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Executives

Scott Murcray – Chief Accounting Officer and Controller

Brian Farley – President and CEO

Peter Osborne – VP, Finance and Administration, and CFO

Analysts

Ben Andrew – William Blair & Company

Tom Gunderson – Piper Jaffray

Matt Dolan – Roth Capital

Greg Brash – Sidoti & Company

VNUS Medical Technologies, Inc. (VNUS) Q3 2008 Earnings Call Transcript October 29, 2008 5:00 PM ET

Operator

Good afternoon ladies and gentlemen, and thank you for standing by. Welcome to the VNUS Technologies third quarter 2008 teleconference. During today's presentation all parties will be in a listen-only mode. Following the presentation the conference will be opened for questions. (Operator instructions) This conference is being recorded today, Wednesday, October 29, 2008. I would now like to turn the conference over to Scott Murcray, Chief Accounting Officer. Please go ahead, sir.

Scott Murcray

Thank you. Welcome to VNUS Medical Technologies regular teleconference on quarterly financial results. Joining me today is Brian Farley, President and Chief Executive Officer; and Peter Osborne, Vice President, Finance and Administration, and Chief Financial Officer.

Approximately one hour ago, we released our financial results for the third quarter ended September 30, 2008. In today's call, we will discuss our business and financial highlights for the third quarter of 2008. We will also provide our business outlook for the fourth quarter and full year 2008. After our prepared remarks we will open the call for questions.

The statements that will be made today on this call may contain certain forward-looking statements that involve a number of risks and uncertainties. Words such as expects, believes, intends, plans, estimates or variations of such words or similar expressions are intended to identify such forward-looking statements and such statements in this conference call will include statements regarding the outlook for VNUS's revenue and earnings, gross margins, commercial success of VNUS's licenses, operating expenses, new product development, marketing programs, foreign currency fluctuations, global investment markets, and pending patent litigation.

Investors are cautioned that actual events or results may differ materially from VNUS's expectations based on various risks and uncertainties. Information concerning risk factors that may affect VNUS's forward-looking statements can be found in the press releases issued by VNUS and VNUS's filings with the Securities and Exchange Commission including its annual report on Form 10-K filed with the SEC on March 14, 2008 and its quarterly report on Form 10-Q filed with the SEC on August 18, 2008. Copies of VNUS's press releases and additional information about VNUS are available on our corporate web site at www.VNUS.com.

Investors are cautioned not to rely on forward-looking statements. VNUS is providing this information as of the date of this conference call and expressly disclaims any intent or obligation to update these forward-looking statements except as required by law.

Now I would like to turn the call over to Brian for a summary of our third quarter and more recent business highlights. Brian.

Brian Farley

Thank you, Scott. And thanks everyone on the call for joining us today. I'm pleased to be reporting VNUS's financial and business results for the third quarter of 2008. Before discussing our performance in this recent third quarter, I want to point out that one year ago in the third quarter of 2007 we had a terrific set of quarterly results and this was again repeated in the fourth quarter of 2007. As a result, our year-over-year comparisons in 2008 are now up against strong performances from quarters in the second half of last year.

Third quarter revenues came in at $23.1 million including $21.9 million of product revenues and $1.2 million of royalty revenues. Total revenues of $23.1 million were above our Q3 guidance which was for total revenues of $21.7 million to $22.5 million. Higher than expected product revenues were the cause of this performance since royalty revenues came in at the midpoint of our third quarter guidance. Growth in product revenue was 25% in the third quarter of 2008 and total revenue growth was 32% compared to Q3 of 2007.

Our net income in the quarter of $0.10 per share was in line with our guidance of $0.06 to $0.12 per share. We’re also very pleased to a report that operating profitability in the third quarter increased significantly to 8.3% of revenues compared to an operating loss of 18% one year ago in Q3 of 2007. In comparison operating profitability in the most recent quarter, the second quarter of 2008, after excluding $8.7 million in one-time royalty revenue was 1.7% of revenues.

Disposable catheter and device unit growth remained very strong at 29% especially when compared to the strong performance in Q3 of 2007.

Our ClosureFAST catheter represented 96% of our total catheter unit sales in the third quarter, identical to the second quarter results. Gross margin in the third quarter of 69.6% improved tremendously compared to 61.5% in the third quarter of 2007. Although the higher gross margin was helped by $1.2 million in royalty revenue the bulk of the improvement is really due to manufacturing efficiencies.

Gross margins from product sales in the third quarter were 67.9%, which was above our guidance range and represents a 250 basis point improvement in product gross margin compared to the second quarter this year. This sequential increase in product gross margin occurred from broad cost reductions in catheter manufacturing, encompassing direct labor, materials, and overhead costs per unit as well as from a higher worldwide catheter ASP due to a higher number of catheter sales in the US sold in Q3 compared to Q2. Interestingly, the ASPs in the U.S. and the ASP internationally in the third quarter remain unchanged compared to the second quarter but due to an increased mix of US catheters sold in the third quarter worldwide ASP increased nearly 1%.

When me look further into where the quarterly unit growth is coming from. We see that in the U.S. approximately 30% of the growth is from increases in utilization rates by our existing customer base, sort of a same-store sales increase, but 70% of the growth is from customers who didn’t order from us in one year ago in the third quarter of 2007.

