Artivion, Inc. (AORT) Q4 2018 Earnings Report, Transcript and Summary

Greetings and welcome to the CryoLife Fourth Quarter and Year-End 2018 Financial Conference Call. [Operator Instructions] As a reminder this conference is being recorded. It is now my pleasure to introduce your host; Lynn Lewis of the Gilmartin Group. Thank you. You may proceed.

Good morning. This is Lynn from Gilmartin Group. Thanks for joining the call today. Joining me from CryoLife management team are; Pat MacKin, CEO; and Ashley Lee, CFO. 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 on this call that look forward in time involve risks 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 risks, uncertainties, estimates and assumptions that may cause actual results to differ materially from those forward-looking statements. Additional information concerning certain risks 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 we issued last night. With that, I'll now turn the call over to CryoLife's CEO, Pat Mackin.

Thanks, Lynn. And good morning, everyone, and thank you for joining us. As you're going to hear today, 2018 was a highly successful year for CryoLife, as we made meaningful progress toward becoming the leading provider of solutions for people suffering from aortic disease. We now operate from a position of strength, due to the quality and breadth of products, our experienced sales team and adept customer support. This morning, I will outline why we expect CryoLife will be even more -- in an even stronger position in the coming years without needing to make a single acquisition. Simply put, we believe our story will keep getting better as we advance our pipeline and execute our strategy. We expect our steady growth to continue and our addressable market to increase by over $1.5 billion due to anticipated regulatory approvals and from geographic expansion we aim to deliver. As we reflect on 2018, our team made significant progress toward the goals we set for our year. We generated topline growth of 11% for the full-year 2018 versus 2017 on a non-GAAP basis, and 10% on a constant currency basis. We completed the integration of JOTEC. We leveraged our global commercial organization. We enhanced our commercial leadership team in Latin America and Asia-Pacific. And we advanced both our product pipeline and our clinical programs meaningfully. Turning to our operating performance in the fourth quarter, CryoLife closed 2018 like it began with solid revenue performance, led by double-digit organic growth from our JOTEC and On-X product lines. Revenue in the fourth quarter was $67.8 million, up 8% on a non-GAAP basis and constant currency basis. Despite revenue exceeding our expectations, our operating expenses were more than anticipated in the fourth quarter due to the acceleration of spending on our product pipeline and increase related to international growth. Ashley will review our fourth quarter financial performance and 2019 outlook in more detail later in the call. Now I'll take a few minutes to summarize the progress we've made toward our 2018 initiatives and then talk about our strategic priorities for 2019 including milestones and goals that we anticipate will drive both near and long-term revenue growth and improved earnings performance. In 2018, we posted strong organic revenue growth driven by On-X and JOTEC product lines. In both instances, we continue to take market share through an experienced and well-trained team of dedicated sales professionals and a highly differentiated product portfolio, backed by significant clinical experience and strong clinical data. We grew JOTEC non-GAAP revenue by 25% for the full-year 2018 versus 2017, while integrating its products and employees into CryoLife. Our best-in-class family of mechanical valves, On-X, posted revenue growth of 21% in 2018 versus 2017, as we continue to demonstrate the clinical advantages of our technology compared to our competitors. Finally, we transitioned a large portion of our European markets to direct sales from distributors and we are already starting to enjoy the benefits of that decision. We also achieved our second key initiative completing the integration of JOTEC and delivering double-digit non-GAAP revenue growth in 2018. We estimate that the international market for which our JOTEC portfolio competes is growing in the low single-digits. In the fourth quarter, the JOTEC portfolio recorded non-GAAP revenue growth of 17% and 19% on a constant currency basis. This is implying meaningful share gains. We believe this is driven by the combined effect of our experienced direct sales team selling the best and broadest portfolio of branched stent grafts on the market. Turning to On-X, our fourth quarter for On-X was up 13% as reported and 14% on a constant currency basis. North American On-X revenue grew over 13% in the quarter, while our European, Middle East and Africa business grew over 22%, we expect On-X revenues will remain solid as it's the only mechanical aortic valve in the world that carries the FDA label, allowing patients to be managed starting three months after their surgery at an INR level of 1.5 to 2.0. And that difference gives us a tremendous competitive advantage. Another key initiative for 2018 was to expand our addressable market opportunity through investment in our R&D product pipeline. And