Greetings, and welcome to the CryoLife’s Second Quarter 2019 Financial Results Conference Call. [Operator Instructions] Please note this conference is being recorded. At this time, I’ll turn the conference over to Greg Chodaczek from the Gilmartin Group. Thank you, you may now begin.

Thank you, operator. Good afternoon. This is Greg Chodaczek from the Gilmartin Group. Thanks for joining the call today. Joining me today from CryoLife’s 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 these 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 was issued earlier today. Now I’d like to turn it over to CryoLife’s CEO, Pat MacKin. Pat?

Thanks, Greg, and good afternoon, everyone, and thank you for joining us. Our second quarter delivered inline results despite unexpected headwinds that impacted the quarter. We demonstrated, once again, our differentiated portfolio can drive consistent results even while facing short-term challenges. In the quarter, we simultaneously produced solid organic revenue growth and made further progress towards a number of our key development objectives. Those of you who have been following the company know that in the second half of 2019, we expected to launch three next-generation JOTEC products along with continued progress on other pipeline opportunities. I’m pleased to report execution on our strategy and delivery of our 2019 objectives is still on track. Turning to our second quarter performance; total revenue for the second quarter was $71.1 million, reflecting 4% on a GAAP basis and 7% on a non-GAAP constant currency basis as compared to the second quarter of 2018. This strong consistent growth is delivered primarily by BioGlue, On-X and JOTEC product lines. JOTEC grew 8% on a non-GAAP constant currency basis relative to the second quarter of 2018, driven by increased penetration in our international markets. During the second quarter, our primary sterilization partner experienced a failure of one of its sterilization lines that caused us to lose product. Excluding the loss of revenues, stemming from this situation, our JOTEC growth rate would have been approximately 11% on a non-GAAP constant currency basis. Looking forward, we expect the growth trends for our JOTEC products to continue driven by the platform’s differentiation as well as the introduction of three new next-generation products into key European markets by the end of this year. Turning to On-X; revenue increased 5% on a non-GAAP constant currency basis as compared to the second quarter of 2018, with non-GAAP constant currency revenues in…

Thanks, Pat, and good afternoon, everyone. Total company revenue has increased 4% to $71.1 million and grew 7% on a non-GAAP constant currency basis compared to the second quarter of 2018. We saw a year-over-year revenue increases across all four of our major product lines. As Pat mentioned, we lost a very large JOTEC production run during the quarter, that would have generated approximately $500,000 in additional revenue, which would have resulted in reported revenue growth of approximately 5% and non-GAAP constant currency growth of approximately 7%. Recall that we posted strong revenue growth in the second quarter of 2018, which has created our toughest quarterly year-over-year revenue comp. Looking at individual product lines; JOTEC revenues for the second quarter were flat and increased 8% on a non-GAAP constant currency basis, both compared to the second quarter of 2018. This large difference in reported versus constant currency growth rates is due primarily to the year-over-year weakness in the euro versus the U.S. dollar. Considering the impact of the loss production run, reported JOTEC revenue growth would have been approximately 5% and non-GAAP constant currency growth would have been approximately 11%. On-X revenues for the second quarter increased 4% on a GAAP basis and 5% on a constant currency basis, both compared to the second quarter of 2018. BioGlue revenues in the second quarter increased 5% on a GAAP basis and 7% on a non-GAAP constant currency basis, both compared to the second quarter of 2018. Revenues were particularly strong in international markets where we experienced a 20% year-over-year increase in revenues on a constant currency basis. We saw growth in every OUS geography during the quarter. The growth has been augmented by the expansion of our direct strategy. Total tissue processing revenues for the second quarter increased by 4% compared…

Thanks, Ashley. So as you’ve heard today, we’re making great progress advancing on our key objectives. We expect to launch three of our next-generation JOTEC products over the next two quarters. We filed our BioGlue application for regulatory approval in China. We expect to start the PROACT 10A trial in the third quarter, and we anticipate submitting our PerClot obligation to the FDA in early 2020. We believe we have the pieces in place to drive consistent growth and take the company to the next level. That is why I can say with confidence, our best days are still ahead. Well, I also like to thank all of our employees who’ve helped make the second quarter a success. Your important work not only benefits the company but the many people and families around the world. With that, we will now open the line to questions. Operator, will you please proceed with the call?

