Artivion, Inc. (AORT) Q3 2016 Earnings Report, Transcript and Summary

Greetings and welcome to CryoLife's Third Quarter 2016 Financial Results Conference Call. At this time all participants are in a listen-only mode. A question-and-answer session will follow the formal presentation. [Operator Instructions] As a reminder, this conference is being recorded. I will now turn the conference over to management. Thank you. You may now begin.

Good morning and thanks for joining the call. I'm Ashley Lee, the CFO of CryoLife. 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. These forward-looking statements are subject to a number of risk, uncertainties, estimates, and assumptions that may cause actual results to differ materially from current expectations. 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 last night. Now I will turn it over to our CEO Pat Mackin.

Thanks, Ashley, and good morning, everyone. I'm pleased to report another strong quarter of financial and operational results. We not only posted solid financial results, we are also raising our guidance. We made substantial progress on each of our key strategic initiatives which we believe will drive continued growth in the future. Our expanded cardiac surgery sales force is increasing momentum in the market, leveraging cross-selling opportunities and expanding awareness for our On-X valves and their unique clinical benefits for patients. Given our progress in the quarter, we are confident in our ability to continue to capitalize on the opportunity in the cardiac surgery market we serve. As a result of decisions made over the past year, year and a half, CryoLife now has a more focused product portfolio, a pipeline, and business development criteria. Our strategy provides us with a strong presence in our target market, something that is typically enjoyed by much larger companies. We can now offer our customers in most cases multiple solutions for their patients. This morning I will provide an update on our progress against our 2016 initiatives, and then I will turn the call over to Ashley to provide a detailed review of our third-quarter financial results. I will conclude with my closing remarks before opening the call for your questions. Our first key initiative for 2016 is achieving our full-year 2016 revenue and EPS guidance, which we increased last quarter. I'm pleased to report that we continue to track ahead of this objective with our strong results in the third quarter. Revenue for the third quarter of 2016 was $45.3 million, representing 23% growth or 6% on a non-GAAP basis. Gross margin in the third quarter of 2016 was 66% and we delivered non-GAAP EPS of $0.13 per share. To account for our continued strong performance momentum in our markets, we are raising our full-year 2016 revenue guidance to the range of $181 million to $182.5 million and our full-year 2016 EPS guidance to a range of $0.43 per share to $0.45 per share on a non-GAAP basis. As a reminder, our non-GAAP revenues include On-X revenues for the period of 2016 prior to the closing of the acquisition and On-X revenues for the comparable periods of 2015. It also excludes revenues for the divested HeRO Graft and ProCol product lines for 2016 and 2015. Our second initiative for 2016 is realizing the potential of our On-X acquisition, with a goal of delivering double-digit percent compounded annual revenue growth over the next five years. On-X revenue during the third quarter reached $8.9 million, representing year-over-year non-GAAP revenue growth of 6%. Sales are tracking in line with our expectations and we remain well positioned to begin accelerating growth, particularly as we were able to work through the administrative requirements to get On-X into more new hospitals in the US. Interest in the On-X and its clinical benefits remains high among physicians and we expect our work in the field to expand such interest in the fourth quarter of 2016 and as we move into 2017. We also made two important hires that strengthen our ability to meet our growth objectives and leverage our repositioned and expanded sales force. Jim McDermid joined our team as the Chief Human Resources Officer and Mike Tuckerman joined as Vice President of Sales for North America. Both Jim and Mike most recently worked at Medtronic and add decades of medical device leadership experience to our team. In the US, On-X is benefiting from increased cross-selling opportunities through our expanded team of 51 cardiac sales reps. Our sales force started selling the On-X valve in the first quarter, but our official launch did not occur until September when we fully completed our product positioning messaging, related marketing materials, and sales rep training. In order to prioritize our activity, we have identified a list of the top 50 cardiac surgery accounts that have not yet adopted the On-X valve and where we are still in the process of gaining administrative approvals. Many of these accounts are already CryoLife customers and our sales team will be focused on completing the necessary steps to begin increasing sales of On-X valves in these key accounts. In Europe, our team of 25 direct sales reps had an excellent quarter, delivering double-digit BioGlue and On-X revenue growth. In the third quarter, we continue to realize the benefits in key European markets of transitioning On-X to our direct sales reps, who now dedicate their time to cross-selling our portfolio of cardiac surgery products. Our third key initiative for 2016 is driving efficiency in our tissue processing business. In the third quarter, our tissue revenues were up 2% year-over year. Our cardiac tissue processing business grew 10%, continuing the positive momentum from the second quarter. Vascu [ph] tissue revenue was down 4%. Our recent focus on the vascular side has been to improve tissue processing operations in order to meet the pent-up demand from existing customers, which we largely accomplished during the second quarter. We are now turning our attention to new customers where our market research indicates we have a meaningful opportunity to gain share. Now that our vascular tissue inventory has improved, we believe that a pathway to sustainable growth on the vascular side and to gain market share. Our fourth key initiative for 2016 is continuing to grow BioGlue in the US and international markets. Total BioGlue in the third quarter was $15.9 million, up 12% compared to the same quarter last year. BioGlue sales in North America were down 3%, primarily due to customer ordering patterns, while OUS sales were up 35%. OUS sales positively affected by the sales increases in France and Japan. Our fifth key objective for 2016 is investing in clinical programs focused on gaining regulatory approvals that will significantly expand our future market opportunities. In the US, we expect to resume enrollment in the PerClot trial in the fourth quarter. As a reminder, last quarter the FDA approved a revised study protocol that we believe will drive faster enrollment. And based on our estimates for enrollment timelines and follow-up, we believe we remain on track for FDA approval in the first half of 2019. In China, we remain on track to begin enrollment of our BioGlue clinical trial in the first quarter of 2017 and expect approval sometime in 2019. Our last key initiative for 2016 is continued business development activity. In the first nine months of the year, we have successfully repositioned the Company to focus on cardiac surgery with the On-X acquisition as well as the divestiture of the HeRO Graft and ProCol as well as the completion and integration of transition activities related to these deals. In addition, we continue to make progress on transitioning manufacturing of the PhotoFix product line to CryoLife and remain on track to complete the transition by mid-2017. In terms of additional business development, we continue to evaluate opportunities to add complementary cardiac surgery products to our portfolio and are encouraged by the prospects we have seen in the market. I will now turn the call over to Ashley for a more detailed review of our third-quarter results and our updated 2016 financial guidance.

