Artivion, Inc. (AORT) Q1 2015 Earnings Report, Transcript and Summary

Greetings, and welcome to CryoLife First Quarter 2015 Financial Conference Call. At this time, all participants are in a listen-only mode. A brief question-and-answer session will follow the formal presentation. [Operator Instructions]. As a reminder, this conference is being recorded. I would now like to turn the floor over to management.

Good morning. This is Ashley Lee. Before we begin, I'd like to make the following statements to comply with the Safe Harbor requirements of the Private Securities Litigation Reform Act of 1995. Comments made in this call that look forward in time involve risk and uncertainties and are forward-looking statements within the meaning of the Private Securities Litigation Reform Act of 1995. The forward-looking statements include, statements made as to the Company's or management's intentions, hopes, beliefs, expectations or predictions of the future. Additional information concerning risk and uncertainties that may impact these forward looking statements is contained from time-to-time in the Company's SEC filings and in the Press Release that was issued this morning. Now, I'll turn it over to Pat.

Thanks, Ashley, and good morning to everybody. And thanks for joining the call today. This morning, I will cover the following four topics. First, significant developments in quarter; second, a high-level summary of our first quarter results; third, an update on our key initiatives for 2015; and fourth, the strengthening of our management team. Following my comments, D. Ashley Lee, our CFO, will provide detailed review of our first quarter financial results and provide an updated 2015 guidance. We will then open the line for Q&A. There were three significant developments for the company in the first four months of 2015. First, the FDA spent two weeks in early March conducting a re-inspection of our facility and reviewed all 483 observations from the previous inspection conducted in March of 2014. I am very pleased to report that we passed the FDA re-inspection with no 483 observations and that the FDA has lifted our Warning Letter confirming that all items in the warning letter were closed. I am very proud of our team for their commitment to the continued enhancement of our quality systems. As you all know, this has been my top priority since I joined the company eight months ago. And this positive result illustrates our underletting focus on producing the highest quality products for our patients. The second positive development was the enrollment of our first patient in the PerClot IDE pivotal trial. This is an important milestone for CryoLife in our efforts to expand litigation for our products. We enrolled the first patient in the trial earlier this week at Indiana University. We continue to work to bring other trail sites online in the coming months and we estimate that we will complete enrollment in the trial in the first half of 2016. With a three month follow-up period, we are on track to gain U.S. FDA approval for PerClot in cardiac, general, and urological surgery, in the second half of 2017. As we reported in March, we were enjoying from selling PerClot Topical in the U.S. by the District Court's ruling on the preliminary injunction motion filed by C.R. Baird Subsidiary, Medafor. As required by the court's ruling, we immediately see selling PerClot Topical in the U.S. and we have adjusted our 2015 guidance to reflect this development. Ashley, will provide more details regarding the adjusted 2015 guidance later in the call. While we were disappointed with the court's ruling, we continue to believe that we have a strong case, and we remained focused on securing the best long-term outcome in this litigation for our shareholders. To that end, we have appealed the court's decision regarding injunction and the appeals process is expected to take most of the rest of 2015 to run its course. In the meantime, we expect that activity and the resulting legal spend on the broader patent infringement lawsuit will decrease significantly, while the appeal is pending. Turning to the quarter, this morning we reported revenues of $33.8 million for the first quarter, down 5% year-over-year. There were three factors that contributed to the decline. First, the anticipated impact of decreased tissue availability resulting from our recent quality initiatives; second, our decision to go direct in a major European country; and third, the continued strengthening of the U.S. dollar in a change in the timing of distributed orders. Ashley will provide further details about the quarter during his remarks. On the positive note, TMR revenues were up 27% for the quarter, HeRO revenues were up 15% on the quarter, and PerClot was up 7%. Additionally, our launches for ProCol and PhotoFix are going well. So we continue to generate revenues or we generated revenues close to $200,000 in each of those product lines in the first quarter. During the quarter, we continue to make progress on the key initiatives that I laid out during our last conference call, with several opportunities for growth and value creation over the next few years. The four key areas that we are focusing on are one, to improve our quality systems and resolving FDA Warning Letter; two, building momentum for our recent product launches ProCol and PhotoFix; three, increasing our global product and distribution footprint; and four, expanding indications for key products particularly, with PerClot