we made meaningful progress toward advancing our clinical programs as well. And finally, we also achieved an important initiative completing the transition to direct sales channels for our legacy CryoLife products in Spain, Italy and Poland. I am proud that all we've accomplished in 2018 and agile here we have an equally ambitious 2019. For 2019, we expect to achieve high single-digit growth in total revenues and double-digit growth in our JOTEC and On-X product lines. We anticipate performance this year will be driven by further market share gains from existing products and new product introductions via our direct sales force. We also have several catalysts in 2019 to fuel our continued top line growth. First, we expect to introduce three next-generation JOTEC products into select international markets in 2019. These include our next-generation Frozen Elephant Trunk called E-vita Open Neo, our second-generation thoracic stent graft called E-nya, and our -- and the first-ever off-the-shelf branched thoracoabdominal device called E-nside. Second, we are continuing to advance our regulatory approvals. As you recall, we completed the enrollment of our clinical trial for BioGlue China in 2018, and we remain on track for regulatory submission in the first quarter of this year. Third, we also recently completed the enrollment of the PerClot study of United States, setting us up for a PMA submission to the FDA in early 2020. This is delayed compared to our previous guidance due to work establish -- to establish our large-scale manufacturing process and the related verification and validation work including shelf-life studies to support the anticipated launch post approval. Fourth, we are excited about the upcoming Ross Master Class at the upcoming AATS Meeting in May. Dr. Paul Stelzer from Mount Sinai, New York will be presenting a subset of the 600-plus Ross procedures with up to 20-year follow-up. The Stelzer series when combined with the recent JACC publication by Mazene [ph] coworkers provides a retrospective look at more than 4,600 patients from 10 different literature reports that underwent the Ross procedure. For those who are unfamiliar with the Ross procedure, it is a double valve a procedure where pulmonary allografts are used to replace the patient's native pulmonary valve which has been moved into the aortic position. We've seen an uptick in the Ross procedure over the last couple of years and it has helped to drive over cardiac tissue revenues. The data shows that the Ross procedure restores normal life expectancy to patients and it appears to be the best option for young to middle-aged patients with the diseased aortic valve. The symposium will highlight the very compelling long-term efficacy data for the procedure and should be a clear positive for our cardiac tissue business. Fifth, we are investing in the development of our distribution channels in Asia-Pacific and Latin America. Last year, we strengthened our commercial leadership team with the addition of two seasoned sales professionals to lead our commercial efforts in these geographies. We will begin migrating to a direct sales model in the second quarter in Brazil with our legacy CryoLife products. And sixth, we will enhance our sales channel across Asia-Pacific with a focus on China, where we expect to have new distributors in place by mid-year. We expect these initiatives to deliver high-single-digit revenue growth in each of the next five years. And with that, we are providing 2019 revenue expectations between $280 million and $284 million. In addition to these near-term catalysts just described, we have a rich long-term pipeline filled with opportunities that we believe will increase our addressable markets. I would like to highlight several important opportunities in our pipeline. First, we have submitted our IND for the PROACT 10A trial and are hoping to begin enrolling patients in the first half of this year. We held an investigators meeting in late January at the Society of Thoracic Surgeons Meeting and there's significant enthusiasm for the trial and great anticipation for the commencement of the study. Through this trial, we will seek to obtain FDA approval with the On-X aortic valve using Eliquis rather than Coumadin as the blood thinner. We look forward to working with the FDA; we'll provide more details as they become available. Second, we will file a regulatory approval for BioGlue in China in the first quarter of this year and for PerClot in the U.S. in early 2020 -- in early 2020. We could potentially have both of those products in the market in 2020. Third, in 2021, we expect to have the E-ventus SX, our self-expanding peripheral stent, in the market in Europe and expect our On-X micro valve to receive regulatory approval for a lower INR similar to the On-X aortic valve in both the U.S. and Europe. That valve would offer doctors and patients the same lower INR profile found with our aortic valves. And fourth, beginning in 2023, we look to leverage our JOTEC product line, which is currently not approved for sale in United States. We plan to conduct clinical trials in the United States with the three next-generation JOTEC products that are slated for launch in Europe this year, with the goal of obtaining FDA approval for each product. With that, I will now turn the call over to Ashley.