Thanks, Pat. This morning we reported our results for the third quarter of 2016. Compared to the third quarter of the prior year, total Company revenues increased 23% to $45.3 million. This was primarily driven by the acquisition of On-X and increases in BioGlue and cardiac tissue revenues. On a non-GAAP basis, revenues increased 6% compared to the third quarter of last year. The non-GAAP revenue increase was primarily driven by improved performance in BioGlue, cardiac tissue processing, On-X, and PhotoFix. Please refer to our press release for additional information about our non-GAAP results, including a reconciliation of these results to our GAAP results. On a geographical basis, North American revenues, which include the United States and Canada, were $33.1 million, up 11% year over year, driven largely by the acquisition of On-X. On a non-GAAP basis, North American revenues were flat compared to the prior year. Revenues from our European region were $7.2 million, up 65% year over year, primarily as a result of the acquisition of On-X and commencement of our direct sales operation in France in October 2015. On a non-GAAP basis, revenues from this region increased 20%, driven primarily by increases in BioGlue and On-X revenues. And finally, revenues from Asia-Pacific and Latin America were $4.9 million, up 100% year over year, primarily as a result of the acquisition of On-X and an increase in BioGlue revenues. On a non-GAAP basis, revenues from Asia-Pacific and Latin America increased 32% year over year, primarily due to an increase in BioGlue revenues. I'd like to spend some time focusing on individual product lines and specifically tissue processing, BioGlue, and On-X, which combined account for 90% of our total revenues. As Pat mentioned earlier, we continue to make progress in our tissue processing business, where both revenues and gross margins are improving. In total, tissue processing revenues increased 2% for the quarter compared to the third quarter of 2015. We are continuing to see the results of our initiatives to improve cardiac tissue processing. During the third quarter, cardiac tissue processing revenues increased 10% year over year on a 12% increase in unit shipments. Vascular revenues decreased 4% year over year on a 10% decrease in unit shipments. As Pat previously touched on regarding vascular tissue processing revenues, our focus over the past 12 to 18 months has been on improving productivity in our processing operations and meeting the latent demand from our existing customers who were not previously able to consistently supply with tissue. To a large degree, we have satisfied that demand and we are now turning our attention to new customers. Our channel checks indicate that there is a significant base of business for us to pursue and we will be doing so in the coming months. BioGlue revenues in the third quarter increased 12% year over year to $15.9 million. North American BioGlue revenues were $8.4 million, which was a decrease of 3% year over year. The decrease primarily results from customer ordering patterns. OUS BioGlue revenues increased 35% year over year to $7.5 million. The primary driver of the OUS increase was our direct sales efforts in France and an increase in Japan. On-X revenues for the third quarter were $8.9 million, a 6% non-GAAP increase compared to the third quarter of 2015. North American On-X revenues were $5.4 million, which represented a 2% increase year over year. OUS On-X revenues were $3.5 million, which represented a 13% year-over-year increase. Moving on, our overall gross margins for the third quarter were 66%. This was ahead of our full year guidance of 64%. If you exclude the $750,000 write-up of acquired On-X inventory that is included in cost of goods sold, gross margins would've been 67%. We estimate that the remaining On-X inventory step-up that will be amortized in the cost of goods sold over the balance of the year to be around $1 million. In addition to the inventory basis step-up, we have purchased inventory from previous international and domestic distributors. The unit cost of that purchased inventory is higher than the unit cost to manufacture valves. The current aggregate incremental carrying value of that inventory, which is approximately $1.9 million, will eventually run through cost of goods sold beginning late this year or early next year and will accordingly reduce gross margins up through the first quarter of next year. Tissue processing gross margins improved to 49% for the quarter, up from 47% for the second quarter and 44% in the third quarter of 2015. This is a result of our efforts in late 2014 and during 2015 to improve efficiency and throughput in the tissue processing lab. SG&A expenses during the quarter were $20.6 million, including approximately $413,000 in business development transaction and integration-related cost. In the fourth quarter, we expect to incur approximately $300,000 more in integration-related cost, primarily salaries and other miscellaneous cost. Amortization charges were approximately $1.2 million for the quarter. This includes approximately $600,000 in amort related to the On-X acquisition. Going forward, we anticipate that total amortization expense, which is included as an add back to arrive at non-GAAP income, will be approximately $1.1 million to $1.2 million per quarter. Our tax rate for the third quarter was 37%. We expect our tax rate for the fourth quarter to be approximately 40%. On the bottom line, we reported GAAP net income of $3 million or $0.09 per share in the third quarter of 2016 compared to net income of $2.1 million or $0.07 per share in the third quarter of 2015. Non-GAAP net income was $4.4 million or $0.13 per share for the third quarter of 2016 compared to non-GAAP net income of $3.3 million or $0.11 per share in the third quarter of 2015. Non-GAAP income in the third quarter of 2016 excludes business development and integration charges of $413,000, amortization expenses of $1.2 million, and On-X inventory basis step-up of $750,000. In calculating non-GAAP income, a 38% normalized income tax rate was applied to pre-tax income. A complete reconciliation of GAAP to non-GAAP net income and earnings per share is included in the press release that we issued last night. As of October 17, 2016, we had approximately $57 million in cash, cash equivalents, and restricted securities. We had approximately $74 million outstanding on our senior credit facility and had our full $20 million revolving credit facility available to us. The interest rate on our credit facility is approximately 3.3%. Now for our 2016 financial guidance. As Pat indicated, we are raising our 2016 full-year revenue and non-GAAP earnings guidance. We now expect total revenues to be in the range of $181 million to $182.5 million compared to our previous range of $180 million to $182 million. Gross margins are expected to be approximately 65%, up from our previous guidance of approximately 64%. And non-GAAP earnings-per-share are now expected to be in the range of $0.43 to $0.45 per share compared to our previous guidance of between $0.32 and $0.34 per share. I wanted to make a quick comment regarding 2017. Pat previously updated you on several clinical and R&D projects that we are working on. Based on our current pipeline, R&D and clinical expenses could be as high as 10% to 11% of the revenues for the full year of 2017. We plan to issue our full initial 2017 guidance in connection with our year-end earnings announcement in February. That concludes my comments and I'll turn it back over to Pat.