Surgical IDE clinical trial, as well as the BioGlue indication expansion in Japan. First, I'll begin with an update on the quality systems. As I mentioned earlier in my comments, the Warning Letter is now closed, and we will now be focusing on our efforts to improve the efficiency of tissue processing operation, while at the same time sustaining the major quality enhancement that we have made. We've already identified several key initiatives in the tissue processing operation that will increase tissue supply as we move through 2015. We expect that these initiatives will be completed during Q2 and Q3 and fully implemented as we enter Q4. We believe that we should be able to realize significant positive benefits from these initiatives in the second half of 2015 and are committed to delivering the full-year tissue guidance that we provided on our last call. Second, on the new product front. The initial feedback has been excellent. We launched ProCol in late 2014 and during the first quarter we achieved approximately $200,000 of revenue. For those of you who may not be aware ProCol is a complementary product to the HeRO Graft and the treatment continuum for end-stage renal disease, after a failure of a synthetic graft. We believe that our ProCol product, which is comprised of bovine mesenteric vein is -- were also processed using a proprietary method offers a significant advantage over synthetic graft failure. ProCol is proven and effective and we expect continued surgeon adoption and sales growth in the coming quarters. In January, we launched the PhotoFix Bovine Pericardial Patch in the U.S. and our team has already achieved key wins in the pediatric market and received favorable surgeon feedback. We recorded approximately $200,000 of sales of PhotoFix during the first quarter. Surgeon feedback during my site visits at the FDS meetings have been extremely positive, as surgeons are excited about the availability of PhotoFix for their patients. Our teams are working to gain approval for PhotoFix in Europe and we are in the process of evaluating a pathway to use PhotoFix in the U.S. carotid endarterectomy market. Once the full product line is available, we believe PhotoFix has the potential to become a leading product in $30 million market for biological patches using cardiac and vascular surgical applications. Our third key initiative is increasing our global product and distribution footprint. And we revealed in our last conference call our plans to transition a major country in Europe from distribution to a direct sales model. As Ashley will outline, this had a near-term impact on our 2015 international revenue, as our distributor sell down their inventory before we launched direct operations in Q4. However, once we are operating under the direct distribution model there, we will benefit from the transition to direct sales pricing in margins, with greater control over the sales strategy, initiatives for the team, and further product launch synergies. At this time, we have not committed to transition any additional markets but it is something we consider on a case-by-case basis and in the future we believe there is a strategic benefit to doing so. The fourth initiative of our strategy is expanding indications for products in our portfolio. Our biggest opportunity for midterm growth is the expansion of the U.S. indication for PerClot into general surgery, cardiac surgery, and neurology surgery. Now that we have initiated enrolment in the trial, we believe that we are well-positioned to receive FDA approval in the second half of 2017. Another indication expansion opportunity is BioGlue in Japan. The current indication for BioGlue in Japan is only for aortic dissections. With the new expansion, we would broadly use BioGlue to all cardiac and large vessel procedures, essentially doubling the market opportunity. We are continuing to work through our distribution partner and with MHLW in Japan, exploring an approval for the second half of the year. The final topic I want to cover is the strengthening of the CryoLife leadership team. I've made two new additions to the leadership team since the beginning of the year. As we've announced earlier this month, I added Jean Holloway as our new General Counsel. With her extensive legal experience and talent in the medical device industry, Jean is an important addition to our leadership team as we continue to execute on our growth strategies. Jean was previously the General Counsel for C.R. Bard a Fortune 500 Company. I also worked with Jean at Medtronic, where she was a Deputy General Counsel. In addition, yesterday, we announced the addition of a Seasoned Industry Executive, Bill Matthews, as our Senior Vice President of Operations, Quality and Regulatory. In his previous consulting role, Bill worked very closely with CryoLife management team and me during the preparation for FDA re-inspection, and was instrumental in achieving a no 483 observation and the lifting of the Warning Letter. Bill brings over 30 years of senior level experience in quality, regulatory, and operational leadership for Major Corporation. Bill's knowledge and unparalleled expertise in operational management integration, new technology startups, and the FDA, will contribute significantly to our company during his transformative time. I'm very confident both Jean and Bill will add to their capabilities. I will now turn the call over to Ashley for a detailed overview of first quarter results and the updated 2015 financial guidance.

