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Executives

Julie Tracy - Chief Communications Officer

Bob Palmisano - President and Chief Executive Officer

Pat Spangler - Chief Financial Officer

Analysts

Peter Bye - Jeffries

David Lewis - Morgan Stanley

Tom Gunderson - Piper Jaffrey

Chris Pasquale - JPMorgan

Chris Warren - Caris

Charles Chon - Goldman Sachs

Joshua Zable - Natixis

Bob Hopkins - Banc of America

ev3 Inc. (EVVV) Q3 2008 Earnings Call October 31, 2008 8:30 AM ET

Operator

Good day, ladies and gentlemen, and welcome to the Third Quarter 2008 ev3 Incorporated Earnings Call.

My name is Ann, and I'll be your coordinator for today's call. (Operator Instructions). As a reminder this conference is being recorded for replay purposes.

At this time all participants are in a listen-only mode. We will be facilitating a question-and-answer session towards the end of the presentation.

I would now like to turn the presentation over to Julie Tracy. Please proceed.

Julie Tracy

Thank you and good morning everyone. Welcome to ev3's third quarter 2008 conference call. We appreciate you joining us. I'm Julie Tracy, ev3's Chief Communications Officer.

With me on the call today are Bob Palmisano, ev3's President and Chief Executive Officer, and Pat Spangler, ev3's Chief Financial Officer.

We issued a press release this morning, regarding our third quarter 2008 results, and updated 2008 guidance. A copy of that press release, along with an investor presentation summarizing our third quarter results is available on our website at www.ev3.net.

The agenda for this call will include a business update from Bob, a review of our third quarter financial results from Pat followed by a question-and-answer session, and closing comments from Bob.

Before we begin, I'd like to remind you that during the course of this conference call, we will make forward-looking statements regarding our future financial and operating results and our business plans, objectives and expectations.

These forward-looking statements are covered under the Safe Harbor provision of the Private Securities Litigation Reform Act of 1995, and ev3 desires to avail itself for the protection of the Safe Harbor for these statements.

Please be advised that actual results could differ materially from those stated or implied by our forward-looking statements, due to certain risks and uncertainties, including those described in our most recent Annual Report on Form 10-K and our subsequent quarterly reports on Form 10-Q.

We suggest that you read these reports and other future filings that we may make with the Securities and Exchange Commission. ev3 disclaims any duty to update or revise our forward-looking statement.

On this call today, we will also disclose certain non-GAAP financial measures. We use non-GAAP financial measures as supplemental measures of performance, and believe these measures provide useful information to investors in evaluating our operations, period over period.

For each non-GAAP financial measure that we use on this call, we have posted a reconciliation of the non-GAAP financial measures to the most directly comparable GAAP financial measure on our corporate website at www.ev3.net, under the subsection entitled non-GAAP measures in the Investor Relations section.

Please note that non-GAAP financial measures have limitations as analytical tools, and should not be considered in isolation or as a substitute for our financial results prepared in accordance with GAAP.

And with that, I'll now turn the call over to Bob for our business update. Bob?

Bob Palmisano

Thanks Julie, and welcome to everyone that has joined us on the call today. This morning, we reported net sales for the third quarter of 107 million, and non-GAAP adjusted net earnings per share of $0.04, which was $0.03 per share better than the high end of our guidance.

Total product sales for the quarter was $100 million, in line with our previous third quarter guidance; this despite the entry of two new peripheral competitors and the impact from a stronger dollar than was anticipated in our guidance.

ev3 peripheral vascular and neurovascular net sales excluding atherectomy and research collaboration revenues increased 21% in the third quarter of 2008, versus the prior quarter.

In our peripheral vascular segment business, ev3 product sales excluding atherectomy increased 19% in the third quarter of 2008, versus the prior year quarter.

Notably, our neurovascular segment business posted solid growth, increasing 26% versus the prior year quarter and 8% sequentially. And our international business grew by 37% over the prior year quarter.

We believe that this strong performance underscores the increasing value of our number two position in terms of revenue in the worldwide neurovascular market, and the strides we continue to make in our international business.

As I stated on our last quarter call, achieving sustained profitability and improving our cash position remain our top priorities. So I was particularly pleased to see the progress we made this quarter in both areas.

Our cash and cash equivalent balance increased $7.2 million as of the end of the third quarter of 2008, compared to the end of the second quarter of 2008; and we reported another substantial decrease in our SG&A expense as a percentage of sales, which declined 20 percentage points in the third quarter versus the third quarter of last year, and 11 percentage points versus Q2 '08.

In addition, day sales outstanding excluding the receivables from Merck decreased by two days; the inventory days on hand decreased 19% versus Q2 '08.

For the remainder of 2008, our focus will be on improving execution and optimizing our cost structure, to balance the investment we need to build our business and deliver profitable growth and value to shareholders.

We believe that our efforts to bring innovative breakthrough endovascular treatments to physicians and patients around the world will create a foundation for continued long-term growth and future profitability.