Thanks Pat. I'll now review the results for the fourth quarter as well as our financial outlook. Total company revenues increased 28% to $67.8 million when compared to the fourth quarter of the prior year. Q4 total revenues grew 8% on a non-GAAP and constant currency basis compared to the fourth quarter of 2017. Q4 North American revenues were $37.9 million, an increase of 5% year-over-year. The increase was driven by 13% increase in On-X and a 6% increase in tissue processing. Q4 revenues from our EMEA region, Europe Middle East and Africa were $23 million, an increase of 11% and 13% on a non-GAAP basis, compared to the prior year. Revenues from Asia Pacific and Latin America were $6.9 million for the fourth quarter, an increase of 28% and an increase of 9% on a non-GAAP basis compared to the prior year. Looking at individual product lines. On-X revenues for the fourth quarter were $11.3 million, an increase of 13% over the fourth quarter of 2017. Q4 On-X revenues increased 14% on a constant-currency basis compared to the fourth quarter of 2017. JOTEC revenues for the fourth quarter were $16.7 million. Non-GAAP JOTEC revenues increased 17% compared to the fourth quarter of 2017 and 19% period-over-period on a constant-currency basis. BioGlue revenues in the fourth quarter increased 1% year-over-year to $17.9 million. North American BioGlue revenues were $9.4 million. OUS BioGlue revenues increased 3% year-over-year to $8.5 million. BioGlue revenues for the fourth quarter of 2018 increased 7% in the Europe, Middle East and Africa region and decreased 1% year-over-year in Asia Pacific and Latin America. Tissue processing revenues for the fourth quarter were $18.5 million, an increase of 4% compared to the fourth quarter of 2017. During the fourth quarter, vascular revenues and cardiac tissue processing revenues increased 4% and 5% year-over-year, respectively. Our gross margins were 66.7% for the fourth quarter and 65.8% for the full year. Our pro forma gross margins excluding JOTEC purchase accounting adjustments were 66.7% for the quarter and 66.9% for the full year of 2018. SG&A expenses during the fourth quarter were $35.6 million, which includes $1.4 million in integration and business development related expenses. These charges include ongoing expenses related to the JOTEC integration, which primarily relates to stocks implementation. Our operating expenses, however, where more than anticipated in the fourth quarter due to the acceleration of spending on our product pipeline and increased cost related to international growth. On the bottom line, we reported GAAP net loss of $1.7 million or $0.05 per fully diluted share in the fourth quarter of 2018 and non-GAAP net income was $1.9 million or $0.05 per share for Q4. Our non-GAAP EPS was adversely affected by the items I previously mentioned. Please refer to our press release for additional information about our non-GAAP results, including a reconciliation of those results to our GAAP results. Also our reported financial results were preliminary pending the completion of our audit and the filing of our Form 10-K, which we expect to file next week. As of February 11, 2019, we had approximately $46 million in cash, cash equivalents and restricted securities. We had approximately $223 million outstanding under our term loan B. And based on our credit documents, our current gross leverage stood at approximately four times, and our net leverage was approximately 3.5 times. We expect our net leverage to be around three times adjusted EBITDA by the end of the year. We can comfortably service our debt and have no financing needs to support our current business model. Now turning to our outlook for 2019. We expect full year revenues in 2019 will be in the range of between $280 million and $284 million. We expect first quarter revenues of between $66 million and $67 million. We expect non-GAAP EPS to be between $0.28 and $0.32 per share. This includes approximately $3 million in non-recurring costs associated with work necessary to comply with the new medical device regulation in Europe, which is scheduled to go into effect in 2020. Compared to the current medical device directive framework, the new regulations have increased the requirements and costs to get existing product certification renewals and new product approvals. These new regulations have essentially moved Europe closer to what is required by the U.S. FDA. The costs, I've referred to earlier, primarily relate to costs for certifications of products already on the market in Europe. The bottom line also reflects approximately a $2 million investment in the acceleration of our channel development in Asia-Pacific and Latin America. That concludes my comments, and I'll turn it back over to Pat.

Thanks, Ashley. So, in closing, we had an exceptional 2018, in which we achieved many product development and regulatory milestones and delivered strong financial performance. I would like to thank all those at the company who made 2018 such a success. Your hard work literally improves the lives of people everyday around the world. Our mission is straightforward. If we execute on the goals and objectives I've outlined today, we expect to be a significantly larger company with a stronger leadership presence in the markets we serve. Fortunately, we have all the pieces in place including a strong leadership team to drive the process. We entered 2019 well-positioned to continue delivering solid and sustainable financial performance. So given all the opportunities for growth I've outlined this morning, it's easy to understand why we are so optimistic about our future days. With that, we'll now open the line to questions. Operator, please proceed.

Thank you. We will now be conducting a question-and-answer session. [Operator Instructions] Our first question is from the line of Jason Mills with Canaccord Genuity.

Thanks for taking the question, Pat and Ashley, good morning. Can you hear me Okay?

Yes, yes, good morning.