Thanks, Pat. This morning we reported our results for the first quarter of 2015. The following factors influenced our first quarter performance. Total company revenues decreased 5% to $33.8 million for the first quarter, driven by an 11% year-over-year decrease in tissue processing revenues, and an 8% decrease in BioGlue sales. As Pat previously mentioned, the primary contributing factors were decreased tissue availability, the conversion of a distributor to a direct sales model in a major European market, foreign exchange, which has resulted in both currency translation issues and affected orders from our OUS distributors to order in U.S. dollars, and a change in the timing of distributor orders. Focusing on geography revenues, our first quarter international revenues were $6.8 million, down 18% compared to the first quarter of 2014. International revenues accounted for 20% of our business in the first quarter. The decrease in the international revenues was driven by the transition to a direct sales model in a large European market and the effects of foreign currency, which has affected our distributor ordering patterns and volumes in several large OUS markets. Our domestic revenues decreased 1% for the first quarter of 2015, compared to the prior year. The decrease was primarily driven by decreased availability of tissues, mostly offset by the recent launches of ProCol and PhotoFix, and increases in TMR, HeRO, and BioGlue revenues. Focusing on individual product lines, worldwide BioGlue revenues in the first quarter decreased to 8% year-over-year, slightly more than expected, driven primarily by a decrease in international revenues, partially offset by an increase in domestic revenues. HeRO Graft revenues increased 15% to $1.9 million in the first quarter of 2015, compared to $1.6 million in the first quarter of 2014. The increase was driven by increased adoption of the HeRO Graft in both domestic and international markets. PerClot sales increased 7% for the first quarter of 2015, compared to the first quarter of 2014. The increase was due primarily to sales of PerClot Topical in the U.S. prior to the injunction. Revenues from our TMR product line increased 27% in the first quarter of 2015, compared to 2014, which resulted primarily from a 28% increase in hand piece volume. Tissue processing revenues were down 11% for the quarter, compared to the prior year, which is down slightly more than we expected, while our tissue processing gross margin also decreased year-over-year for the first quarter. Tissue processing revenues were down due to processing changes resulting from our efforts to enhance our quality systems. These changes have resulted in a temporary decrease in processing capacity and reduced availability of certain high demand tissues. The net result is that our revenues decreased due to the lack of availability and our cost have increased, which is reflected in our lower tissue processing gross margins in the first quarter of 2015 compared to the first quarter of 2014. However, as Pat mentioned previously, we have several key initiatives underway that we believe will begin to significantly improve availability of tissues in the third quarter. Gross margins for the quarter were 58.1% compared to 62.9% last year. We previously disclosed that we expected overall gross margins to be affected by lower margins in our tissue processing business and the effects of foreign currency. In addition to those factors, gross margins in the first quarter were adversely affected by a write-off of approximately $500,000 of PerClot Topical inventory, which amounts to about 1.5% of quarterly revenue. SG&A expenses were $19 million for the quarter, up from $18.3 million last year. The first quarter included $443,000 in legal expenses associated with our patent infringement lawsuit, a charge of $457,000 to write-off certain PerClot Topical intangibles assets and $468,000 charge related to a severance. We had a tax benefit in the first quarter of 2015 of $1.5 million and we currently estimate our 2015 effective tax rate to be approximately 85%. With our bottom-line guidance projected to be near breakeven, it is difficult to accurately predict our 2015 effective tax rate, which can change significantly during the year based on what may seem to be minor changes in projected 2015 pre-tax income. We will continue to update our 2015 effective income tax rate, as facts and circumstances change during the year. As of March 31, 2015, we had $38.2 million in cash, cash equivalents, and restricted cash and securities. We continue to carry no debt and expect to continue to generate operating cash flow. And now, for our updated guidance for 2015. We expect total revenues to be between $148.50 million and $150.50 million, which is down slightly compared to our previous guidance. This reflects the removal of approximately $1.75 million in PerClot Topical revenues and the estimated effects of the continued strengthening of the U.S. dollar. We continue to expect revenues from our higher margin product segment to increase in the mid-single-digits on a percentage basis for the full-year of 2015, and we expect our tissue processing revenues to grow low-single-digits on a percentage basis for the full-year of 2015 as compared to 2014. We still expect our gross margins in 2015 to be around 60% for the full-year. We expect research and development expenses to be between $13 million and $14 million in 2015. Earnings for the full-year of 2015 are expected to be near breakeven, up from our previous guidance. This guidance includes a charge of approximately $1.2 million in the second quarter for the recent retirement of our Executive Chairman. Our guidance does not include the impact of any ongoing or future business development activities. That concludes my comments, and I'll turn it back over to Pat.

Thanks, Ashley. Now we open up the call for questions. Operator?

Thank you. We will now be conducting a question-and-answer session. [Operator Instructions]. Thank you. Our first question comes from the line of Tom Gunderson with Piper Jaffray. Please proceed with your question.