Yes, thank you. We’ll now be conducting a question-and-answer session. [Operator Instructions] Thank you. First question comes from the line of Jason Mills with Canaccord Genuity. Please proceed with your question.

Hey, Pat, actually, this is David Rescott on for Jason. Can you hear me all right?

Yes. We can hear you fine, David.

So firstly, I wanted to start on two questions, may be on JOTEC. So looking forward, could you provide some color on kind of where you think the JOTEC product rollouts in Europe look going forward? Kind of how we should think about the commercialization process for those? And as kind of the second part to that one, where do you think will you kind of see any type of acceleration coming from either the U.S. or European rollout? And really, just trying to get a better sense of how we’re thinking about or how you guys are thinking about setting up commercialization ahead of the rollout?

Yes, so – I mean, a couple of things. Number one, we said from the beginning that with the CE mark applications that we’ve added a little bit extra time, and we’ve always contemplated, and we talked earlier on in the year about the first two submissions; the thoracic stent graft, E-nya, and the branched thoracoabdominal graft, E-nside, that we expected kind of a Q3 approval, and we still feel like that’s on track. Obviously, we’re in the early days of Q3, but we feel like we’re going to get that, both of those devices are approved in Q3. The third device, which is the E-vita Open Neo, which is our Frozen Elephant Trunk device, we will be submitting that in the next week, and we expect to get that approval in the fourth quarter. So – I mean, we will obviously – as those products get approved, we’ll be – and that’s one of the reasons you see kind of an acceleration in the second half because we think those products will meaningfully add to the top line. I think probably the most important message around that is, I mean, we’re extremely bullish, and we had kind of a softer growth rate around 8% constant currency, but it was all – frankly, we talked – we had a sterilization problem in the quarter, and we’ve got some supply challenges in the near-term, but I’m extremely bullish on the JOTEC product line, particularly with these three launches coming out. I think it’s like 60-plus percent of our portfolio is getting upgraded. So we expect to see improved performance in the second half. And as the supply kind of loosens up and becomes more prevalent, we certainly expect to see better growth rates of JOTEC exiting 2019, but we think 2020 is going to be a very nice year for all those products in Europe.

Okay, thanks. Then maybe the second one, talking about margins, I guess, for the second half of this year and maybe looking into next year. I guess, could you go into detail last time what kind of the initiatives you have in places as far as what’s kind of boost margins? Whether it would be product mix, structural changes, some levers in the product launches or the OUS direct sales force transition? If you could provide some color on that, that would be great.

Yes. David, we’ve touched on a couple of these in previous calls, but there are several things that are going on within the company that we think are going to result in gross margin improvement over the next several years. First and foremost, one of the things that we started to focus on this year is just cost down initiatives. It was just a discipline that, as a small organization, that we had not previously had. And with the enhancement of our management team and some of the new ops people that we’ve brought in, it’s a focus of the organization now. So we think that just cost down is going to help to drive margins higher this year and over the next three to five years. In addition to that, there are some things that are going to help enhance margins, both near-term and long-term. The initiatives that we have going on around the world where we are going direct in certain markets and we’ve talked about some of those previously, just after the JOTEC acquisition, taking both company’s product lines direct in markets where we weren’t currently direct in Europe. We are taking the former CryoLife product lines of On-X and BioGlue direct in Brazil. And that initiative has really just kicked off in the second quarter of this year. Another thing that we’re working on is enhancing our distributor networks, both in Asia-Pacific and Latin America. And by doing that, we’re optimizing our distributor networks that’s allowing us to capture margin as well. And then the last thing, little bit longer term, as On-X continues to grow and as we look more into the future with getting the JOTEC product line in the U.S., we think that those are both going to be margin expanding opportunities for the company in the future.