Our unit sales in RF generators also very solid with 100 radio frequency generators sold in third quarter compared to 120 in the second quarter of this year, and compared to 80 one year ago in Q3 of 2007.

Now looking into reports from our direct sales teams in the U.S., Germany, and the UK and combining these reports with analyst reports on our competition in the United States it appears that we’re winning approximately 80% of the new customers who are making a capital equipment purchase decision between either a laser or radio frequency generator for our endovenous ablation. In addition, our report of RF generator unit sales did not include upgrades from our older model generators nor did they include RF generators that are placed with customers in exchange for a disposable contract or a swap out of the laser console. These types of transactions represent another approximately 25 RF generators per quarter being sold; excuse me, being placed into service in 2008 in each of the first three quarters. And also underscore not only the demand for a product but the health and the growth of the endovenous market.

Now international product sales continue to be a driver in our business. In the third quarter, international revenues were11% of product sales and grew 108% from the third quarter of 2007. As we look further into our international business we have updated our estimates of the size of the worldwide and European markets for saphenous vein procedures.

For 2007, we estimated the worldwide market was approximately 1.25 million saphenous vein procedures annually. This breaks down to approximately 235,000 in the United States, 370,000 procedures in nonEuropean international countries where we have a distributor and approximately 640,000 saphenous vein procedures performed annually in Europe. Outside the United States, vein stripping is a procedure for saphenous vein reflux in approximately 95% or more of patients treated. Now in Europe, approximately 100,000 of the saphenous vein procedures are in countries where public health insurance reimbursement is available for our endovenous vein ablation procedure. We have received notification recently that the French health authorities after a thorough review of the clinical research and the patient outcomes with our products have approved our radio frequency vein ablation procedure for public reimbursement in France beginning January 01, 2009. We have not yet seen the amount of reimbursement that will be provided to doctors and a facilities and expect that some of this payment information in France will become available in the first quarter of 2009.

We are especially pleased that our VNUS Closure product in radio frequency ablation was the one remaining minimally invasive endovenous technology and product approved by the French authorities for public reimbursement. The French approval document indicates that approximately 90,000 persons in France will become eligible for treatment with our procedure each year. This adds to the 100,000 that are already available in other countries in Europe.

So in addition to France, the public health system coverage for our procedure is now available in the UK, Belgium, the Netherlands, and Finland. We will continue to strive to obtain public reimbursement in additional European countries and hope for example, (inaudible) will help this process along.

On the U.S. side, the reimbursement for our VNUS Closure procedure remains solid and we see no issues with the preliminary 2009 Medicare reimbursement for RF vein ablation for either the hospital setting or the physician office setting. The medical – the final Medicare fee schedules are typical a published in the first week of November. So we want the commenting on preliminary numbers with such a short time frame, until the “final numbers” are published. We will, however, speak about reimbursement in our upcoming investor presentation that will be aired via web casts associated with investor conferences scheduled for November 19 and December 3.

Now irrespective of the Medicare reimbursement rates that get set for 2009, it is clear that today we are winning significant market share today with our current business and our current situation. Not only are we winning market share by winning an estimated 80% of new box sales but in the third quarter we believe that our procedure market share in the United States increased from approximately 40% in Q2 to 45% in Q3. We also estimate that VNUS’s revenue market share from product sales in the United States surged from 59% in Q2 to 67% in Q3, which would further increase to 68% when loyalty revenue is also accounted.

On the competitive front, our marketplace has continued to evolve. Some of our competitors have indicated in recent months that they were raising prices and we’re starting to see this increase in the marketplace. As we previously reported, we are pursuing patent litigation with four other companies including, CoolTouch, Dornier Med Systems, Biolitec, and total vein systems.

In parallel with this new patent litigation, licensing discussions continue. And we won't be providing commentary on the status of negotiations with any of the parties.

Now the next two quarters are exciting times for VNUS in addition to the businesses performing well, we have some products entering first clinical use, including a product that eliminates the time and patient discomfort associated with administering (inaudible) local anesthesia. (inaudible) is the requirement of both RF and laser vein ablation and often requires about seven to ten minutes to administer and requires several injections of anesthetic into the patient’s thigh. We can eliminate this with our new product and it will be initially tested in a Phase I clinical study expected to start before year end and continuing to subsequent phases of clinical study in 2009. We hope to release the product sometime in 2010.

Another product soon to begin first human use is a product line extension of our highly successful ClosureFAST catheter in which we add a light source at the end of the catheter. This makes the catheter tip easy to see through the skin and should make the procedure easier and faster. Doctors can use the light to visually position the catheter, confirm with ultrasound the position and again to use the light to guide external compression during segmental ablations. This product could be launched in the first half of 2009.

Additional products in development are moving forward on scheduled but due to competitive reasons we’re not going to describe these products at this time other than to say that we remain focused on developing innovative products for venous disease and that these products are primarily for the treatment of symptomatic venous reflex disease as well as varicose veins.