Thanks, Ashley. So as you've heard today, we continue to execute on all of our key strategic initiatives. We expect to deliver solid Q4 results and meaningful growth in 2017. Our momentum continued in the third quarter, where we benefited from leveraging our cross-selling opportunities, our expanded cardiac sales force, and our portfolio of high-quality cardiac products. We are receiving outstanding feedback on our On-X valves and expect market awareness and adoption to ramp up going into the fourth quarter and 2017. We believe we are just scratching the surface on the potential for the On-X valve. Additionally, we further depend on an already -- we further deepen an already strong team of senior managers. Outside of our product portfolio, we continue to evaluate several business development opportunities that are complementary to our core strengths. Overall, we made meaningful strides towards our goal of establishing ourselves as leaders in the cardiac surgery market and strengthen our ability to compete and win. Lastly, I'd like to thank all of our employees for making this quarter a successful one. Your work is important and makes a positive difference in people's lives around the world. With that, we will now open the lines for questions. Operator?

Thank you. [Operator Instructions] Our first question is from Brooks West of Piper Jaffray. Please go ahead.

Hi. Good morning. This is Tom Bakas on for Brooks. Thank you for taking the questions and congrats on another strong quarter.

Hey, Tom.

First – hey, guys. I just want to start with the margin improvement. Just maybe walk through the puts and takes here. And then maybe how much of this was sort of low-hanging fruit that we can sort of sustainably run rate? How much of it was kind of one-time and how much is there kind of left to go? Maybe to pull in a World Series analogy here, what inning are we in of this margin expansion story?

I think it's a number of components. And I'll probably have Ashley chime in as well. I mean, with the acquisition of On-X, and we had talked about this during the announcement, the US -- incremental US revenue for On-X is a 90% gross margin item. So the faster we grow On-X, we are going to see disproportionately higher margins coming out of that product line. You also heard on the tissue front, we've increased margins on tissue from this time last year to this year I think up 400 basis points. I think the other thing to think about, and we've talked about this as we've presented at financial conferences, all of the new R&D projects and clinical projects that we are engaged in, so everything from BioGlue China to the PerClot trial to some of the new products we have in R&D to PhotoFix being brought in-house, every one of those activities, the margins are above 70%. So we actually think we are only in, call it, the third inning, although these baseball games seem to be quite long. We're moving towards over the 5 year period to get our margins up over - our standard gross margins up over 70%.