Great. Good morning. So, Ashley, you sort of got into the first -- line of question, I'd like to get in to which is sort of the earnings profile of the company. We all knew because you guys have been talking about the MDR mandate and necessary spending there, we just didn't know how much it was going to be. So maybe run through more broadly, Pat, the operating expectations, earnings expectations for the company on a pro forma basis, it looks like that $3 million if I tax it – what tax rate I had in my model, is fairly meaningful, 10 -- 10-ish, give or take, we don't know how you calculate it. But generally speaking, looks like the earnings profile of the company could be quite a bit higher without it. And I'm wondering, just as we look into 2020, if that's sort of the baseline we should be thinking about, excluding that $3 million and sort of – assuming the midpoint of your range?

Yeah, let me take the macro question, I think this is a really important one, and I think for investors, and I'll will have Ashley, if there's follow-up, I'll have Ashley, maybe he can get into more specifics. So, when I look at the company today, and I go back, when I got here, we had 10 reps in Europe and a $20 million business, and through the acquisition of JOTEC and going direct and all the things we've done over the last four years, we now have 80 direct reps and $100 million business. And it required investment along the way to get there, but basically, the European infrastructure is now set for us to leverage with our pipeline. The same could be said about the U.S.. When we acquired On-X, we merged sales forces, we built those sales forces. So what we've basically been doing is a step-by-step approach to investing in our channels. So our US is pretty solid and fixed, Europe is pretty solid and fixed, we have basically wide open markets in Asia-Pacific and Latin America. We are choosing to invest a couple of million dollars to build out those channels, but once those are built out, we basically have a global infrastructure that is somewhat fixed, and that comes to the next point, which is the pipeline. We have 13 products in our pipeline that are going to add $1.5 billion to our total addressable market. And as those channels gets fixed in Asia-Pacific and Latin America over the next 12 months to 24 months, the entire global footprint can then be leveraged on every single one of those 13 new products that we launched. So I think what you're going to see and again this goes back kind of our five nearly year-over-year see, and again, this goes back to kind of our five-year goals as a company, we're building a company here and I think we've done a nice job in the last four, but we've got a lot more to do, and I think the opportunities are great. So we think we can deliver high single-digit 7% to 9% growth to investors in revenue over the next five years. Our gross margin is at 67% this year. We're going to try to add one point of gross margin per year over the next five years. And because those channels are mostly going to be fixed in the next 18 months, I would say, the ability to leverage the operating margin of this company as the 13 new products come out is going to escalate quite quickly as we get that infrastructure setup, moving toward a 20% operating margin, which is our five-year goal. So this, we're building the company. We're investing in channels, we're investing in a pipeline and we always had to deal with this MDR issue, which is kind of a one-time thing. But at the end of the day, we are still committed to our five year goals and I think we're very well positioned to do that.

Terrific. That's very helpful color around sort of the longer-term expectations as you'll operate the business and build it. Wanted to move to JOTEC, obviously – and you mentioned it in those remarks, the importance of JOTEC not only from the standpoint of having products that you like and their growing, but also the offerings in the business, strength that you have in Europe relative to where it was when you came onboard. So maybe spend a minute and level set us on the JOTEC business in light of the fact that you have several new products coming in 2019, you're now starting to talk about your regulatory plans and strategy for the US, which is obviously couple of years away, but getting closer. And maybe just talk about the trends across your product line buckets within JOTEC? What you're seeing, not only from a volume perspective but an ASP perspective and a competitive perspective? As you start to get into these new markets, how you expect JOTEC to contribute to Latin America and Asia-Pacific? Just trying to get a sense for whether or not on a go-forward basis and you obviously talked about 2019, but over that five-year period time, what sort of contributions you expect from a growth perspective from JOTEC? I think it's an important part of your business.