All right. Great. Thanks for taking my question.

Next question is from the line of Mike Matson with Needham & Company. Please proceed with your question.

Hi. Thanks for taking my questions. I just wanted to start with On-X. So the growth was a little slower there. And I did hear a lot of commentary. May be I missed it, but going down the regions for that I’ve heard a lot on, kind of, JOTEC. I understand what’s going on there, but just curious what happened with On-X?

Yes. I mean, we’ve obviously been growing On-X pretty significantly over the last several years. And as we kind of do our kind of field checks, there’s nothing kind of out of the ordinary. I think the only thing we’ve heard a little bit of a trend of is some other companies pushing their tissue valves into kind of the younger patient population for a future TAVR device, which we think is not a smart strategy. But it didn’t really – there was anything meaningful that jumped out other than that in our kind of field checks.

Okay. Thanks. Just to clarify, when you say pushing tissue valves, you mean SAVR or TAVR in the younger patients?

TAVR, which again is

TAVR.

Yes, which again is – yes, and it’s part of this – to me this is just something that with the recent PARTNER III data that came out, I don’t think people ask us, is TAVR having an influence on your mechanical valves? And I think that’s a very far reach. If one looks at the trial, less than 7% of the patients were under 65 years old. So this was a trial that was 65- to 80- year-old patients, and the average was 74. So I think that’s the thought of putting a TAVR in a patient that’s under 65 years old is not well supported in the clinical community. That – what we have heard is, some people saying, particularly cardiologist saying, well, put a SAVR tissue valve in, and then we’ll give him a TAVR valve later. And again, I think that if patients were informed with the data, that’s not something that they would accept. There’s extensive literature about inferior performance of tissue valves in patients under 65. It’s well documented. They have more structural valve deterioration leading to reoperation. There’s an increase in mortality. So again, I think this – the tissue in younger patients is already been proven out. In fact, the kind of the most eye-opening data that I heard kind of this quarter from a surgeon meeting was, the mean time to a bioprosthetic failure in the valve and valve registry was eight to 10 years, and that was in 77-year olds. So you can imagine if you start putting tissue valves in younger patients what’s going to happen there. So again, I think we feel very strongly that On-X in the under 65 patient population with a lower INR is a great solution and even better is the PROACT 10A trial, which, as I commented in the script, we’re looking at bringing out in the – we will, hopefully, get it approved in the third quarter. So we feel like we have a great solution for this patient population. I think that the PARTNER data was great for patients at 75 years old. By the way, it was one-year data. So again, I think for a certain patient population it makes sense. I think the other thing people got to remember is, there are now bicuspid valves in those trials and that’s the majority of patients who are under the age of 65. So I think there’s a lot of reasons why TAVR is not coming into our kind of turf. It’s more kind of them trying to bring tissue in, and that’s not a kind of a bright strategy given the data.

Okay. That was super helpful. And then just a couple on BioGlue. So curious any updates or any visibility et al on the Chinese timing? And then also, there was really strong outside U.S., 8%, I think, growth constant currency. So is that cross-selling or just more speed on The Street? Or what’s going on with that?

Yes – no. So on BioGlue China, I mean it’s a little bit of a black box, to be honest with you. I mean, we looked at the approval time lines of other PMA-like products in China, and it’s one to two years. From the feedback we’ve gotten from our partners on the ground in China, we should be hearing back probably in Q4 kind of the initial feedback, what kind of questions we’re going to get, and if and when we’re going to go to panel. So as we get more color from that feedback, we’ll certainly share on a future call kind of what the status is, but we don’t really have anything new at this point. As far as international BioGlue growth, the majority of our sales outside of kind of U.S. and Europe, which are our heavy direct markets, it’s all through distributors. So – I mean, this is not uncommon to see kind of lumpy buying patterns where you have a big quarter one quarter and then a little softer the next, where the distributor may stock up or unwind. It doesn’t necessarily tie into your kind of 90-day reporting quarter. So we obviously had a good quarter with BioGlue internationally. But again, that can be somewhat lumpy throughout the year.