As detailed in the press release we issued this morning, we are raising our full year of 2008 non-GAAP adjusted EPS guidance and updating our full year revenue guidance to reflect an increase in research collaboration revenue and a decrease in product sales, mostly as a result of the recent decreases in foreign currency exchange rate as well as the effect of new competitive entrance in the peripheral vascular marketplace.

Pat will provide more specific details on our guidance later in the call.

Before I provide updates for our peripheral vascular and neurovascular business, I want to formally welcome Doug Kohrs to the ev3 Board of Directors.

As we previously announced, Doug rejoined the ev3 Board in August, and we are delighted to have someone with Doug's proven leadership skills and broad management experience on our Board, as we work towards building the premier endovascular company and a preferred partner for patients and physicians in identifying and treating lower extremity artery and neurovascular disease.

I am personally excited about the opportunity to work closely with Doug at ev3.

Turning now to our global neurovascular business performance, as I summarized earlier, our neurovascular business turned in an excellent third quarter performance as we have continued to drive further penetration of our Onyx Liquid Embolic System and advance our global launch activities on our Axium coil.

We also had strong quarter, we also had a strong quarter for sales on our neurovascular access and delivery products which were up 28% versus the prior year quarter and 13% sequentially from Q2 '08. The launch of the Axium coil continues to progress as planned.

In the third quarter of '08, we saw an approximate 13% increase in a number of US accounts reordering Axium coil as compared to the second quarter of '08 and a 109% increase in the number of US accounts reordering Axium coil as compared to the fourth quarter of '07.

During the third quarter, we successfully launched Axium in Brazil, where it got off to a strong start. Given our progress to date, we continue to expect the Axium coil to be the primary growth engine for our neurovascular business segment for the remainder of 2008 and next year.

Now, turning to our peripheral vascular business. I am also encouraged that we are able to maintain the growth of our peripheral vascular business in the third quarter despite pressure and distraction that resulted from the activities of new competitors. More specifically, our Atherectomy business is still under some pressure due to the entry of a new competitor and the ongoing physician trialing of competitive devices.

However, we believe that physician trialing of competitive products ultimately will confirm the differentiated clinical performance and that the SilverHawk Plaque Excision system offers as a frontline therapy in treating peripheral artery disease. In addition, interest in the SilverHawk is gathering momentum outside the US and we believe that physician enthusiasm for our new definitive clinical trial strategy could prove a positive impact on sales and procedure adoption. You will hear more about our definitive trial shortly.

Improving sales productivity in our US peripheral vascular business continues to be a key focus for us, with the goal of achieving annualized net sales per territory, of approximately $2 million. As expected, sales productivity for our US peripheral vascular sales reps remain constant in the third quarter at $105 million per territory. Although still up 8% from the end of 2008, we are continuing to identify opportunities to drive additional productivity gains which include optimizing territory, configuration and exploring ways to maximize case coverage.

Physician education program remains the key driver for us to demonstrate the clinical value of our products. At the BEVA and TCT meetings, there were several positive scientific presentations from key clinicians highlighting their clinical experience with our products. I am very pleased to report that 12 month follow up results for our European DURABILITY I clinical study were presented by [Dr. Dirk Siant], co-principal investigator for the study.

You'll recall that DURABILITY I is the world's first prospective study to specifically test the efficacy and integrity of long stent and long challenging SFA lesions. It is also the first study to specifically evaluate the use of a single stent up to 15 centimeters long per patient. A total of 151 patients were treated in 13 European centers.

A 12 months follow-up primary patency was 72% which compares quite favorably to other studies and was notable considering the average lesion length with almost 10 centimeters and 40% of the vessel were occluded. Importantly there was no acceleration in the fracture rate from six months to 12 months which was approximately 8% on a per patient basis.

In addition to this, low-per-patient fracture rate, further investigation of fractures indicated that nine out of 10 fractures occurred in stents that elongated at the time of deployment which is contrary to our instructions for use.

We were very encouraged by these results which we believe show that single long stent may be a viable alternative to multiple shorter stents and long challenging lesions. Furthermore, when you consider that the patients enrolled in the DURABILITY I trial had much longer lesions on average, a higher percentage of total occlusion and a higher percentage of diabetes than any other published trial to date. These results are even more compelling.

In the US, we are continuing to roll patients in our DURABILITY II IDE study with the objective of expanding our EverFlex stents and US indication to include treatment of peripheral artery disease.

We are also pleased to receive approval from the FDA early in the third quarter to revise the existing durability to IDE protocol to include changes that we believe can accelerate our patient enrollment rates in the current month. These changes include expanding the number of clinical study sites, widening the lesion inclusion criteria, shortening the study follow up period and offering access to our 200-millimeter link stent to all study sites.

Although early, we are already starting to see improvement in patient enrollment rates and expect further progress in the coming months.

At BEVA and TCT, Dr. [Jim Mackenzie] from Columbia Presbyterian Hospital also presented his SilverHawk clinical data, which is the largest single-center independent database in the world. He found that atherectomy is associated with [minimal] morbidity and mortality, a two-year secondary patency of nearly 80% in (inaudible) long term (inaudible) between 84% and 95% inpatients with critical limb ischemia. This is a very encouraging data that was just published this week in the Annals of Surgery.