Great. Thanks. Then just next is a follow-up. Just 2016 it has been a big transition year with the addition of On-X. But as we look ahead to 2017, just wanted to get your thoughts on key initiatives for the Company. And just also maybe how you are going to prioritize revenue growth versus margin expansion, and any puts and takes we should be thinking about on a financial perspective.

Yes, so I think one of the real assets we have going into 2017 is our direct channels in the US and Europe. You know, we've talked about this a lot, but if you think back to the first quarter, we merged three sales forces here in the US: two CryoLife sales forces and the On-X sales force. We recut territories; we moved to 7 managers. We now have a 50-person sales force, and they are getting stronger every day both through their experience with the product lines and meeting their new customers. So I think that's a tailwind going into 2017 that we are certainly going to leverage. And you can say the same for the European organization, who had a great quarter with 20% growth. So I think that, to me, is an underpinning of 2017. I also, as I made in the remarks, On-X continues to be - we get very positive feedback on On-X. And it is a process that you must go. And you can certainly understand in 2016 in healthcare, you have to get the surgeon support. You then have to go through the value analysis committee. Once you get that approval, you have to get a consignment contract through the hospital legal department. So there is a number of steps that have to happen. And we're seeing very positive kind of traction in that regard. So we do expect to see nice growth in On-X going forward. And I think the last thing is we are very aggressive on the M&A front. We see several opportunities that could play out over the next 12 months that could certainly boost our revenue growth as well.

Thanks so much, guys.

Thank you. The next question is from Jeffrey Cohen of Ladenburg Thalmann. Please go ahead. The next question is from Jason Mills of Canaccord Genuity. Please go ahead.

Thanks, guys. Hey, Pat. Hey, Ashley. Can you hear me okay?

Hey, Jason. We can hear you fine.

Great. Congratulations on a good quarter. I'd like to pick up where you left off, Pat. The channel is something that you talked about for several years. And coming from Medtronic, you've talked about the opportunity globally in the cardiac surgery realm. Could you just remind us of your hard-and-fast criteria as it relates to M&A? What you must see to pull the trigger? And just how many of those assets and sort of the size of those assets that are out there. Are we talking about tuck-in $5 million product lines that can become $10 million product lines? Or are we talking about something, things like On-X that, frankly, it's hard for me to imagine, given its label, that it wouldn't be maybe a $100 million product line at some point. Maybe that's where I'll go next is just the On-X opportunity. But just give us a sense for your M&A and remind us what your criteria are.

One of the things we've been -- from the experience I've had over 25 years in the cardiac field, we've got a very kind of disciplined criteria list. So at the very highest level, in 2016 healthcare, we - our products, we want them to be unique and differentiated. We do not want to be involved in commodity products that are relegated to the purchasing department. And I think On-X is a great example of that. It's totally differentiated by the clinical data and the regulatory approval. So number one: it's got to be unique and differentiated. Number two: it's got to be backed up with clinical evidence. Again, you can test the On-X against that, the 7-year PROACT trial that was $20 million. It showed a significant reduction in bleeding of 65%. So the second criteria is the clinical demonstration of that uniqueness. Third is the ability to reduce healthcare cost. We're obviously all aware of rising healthcare costs. And we believe here at CryoLife that we can actually innovate and bring new technologies that can actually reduce healthcare costs through better outcomes. That doesn't mean that the price of our product will be cheaper. It will probably actually be more. But downstream, it will save the healthcare system money. So those are -- to me, those are three fundamental things that every technology is going to have to have that we look at. There's some other kind of secondary things. We want whatever we acquire to be growing faster than us, to be higher margin than us -- that obviously gets to the previous questions about margin. We are tracking at 66% on a GAAP basis, 67% on a non-GAAP. As we flow those acquired grossed-up inventories of On-X through the P&L, we could be tracking in the 68% range fairly quickly into the deal. And we want things that we acquire to be higher than that, to push us closer to 70%, 71%, 72%. The synergy, it's got to be the customer that we call on. We don't want to kind of defocus ourselves and go somewhere where we are not. So I think those are the types of things that the criteria and maybe the last one would be physician preference. We want it to be a product that our customers care about, not something that's, again, commoditized and there is 10 of them out there. And we also want it to be important in the procedure. So to your second part of your question, there are a number. And one of the reasons we made the strategic pivot a year ago was that one, CryoLife has a deep history in cardiac surgery through our tissue valves and BioGlue. And the On-X acquisition certainly was very synergistic and checked a lot of the boxes I just mentioned. But the other thing as we look at, aside from those reasons, the M&A opportunities on the cardiac surgery side were very appealing. A lot of people kind of talk about the cardiac surgery market being kind of old and stale. I mean, the fact of the matter is that there's 1 million to 1.5 million procedures done. So if you can come up with a technology like I just described that disrupts the standard of care, provides better clinical outcomes at a reduced cost, we think there is huge market opportunities. And then the third part of your question is: are we looking at stuff that's $5 million that gets to $10 million, or an On-X, like $30 million that gets to $100 million? I think one of the challenges that CryoLife has had is that doing smaller -- too many small deals that don't add up to enough. And we're looking at things that, say, are maybe $0 to $10 million today that can get to $75 million to $80 million. So we are really trying to hunt out those unique technologies that I described that can actually be pretty meaningful. One additional product line like that to CryoLife, and we are in the 15% growth range. So that's what we're looking for. And I think they would fall more into the tuck-in category than they would of the On-X scale at this point. So hopefully that addresses your question.