Okay. Great. That’s all I have. Thank you.

Thanks, Mike.

The next question is from the line of Jeffrey Cohen with Ladenburg Thalmann. Please proceed with your question.

Hi, Pat, Ashley. How are you?

Hey, Jeff.

Hey, Good afternoon.

So two questions, if I may. So firstly is just, it feels like your reps are getting more efficient or were more efficient for the quarter. Was that as a result of some of the activities in Europe or any specific callouts on that front? Looks like they have did more with less?

Yes. I mean I think the one thing we’re very excited about, I mentioned this earlier. I mean over the last few years, we have significantly strengthened our channel in Europe. I think we’re sitting at roughly 85 reps in Europe right now. We are on the heels of, basically, a total revamping of the JOTEC portfolio, which we think is going to provide meaningful growth, particularly in 2020. I mean, as many of you know who are in this field, you get the approval, you got to get your launches and all these kind of things. You ought to get your consignment inventory out and train your reps and train your customers. So it takes a little bit to up and going, but we’re very excited, particularly in this new regulatory environment in Europe where this transition to the – from the medical device directive to the medical device regulation, which is going to basically close the door on a lot of people getting approvals without premarket clinical data. So we feel like we’re going to have a world-class thoracic aorta portfolio with a really strong channel to kind of end this year and to kick off 2020. So I think that, that channel is very well prepared to accelerate growth.

Okay. Got it. And then could you talk a bit more about this production run and this $0.5 million? I’m just trying to get a better understanding of...

Yes. It was just – yes, there’s two things that are going on, on the JOTEC front, right? The first one is, frankly, just a mistake. I mean, we have a – like many companies, we have a partner that does have sterilization. They basically sterilized a lot of about $0.5 million worth of product twice. So they kind of cooked it twice, which means you’ve ruined the product. That hurt us to the tune of about $0.5 million as Ashley commented in his remarks. The second thing that’s going on is JOTEC was primarily a – it was a European – German-based European focus company that sold to distributors outside of Europe. And we’ve put in some very strong commercial leaders in Asia Pacific and Latin America. And we’re bringing on new – as you heard in the comments, we’re bringing on new distributors. We’re hiring direct people. And to bring in the inventories to cover cases, launch products, launch distributors, we’re just kind of at max capacity at JOTEC right now. So it’s just – it’s not something you just going to wave a wand and all of a sudden you can just spit out as many more units as you want. It takes some time to get the people trained and get them up and running. So we’re a bit manufacturing-constrained right now. And that is our biggest kind of slowing down our third quarter a little bit, but as I said, we will rectify this. It will get better in the Q4. And as we get these launches coming up, I think we’re going to hit into 2020 kind of in full stride.

And then what about the footprint there? Kind of I know that previously I think the facility was 50% or 60% or 70% capacity with two runs in there, some availability to construct another structure. What’s the story there? And how is that kind of?

Yes, we’ve actually – no, it’s a good question. I mean, I was just over there a couple of weeks ago. We’ve actually just taken another floor of our main building, which is much needed. We’d had to bring in temporary trailers as we’re doing some of that works. I mean, literally it’s – we’re growing – that product line grew, as you well know, 25% last year, and we’ve got a lot of expansion we’re doing. So we’re – we’ve got the capacity in the space. It’s just kind of how fast can you ramp everything up. So our – we’ve got a very strong operations team. It’s a good problem to have. We wish we had full supply today, but we’ll get there. And again, I’m extremely excited about the opportunities for the JOTEC product line to continue to grow in a significant rate as we get these product supply issues resolved.