Yeah, no, absolutely. And I couldn't be more pleased to be honest with you. I've done a number of acquisitions in my carrier and as you well know having watched the number, there's always kind of trips and kind of stutter steps because of things you didn't know about or things that happen. A year after, we acquired JOTEC in December 7th of last year, so we've had it for a full year now, plus a month or so. I mean, it's been, it's frankly been flawless. We delivered 24%, 25% top line growth. We've had no turnover of the executive team. We've had no turnover in the field, and the pipeline is very robust. And so, I think, there's probably three things that I would watch with JOTEC. Number one, starting this year, we've got three new products coming. We have a next-generation Frozen Elephant Trunk, we've a next-generation Thoracic Stent Graft, and we have a next-generation, and actually the first ever off-the-shelf branched thoracoabdominal device, which we think is going to be a kind of a game changer. Those are all planning on being launched this year. Two of those products are being submitted to the CE Mark this month and the other one will be submitted, I think, in Q2. So, the first thing you're going to see is those three products as they get into the European channels, which is a, it's an 80% channel now, you're going to start to see the impact that that fixed kind of footprint has on the, with those new products. The second thing you'll see with JOTEC is our investment in Asia-Pacific and Latin America. We have a tremendous opportunity in China. We already have JOTEC products approved in China. We have JOTEC products approved in many markets in Asia-Pacific and Latin America. The addition is, there's a bunch of markets where we can actually, all we are going to do is get the regulatory approvals in those places and we can the sell the products. So, I think the second kind of vector you're going to see for JOTEC is the expansion into Asia-Pacific and Latin America as we build out those channels. The third is, we are already starting to testing for the U.S .PMA clinical trials. You know, we're going to take those three new products that we talked about that are coming into Europe and we're going to trial those in the U.S. Now, obviously that takes a long period of time, but the total addressable market for those three products that we're launching in Europe this year, is probably in the $700 million range and the margins are higher and we think we have very competitive offerings in those spaces. And then the last thing I would say is, a product we have not talked a lot about from JOTEC is their ePTFE-covered stent called E-ventus SX, that is a, that's a $500 million market if we choose to take that to the periphery. And we haven't even talked about it. So, I guess kind of to summarize the JOTEC, the entire, every product line was growing double-digits last year. The whole business grew 25%. We're getting ready to launch three new products in Europe. We're building on our channels in Asia-Pacific and Latin America which we're going to leverage that. And then we've got this U.S. pipeline kind of in the wings that the work is already being started there. So, as we said when we acquired the company, we see JOTEC as a double-digit grower for a long period of time.

Very helpful color. I'll re-queue. Thanks, Pat.

Thank you. Our next question is coming from line of Brooks O'Neil with Lake Street Capital Markets. Please proceed with your question.

Good morning, guys. I was just curious, if you could describe kind of when you made the decisions to accelerate your spending during the fourth quarter. And would you describe those decisions as sort of strategic opportunities that you found, that you just decided to make the investment in or was it something different than that? Thanks a lot.

Yes. I would say the -- yes, I'll talk about kind of 2019 and then I'll come back to Q4. So we had a meeting with our board in October where we talked about the 2019 plan. And we obviously knew where kind of the Street was with EPS and we saw the opportunities in front of us. And we feel in the long-term value creation for our shareholders, the return on investment is just too great with these channel investments and the R&D pipeline. We could be much more profitable, we could kind of a constrain our R&D pipeline, we could not invest in Asia-Pacific and Latin America, we could deliver way higher EPS. Working with the Board and we all felt with management that, for the long-term shareholder value creation, this company has got so many opportunities. I mean, no company of this size has 13 products in their pipeline, and it's a low-risk pipeline and a high return pipeline. And like I said, we have nascent commercial markets in Latin America and Asia-Pacific, we have a handful of people. So with the support of the Board, they fully agreed that we needed to invest long term in the company and this is a building year for us. And as I said earlier in my first comments with Jason, we are still committed to the financial metrics we talked about, delivering high single-digit growth, and as the pipeline comes forward, we think that will accelerate. We think we can get gross margin expansion of 1 point per year. And we think, because this infrastructure once in place, is largely fixed, that as those pipeline products come out, you're going to start to see the operating margin of the company accelerate through the five-year period. So if I come back to Q4, it's part of saying, we didn't sit down and have a conscious plan. I mean, the biggest overspend was the pipeline. We are pushing hard to enroll the PerClot trial, to wrap up the BioGlue China trial, so for those who have been involved with R&D and clinical trials, I think every quarter we are behind our enrollment and we are pushing hard to get it done and obviously that was a big part of the overspend. So I mean to me its good news. We actually were under our R&D budget for the year, it just was over in the fourth quarter. So again, I'm not that disappointed because we're pleased to have the trial enrolled. A second piece is, as we talked about, we've invested in the bringing on of new leadership and we're starting to put plans in place. We've got BioGlue getting ready to come to China. We've got going direct with the BioGlue in Brazil, so those things started unfolding. And then the third piece there, I would say is, we actually had a commission kind of accrual issue in JOTEC and it was probably one of the only things, I'd say, that there was a negative that we just kind of missed on our earlier commission accrual, but that's not going to happen again. So again, it was kind of a one-time thing. So again, I'm pleased with the direction that we're going, and I think that the EPS goals we set out there are going to allow this company to continue to build the channels in Asia-Pacific and Latin America, to invest in this pipeline, and you're going to see the financial metrics start to accelerate here on all three fronts. Brooks O’Neil: I think, that's great. My own personal view is, investors should be looking to you as a growth business and one that demands and will value the investment. So keep it up.