It does. Just as a follow-up on that, Pat. You've been at the highest levels at -- biggest medical device company in the world. Do you get a sense -- historically, they have not been keen to divest businesses that frankly, probably, in our view, don't add much to their valuation. There have been many incidences of that where smaller companies would love to have small assets of vascular surgery or cardiac surgery. Make a lot more sense for the smaller company to add scale than it does for Medtronic to own it, perhaps. But give us your perspective on that. Historically, they have not been keen to divest them. Is that still remain the dogma at this point?

Yes, I do think you know, I think it's a good question. I think there is several large, we don't want to acquire just, I mean, you can use my list of criteria. We don't want to acquire kind of commoditized product lines that aren't growing. So I have no interest in anything that fits that bill. But there are some assets in the bigger multinationals that I think would be very well suited at a CryoLife. And given the size and scale of some of the big multinationals' cardiac portfolios, I think that some of those things could come loose here in the next couple years. And we are watching, but as of this point, we're not seeing any activity there. But I would be surprise -- again, given kind of where their focuses are, appropriately so, on big areas like VADs and percutaneous valves, I think there's some other things. It's kind of a distraction and it really doesn't move the needle for them to be in some of these other businesses, which would be I think a real opportunity for us. So we'll be clearly aggressive if those things become available.

I appreciate that color. Just a couple more follow-ups. One for you; one for Ashley. On On-X, talk a little bit about the three- to five-year time horizon and specifically PROACT II. Obviously studying On-X within the NOACs. First of all, update us on NOACs. And have they been studied within the mechanical heart valve community heretofore, or is this the first trial. And then sort of what -- when does On-X reach an inflection point? Given the label -- and you walked through very well sort of the hurdle that your sales forces had to get over. That makes sense as to why this already isn't a $50 million business, given the label. But when do you think an inflection point occurs? Where you've done the heavy lifting, you've gone through all the various processes with all these hospitals and the legal departments, etc., etc. And you see an inflection point and the light just turns on with it. Because with that label, it's hard to believe that it won't eventually. And I have one follow-up for vascular.

Let me take them in reverse order, because it's more of a -- in the time frame. So as far as the current revenue of On-X, as I described in the comments -- again, and you appreciate the merging of the sales forces, get new territories, new customers, new product lines. Cross-training people on products. I also mentioned in the comments that On-X was a small company and they had never really invested the money in a sophisticated marketing branding positioning effort. We did that. We almost started that immediately after the acquisition and we rolled that out to our organization in August. So we did a couple days of advanced selling training. We rolled out the new positioning. So we now have a 50-person sales force that's hitting the market with customer-based market positioning, which is extremely advanced and sophisticated. We've also been kind of learning as we've been going and going after group purchasing contracts where those are important. We've been very successful there and still have more to come. But we've got 50 target accounts with the highest-volume centers that we are not in today. And we are seeing tremendous progress from going through the hurdles of getting the physicians engaged to be supportive, getting through the value analysis committee, which can take time, getting the consignment agreement through legal, all those things. And as I said in the comments, we expect to see that growth starting to accelerate into Q4 and going into 2017. And we believe we'll start seeing double-digit growth. We are already seeing it in Europe, and Europe is growing 20% right now. So we feel like this inflection point is coming Q4 into 2017. As far as the NOACs, we think this is a really unique opportunity. In fact, I've had a chance to meet with the -- in one case, the PI of one of the major NOACs, a cardiologist who was the PI of that trial that was published in New England Journal. We had a team meeting of about 12 or 13 investigators, from cardiologists, surgeons, hematologists, statisticians. So we've been very aggressive in pursuing this kind of NOAC opportunity. We still have some work to do before we kind of kick that off, but I really -- we're also doing, which I'll be happy to report on once I get it. We are doing some market research at the same time with cardiologists and heart surgeons to really understand how a PROACT II trial, which, for example, if it was a head-to-head trial of Eliquis versus Coumadin, how would that change the paradigm of how people use mechanical and tissue valves today? In fact, what is the market opportunity? And we should have that research probably for the next call in February. And I expect to be much more advanced at that point to give you more feedback. But I think it's very exciting. And then your last question was about have there been other NOACs tried? The one trial that has been done is called REALIGN. It was done with Pradaxa. And we've spent a lot of time analyzing it. It was actually negative. They had, as you can imagine, they actually had strokes and had to stop the trial. There were a number of things that were wrong with that trial. And part of my discussions with this group of physicians that we brought in was: What were the issues with that trial? The first and probably biggest was that they started them on Pradaxa almost immediately after surgery. And if you recall from the PROACT trial, we waited 90 days for the valves to kind of endothelialize around the sewing cuffs. The other thing that they did is they used mitral valves and aortic valves, which, as you know, mitral valves have a much higher INR requirement than a aortic valve. They also mixed manufacturers. So there were a lot of things wrong with that trial. However, it does make you pause and say: We got to make sure we do things right as before we enter into our trial. And we are doing those things now. So hopefully that kind of checked off the three questions you had.