Okay. And your sole source now as far as the serialization on that front?

I mean, we use lots of different sterilizers around the world for different products. So I won’t say we’re – for – I’d have to check specifically for JOTEC, but we’ve addressed the issue.

Got it. Perfect. Thanks for all for taking the questions.

[Operator Instructions] The next question is from the line of Kalia, Suraj with Northland Securities. Please proceed with your questions.

Good afternoon, Pat. Good afternoon, Ashley. Can you hear me right?

Yes. It’s kind of a scratchy connection. We can hear you.

Pat, I’m at the airport so you might hear the background noise. Hopefully, my questions come through. So Pat, for PROACT 10A, there seems to be a slight delay. Your originally commentary – shed some additional color in terms of the discussions with the FDA? What is the – is there something in the trial design that has a point of contention? Any color would be great.

Yes. Sure. No, I heard the question. No. So I mean, look, we’ve been in discussions with the FDA for probably 18 months. They have been very helpful. And obviously, this is kind of a new area for them. And I think the complexity of the device arm, CDRA, is working with the drug arm, CDER. That’s – there’s some internal complexity there inherent to the agency. They have been very good to work with. We purposely had a number of meetings with them to iron out all the issues. So again, I always say I can predict how long it’s going to take regulators to get stuff approved. I think mostly you would agree with that. I would say we had very good conversations with them, and we’re submitting our final IND this week. So I mean I think we’ve got all of our questions answered, and we’ll wait and see what’s responses, but it’s a 30-day response time. So we feel like we should get an approval in the third quarter for the trial.

Got it. Pat, you now talked offline about this. And I was just curious, obviously, PARTNER III, there’s tremendous anticipation on low-risk approval. Edward said it’s – the approval is imminent. If I remember correctly, the average age in P III was 73 years. My question, Pat, as you look out, how would you – how do you think you would prevent age creep? By that I mean, how would you prevent a 65-year-old patient getting TAVR? I know you mentioned by prospect, but I’m curious that once you get into low risk, as far as I understand, there clearly is no age limit per se. Am I wrong in saying that?

Yes. You’re actually dead wrong. This is a big confusion. Low risk does not mean young age. I mean it was a kind of a tricky way to do this, but I mean less than 7% of the patients in PARTNER III were under the age of 65. So this trial was predominantly – 93% of the patients in this trial were 65 to 80, right? The average age of PARTNER III is 74, right? There is zero durability study of a patient at the age under 65 with TAVR. So I mean I’m not to say that it won’t happen, but again, I think that the data out there does not support. In fact, the surgeon KOLs I talked to, basically feel like TAVR is not indicated in patients under 65. There’s a couple of reasons for it. Number one, there’s no long-term performance data with – how does that tissue valve work in a under 65-year- old because we know prosthetic valves don’t work in under 65-year olds very long. The second is the majority of the patients under 65 have a bicuspid valve, and bicuspid valves were not studied in PARTNER III. So you can talk about age creep, but they didn’t study bicuspid valves, which is the majority of the issue for patients under 65, right? And then you get into the whole tissue – tissue doesn’t last in kind of under 65 years old to begin with. Now you’re going to put a TAVR with tissue inside. I think this data out of the valve and valve registry, that I commented on earlier, the mean time to failure for the bioprosthetic valves in that valve and valve registry, was eight to 10 years in 77-year olds. So what’s the failure rate going to be patients under 65? So again – look, people are going to do what they’re going to do, but I think at the end of the day, the reason patients don’t like mechanical valves because they don’t like taking Coumadin. And with the On-X valves today, you can take half the amount of Coumadin and still get a mechanical valve, which is way better than what our competitors do. And the second piece is PROACT 10A. We hope to start rolling that trail this year. And that’s a total game changer for patients under 65. It’s going to get down to the question, do you want one valve for life or do you want a life full of valves.