Now moving to our DEFINITIVE trial series. The lower extremity and particularly the SFA remain a challenging vascular bed for interventional treatment with no silver bullet yet for the question of long-term patency. The space is also marked by a significant fragmentation of treatment approaches and numerous different endovascular modalities, including at least four mechanical or laser-based atherectomy devices.

Of these, the SilverHawk Plaque Excision System has been the most widely used, but like all atherectomy systems, some of the clinical data that is currently available is not considered DEFINITIVE to support broader adoption. ev3 is committed to resolving these questions and advancing the science of peripheral artery disease treatment for the goal of making plaque excision a frontline therapy.

To accomplish this goal, we have developed our DEFINITIVE trial series. The first trial in the series is the DEFINITIVE Ca++ U.S. IDE study and I am pleased to announce that we enrolled our first patient yesterday. This study will evaluate the RockHawk Plaque Excision System when used in conjunction with the SpiderFX Embolic Protection Device in the endovascular treatment of moderate to heavily calcified peripheral artery lesions.

Our next study DEFINITIVE LE or low extremity is planned as a global multi-center, single-arm study that is intended to collect additional clinical data to confirm the value of plaque excision in both above and below the knee endovascular procedures with the SilverHawk system. This study will look at patency and target limb revascularization, include [core lab and adverse event education] and accommodate interim data looks at specified time points.

We currently expect to begin enrolling patients in this study in the first half of 2009. We are also planning a DEFINITIVE FFE randomized controlled trial versus PTA balloons in the SFA, which is expected to begin enrolling patients in the second half of 2009. This study will look a primary patency at one year with core lab and adverse event education. We anticipate that this data could also be used to support reimbursement in certain international countries.

Lastly, we are in the very early planning stages for our DEFINITIVE AR or anti-restenosis study, which is intended to shape and improve the performance of peripheral local drug delivery technologies. We think that the SilverHawk technology may provide us with the potential advantage versus our competition in developing an optimal, local drug delivery strategy and accelerate a new treatment paradigm to address restenosis.

We are enthusiastic about the DEFINITIVE series and have already received a great deal of interest and support from physicians. As I stated earlier, we also believe that additional clinical data is needed to materially expand the atherectomy market opportunity and the DEFINITIVE series will provide us with the clinical bridge to help improve treatment outcomes, facilitate broader procedure adoption and establish SilverHawk atherectomy as a frontline therapy.

Now, I'd like to provide an update on EverCross and NanoCross peripheral angioplasty balloons development activities and launch plans. As we previously reported our distribution agreement with our current balloon suppliers Invatec expires at the end of December.

During the third quarter we submitted 510(k) applications to the US FDA for clearance of our EverCross.035 and NanoCross.014 peripheral angioplasty balloons and are looking forward to launching both balloons globally in the first quarter 2009.

Based on clinical performance to date, we believe the EverCross and NanoCross balloons can provide enhanced performance to our customers with significantly better margins to us than our current Invatec distribution product. Our ability to offer our own PTA product also provides us with access to key international markets, including Europe where up to now we do not sell balloons because of the Invatec agreement.

With that business update, I would now like to turn the call over to Pat for a discussion of our third quarter financial results and guidance.

Pat Spangler

Thanks, Bob, and good morning everyone. I'd like to begin by covering consolidated third quarter net sales results. Consolidated sales increased 65% to $107 million in the third quarter of 2008 compared to $65.1 million for the third quarter of 2007. Third quarter sales included $21 million of atherectomy product sales and $7 million of research collaboration revenue.

This net sales growth was driven by consistent growth across several of our major product groups, including the pre-FoxHollow acquisition peripheral vascular business segment and neurovascular business segment.

On a geographic basis, US and international third quarter 2008 net sales increased 84% and 37% respectively over the third quarter of 2007. In US, our sales increased to $70.4 million in Q3 of 08 compared with $38.3 million in Q3 of '07, and the sales growth was driven mainly by our acquisition of FoxHollow.

Our international sales grew to $36.6 million in Q3 of '08, up from $26.8 million in Q3 of '07; and this growth was primarily due to our Q4 '07 launch of our Axium coil, continued market penetration of the EverFlex family of stents, and the Onyx Liquid Embolic System for the treatment of brain arterio-venous malformations or AVMs, and the introduction of our atherectomy products into our international Markets.

Changes in foreign currency exchange rates had a positive impact of approximately $1.7 million on third quarter 2008 net sales, compared to Q3 of '07, and a negative impact of approximately $900,000 compared to Q2 of 08.

Despite the negative impact from the strength of the US dollar, product sales remained in line with previous guidance of $100 million to $102 million for the third quarter of 2008.

On a business segment basis, net sales of peripheral vascular products increased 73% to $66.9 million for Q3 of '08, compared with $38.7 million in Q3 of '07.

Third quarter net sales include $21 million of FoxHollow products. Stent sales increased 16% to $26.8 million in Q3 of '08, compared to $23.1 million in Q3 of '07, primarily due not increased market penetration of our EverFlex family of stents.