A small question. I understand it's pretty much standard operating procedure when you go from a distributor to direct, that there's this lag period where they burn off inventory. When -- did you say when you expect to be direct? Is that a third-quarter event, or how long do we have this lag?

Ash, I don't know if we communicated when we expected its going to affect.

I think we have previously. We're looking at October 1, right now, to go direct in that major market.

Got it, thanks. And then, Pat, kind of a convoluted question; I apologize ahead of time. But I was going to ask you about management, but you went through that, and obviously the FDA clearing the Warning Letter is good. Can you tie in may be the hiring of Bill, and I think you also got a regulatory guy. I don't know if it was a promotion or an outside guy. And talk about the ongoing quality system improvements that you've got going at CryoLife.

Yes. Well, it's not that convoluted because your question is a good one. Bill Matthews, who we just announced yesterday was our -- is going to be our new Head of Operations, Quality and Regulatory. He was brought in even before I joined the company back in the June timeframe. And he has been a senior partner in a firm that kind of solely focuses on companies that are in a situation of a Warning Letter. So he comes in, brings a team of X -- typically X FDA employees, and then, we basically worked together over the last seven or eight months since I've been here going through every subsystem of the quality system. And in that experience of working with Bill, it was very clear to me that he is an expert in the field of quality. If you look at his kind of background, he has worked for major Fortune 500 companies in the areas of quality and regulatory, as well as operations. So I think we -- if you ask somebody, a year ago the company got a 18 item 483 on the re-inspection for the Warning Letter. And to go one year later and have no 483 observations at all is a major accomplishment. And the whole team at CryoLife accomplished that and Bill was instrumental in that. And I felt bringing him in would help us to one, build upon what we already have. But our quality systems are in very good shape and we're going to continue improving them. And as you heard Ashley say, we're now going to start working on getting the efficiency in the tissue processing area those have been a little bit bogged down since we've been still focused on the quality. And that's very doable that we can actually improve efficiency and maintain and sustain the quality.

Got it. And then thanks for that. And then, as long as you brought up tissue and initiatives, you are improving the quality. That was kind of a step back on availability for the customer, and so you can now go forward. But you mentioned some key initiatives that are planning. In the past you have talked about may be increasing the yield by identifying the material that goes into the system as being approvable or not. I'm not using the right word but I'm just curious -- are those initiatives that you thought originally as far as improving yield going forward?

We look at -- we're actually looking at a number really across the whole continuum of kind of the supply chain for tissue processing. I mean the first thing is, we -- may be I surprised you but we haven't brought in a new organ procurement group in five or six years. And the reason for that is the inefficiency in the tissue processing line. We have now, as I said, once we got the quality established, we're now shifting gears to focus on productivity and efficiency and there is a number of initiatives in getting the tissue processing lab more efficient. That allows us to actually bring in more procurement from turning on new procurement organizations. We're probably going to see a 30-plus-percent improvement in efficiency and productivity in the tissue processing lab. The point you mentioned was really on the back-end after you process the tissue, you trying to use some sophisticated statistical analysis to predict which tissues are going to be most likely to yield a higher outcome than not and that work is going on as we speak. So there is initiatives going on at bringing in more procurement organizations, there are issues going on improving the efficiency of the processing lab, and there's initiatives going on, on the back-end of the QA quality inspection to make sure that you yield as much tissues you possibly can. And in totality when you combine all that together, we feel pretty good that this will improve our situation going forward, while at the same time maintaining or even improving the quality.

Got it. Thanks. That's it for me.

[Operator Instructions]. Our next question comes from the line of Jeffrey Cohen with Ladenburg Thalmann. Please proceed with your question.

Could you talk about the PerClot trial and the timing a little bit? So you started enrolling; I guess the first center will pop up on clinical trials at some point. But you said that you expect to be fully enrolled by first half of 2016. Why do you anticipate it's going to take a full-year to enroll that out over 15 centers?