Thank you.

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

Good afternoon guys. Can you hear me okay?

Yes. We can hear you fine, David.

Pat, actually, first question revolves around the third quarter guidance. I’m just curious, let’s say, all things being equal, you’re hitting on all cylinders with JOTEC both on sterilization and the supply issues, how much of an impact do you think it would have had on the third quarter?

I mean, it’s hard to say. I mean, we know from our kind of orders that we have and how that we can’t fill in the third quarter. It’s probably, I mean, in the range of $1.5 million to $2 million.

Okay. That’s helpful. And then on the On-X side, I don’t have the numbers in front of me, but the confidence had always been for double-digit growth in that business, a little softness in this quarter. I guess, how do you overcome some of those issues you just spoke about regarding data from PARTNER III, and potentially, overcoming that to drive growth in the On-X business back to double digit?

Yes. I think there’s a couple of things. I mean, one, currency has been a big issue for us this year, I mean, there’s no question. So our constant currency On-X growth was in the kind of the 8% range. We did some market checks on key accounts in the U.S. as well as overseas accounts. I say the only noise we heard was some noise around the kind of the – this kind of move to tissue to setup for TAVR. That being said, I mean, I think that the PROACT 10A trial is a total game changer in the field. So it’s not like we’re kind of standing still. We think that a one valve for – again, we’re talking about – we’re not talking about – we’re talking patients under the age of 65. For that patient population, the idea of getting multiple valve operations over a lifetime doesn’t make a lot of sense for the patient or the payer. So if you can have a more benign anticoagulant, like Eliquis, we think it would really change the landscape of the On-X valves in the aortic position in patients under 65. So it’s not like we’re just sitting still and going to have to deal with the kind of PARTNER III, and we’ve got a very unique clinical trial kind of coming this quarter.

Okay. That’s helpful. And then I guess my last question, on the vascular – on the tissue business, we talked about competitive pressure as well as supply constraints. I’m just curious how much of the short – of the decline is weighted to either supply or competitive issues?

Well, I think they are tied together. I mean this is been a real issue and we’ve made significant improvements in that area, and we expect our vascular tissue to be much stronger in the second half as we commented kind of last quarter. But it’s – the two kind of trigger each other, right? So we can’t cover a long saphenous vein case because we don’t have product. And then they call the competitor and the competitor drops price. So we’ve kind of let him into our accounts. And so by eliminating the supply problem, we eliminate the competitive problem. So I think we’re – the CryoLife brand is extremely strong. We’ve been doing this for 30 years. If we get our field, the full supply of saphenous vein, we’ll eliminate this issue.

Okay. Thank you.

Mr. MacKin, there are no further questions at this time. I’ll turn the floor back over to management for closing comments.

Well, thanks, again, for joining the call. And I think one of the points I would – we set out our number for Q2 and actually beat the top line and the bottom line even in the face of the currency challenges. So I’m proud of our team for delivering on that. The second thing is we’ve got a lot coming in the back half. We’ve talked about – we expect to get the PROACT 10A trial approved in Q3. We expect to get our next-generation thoracic stent graft, our next-generation thoracoabdominal stent graft approval in Q3. We’ve got our E-vita Open Neo, our next-generation Frozen Elephant Trunk, that should get approved in Q4. Our JOTEC supply and our vascular tissue supply should both be improving in the second half. So again, we feel like as we work through this kind of JOTEC supply issue in Q3 that, Q4 will be strong, and we’ll be heading into a really strong 2020 because then we’ve got kind of BioGlue China and PerClot in the U.S. hitting. So we had a – I think a – it was a solid quarter. We had some headwinds, but we’re going to deal with them and move forward to a stronger Q4 and then I think with nice momentum going into 2020. So thanks again for joining

This concludes today conference. Thank you for your participation. You may now disconnect your lines at this time.