Thrombectomy and embolic protection sales increased in Q3 of '08 to $6.9 million, compared to $5.4 million in Q3 of '07. Procedural support and other net sales increased to $12.2 million, up 19% from Q3 of '07.

In the neurovascular business segment, net sales of neurovascular products increased 26% to $33.1 million for Q3 of '08, up from $26.4 million in Q3 of '07. Within the neurovascular segment, embolic product sales increased 24% to $18.2 million, compared to $14.7 million in Q3 of '07, driven by the Q4 '07 launch of our Axium coil and the continued market penetration of the Onyx Liquid Embolic System.

Sales of neuron access and delivery products increased 28% to $14.9 million in Q3 of '08, compared to $11.7 million in Q3 of '07 on strong sales of catheters and neuro balloons.

Research collaboration revenue resulting from our former agreement with Merck & Company was $7 million for the third quarter of 2008, which included approximately $2 million for the wind down activities as negotiated with Merck.

We expect to recognize an additional $800,000 of research and collaboration revenue in Q4 of '08.

In Q3 of '08, we achieved an overall consolidated gross margin of 64.2%. Excluding research collaboration, our product gross margin was 63.8%. When comparing Q3 of '08 to Q3 of '07, product gross margin decreased by seven-tenth of a percentage point.

This slight decrease in product gross margin was primarily due to additional [access] and obsolete inventory reserves, related to our planned product transitions to next generation devises and costs associated with the consolidation of our Redwood City manufacturing operations into our Irvine and Plymouth facilities, offset by manufacturing efficiencies and increased sales volumes.

On a sequential quarter basis, product gross margin decreased by 2.4 percentage points.

Operating expenses in the third quarter of '08 increased in absolute dollars, when compared to third quarter of '07, primarily as a result of our acquisition of FoxHollow.

However, SG&A expenses as a percentage of net sales, declined by 20 percentage points to 50% of sales in Q3 of '08, as compared with 70% of sales in Q3 of '07, as a result of cost synergies implemented in Q4 of '07.

Amortization of intangibles increased approximately $4.1 million to 8% of net sales in Q3 of '08, compared to 6% of net sales in Q3 of '07, and was primarily due to the additional intangible assets recorded as a result of our acquisition of FoxHollow.

Our research and development expenses increased in Q3 of '08 in absolute dollar terms. But as a percentage of net sales, R&D expenses declined to 11% of sales in third quarter of '08, compared to 16% in the third quarter of '07.

Operating expenses in the third quarter of '08 decreased in absolute dollars, when compared to second quarter of '08. SG&A expenses as a percentage of net sales declined by 11 percentage points to 50% of sales in Q3 of '08, as compared with 61% of sales in Q2 of '08, as a result of our continued efforts to achieve cost synergies.

Operating expenses in Q2 of '08 included an asset impairment charge of $10.5 million, as a result of the termination of our former collaboration and license agreement with Merck.

ev3's net loss for the third quarter of 2008, declined to $7.3 million or a loss of $0.07 per common share, compared to a net loss of $36.5 million or a loss of $0.60 per common share for the third quarter of 2007.

The third quarter of 2007 net loss reflects a special charge of $20.2 million related to the agreements in principle to settle certain patent infringement and other litigation between ev3 and its subsidiaries, the [regions] of the University of California, and Boston Scientific.

In addition, the net loss for Q3 of '07 also includes $4.6 million of integration expenses related to the acquisition of FoxHollow.

On a non-GAAP basis, ev3’s adjusted net income was $3.9 million for the third quarter of ‘08 compared to an adjusted net loss of $30.1 million for the third quarter of ‘07. Non-GAAP adjusted net earnings per share was a positive $0.04 per diluted share, which exceeded the previous range of guidance of a negative $0.02 to a positive $0.01 per diluted share.

Moving on to the balance sheet, our cash balance as of September 28, 2008, was $45.9 million, reflecting an increase of $7.2 million from our balance of $38.7 million as of June 29, 2008. This increase was largely as a result of cash provided by operating activities, including improvements in working capital through reduction of both our days sales outstanding excluding the Merck receivable and our inventory days on hand.

As a reminder, we extended and modified our existing undrawn credit facility agreement with Silicon Valley Bank during the second quarter of 2008. We believe that this credit facility along with our existing cash and short-term investments will provide sufficient liquidity and financial flexibility to meet our anticipated operating and strategic needs for the foreseeable future.

Let me now turn to the financial targets for the full year and fourth quarter. We expect our full year 2008 net sales to be in the range of $418 million to $423 million consisting of $398 million to $403 million of product sales and $20.2 million of research collaboration revenue.

Full year revenue guidance has been updated to reflect a $3.7 million increase from ev3’s previous guidance of $16.5 million of research collaboration revenue and a decrease in product sales from a range of $408 million to $413 million to $398 million to $403 million as a result of recent decreases in foreign exchange rates and new competitive entrants in the peripheral vascular marketplace.

For the fourth quarter of 2008, we expect net sales to be in the range of $102 million to $107 million. We continue to expect international sales to grow approximately 30% to at least $140 million in 2008 when compared to 2007.