With the success of our business, improving profitability and demonstrated capability to take market share, we believe it is now time to add staff to enhance our marketing and selling efforts. During our last earnings call we indicated that we were considering an expansion of our sales forces. After two years of keeping the U.S. sales organization at a constant size we have increased the size of U.S. field and sales organization from 63 persons last quarter to 65 for the fourth quarter of this year and may add 6 to 8 more field staff by the end of 2009. In addition, we expect to be modestly increasing the size of our international sales teams in 2009 and we will provide more details on the size of the expansion once we receive information on the public reimbursement payment level for our procedure in France.

Another initiative we have decided to fund is the creation of a dedicated group that is charted to help physicians successfully grow their vein practices. The incremental operating expense required to fund these initiatives in the fourth quarter that are aimed all at increasing revenues; it is expected to be $500,000.

I would like to wrap up now with a couple of comments on our business versus that of the economy. As we have stated all year long we continue to grow well and have no indication that the weaker U.S. economy is impacting our business. Perhaps this is because our product performance and customer demand is strong or perhaps it is because varicose vein patients who receive our endovenous ablation or saphenous vein blocks and receive our product are truly dealing with significant symptoms.

Recently we have heard questions about the cost that the patient incurs to receive our closure procedure. In the U.S. we estimate about 98% of the patients treated with our closure catheter had the procedure paid for by a health insurance plan. These patients are responsible for a co-pay, which may range from 0 to $10.00 with many HMOs to larger co-pay amounts with PPO plans. For example, when a patient is covered under a PPO plan and receives our closure procedure, the patients will typically pay $200 to $400 out of their pockets because of a 10% to 20% co-pay amount. This has always been the case during the seven years in which our procedure has been routinely covered by insurers in the U.S. Any way we look at it today, however, we don’t see an effect of the economy on our business. In addition, our cash position is strong growing nicely from ongoing operations and is safely invested in a conservative manner.

Now I will turn the call over to Peter, for his review of the financial results from the third quarter and other business outlook for the fourth quarter and full year 2008. Peter.

Peter Osborne

Thanks, Brian. For the third quarter, net revenues were $23.1 million, including $21.9 million of net product revenues and $1.2 million of royalty revenues. Net products revenues are derived from the sale of disposable endovenous catheters and devices, RF generators, and accessory products. Royalty revenues are derived from the licensing of certain patents previously subject to an infringement lawsuit. Total net revenues increased 32% from the prior year, and decreased 28% sequentially. For the third quarter net product revenues were $21.9 million, an increase of 25% from prior year and 2% sequentially. The company has historically experienced a seasonal down sequential third quarter in product revenues and had previously guided to that. So the reported positive third quarter 2% sequential growth is significant.

Compared to a year ago, we experienced a 29% increase in catheter unit sales while compared to prior quarter, we saw a 3% increase. The RFS family of devices represented approximately 10% of our disposable vein, catheter and device unit volume in the third quarter of 2008.

Sales of disposable catheters and devices accounted for approximately 77% of third quarter net product revenues. Sales of RF generators accounted for 9% with accessories and other revenue representing the remaining 14%.

In the third quarter of 2007, sales of disposable catheters and devices accounted for approximately 76% of net product revenues. Sales of RF generators accounted for 10% with accessories and other revenue representing the remaining 14%. In the second quarter of 2008, sales of disposable catheters and devices accounted for approximately 76% of net product revenues, RF generators accounting for 10%, and accessories and other revenues the remaining 14%.

International sales more than doubled from a year ago and accounted for approximately 11% of third quarter net product revenues compared to 6% for the third quarter of 2007 when compared to 13% sequentially. In Q3 2008, we sold into 39 different countries versus the comparable period in 2007 of 31 countries. The year-over-year increase in international sales was seen in RF generator sales and even more so in catheter unit sales. Of our international sales, approximately 73% of those transactions in the third quarter were denominated in a foreign currency.

(inaudible), our average U.S. catheter pricing and average U.S. RF generator selling pricing did not change compared to the prior quarter. The outlook for the U.S. catheter pricing could be favorably impacted in the future by the pricing strategies of EBO companies who have executed agreements with VNUS, all by 2009 reimbursement levels for our procedure. At this time it is too early to guide more specifically on U.S. selling price trend.

We continue to track the rate at which our customers perform the closure procedure in the office versus the hospital. 55% of new customers added in the third quarter in the U.S. are performing the closure procedure in the office compared to 67% of new customers added in the second quarter.

U.S. customers performing the closure procedure in the office represented approximately 68% of the unit volume of catheters for the third quarter compared to 67% in the prior quarter.

Excluding upgrades, laser swaps and trade-ins, we sold 100 radio frequency generators worldwide in the third quarter of 2008, compared to 80 in the third quarter of 2007 and 120 sequentially. Royalty revenues in the third quarter of 2008 were $1.2 million and include a negotiated payment of $0.3 million from the Diomed bankruptcy estate for royalties of relating to Diomed’s post bankruptcy patent infringement. VNUS has also filed an unsecured claim of $3 million for royalties relating to Diomed’s pre bankruptcy patent infringement. Due to the nature of bankruptcy proceeding, VNUS know the eventual amount or timing of the payment of this general unsecured claim. However, court documents preliminarily estimate that unsecured claims may be paid at approximately $0.20 on the dollar. Excluding the Diomed payment in the third quarter royalty revenues were below our earlier guidance of $1.1 million to $1.3 million. The company expects slower growth of royalty revenues in the future.