Yes. It's just -- I mean, to me it's one of those things that -- I mean, I've had a lot of experience with clinical trials and I always wonder why it takes so long. But there is pretty significant process from going through the hospitals IRB system, getting the contracts reviewed, training the center, screening the patients, getting the patients in the queue. I mean this is a pretty involved process. So we've got one center obviously in the Indiana University is live, they've gone through all the process and they're now starting to enroll and we're already -- patients are already lining up there. We've got three centers that are kind of through the IRB process and are getting ready to enroll. We've got another I think six that are in the process of moving through that cycle. So they're kind of phased in over time. Once you get all your centers up is when you obviously your enrollment picks up pretty significantly. The good news is there is lots of procedures in each of these areas. So that's not going to be a limiting factor. The other piece that's good is there is only a three month follow-up. So we don't have to wait a year like a lot of trials for the result. So we're just going to be very focused on the getting centers through the process from IRB, to contract approval, to train, to enrolling and the more we get those up and running the faster the trial will enroll. So I think that's a pretty -- if you look at a clinical trial of this size with this number of patients that's a pretty aggressive timeline, I think it's doable but it's not -- this is not kind of a sandbag timeline.

Got it, okay. As far as the country that you are transitioning from a distributor to direct, can you give us a sense of the size of the market of your revenue that the country has played over the past couple of years?

Yes. So I would say that as a distributor this is a country that's probably been in the $3 million dollar range and when we go direct at the end user level that will go up by 70%. So that will be more like a $5.50 million to $6 million country. So as was asked earlier, I mean the challenge when you do this is there is only a couple ways to address with the current existing inventory. We obviously don't want the distributor dump inventory on the market. So we made a decision to work with that distributor to kind of burn the inventory down and have a reasonable transition. The good news there is, we have already -- we are in the final stages of signing that agreement and also, we basically got the entire sales team that was our distributor sales team, is going to be -- is committed to be working with us. So the transition should be almost like flipping a switch and we're going to move to get that. As Ashley said, October 1 is the date and we're hopefully -- we will be able to do that a little bit sooner if possible.

Got it, okay. Now, a couple clarifications. Ashley, you were talking about $1.5 million tax benefit, and then you said something about 85%.

That's correct, Jeff. And again, we're currently projecting to be near breakeven on the bottom-line in 2015 and on -- at breakeven or very low levels of income considering permanent items and tax credit and so forth your effective tax rate can vary widely so. Our best estimate at this point is 85% it's likely to change as circumstances change throughout the year. And we'll just do our best to keep you updated on a quarterly basis at -- where we expect to be for the full-year.

Okay. And as far as next quarter, you talked about $1.2 million in severance. That will come out of G&A, correct? SG&A?

That's correct.

Okay. And then lastly, if you could provide any commentary, either of you, on the M&A front, or any follow-on product developments, or any new developments that are ancillary to your current portfolio.

Yes. I think the one -- there is a couple things I would say. One, this -- I had mentioned this in my remarks. I think this PhotoFix product is -- this is a bovine pericardial product we -- was a partnership that the team had struck before I got here, but I think that has proven to be a very, very unique product. We have plans. All we have now is one, kind of one size in the U.S. and its lot of very high interest in the pediatric world. We are looking at bringing that as a Company -- and my comment and my remarks. We're looking at getting that product in the Europe with a CE mark. We're looking at getting larger sheets and we're also looking at the entry into the carotid endarterectomy market. And I think the combination of those is going to be a nice -- that's going to be nice offering for us. And those things are in our plans and I commented that on the last call. On the M&A front, I mean we're obviously actively looking at things and we looked at a lot of things and we've got a pretty high bar as far as what we want to see when we look at an acquisition. Some of the screens that we are using is we want a very high-end physician preference product. I don't want to buy commodity type products. So something that a physician actually cares about, high margin, typically higher margin that we have, higher growth that we have, and something that we think has got a future either it's a new market with a lot of growth or it's a product that has a competitive differentiating feature to allow share capture in a bigger market. So if you apply that screen that's a pretty tall order. And we've been looking at a lot of things. And yes, good news is, there is lot of things out there, but that's about as far as I can go with as what were the types of things we're going to be looking at. And as soon as we -- if we have something down the road, we will obviously let people know when we get to that point.

Okay. Super. Thanks for taking the questions.

Thank you. It appears we have no further questions at this time. I would now like to turn the floor back over to management.

Yes, well, listen, thanks for joining the Q1 call. Obviously, we are very pleased with the clearance of the Warning Letter, we are very pleased with the first moment in our PerClot trial, we are pleased with some of the new management additions. We obviously got some work to do on the tissue front, which we're committing to hit the year-end numbers. And we're working hard to make sure we deliver the numbers that we put out there. We've adjusted the guidance for the injection and we're going to appeal that. And we've also had a little bit of headwinds on FX, which should be news to anybody. So on balance, we put our new guidance out there. We are committed to delivering it and look forward to the next call and updating you on our progress. Thanks again for joining.