It does. That's very helpful. Look forward to that research on the next call. Lastly, Ashley, the SG&A leverage here that you are showing pro forma is compelling. Should that continue into next year and finance maybe a little bit more spending on the R&D line?

Yes…

That's - you would still get some operating leverage overall?

Specifically on the third quarter, we had some delays in hiring and so forth as well as just other good spending discipline, which kind of led to a lower SG&A for the third quarter. I alluded to on a previous call that we expected our G&A expenses for each quarter of this year to be between $21 million and $22 million. And we were a little bit below that in the third quarter. As we fill some of these open positions, we think that will move back into that range. Going forward into 2017, there probably will be some increases in G&A expenses to support the ongoing growth of the business. But the growth in that line item is certainly going to be much smaller than our top-line growth. So we think that with the infrastructure that we have set up right now that we can see a lot of operating leverage in 2017 and maybe even more so beyond 2017.

Yes, that makes sense. Thanks, guys. I'll get back in queue.

Thanks, Jason.

Thank you. The next is from Jeffrey Cohen of Ladenburg Thalmann. Please go ahead.

Good morning. Can you hear me, okay?

We hear you fine.

Hi, guys. So most of my questions were addressed. But one, if you could talk about as far as the cross-selling and the accounts in the marketplace, could you talk about pullthrough from both directions? New accounts from the On-X side as well as existing accounts from the tissue forms? Thanks.

One of the things we've done and it's with people getting new territories, you'll understand this quickly. We have reps who have a new territory as of February 1 compared to their territory last year. So doing an apples-to-apples comparison of pullthrough is somewhat challenging. What we have been able to look at is at least in that territory. So again, if you were the rep in Miami and you lost some of your accounts and picked up some new accounts, you are cross-selling kind of year over year, it was kind of figure out what that was. But what we have done is we've looked at kind of the legacy CryoLife cardiac reps -- the three buckets: the legacy CryoLife vascular reps and the legacy On-X cardiac reps -- to find out who is selling the new portfolio in addition to the existing -- the product portfolio that they brought with them, if you will. And we've seen some very positive results kind of across the board. There's some other areas that we need to do some work. And again, we are only kind of nine months into the acquisition. So it's still fairly new. But as we get people in these territories longer, that is something we will be looking very closely at. But we've seen some nice kind of examples of On-X reps opening up -- legacy On-X reps opening up new tissue accounts and Glue accounts. We've seen examples of CryoLife cardiac reps selling On-X, and some in a significant way, and likewise on the vascular side, having legacy vascular reps opening up On-X accounts. So we've seen positive activity and cross-selling in all three buckets. We just want more of it. And that's -obviously as each day that goes by, the field force gets stronger. And we'll be working - our kickoff sales meeting in January, that will be a big focus of our efforts.

Perfect. And would you expect the size of the North American force to change in the next few quarters? Do you expect an increase or you are happy with the 51 now?

One of the things, as I said, I ran a cardiac surgery business probably 15 years ago. And one of the things that I always liked about the US cardiac surgery market is with 50 reps, you can pretty much cover the geography. Our - we used to have 15 cardiac surgery reps at CryoLife and now we have 50. Our territories are two-thirds smaller, so there's less -- a lot of these territories don't have overnights. People can drive a three-hour radius from their home and can hit all their accounts. So there's a tremendous amount of efficiency and frankly cost savings from doing this. I just don't think we need to add more reps at this point. And I don't think we're going to need to add more reps in the US for some time. Now that could change if we do a bigger deal, which we don't have on the table at this point. But I think for what we have in our bag today, the tuck-ins I described over the next couple years, I think we can hold our channel kind of fixed as it is. Now, that's aside from if we go direct in some countries. If we go direct in some markets, which I'm not going to get into for obvious reasons, that could beef up our numbers in developed markets where we are not direct today.

Okay, got it. Perfect. Thanks for taking the questions.

Thanks, Jeff.

Thank you. The next question is from Joe Munda of First Analysis. Please go ahead.

Good morning, guys. Can you hear me, okay?

Good morning, Joe.

Morning, Joe.

Real quick. Ashley, on your comments regarding the tissue processing business and I guess following up or piggybacking off the last caller's questions, you talked about channel checks. You are seeing possibly significant opportunities. Is that as a result of cross-selling some of those other businesses -- I'm sorry; those other products like On-X that you are seeing these opportunities? Can you provide us a little bit of detail there, especially after vascular kind of had the quarter that it did. And what you guys are projecting going forward. I just want to kind of get a little bit more of a handle on what you are seeing as far as the opportunities are concerned.