Gross margins for the third quarter were 69.6%, an increase of 8.1 percentage points from 61.5% for the third quarter of 2007, primarily due to the recognition of $1.2 million of royalty revenues recognized in 2008 and manufacturing efficiencies achieved since the introduction of ClosureFAST in the first half of 2007. Gross margins decreased 7.1 percentage points from 76.7% for the prior quarter, primarily due to the recognition of $10.4 million of royalty revenues recognized in the prior quarter.

Third quarter operating expenses were $14.2 million or 61% of net revenues compared with $13.8 million or 79% of net revenues year-over-year and with $15.4 million or 48% of net revenues sequentially. Third quarter operating expenses include $1.3 million of non-cash stock-based compensation compared with $0.6 million year-over-year and $1.6 million sequentially.

Sales and marketing expenses were $6.8 million, up 24% from a year ago, primarily due to higher sales commission expenses and international sales and marketing expenses and were down 7% sequentially. Research and development expenses were $2.6 million, up 13% from a year ago primarily due to headcount increases and down 1% sequentially.

General and administrative expenses were $4.9 million, down 21% from a year ago, and down 12% sequentially, primarily due to lower patent litigation legal costs. Patent litigation expenses included in the quarter were $0.3 million.

Operating income for the third quarter was $1.9 million or 8% of net revenues compared with an operating loss of $3.1 million or 18% of net revenues for the third quarter a year ago and with an operating income of $9.1 million or 28% of net revenue sequentially. Interest and other income net was $24,000 compared with $0.9 million year-over-year and was $0.3 million sequentially. The decrease was primarily attributable to overall declining yields on cash, cash equivalents, and short-term investments, and foreign exchange translation losses on net assets resulting from the strengthening of the US dollar.

Net income includes a provision for income taxes of $0.3 million with retroactive effect back to the beginning of the year with a two year suspension of California net operating loss carry forwards and limitation of tax credits, which were implemented by the budget of the State of California on September 18, 2008. The result of this cumulative catch up on taxes was an effective 18% tax rate in Q3. The company expects the annual effect of tax rate to approximate 8%.

Net income for the third quarter was $1.6 million or 7% of net revenues compared with a net loss of $2.2 million or 12% of net revenues a year earlier and net income of $8.8 million or 28% of net revenues sequentially.

Third quarter net income per share was $0.10, based on 16.8 million fully diluted weighted average shares outstanding. This compared with a loss per share of $0.14 in the third quarter a year ago, based on 15.5 million weighted average shares outstanding and second quarter 2008 net income per share of $0.53, based on 16.6 million weighted average shares outstanding.

Adjusted EBITDA for the third quarter of 2008 was earnings of $3.6 million as compared to a loss of $2.2 million in the comparable quarter of 2007 and an income of $11.1 million in the second quarter of 2008. The company expects to be in a fully taxed EPS position on a GAAP basis during 2010 or 2011. Accordingly, the company has decided to provide supplemental disclosure of fully taxed EPS as a long-term measure of growth in earnings on a comparable constant per share basis, absent the utilization of net operating loss carry forwards and one-time events, such as the payment of royalties in the second quarter of 2008 related to periods prior to 2008.

Earnings per share is fully taxed at 38% would be $0.07 for the third quarter of 2008 and $0.03 per share in the second quarter of 2008 after removing the $8.7 million of income from nonrecurring royalty revenue relating to periods prior to 2008.

On the balance sheet at September 30th, 2008, we had cash and cash equivalents and short-term investments totaling $78.2 million, an increase of approximately $14.2 million from a year ago, primarily due to royalty income and cash generated from improved business operations, and an increase of $3.5 million sequentially primarily due to royalty revenue collected of $0.3 million and cash generated from improved business operations of $3.2 million. Accounts receivable days sales outstanding at the end of September were 48 compared with 55 days year-over-year and 46 days sequentially. We expect days sales outstanding will remain between 46 and 48 days for the fourth quarter 2008.

Inventories increased $0.5 million from a year ago and were relatively unchanged sequentially. Our inventory levels at the end of September represented approximately five annual turns, which compares to approximately five annual turns year-over-year and five annual turns sequentially. We expect inventory to remain constant in the fourth quarter and annual inventory turns to range from four to five for the quarter.

Now, I will provide a fourth quarter and updated full year 2008 business outlook, which takes into account the risk factors regarding forward-looking statements factored at the beginning of this call. We currently estimate that our fourth quarter 2008 net product revenues will range from approximately $23.1 million to $24.2 million, translating to year-over-year growth of 12% to 18%. We expect international revenues to remain approximately 11% of total quarterly sales and expect approximately 73% of these transactions to be denominated in a foreign currency. Royalty revenues are expected to range from $0.9 million to $1.1 million.