Thank you.

Thank you. The next question is from the line of Suraj Kalia with Northland Securities. Please proceed with your question.

Good morning, Pat. Good morning, Ashley. Can you hear me alright?

Hey, good morning, Suraj.

Pardon the background noise, if any. So Pat, three buckets of questions. First and foremost, can you quantify for us the cross-selling efforts and the results for CryoLife and JOTEC in Europe? Also, can you help us quantify the cross-selling between CryoLife and On-X in the U.S.?

Yeah, so, one of the things that -- actually just I was at the -- we had an international sales meeting back in January, so I was actually with the team in Europe and one of things that's interesting, if you think about it, trying to capture cross-selling in the first year is difficult because you didn't have a prior year comparative with your new structure. We now have a kind of a prior year comparative to the existing structure. We'll be able to better manage I'll tell you this year. I will tell you BioGlue is an example. So we -- one of the cross-selling opportunities between JOTEC and CryoLife was BioGlue, and we grew BioGlue 8% in Europe this year -- or in 2018. That was probably twice the growth rate of the prior year. So I would tell you that adding that additional channel clearly benefited, it was a benefit from cross-selling. That's also an easier product to note from a training requirement standpoint. We had the full vascular teams trained in -- a year ago. I think the second opportunity was kind of going the other way, which is the legacy CryoLife cardiac surgery reps started selling the Frozen Elephant Trunk from JOTEC and we've also seen a pickup there, although that's a much more difficult kind of a from a training requirement standpoint. So I think we'll actually particularly when we get the new product, I think we're going to see that accelerate rapidly. We're probably a little behind on the technology there. So I think you're going to see the benefit of that, once we start to sell our new Frozen Elephant Trunk. As far as the U.S., kind of the On-X kind of CryoLife cross-selling, I would tell you that the two things -- I would look at two metrics, I would look at is, we grew On-X 20% this year, year-over-year. Number two, we grew cardiac tissue valves 10%. And again, I'm talking about 2018. Those two metrics, I would tell you -- would tell me that there some serious cross-selling going on. I also think that as the data continues to come out on the Ross procedure, and as we start this PROACT 10A trial, CryoLife is extremely well positioned to be the market leader in patients undergoing aortic valve surgery under the age of 70. So we think there's a lot of synergy between the SynerGraft, Ross procedure and the On-X aortic valve with the PROACT 10A trial to literally we have -- we think is what is the best offering for a patient under 70 years old for getting aortic valve replacement.

Got it. And, Pat, forgive me, if this is an unfair question. In my experience over the last two, three years, you guys, unlike others, you guys don't throw around flashy words and you guys get down to brass action building a biz. That having said, we know in a couple of months PARTNER III results are going to come up. We know the age delta between mechanical and the transcatheter valves. Do you think any change in messaging is required by the On-X sales force, if any? And at the same time, have you all factored any impact whatsoever from PARTNER III, obviously, the trial is enrolled although approval is not going to come till next year. Just curious how you all are thinking about more of the messaging impact, if any?