We now expect our full year 2008 non-GAAP adjusted net earnings per share to be in the range of $0.06 to $0.08 per diluted share based on approximately 105 million of outstanding shares. Non-GAAP adjusted EPS excludes estimates for amortization expense of approximately $31 million, non-cash stock-based compensation of approximately $14.3 million and a $10.5 million Merck research collaboration asset impairment charge.

For Q4 of 2008, we expect non-GAAP adjusted net earnings per share to be in the range of $0.04 to $0.06 per diluted share based on approximately 105 million of outstanding shares. On a quarterly basis, non-GAAP adjusted net earnings per share excludes estimates for amortization expense of approximately $6.7 million and non-cash stock-based compensation of approximately $2.6 million.

With that update, we would now like to open up the call for questions.

Question-and-Answer Session

Operator

(Operator Instructions). And thank you for your patience while the queue is being populated. And the first question comes from the line of Peter Bye with Jeffries. Please proceed.

Peter Bye - Jeffries

Hey, thanks guys. And Bob, good morning. Just, I guess, looking at the numbers, I guess, we are curious to how successful you were on the SG&A front and sort of how does that continue into maybe 2009. I know you are not giving guidance there. And I guess, whenever we see some companies that are that successful on that front, quicker than we thought, it always seems to be a quarterly impact on the top line. So, you knew competition was coming. FX was a surprise. So, was there some sort of a collateral damage when you cut that deep that obviously you needed to do to impact the top line on that front?

Bob Palmisano

Good question. No, I would say though that the competition had two effects on us. One is more trialing of the devices. And secondly, it increased the turnover in our organization to some extent. And it’s very attractive for and I can understand why that some people would like to go to start up with that and give a significant amount of equity pre-IPO kind of thing. So, we have seen quite a bit of turnover in our sales organization during Q3. But I will also say that we should continue to see a decrease in our SG&A.

I think I have said in previous calls that I thought that we were too high in this area. We needed to make sure that we balanced out the top line opportunities with the proper structure so that we would be able to have not only good growth but good profitable growth. And I think that’s really what we are focused on, Peter. And I think that there are still opportunities in front of us here, but we will take a very balanced approach to growing our top line, at the same time, having a cost structure that will enable the company to be profitable.

Peter Bye - Jeffries

Okay. So, I mean, you are talking about further declines from the Q3 run rate going into next year?

Bob Palmisano

Yes.

Peter Bye - Jeffries

Okay. Thanks. And just a one follow-up on the competition. It is a big sequential decline on the front. Is there something because I believe Pathway did something about 100 cases or something in Q3 and are you just expecting a bigger ramp up, or are you seeing changes since TCT or…?

Bob Palmisano

I think all these companies [that get trial], they also have stocking orders too. I mean, so that’s a piece of it. Both competitors, CSI and Pathway are aggressive, and they have stocking orders or doing some cases, clinicians are trialing those devises. And I think that from our point of view that doctors try them. There are some R&D issues that are out there. But at the same time, I think that given the experience they have with SilverHawk and certainly the clinical work that we are doing is that we feel that we will certainly maintain and grow our market share versus the new competitors as we go forward.

Peter Bye - Jeffries

Okay. Thanks. I’ll jump back in queue for now.

Operator

And the next question comes from the line of David Lewis with Morgan Stanley. Please proceed.

David Lewis - Morgan Stanley

Good morning.

Bob Palmisano

Good morning.

David Lewis - Morgan Stanley

I wonder if you could give us an update on employee headcount at the end of the second quarter and the current employee headcount.

Bob Palmisano

We’re trying to pull that number out of our heads here. I think it’s about 1,200 to 1,300 at the end of Q3 and that’s relatively close to where we were at the end of Q2.

David Lewis - Morgan Stanley

Okay. So, maybe you can give us more specifics on how the SG&A reduction was possible. It’s about a sequential reduction of SG&A that’s $7 million to $10 million. Obviously, there were some one-time charges for compensation expense in the second quarter, but I am just trying to rectify the magnitude of the expense with the employee size.

Pat Spangler

David, I will take that question. You are right. There was some compensation in the second quarter obviously with the CEO transition. So that was a piece of the step down. But in addition to that, we also basically looked at, as we indicated before, we have been working on our [vital fuel] and we have been looking at where we are spending our money.

And essentially, we have kind of looked across the board. We have had some reductions in T&E. We have had some reductions in just insurance charges and other things. But also just looking at kind of the expense base and the spend base to really support our [vital fuel], and really the diligence there really resulted in some savings. We obviously had some costs that we have been able to take out even since post-merger with FoxHollow. And so, that was a small piece of it as well.

David Lewis - Morgan Stanley

That's very helpful. So, can I assume that you have made some changes to your sales force compensation practices?

Bob Palmisano

No. I think that was fairly constant in Q3 versus the previous. I think, going forward, we always look at that. Everyone realizes that the biggest influence on behavior in a sales organization is the comp plan. And so, we want to make sure that we have a comp plan that certainly rewards people who perform outstandingly and we will continue to do that. So we haven’t had any significant changes so far in the comp plan for sales people, no.