Gross margin is expected to range from 68% to 69% in the fourth quarter. Fourth quarter operating expenses are expected to range from $14.8 million to $15.1 million. Fourth quarter net income is estimated to range from approximately $1.4 million to $2.2 million, or earnings of $0.09 to $0.13 per share. The number of weighted average shares outstanding used to calculate estimated earnings per share for the fourth quarter is expected to range from approximately $16.7 million to $17.0 million. We expect adjusted EBITDA for the fourth quarter to range from $3.1 million to $4 million. Fully taxed EPS is expected to range from $0.06 to $0.09 per share. The global markets are impacting our yield on our cash, cash equivalents, and short-term investments and the reason strengthening of the U.S. dollar will likely impact our foreign currency denominated transactions in the fourth quarter and we expect interest and other income net to be immaterial.

As Brian has detailed in his remarks, the operating expenses in the fourth quarter include new sales and marketing investments in our business both domestically and internationally, to take advantage of emerging opportunities we feel will benefit the business in 2009 and beyond. Our investment in our vein practice development group aimed at working with our physician customers to grow successful vein practices and the additions to the sales force will increase annual operating expense to approximately $1 million and $2 million respectively but will also be generating additional revenue for the business.

We currently estimate the full-year 2008 net product revenues will range from approximately $85.4 million to $86.5 million. Royalty revenues are expected to range from $4.5 million to $12.8 million.

Gross margin is expected to range from 70% to 72% for the full year. Operating expenses are expected to range from $58 million to $58.6 million, including patent litigation expenses of $2 million to $2.3 million and stock compensation expense of approximately $4.7 million. The increase in year-end guidance to annual operating expenses is due to increases in stock compensation expense of approximately $1 million, litigation expense of approximately $0.5 million, selling and marketing expenses of approximately $0.5 million, offset partially by reduced R&D expenses of $0.4 million.

Full year net income is estimated to range from approximately $11.5 million to $12.2 million or earnings of $0.69 to $0.73 per share. The number of weighted average shares outstanding used to calculate estimated earnings per share is expected to range from approximately 16.7 million to 16.9 million. We expect adjusted EBITDA for the full year to range from $17.4 million to $18.3 million. Fully taxed EPS is expected to range from $0.14 to $0.17 per share. Plus we have no indication that the weaker U.S. economy is impacting our business. We’re not providing any specific guidance for 2009 until our Q4 2008 earnings call on or about early February 2009.

Now, we'll open the call for your questions. Operator?

Question-and-Answer Session

Operator

(Operator instructions) And our first question comes from Ben Andrew with William Blair & Company. Go ahead please.

Ben Andrew – William Blair & Company

Good afternoon Brian.

Brian Farley

Hello Ben.

Ben Andrew – William Blair & Company

Just wanted to ask a couple of questions. You mentioned a bit slower a royalty growth in the fourth quarter and maybe talk about what is driving that versus what you were expecting before?

Brian Farley

Yes, we certainly see that we’re taking market share, but we don’t have the kind of granularity in our market share data to know for example, that it is from the royalty paying companies Angio-Dynamics and Vascular Solutions. It may be partially but I suspect a part of the issue is really the absorption by Angio-Dynamics of the Diomed bankruptcy and organization probably didn’t go as quickly or smoothly and I – of course I’m speculating but we know from their public reporting that they had a relatively weak reported quarter for their endovenous vein ablation sales perhaps that is a transitional issue. We really don’t know. We will need more run – quarter-over-quarter run experience to know whether that is transitional and will resume back at the kind of levels prior to the joining of those two businesses or not. But in general, I think the weakness in the royalties in the endovenous ablation business is partly a combination of our success in the marketplace with that integration delay.

Ben Andrew – William Blair & Company

Okay and then the product sales guidance that you gave what sort of shared gain does that beckon and what sort of pricing assumption does that beckon?

Brian Farley

Well the share gain has no price change from us but we – if I understood your question correctly we don’t know how much the competitive pricing increased in the marketplace. We just know that in talking to specific accounts and doctors out there that they have reported to us that they have received price increases. So I probably didn’t answer your question. Well why don’t you take another run at me with that.

Ben Andrew – William Blair & Company

Sure. What I was trying to get at is the guidance on product sales seems a little conservative to me and I am curious if you are assuming given your uncertainty about where your current income is coming from, does that assume additional share gains for VNUS in the market or is it just something else?

Brian Farley

Yes, what we have done for the fourth quarter guidance is we have assumed that we’re going to grow pretty close to the market rate here. We don’t anticipate another quarter like we did just had in Q3 where we took a lot of market share. Furthermore, the overall revenue guidance that we’re providing is impacted by two things. About $300,000 less royalty revenue then we would have thought one quarter ago. So we’ll have $300,000 less Q4 royalty from that. And then the strengthening of the U.S. dollar translates into about another $300,000 less of international revenue. But if you contrast that with where the core businesses, in procedure growth and in units we’re still projecting very healthy growth, for example, although we didn’t describe this in the script I can add to the picture by saying that we expect our unit catheter and device growth in the fourth quarter to be approximately 18% to 20% versus the Q4 2007 numbers and again as a reminder that is against an extraordinary Q4 2007 that we’re up against in comparison. And also RF generator units are continuing to move very nicely. We’re seeing actually a growth in RF generator sales this year over 2007, which is a little ahead of our expectations and those things generally translate into additional catheter revenues in one or two quarters down the road once those practices get up and running at a higher level. So there is some conservatism from the revenue focused based on those elements and if the – if our competitors improve their business the royalty revenue will improve but we think that the foreign exchange effect is real and it is going to stay in place.