Yeah, I mean we've talked a lot about this on previous calls as well. I mean this is a call that Ashley and I are -- a question we get with investors often in, you're trying to predict the future, I mean, it's -- people have different opinions of what's going to happen, what the data is going to be. And I just think there is such a gap between the average age of TAVR patient and the average age of a On-X aortic valve patient that even with that data, the average age of the On-X aortic valve is 58. The average age of a current TAVR patient I think is 78, maybe higher. You probably know the data better than I do on that. So you got a 20-year gap. It is not just the age, right. So let's say the PARTNER III data comes out and the age starts creeping down. The problem is you don't have long-term data for TAVR. And so every year you go lower, you're making a bet for the patient that valve is going to last. So you tell me a 58-year-old is going to get a TAVR valve. How long is that valve going to last and then what do they do on the next operation? So I just think again, we'll see what the data looks like. It's hard to comment because I haven't seen the data. But then I also say you're asking the question in the backdrop of a PROACT 10A trial that's about to start where we can offer a patient under the age of 70 one operation and Eliquis for the rest of their life. I'd love to hear about what the TAVR companies are saying about the data coming out on the requirement to actually anticoagulant the TAVR valves. So if you were to going to put people on Eliquis or some anticoagulant, why are you getting a percutaneous valve when you get a one operation and if you're going to be for the rest of your life? So the way to frame this in my mind is the target is moving for TAVR because maybe it is moving lower. The target is moving for On-X and we're going older because of PROACT 10A. Q – Suraj Kalia: Pat I love the enthusiasm and the passion. It will be fun watching this battle. One final question and maybe I got my numbers wrong and maybe Ashley can chime in. Pat you said five-year target 20% operating margins, okay. There was some mention about 100 bps per year improvement in gross margin. Can you quantify for us how much do you see is the improvement or what percent contribution from the channel, what percent contribution from product mix, what from new markets, just kind of frame it how you're all thinking this five-year outlook? Thanks for taking the question. A – Pat MacKin: When we put together our five-year strategic plan, we look at all these considerations. And so again one of the things I think we've shown and you would agree that as we kind of solidify a market like the U.S. once we acquired On-X, we have not really invested. In fact their year-over-year spending increased from 2018 to 2019 was like zero. We don't have to add investment into the U.S. channel. We're still -- we're one year into JOTEC and so we just want to record a bunch of countries, we’re still rounding that out. But that infrastructure will be fixed in 2019. So in 2020, I don't see a big increased investment in the JOTEC channel in Europe, so those two are fixed. We just told you, we're investing $2 million in Asia Pacific and Latin America. Those will be fixed probably at the end of 2019 as you get to full year '20 once they annualize on themselves. So when you finish 2020, your global channels are fixed. I then backed it up with 13 new products that are coming out around the world and I don't have to add any new reps. So it doesn't take a lot of math to figure out how you get to the operating margin of 20% just by leveraging your channels with 13 new products. As it relates to gross margin, we have a goal. We're not good to break out where it all comes from, but we are looking particularly on the cost downside. I hired a former operations executive, I worked with at Medtronic, also he ran the global supply chain at Baxter. CryoLife, legacy CryoLife, kind of, On-X and JOTEC have done zero cost down in the last five years, it just wasn't something they focused on, right. We have got the pieces in place just on the cost downside to get one point over the next five years. It's not easy. We'll be using all kinds of employing things like lean, like design for liability, like purchase price reduction from our suppliers, but not even getting into kind of mixed new products and all these kinds of things. We're working to get to the 1% cost down frankly on basically on cost, cost reduction, something we have very high control over.

Thank you. Our next question is from the line of Joe Munda with First Analysis. Please proceed with your question.

Good morning, Pat and Ash. Can you hear me okay?

Yeah.

Hey. Good morning, Joe.

So first off, I just wanted to touch on the pipeline. A lot of moving pieces here, a lot of excitement that I just wanted to get some clarity maybe on the cadence of R&D going forward. Obviously probably picking up, but I was wondering if you could give us your thoughts as well as what to expect in regards to the $3 million related to the med device framework in Europe, how that will play out over the year?

Yeah. So I think one of the things that for investors that's a real positive is that those 13 products that I mentioned, right, so I'm not going to go back to the laundry list, but we've got 13 products in the pipeline. We are able to fund that pipeline -- again, I'm talking about over a five-year period and roughly keep our R&D spending around 10%. I think that's a big deal. I mean that pipeline is about $150 million investment over the five years, but we get access to a $1.5 billion opportunity. So, we're not spending crazy percentages on our R&D because of our top line continues to grow, we're able to fund our R&D pipeline this year actually under a 10% R&D spend. And I think, again, some years it may go up a little bit, it may go down a little bit, but that's another piece of the income statement we're going to leverage over time because as we continue to build this business and grow this top line, our R&D spending can also come down, which will contribute to the 20% operating margin. So, again, that pipeline is affordable because the size of our business, and even keeping at 10% or a little bit lower. As far as the MDR throughout the year, I mean it’s -- I don't know that we've given kind of breakout to that.

Yeah, I mean, I think we expect R&D expense to be somewhat level quarterly throughout the year with the exception of -- with the final work that we're doing to get the BioGlue China submission and the work that we're doing on the PerClot PMA submission. The first and second quarters could be a little bit higher from an R&D standpoint than the last two, but overall, as Pat mentioned, we are estimating high single digits up to 10% of revenue for R&D in 2019.

