re starting to see a little bit of push back on pricing in the fourth quarter. A lot of it, again, related to budgetary constraints that hospitals are operating under; nothing significant, but we are starting to see a little bit more of it.

[Matt Dolan:]

Okay, on SG it looks like the run rate was flat sequentially. Can you talk about how you’re doing there relative to both your ability to supply as well as demand and receptivity there?

[Ashley Lee:]

I think that one of the reasons that we are not able to continue the conversion of our pulmonary valve business over to SG relates to the one year shelf life issue and we are currently in discussions with the FDA to get an extension of the shelf life. We just don’t want to convert all of the inventory over and be stuck with some inventory that potentially we won’t be able to ship before the one year shelf life. So, we are in discussions with the FDA. We believe that when and if we get that shelf life extension, we’re going to be able to continue the conversion of that business over to SG, which will obviously result in some premium pricing and give us the ability to expand the margin a little bit on that business.

[Matt Dolan:]

Finally, on your ‘09 guidance, I think if I assume a consistent gross margin, I guess my first question would be is the gross margin you exited the year with sustainable? If you assume that, going forward it looks like you’ll have at the mid point kind of a mid teens type of operating margin. Is that a reasonable goal for this year?

[Ashley Lee:]

I will say for your comment on gross margins, and I mentioned something in my prepared comments about gross margins, because of everything that’s going on with exchange rates, with what we’re seeing on, a little bit of push back on pricing. But, the growing significance of Hemostase in our business going forward, which is a product that’s in the upper 50% range; we think that our margins are going to come down slightly from where they are

[Matt Dolan:]

Okay, thanks a lot.

[Operator:]

Your next question comes from Patrick Schaffer.

[Patrick Schaffer:]

I have a question about deferred preservation costs. It looks like they were up about 30% year-over-year and that coincided with an increase of about 250 basis points in gross margin. Are the two related?

[Ashley Lee:]

Not necessarily. I mean some of the margin expansion is related to some price increases that we implemented at the very beginning of the year. We also had the CryoValve SG that we introduced in February or March of this year, which carried premium pricing and also gave us the ability to expand our margin also.

[Patrick Schaffer:]

Okay, so you don’t think that the two are related?

[Ashley Lee:]

Well any time that you have increased through put I think it’s going to be a little bit beneficial to your margins, but is it the primary factor? No.

[Patrick Schaffer:]

Okay and do you expect this trend of increasing deferred preservation costs to increase in ’09?

[Ashley Lee:]

Well that’s an interesting question. We implemented some strategies at the very beginning of the fourth quarter of 2008, which were designed to help us optimize this deferred preservation cost balance. That included reducing procurement in certain areas, restricting criteria of incoming tissues and had we not seen the macro events that occurred during 2008 in the fourth quarter, that really led to the short fall in the top line, we would have seen a very minimal increase in deferred preservation costs during the fourth quarter of this year. So, I think that we have appropriate programs in place right now. We continue to look at programs to optimize those balances and could you see growth in the balance in 2009? Sure you could. But I think that we’ve got appropriate programs in place to manage that going forward.

[Patrick Schaffer:]

Okay, great, thanks guys.

[Operator:]

Seeing as there are no further questions, I would like to turn the call back to management for any concluding remarks.

[Steven Anderson:]

Okay, thank you very much for joining us and we look forward to talking with you at the end of the first quarter.

[Operator:]

Ladies and gentlemen, this concludes today’s teleconference. Thank you for your participation.