Ben Andrew – William Blair & Company

Okay and one more quick question, as you think about the build out in international the sales force, clearly you are not going to give any guidance on ‘09 at this point, but you sort of pointed to a range of potential spending for 2009 on that side depending upon what happens in France, what happens I guess with the U.S. with the reimbursement for the build out here. You know, could international be 15% plus revenues next year or is that just not in the cards?

Brian Farley

Yes definitely, we have been at 13% just last quarter. We are 11% in Q3, which is a very weak quarter for Europe typically and we expect 15% is very achievable, maybe even better than that you. When you look at the fact that again we again grew 108% year-over-year in the third quarter international sales were certainly on track to see that become a larger and larger percentage of the product sales. And the other piece of it is that if you look at that overall worldwide market that we’re dealing with 1.25 million saphenous vein procedures, if you look at our run rate this year by the end of the year we will have, by our estimates, approximately 10% penetration into that marketplace with selling our catheters and devices. So lots of opportunities overseas. The results from the French health authorities are very encouraging and I think that the combination of that with doctors picking our products about 80% of the time compared to laser in an initial purchase selection really suggest that we’re in a really good position to take a big chunk of this saphenous vein market on a going forward basis. And the market is now ready to accept endovenous like there’s never done before outside the United States.

Ben Andrew – William Blair & Company

Great, thank you.

Operator

Thank you and our next question comes from Tom Gunderson with Piper Jaffray. Go ahead Please.

Brian Farley

Hello, Tom.

Tom Gunderson – Piper Jaffray

Hi Brian. I have got three areas, one is FX, one is France, one is expanding the market. On FX, I didn’t hear if you said it, what was the FX impact in Q3?

Peter Osborne

We did not talk about an FX impact in Q3. I can tell you that it was immaterial. The FX impact in Q4 is $300,000 on revenues.

Brian Farley

Well, let us make sure we distinguish there are two FX issues. One is on revenues and one is on the asset of our receivables. So the Q3 foreign exchange effect on our revenues from international sales as Peter indicated was negligible or immaterial. Peter you want to speak to this on the other income line.

Peter Osborne

On the other income line it was $200,000 loss from the strengthening dollar.

Tom Gunderson – Piper Jaffray

Thanks Peter. And then on France, Brian could you remind us you have a single distributor there? What is the relationship, and is reimbursement on your mind the last barrier or are they going to be some timing issues and education of the market issues?

Brian Farley

Good question. The situation in France is we are direct in selling there. We have one sales rep. We also have a senior clinical research manager who has been with the company almost ten years there. We have a – some of the very earliest clinical work when key investigators were in France going way back to 1998. So, we actually had a core group of about 5 or 6 physicians who can be training in reference [ph] centers. We will conduct our first training workshop in December with one of those doctors. I think we are well positioned to really go through and train the approximately 500 vascular surgeons in France and possibly even extend it beyond that to some of the angiologists who are interested. Angiologists in France perform a lot of vein procedures as well. As far as is the market ready and is reimbursement the last barrier? Reimbursement definitely is the most incredible important barrier. We don’t have the reimbursement numbers yet. We had hoped to receive some of those by this quarter, but it does look like now that in the first quarter according to the best estimates of our physician advisors over there that we will see reimbursement levels published for the physician fee and possibly for the procedure fee then or a little later. Once, however, the January 1st date clicks on by physicians know that they will be paid, they just won’t know how much. And so we do expect business to start running at a higher clip really right away as we start the year even though there will be some uncertainty over the level of payment. I don’t think anybody expects that the doctor will be paid less than what they were already getting with vein stripping and that is a potential that it could be higher because they also employ ultrasound guidance during the procedure and very well get a professional fee for the combination of the ultrasound and procedure. But of course, that is speculating on my part and in general we are in good shape. We have definitely some sales force expansion to do there and we’re doing a number of things internally with the French language materials right now to be completed in December.

Tom Gunderson – Piper Jaffray

And then the last thing on expanding the market times thinking just in the U.S., I understand the sales force adds, but could you elaborate a little bit more on what you are planning on doing with the – helping out on the marketing for individual docs?

Brian Farley

Yes. I will provide a little bit on that. We also had the opportunity to hire some very experienced individuals who are well connected and knowledgeable and experienced at helping doctors grow from modest to very healthy driving vein practices and they do this by providing a set of services to doctors including marketing, education, and various back office support activities and a it is just at the infancy stage right now but we do anticipate that they will be signing up and becoming more engaged with certain accounts over the next year and that the effect of that will be to generate revenues both in product sales and services for us.

Tom Gunderson – Piper Jaffray

And just – I think you said this but I just want to make sure, these people are doing medical marketing or direct employees of VNUS?

Brian Farley

Yes they are.

Tom Gunderson – Piper Jaffray

Okay. That is it from me. Thank you.

Operator

Thank you. And our next question comes from Matt Dolan with Roth Capital. Go ahead please.