David Lewis - Morgan Stanley

Okay, Bob. And just to your comments that SG&A continue to go down on an absolute basis. These will be changes that will be non-comp plan changes, non-body count changes and you still believe you can reduce SG&A?

Bob Palmisano

No. I didn't say that. I think that as we go forward, we are evaluating the comp plan to make sure that we're getting as much value there as possible. There potentially could be some changes in that, and I also think that there's potential that there may be some changes in the number of territories that we have.

That's something that's not nothing new, we constantly have evaluated that, and we want to make sure that we are covered to make sure that we can attain the growth on the top line but also make sure that the growth is profitable growth. I think that gives us the opportunity to either plus or minus that sales organization as necessary.

David Lewis - Morgan Stanley

Okay, that's very helpful. And just two more quick ones; I guess first off just for Pat. Obviously atherectomy will have a pressuring effect on GMs. Can you just cipher out for us what impact of the gross margin was because of the loss of atherectomy sales, and what were the one-time items so we can better understand where GMs will level out in '09?

Pat Spangler

Yeah. The dip in the atherectomy didn't have a significant impact on the gross margins. Essentially what we had is, we had some one-times that were related to product transitions from our Invatec balloon line to our new balloon line. Some of the previous versions of our Axium coil to our most recent version of Axium coil.

So in terms of that transition, that was kind of the biggest impactors that we had within the quarter, but we also had some costs related to the actual move from Redwood City to Irvine that also came to our gross margin line.

David Lewis - Morgan Stanley

So a 68% product sale gross margin is not impossible for 09?

Pat Spangler

No, not impossible for '09.

David Lewis - Morgan Stanley

Great, that's helpful. And one last question. Bob, your commentary on atherectomy implies this trailing is temporary. The FoxHollow business looks like a $21 million business. Is it your view that that should be the new base? Or because this is trialing that number is going to be in the next two to three quarters easily back up to $25 million to $28 million?

Bob Palmisano

Well, I think that my opinion is that the atherectomy business is going to be a modest growth business for us, until we complete these trials that we're working on. That's the breakthrough that is necessary.

I would also say that we do have more opportunity than normal and in that we are launching and being successful in our international markets in atherectomy.

But in the US market, I'd say this is a modest growth opportunity, until the point that we actually do get the state of that we are so keen on getting.

David Lewis - Morgan Stanley

But we are comfortable with the $21 million trough level for atherectomy sales?

Bob Palmisano

Yeah.

David Lewis - Morgan Stanley

Okay, thank you very much.

Operator

And the next question comes from the line of Tom Gunderson with Piper Jaffrey. Please proceed.

Tom Gunderson - Piper Jaffrey

Hi, good morning. Let me follow-up on the OUS sales for FoxHollow. You said both just now, Bob and then in the prepared remarks that they were up.

FoxHollow had essentially no overseas sales when they were a single entity. I know you don't want to break it out exactly, but can you give us some sense of what percentage of this quarters sales were US/OUS? Was it 10%, less than 20%?

Bob Palmisano

Less than 10%, Tom, but I think that has the opportunity to grow significantly. You know it's a new technology, so there's a lot of pre-work that needs to be done and has being done.

Secondly is that, on the reimbursement front, we are in Germany for example, which is our largest international market for SilverHawk, there's full reimbursement there.

In other countries, in Europe, it comes of out of the hospital budget kind of thing. So they have to weigh how much money they actually have to spend on each procedure. And in France it's not approved or reimbursed in any way.

And that reimbursement piece of the equation is really tied to the clinical trials that we need to do, so that the clinical trial that we're doing in atherectomy served two purposes. It gets us the data that is necessary to move the non-believers if you will into the believers camp; and secondly, (inaudible) have broad range implications regarding reimbursement in OUS.

Tom Gunderson - Piper Jaffrey

And then sticking with FoxHollow. You may have mentioned this, but I missed it. US excess inventory in the hospitals, what's the latest assessment?

Bob Palmisano

It's not an issue any longer, Tom.

Tom Gunderson - Piper Jaffrey

Okay.

Bob Palmisano

It's non-existent as far as I can tell.

Tom Gunderson - Piper Jaffrey

Okay. And you mentioned a turnover to some of the new competitors in Q3. You have some ongoing lawsuits with CSI for what I would call poaching. Was there any shift in this turnover as Pathways comes into the frey?

Bob Palmisano

No. Not that I would care to say. But I think that this it's competitive environment for people. When new company comes in, they're pre-IPO, they offer a lot of equity, they offer guarantees, they offer the sales rep to sell one product that they like to sell. So I think that has more to do with it than anything.

I think on the other hand of it, some people I would say quite a few people that have left us to join either of the two direct competitors, some people have come back and said that was a mistake, they would like to rejoin us.

So I think that's just going to be an ongoing thing that we have to figure out as a management team how to very effectively deal with it and make sure that we're fully staffed to a level that we want to be fully staffed at, have the best people, pay them well and get the results that we want.