Yes, Joe, I'll take that. So to me - and I think you guys all cover multiple companies, right? So you see some cyclical nature and kind of from quarter-to-quarter variations of a business. So we -- first, we like to look at a business on a - we guide to a yearly number and we look at our business on a yearly number. We obviously watch them very closely on a quarterly basis. And if we see things we don't like, we obviously adjust. But in particular, the comments about vascular tissue. We guided to mid-single-digit revenue growth on our tissue for the year. And we're currently sitting at 7% for the whole tissue business. So we are pleased to see that we are kind of upper-single digits on tissue thus far. On the vascular front, we are 9% year to date on vascular tissue. We've had a very strong first 3 quarters on vascular tissue. There are some, as I just described, there are some business model nuances with the tissue business. So each of these hospitals have freezers. They want to make sure that they've got enough stock in their freezer to cover the cases that are coming. So we can sometimes get big orders. And then they may wane in the next quarter and then we get big orders the next quarter. So there is some kind of cyclical nature and ups and downs quarter to quarter, but we look at this business on a yearly basis. The comments that Ashley made that we think are extremely positive for the vascular side is that all these tissue processing improvements we've made over the past 12 months, we now have a very strong inventory position. And particularly for our long saphenous vein, which is what our surgeons are looking for. Just as a comparator, a year ago, we had nothing in the freezers. We had no inventory of our long saphenous veins. So it was kind of hand them out. We now through all the improvements we've made have significant inventory positions on the longer segments, which is what our customers want. And then you combine that with our 50-person sales force, and we have people in territories that, frankly, had no vascular tissue exposure, we feel that that's a very nice combination and an opportunity to grow that segment even further.

Okay, that makes sense. That definitely makes sense. Switching gears here a little bit, now, you touched a little bit on the competitive landscape. How do you guys continue to grow and obviously displace possibly some of your competitors? A, I mean at what critical size do you really feel like you are on their radar screen as far as competing on a head-to-head basis for an account as well as what gives you confidence that you are able to really compete effectively against some of these largest competitors? I mean, acquisitions like On-X are obviously helping to that story. But I guess can you give us a little bit more color as to what you see as far as the competitive landscape and where CryoLife can effectively compete against the marketplace? In the marketplace?

The one thing that's nice about a competitive marketplace is that you go and compete with what you have. And to me, I think one of the reasons we were excited about On-X -- and it goes back to my answer to Jason's question about our criteria for business development. One of the reasons we want things that have a competitive advantage and aren't commoditized is because we don't want to go up against a bigger company without a good, strong differentiated message. It's one of my first criteria. So the idea of going into a major hospital with an undifferentiated mechanical heart valve makes no sense for CryoLife. What On-X does have, as we've talked about a lot, is a trial called PROACT, which was 7 years, $20 million. The only product that has the FDA label of a 1.5 to 2.0 INR, which when you do that, you get a 65% reduction in [indiscernible] And we've tested this with a market and we ask surgeons questions after we show them the trial. And we say: Based on the clinical data you saw in the PROACT trial, do think it's compelling enough to get a surgeon to switch from his current mechanical valve to On-X? And about 80% of the people say yes. So I don't care who I'm competing against. I don't care if it's big company, little companies, we got a better product. We got a great sales force. They are getting stronger. We've got great data, and we are getting the message out there. So to me - and again, you can kind of go right down the product line. You look at our SynerGraft technology. We have one competitor in that space. They don't have SynerGraft. We've got new clinical data coming out this year that is extremely compelling showing a 20% improvement in lack of re-operations with our valve versus their valve. And we're going to take advantage of that. I look at BioGlue. That product has been out for 20 years, but we've got 350 clinical papers. It is a staple in cardiac surgery. So again, we don't mind competing, but we like going into battle with unique differentiated products that are backed up with strong clinical data and economic evidence. And I will go against anybody, any day of the week with that portfolio.

Okay. The last question I had, I guess in terms of acquisitions, as far as assets are concerned, and valuation, that's really the key here, I mean, do you feel like the opportunities that are out there are attractive enough? Or do you feel that valuations on some of these assets need to come down before you'd have to dip your toe in the water and make an acquisition?

Yes, it's always, that's always a tough topic. It's like when you try to sell your house. What is it worth? You think it's worth more than the other guys think its worth. But to me, one of the nice things about this segment that we are in and the size of CryoLife is that a lot of the assets we're going to be looking at are probably not going to be on the radar screen for the big multinationals. Because they just don't have the size and the scale to get the growth rates that will make a difference to their growth rate. Whereas for CryoLife, I answered it with Jason's question, if we can take a product line that's doing $10 million and it can go to $75 million over 5 years, it's a huge change for us. If you drop that in that same Jude or a Medtronic, it doesn't even make a -- it's not even a rounding error. So we're not showing up at the kind of bargaining table, the negotiating table, with the multinationals for some of these assets. Part of what we are doing is we're working hard to really ferret out the really unique differentiated technologies that can improve outcomes, reduce cost, and that have a lot of runway. And that we, our sales force, can sell a differentiated message and really also change healthcare at the same time. So we are excited about the assets we see. As it comes to valuation, we're not going to overpay. If we buy something, we are going to feel like we can get the return on invested capital for our shareholders. So that will remain to be seen as the acquisitions unfold, but we want to get a good price. But if we feel like we can get that kind of growth, then we are willing to pay for it.