Matt Dolan – Roth Capital

Hi, Brian and Peter.

Brian Farley

Hi, Matt.

Peter Osborne

Hello Matt.

Matt Dolan – Roth Capital

A couple of follow-ups on the Q4 product revenue growth Brian. First of all a nice gain obviously competitively on market share competitively there in Q3, can you tell us what the dynamics were in Q3 and why you do not expect that to persist in the quarter, maybe it is relative to the settlement. What have you? But why should you that continue?

Brian Farley

Well, you know, there is always a possibility it could. We’re definitely trying to be cautious about our assumptions of being able to take market share with that (inaudible) in every quarter. Most of the time in the past when we have gained market share we have gained it by a percentage point or so during the quarter. We have really not seen such a disruptive quarter as we had in Q3 in the past. So we don’t want to assume that will be repeated. On the other hand our sales channel looks very healthy. We’re continuing to believe that when a doctor is new and they’re really objectively looking at both the clinical outcomes of the technology to support and the reimbursement and profitability of these procedures that we win those head-to-head comparisons 80% of the time. And we hear that not only from our U.S. but our German and British sales forces as well. So we remain very confident. At the same time the Q4 is a bump up, a nice bump up in revenue, and we just had a few negative effects which is what I mentioned earlier, lesser royalty revenue and less international sales due to the stronger dollar. Our unit growth continues to be very strong 18% to 20% expected growth in the fourth quarter over the prior year quarter.

Matt Dolan – Roth Capital

And I guess the follow-up there. And that is helpful thanks. But what is unit growth a, related to your prior expectations what you provided after the Q2 results. When I look on a sequential basis and look back historically over the business over several years not just last year with ClosureFAST to back into the ClosurePLUS days. You never grew less than double digits sequentially. So maybe that would help us all to think about on a unit basis what are you seeing relative to our prior expectations that you gave the market and what are you seeing on a unit basis in terms of growth sequentially?

Brian Farley

Yes, what we’re expecting is unit growth is very close to where we were on our prior estimates. We are about a 1% haircut off of that and that is really related to just being a little cautious about the U.S. economy even though we haven’t seen an effect. You know, things have changed so quickly in the last three weeks that we want to be a little cautious on this and leave some room for success here.

Matt Dolan – Roth Capital

Okay, great. That is very helpful. And then on the R&D side I appreciate you telling us about some new products coming down on the lighted catheter, do you have any thoughts there relative to pricing or maybe revenue per procedure that we could just broadly think about at this stage. That is question one.

Brian Farley

No, it is too early to talk about pricing and we probably won’t be able to do that until exactly coincidence with the launch in the – sometime in the first half of next year.

Matt Dolan – Roth Capital

And then generally on R&D, is there any – I know you don’t want to talk about for competitive reasons about the broader pipeline but is there any – are there any general goals for the company to have a certain number of products per year here over the next couple of years?

Brian Farley

Yes, in general we try to release a product every year that has helped the business and last year was a bit of an exception for us. We ended up launching four total products in 2007, two of which were significant for the business including our updated perforated [ph] treatment device in ClosureFAST. So that definitely depleted the well just a little bit but we’re really right back where we should be with multiple products entering first human use. And a good pipeline behind it. So in general, yes about one significant product per year for the company is about the investment level. And then there’ll be some years that where we will be better than that.

Matt Dolan – Roth Capital

Okay, great. Thanks a lot guys.

Operator

Okay, thank you. And our next question comes from Greg Brash with Sidoti & Company. Go ahead please.

Greg Brash – Sidoti & Company

Hi guys. Thanks for taking my call. I don’t know if I heard you correctly on the increased spending on marketing and sales reps, how much is that going to add here in Q4. Do you mention what it could potentially add in 2009?

Brian Farley

Yes, the – we expect the combination of the new marketing initiative that is helping practices grow as well as the addition of two additional sales reps in the U.S., the $0.5 million impact in Q4 and that next year the effect of the marketing organization is another $1 million per year and the effect of another 6 to 8 additional field sales people in the U.S. is another $2 million. So that extra – just to be clear about that, that extra $3 million is not just all dilutive to earnings though the extra revenue and margins that are produced from all these efforts and we will provide more clarity around that when we give our 2009 plan and guidance.

Greg Brash – Sidoti & Company

Is that a typical maybe 6 to 9-month ramp up here before you expect any rep to become productive?

Brian Farley

Yes 6 months is definitely where we expect most of the learning curve to be and by the third quarter that they are hired they’re usually close to margin breakeven and by the fourth quarter they are right at margin breakeven. After one year they are contributed nicely to margins. So any time our estimates that we add a new sales rep it will be a dilutive process for that one individual let us say, for the first four quarters.

Greg Brash – Sidoti & Company

Okay, and Brian I know you are not giving guidance here for ‘09 but you have spoken in the past sort of looking for around a 14% operating margin in ’09. Does that change at all with this plan to hire reps in your marketing initiative?