Tom Gunderson - Piper Jaffrey

Okay. And then on the guidance for Q4 and the product revenues down 10 million from previous guidance, I'd assumed that the product was FoxHollow, but you sort of blended that into new competition, not just new atherectomy competition. Can you give us some sense of that $10 million, how much is FX, how much is Invatec?

Bob Palmisano

Yeah, I think probably close to 4 million, maybe give or take a little bit is FX, and without that, given the high end of our current guidance would be where we were before. So that's a big effect and the remaining $3 million or $4 million is in product revenue mostly in Atherectomy.

Tom Gunderson - Piper Jaffrey

Okay, thanks. And then last question. Pat in your remarks, you said you have cash sufficient for the foreseeable future. On other company calls we are finding out that the foreseeable future isn't very far out. I am assuming through 2009 is that a fair assumption?

Pat Spangler

Yes, that's a fair assumption.

Tom Gunderson - Piper Jaffrey

Okay, thank you.

Operator

And the next question comes from the line of Jason Mills with Canaccord Adams, please proceed.

Jason Mills - Canaccord Adams

Hi, everyone. Thanks for taking the question. Bob, you mentioned that your sales per territory was about what it was in the second quarter. In the Second Quarter it took a nice step up from where it was before you joined the company.

Where do you see that in the fourth quarter and what's your target? What is the trigger to get to that target and how long will it take to get to that target? I'm sort of assuming it's more than 1.5 million. I'm sort of also going on what the answer you gave to David's question earlier with respect to sort of constantly looking at the territories perhaps limiting or reducing the number of territories to drive value, etcetera.

Bob Palmisano

Well, yeah, I do expect that we should be kicking up in Q4 on a productivity basis. And we think that we should be averaging about $2 million of territory. Now that may occur as early as 2009 or it may take a little bit longer. I don't want to get really tied down to a specific time, but we certainly think that is our goal.

There are two levers really to get there. One is that the growing into that increasing these territories, putting more training and more muscle behind atherectomy. But as I said before, I think that the real breakthrough in atherectomy is going to be when the clinical information is seen to be as definitive.

We named our trial definitive for a reason that we think that this data will be definitive. And the other part of that is making sure that we don't have too many sales reps or reps in territories that are just so small and do not have the potential to become profitable territories. And so that's the constant evaluation.

So I think there are both [levers] there, but certainly we have a clear objective; as quickly as possible to get to a point where we are about $2 million per territory in the US.

By the way, that's where our neuro business is today, we're a little over $2 million per territory in the neuro business.

Tom Gunderson - Piper Jaffrey

In the US, Bob?

Bob Palmisano

That's right.

Tom Gunderson - Piper Jaffrey

Okay. And I may have missed this, been popping back and fourth between calls. Did you mention with respect to the atherectomy business, did you mention sort of the competitive landscape in terms of market growth? It's our estimation that they probably saw negative procedure growth using the laser atherectomy.

You obviously have two new competitors that are growing on a year-over-year basis sort of in infinity because they don't have a comparable year last year. What are your expectations at this point given, seeing some competitive data and your own data that the atherectomy market is growing, actually maybe the atherectomy market and the entire PAD procedural growth market?

Bob Palmisano

Well, when you look at the total PAD marketplace, it's growing nicely. I mean you look at it in total. We've had good growth in that and continue to see good growth sequentially in every quarter.

Now atherectomy procedures are probably flat in the US. Even though there are more competitors, I think that the market is pretty flat, where it's growing and again, it's off a very small basis certainly in some of our OUS markets.

Tom Gunderson - Piper Jaffrey

Thank you for that. That's helpful. That implies, Bob, that other devises are growing perhaps accelerating their growth within a PAD procedure, whereas atherectomy may be flat to down in terms of it's use in a procedure, the PAD procedure market is up.

Am I reading that right, are we seeing increased utilization of stents notwithstanding the Department of Justice inquiries?

Bob Palmisano

Well we feel that in the stent business we are probably gaining some share there. I think that's fair to say. So I think that's driving our business to some extent.

Tom Gunderson - Piper Jaffrey

That's helpful. Just a few more and I'll get back in queue. Pat, on the gross margin side and I may have missed this too so I apologize. Did you break out or give directionally the product gross margins by your two divisions?

Pat Spangler

No, I didn't. But essentially where we came out on is for the neurovascular division it was in the mid 70's, and then on the overall peripheral vascular business it was near 60.

Tom Gunderson - Piper Jaffrey

And that includes the 2 million COGS from the Merck collaboration?

Pat Spangler

No. Those are just the two businesses themselves, but the Merck collaboration was higher for the quarter.

Tom Gunderson - Piper Jaffrey

The cost of goods sold right, Pat?

Pat Spangler

Yeah. The actual margin itself was higher on the research collaboration, near 70% for the quarter.

Tom Gunderson - Piper Jaffrey

So the entirety of the sequential decline was in peripheral vascular then?

Pat Spangler

Yeah, for the most part --.

Tom Gunderson - Piper Jaffrey

In gross margins, okay. And then to follow-up on Tom's question Bob on Invatec. I don't know if you've heard that part of his question, but are you seeing competitive inroads made by Invatec in the balloon line. I know the estimates suggest 25-30 direct drafts. They are obviously going to try to gain some of the customer s that their product had under your stewardship the last several years.