Yeah, I think also -- I think Joe, the other thing that's I think really important for investors is, we don't have to do another acquisition. We don't need to raise money. We don't need to issue shares. We don't need to do another acquisition, okay. I'm not saying that we're not going to, I'm just saying we don't need to. You can look at our pipeline as an acquisition. It's a $150 million investment over five years, but I can keep my R&D spend under 10% and probably decelerating over the five years, which should contribute to the operating margin, but we got 13 products that, by the way, it's a very low-risk pipeline, lots of these products are either approved in other markets, it's just doing the trials and getting a move to new regions or new geographies. So we feel very confident with this pipeline, and as I said before, as this channel investment solidifies in 2019 and 2020, particularly in Asia-Pacific and Latin America, we don't have to really increase our channels after 2020, and that's when all the product starts hitting. It will drive margin, it'll drive operating margin. So, again, we're building the company, and I think we've shown what we've done with On-X in the U.S., JOTEC in Europe. This is the next piece of the puzzle and this thing is very well put together in the next 24 months.

Okay, that makes sense. Thank you for that. The other -- two other questions I had here, based on the first quarter guidance that you're giving, from my model, it looks like expecting a strong ramp in the second half of 2019 and that's -- I'm assuming as a result of the new product launches. But is there anything else there may be in regards to tissue -- tissue had a strong year this year, you're talking about a lot of excitement about Ross procedures. Maybe a little bit of clarity, are you expecting a ramp in the growth in the second half of this year? I'm just looking for clarity there.

Yes. So, if you go back, and I know we went through it quickly, but if you look at the catalysts for 2019, is that we've got like seven or eight catalysts for 2019. The first three are the new JOTEC products and those are hitting in the second half, so clearly, those are going to start -- as soon as those get approved and we get them rolled out in the market. So, the back half of 2019, we will start to see accelerated growth with JOTEC with those three new products. We're starting to go direct with BioGlue in Brazil in the second quarter. We have the new distributors in China for both for our JOTEC portfolio and our On-X portfolio in the second half of the year. So, we clearly have -- we've got the PROACT 10A trial starting kind of in the first half, but starting to get momentum in the second half. So, clearly a lot of these catalysts are starting to hit kind of mid-point of the year. So clearly I think the back half, just inherently because of all those catalysts kind of coming to fruition, are going to drive the back half.

Okay. And then I guess on the tissue business, you had been forecasting in the past, mid-single-digit growth, but it appears cardiac is really taking hold. Is this something -- is this a trend we're going to expect it to continue in 2019 and going forward?

Yes. So, I think we're pretty transparent on the tissue. We basically said, we thought it would grow kind of mid-single-digit and so we had internal goals like, I would say, call it 5% and we grew almost 8%. I was very pleased to see the cardiac tissue business up 10% last year. I made some comments earlier about the Ross data. There is a big paper and symposium at the AATS Meeting in May, 600 patients with 20 years follow-up. There is a resurgence of the Ross and we are the market leader in that segment. So I think that -- if that's how that data is received could be another positive for the pulmonary valve segment of our business. The second is we've -- and we mentioned this over the calls over the years, we've got a 2,000-patient trial going on at the Cleveland Clinic for our aortic tissue valve. That data should be coming out this year. So those two things could not only be kind of keep us in the mid-single, that could actually bump us up and we'll see how that unfolds. But we are actually very encouraged by what we're hearing about some of the data coming out on our tissue valves.

Okay, thank you.

Thank you. It appears we have no further questions at this time, so I'd like to pass the floor back over to management for any additional concluding comments.

Well, listen, I want to thank all of the -- everyone who joined the call this morning. And as hopefully you can hear from our enthusiasm that we are excited about what we're doing with the company. I think if you've been with us for the last four years, this company has transformed. And I think probably the best the most important takeaway message is that we have made the decision to invest in our pipeline and we don't need to do an M&A, we don't need to issue new shares, we don't need to issue new debt. Our debt is coming down and we are investing in two things. We're kind of fixing our international channels outside of Europe and the US, so Latin America and Asia-Pacific is requiring some investment. As those things take hold, those will be fixed at our income statement without a lot of need for additional investment as those annualize in 2020. And we've got a pipeline of 13 products with the market -- total addressable market of $1.5 billion. And we can do that by spending less than 10% in R&D over the next five years. And what that will give you is, we think we can give investors high single-digit growth as we do this, accelerating as the pipeline matures, we're going to try to get one point of gross margin per year and we think as those channels get fixed in 2020, as you move to the second half of the five-year plan that you will start to see our operating margin move up into the 20% range. So again, I think, we think this is a great company and we've got lots more to do, but we're extremely excited about our future and we appreciate all the support from our investors. Thank you and have a great day.

Ladies and gentlemen, this does conclude today's teleconference. Again, we thank you for your participation and you may disconnect your lines at this time.