Brian Farley

It does and it is one of the reasons we provided that extra information today, the extra $3 million was not folded [ph] into that expectation previously. And further neither was the strengthening of the dollar to the extent that we have seen it and that is right now has an exchange rate impact of about 15% to 18% on revenues from France, Germany, and the UK and as Peter indicated that’s about three-quarters of our international sales. So all those three things, excuse me, yes, all those three things the marketing, the sales, and the FX on revenues translate into lower operating profitability for us next year and we will provide additional guidance on that but I think it is safe to say that that is probably in the range of more than a couple of percentage points.

Scott Murcray

Okay, and then just

Peter Osborne

I also want to reiterate though the unit volumes in ’09 are still healthy and we don’t see a decline in our underlying fundamental business at the unit level yet.

Greg Brash – Sidoti & Company

Okay, and then I would just like to touch on the economy briefly. I mean, obviously, what is going on in the world isn’t really affecting you guys at all. Is it something you are pretty concerned about or do you believe since the majority of patients are reimbursed that you don’t expect it to be much of an issue?

Brian Farley

Yes I can predict where it’s going to go from here but all recent feedback from the field, including I’ve recently touched bases with our international direct selling teams. And the exact same answer we have received from every time that I get to post this question from Q1 through today, and that is we continue to not see an affect on our business from the weakening economy that has now actually even extended into the UK and Germany, although not quite as badly into Germany. So, we remain optimistic that patients are still coming forward and will continue to come forward to get their needs taken care of and these are patients who have symptomatic needs. It is not necessarily a procedure. So, – and it is not that expensive for the patient to move forward and pay the co-pay to get this procedure. So, we remain pretty optimistic about the business as long as there is not further sudden worsening in the world economy.

Greg Brash – Sidoti & Company

Do you think just because there is such a small percentage of people in the world with symptoms who are actually getting treated, do you think it is just from an education standpoint maybe those people with symptoms don’t even know that it is a reimbursed procedure. Do you have any sense?

Brian Farley

I don’t think that is the real issue. I think it is well known and understood in Europe which is half the world market that this is covered by national health services and you know, in any country where there is national health service is available the population of (inaudible) in the countries just assume health care is free. And so that is not really an issue. That only becomes an issue in the United States but I think the publicity of this procedure being available, the great public relations work that not only we but what our competitors have done over the last 6, 7 years has probably made this –made patients reasonably well aware of something being available. Nevertheless, you are right, that is 40 million patients with moderate to severe varicose veins in the United States and 235,000 last year who received some sort of saphenous vein treatment. So it is a big gap and I think a big part of it continues to be the need to get more physicians out there educated and performing the procedure. And we’re really pleased to see that we’re still seeing on the order of 18% to 20% increases in the number of users each of the last several years. So this is a great indication that we’re going to start meeting that demand better and those physicians do a lot of their own outreaches to patients to educate them. But this is a huge market. Lots of room to penetrate and I’m confident that patients are aware of the insurance availability.

Greg Brash – Sidoti & Company

Have you considered direct to consumer marketing at all. And do you think that is something that could help even double the growth rates here. Do you think the vein clinics and doctors are doing a good job of that?

Brian Farley

One of the reasons behind our foray into this new group to develop physician practices, is we have done a lot of work in the past with direct to consumer as well as referral marketing and whether it be TV, print ads, or various other experiments and pilot runs. We have a good experience base with this and we’re taking that to the physicians now to let them really run with it. The physicians are really true benefactors of these kinds of programs much more than the company is because anytime you do a direct outreach to patients with varicose veins or symptoms like this, you get a huge variety and array of patients who have early stage disease which don’t – aren’t necessarily applicable for the business but the great for the doctor’s practice as well as the later stage disease patients who need the therapies that our products address. So by setting up this marketing group we think we will help the doctors grow the practice in the most cost effective way for us and still grow the market.

Greg Brash – Sidoti & Company

Great. That is all I have. Thanks for your time.

Operator

(Operator instructions) And our next question comes from Sean Lavin with Lazard. Go ahead please.

Brian Farley

Hello, Sean.

Scott Murcray

Hi, Sean.

Operator

Mr. Lavin, make sure that your mute button is not on. Okay, it looks like Mr. Lavin has disconnected. And ladies and gentlemen, that does conclude the question and answer session for this conference call. I would now like to turn the conference back over to management for any closing statements.

Brian Farley

Thank you. This is Brian Farley and in summary we’re very pleased with the third quarter results and our recent successes at improving our profitability and taking market share. Also with further major successes in international reimbursements starting to accumulate in key countries such as France and the UK along with our very strong legal data and doctors routinely choosing our products, we believe we are increasingly well positioned to establish VNUS Closure and radio frequency vein ablation as the standard of care. But becoming a standard care this allows us to better penetrate the worldwide saphenous vein treatment market of 1.25 million procedures annually where in 2008 we estimate that our products will be used in approximately 10% of these procedures. This makes us more positive than ever about the near and long-term prospects for our business as we remain focused on vein care. This concludes VNUS’s teleconference on third quarter results. We look forward to speaking with you again as and when we report our fourth quarter 2008 results. Thanks again for joining us today.

Operator

Ladies and gentlemen, this does conclude the VNUS Technologies’ third quarter 2008 teleconference. You may now disconnect and thank you for using AT&T conferencing.

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Source: VNUS Medical Technologies, Inc. Q3 2008 Earnings Call Transcript
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