Okay. Thank you.

Thank you. The next question is from Bruce Jackson of Lake Street Capital Markets. Please go ahead.

Hi. Thanks for taking my question. First one is on the cardiac tissue business and the tissue business in general. You've been historically supply constrained there and now you've addressed that issue. How much more demand do you think there is out in the marketplace? And can we see that growth rate that the business has right now carrying forward?

Yes. So again, I like to - you got to look at these as different segments. Again, it's been kind of a tale of two cities going throughout the year between vascular and cardiac. Vascular came out of the chutes very strong in the first half. Cardiac kind of lagged. We had mentioned we had made a big push on the procurement side on cardiac tissue and we now see cardiac tissue doing well. So again, we look at the business as a whole, and a business that was growing 1% over the last 5 years is now up 7%. So I don't think we're going to see double-digit growth with tissue, but I think if we can get to mid-single-digits on tissue going forward, as we can put the pieces together, there's clearly opportunity. I made a lot of comments around the vascular tissue, where we have full supply of long saphenous vein segments with a 50-person sales force. So I think there's opportunity there. I also mentioned the SynerGraft clinical data that will be coming out. And I think there is opportunity to take market share in the pulmonary valve space. So I think, frankly, that we - I want to be cognizant of getting ahead of ourselves. But I do think we have the ability to grow that tissue business mid-single- digit and beyond, depending on how successful we are in taking share on vascular and taking advantage of the clinical data with our SynerGraft valve.

Okay. Great. And then my other question is more of a general question around the heart valve market. So we had a transition to the tissue valves and then the mechanical valve -- the mix has sort of stabilized. Now you've got a competitor talking about potentially doing some trans-catheter valve and valve procedures. Do you think that the mechanical valve market is going to remain stable in that case, and it's full steam ahead or how do you view this new treatment option?

It's a good question, Bruce, and it's one we hear a lot about from investors. Because I do think there's obviously the TAVR train is moving fast, although it was not as good last quarter. You know, we've done, in fact, we're doing some research right now, as I commented, on the PROACT II trial. And one of the things we're going to try to understand, and we've got data on this, is what age group do heart surgeons use mechanical valves, tissue valves, and TAVR valves? And I actually have this conversation with surgeons all the time, 100 guys a quarter. And frankly, today, the TAVR valves are relegated to a 70-plus, 75-year-olds and beyond that have lots of comorbidities, high risk. And those trials are coming to a lower risk group. But frankly, TAVR is eating into kind of tissue. Most of our mechanical valves are going to people under the age of 60. So I think it's a real stretch to talk about putting a tissue valve and then a TAVR valves in a 60 year old. And I think most clinicians would agree with us. I'm out in centers all the time. The mechanical valve market is 15% of the overall market and it's typically in patients under 60. So it's something we are going to watch, but I actually think the other way, which is I think a PROACT II, which is if you could offer an On-X valve with a novel anticoagulant like Eliquis, not have to check your INRs, not have to watch your diet, I actually think it will expand the mechanical valve market significant. And I'm going to get some data to back that up. So I think we are comfortable in the space that we operate. And in fact, as a company, for a little company like CryoLife, we are the -- a very strong player in aortic valve surgery under the age of 60. There's very compelling data. There is been editorials out of JAC saying that the best operation in the aortic position for a patient under 40 is a ROSS procedure with a CryoLife valve. And in patients under the age of 60, between 40 and 60, it is a mechanical valve with On-X. So for a small company to have a very strong hold in patients between 0 and 60 on aortic valves, I'll play in that market all day long. And we'll look to expand it with the PROACT II trial.

Okay, that's great. Very helpful. Thank you.

Thanks, Bruce.

Thank you. We have no further questions in queue at this time. I would like to turn the conference back over to management for any closing comments.

Yes. And so I want to thank everybody for joining. And as you can hear, we are happy about the quarter. Our year looks very good. We've raised guidance the last two quarters. We're seeing strong gross margin expansion, as we expected. We are seeing good revenue growth. We've been very disciplined on our spending. We've seen nice drop through to the bottom line. And we are setting up very well for a 2017 with a stronger sales organization. We continue to look at our M&A opportunities. And at the end of the day, I think we are very excited about the opportunities to increase shareholder value over the coming years. And look forward to updating you on our next call with our Q4 results and 2017 guidance in February. So thanks, everybody, for joining.

Thank you. Thank you, ladies and gentlemen. This does conclude today's teleconference. You may disconnect your lines at this time and thank you for your participation.