How do you think about that, and what can you tell us to give us some confidence that you guys are just going to continue as usual?

Bob Palmisano

Yeah, haven't seen anything at all that affects us. They actually launch their product in I guess Q3, some time during Q3. Our agreement with them runs out at the end of the year, we can still sell product that we have until mid next year.

But when I look at this whole thing, I seriously say this is the best thing that ever happened to us, and that we developed a better product that has trialed better. We have the ability to be the masters of our own kingdom, we have better margins, and we have the ability to sell internationally that we didn't have before.

So this is all good. So we have a competitor, but we think we have developed better product, better margin, and more opportunities to sell it, so it's all good.

Tom Gunderson - Piper Jaffrey

Very good. Thanks guys. Happy Halloween.

Bob Palmisano

Thanks.

Operator

And the next question comes from the line of Mike Weinstein with JPMorgan. Please proceed.

Chris Pasquale - JPMorgan

Good morning, this is Chris Pasquale here for Mike.

Bob Palmisano

Hi, Chris.

Chris Pasquale - JPMorgan

Just to get back to SilverHawk and may be push you on a couple points here. First, is price becoming a point of competition in this market, it's always been a fairly pricey product for the (inaudible) lab.

Bob Palmisano

Well, my first reaction is to say, no. But then when you look at the general economic situation in the country and in the world, I'm just speculating this is my own thought, I don't have any data to back this up, that it might have an effect.

People have co-pays and deductibles in their insurance plans, there is no doubt using atherectomy would cost more out of pocket when you look at it that way.

Chris Pasquale - JPMorgan

But specifically from a competitive standpoint do you see your competitors competing on price? Are you seeing pressure on your own ASPs?

Bob Palmisano

No.

Chris Pasquale - JPMorgan

And then you previously cited 30 million to 35 million as a normalized run rate for your atherectomy franchise exiting 2008. Where is that bar today assuming that trialing is temporary?

Bob Palmisano

Yeah, the run rate that we are looking at is in the low 20s, Chris.

Chris Pasquale - JPMorgan

Okay. And then you talked about this business being a modest growth business is what you said, until you get clinical data. Obviously you've started the process with a definitive series of trials, but it's going to be an extended one with enrollments, some of those trials not starting until second half of next year.

When do you think the inflection point comes and does that mean that this is a business that we don't see much growth from until the next 18 months or more?

Bob Palmisano

First of all to be clear, there is a lot of data, and the most recent piece of data that was just published yesterday in the journals, the (inaudible) of surgery is terrific data. But it's a single site and we know that to move masses of people using one technology to next technology is you need overwhelming definitive data, and that's what we're getting after.

Now, the exact time period that this will be, that we will have this is, I can't give you. But we have designed this study, we are launching the study, and we have designed it in a way that we will be able to get interim data looks that would help us along the way.

So I would think that some time in late next year, or the year after is we will have data that we think would be really good data that would help move the market. Until then, I think that it's still, this atherectomy still has the opportunity to grow, but the breakthrough really is going to come when we have this overwhelmingly definitive data and that's the point that I've been trying to make.

Chris Pasquale - JPMorgan

Okay. And then just to sneak in one neuron question here, since it had another solid quarter of it doesn't get asked a lot. Where is Axium today as a percentage of your coil mix and where does that go overtime?

Bob Palmisano

I don't think that we would break it out. I would say that it is the driver, the future driver in our neuro business which is a terrific business and growing nicely, terrifically managed business. We have a new President, and consolidated neuro into a worldwide business, and but I don't think, we don't break that out, but it is the driver of our neuro business, I'd put it that way.

Chris Pasquale - JPMorgan

Is it fair to say it becomes the majority of your unit mix overtime?

Bob Palmisano

Yes, absolutely.

Chris Pasquale - JPMorgan

Okay. Thanks guys.

Operator

And the next question comes from the line of Chris Warren with Caris. Please proceed.

Chris Warren - Caris

Thanks for taking the question. Wanted to get an update on, I think what you'd previously put out there was at some point during Q4 you expect it to be GAAP profitable. Could you just touch base on that?

Bob Palmisano

Yeah, that's true. We did say that, and the big difference is currency. If currency had stayed where it was at the end of Q2, that would definitely be the case and now it's going to be slightly on the negative side in terms of GAAP profitability, but certainly on an adjusted basis really exceeding the high end of what we had said previously.

Chris Warren - Caris

Okay. And just your ability to take more working capital out of the system and improve the cash position in 4Q?

Bob Palmisano

Go ahead Pat. Do you want to take that?

Pat Spangler

Yeah, I think we obviously are continuing to drive to do that. Part of that is we have to balance because fourth quarter is usually your strongest quarter, so you end up having a little bit of pressure or increase on the working capital.

But we are continuing to improve our DSOs and our days on hand in the inventory side, and so on balance we think that we are going to be pretty constant between Q3 and Q4 in terms of our cash levels.

Chris Warren - Caris

Okay. And then just a forensic question. I noticed there was some durability in the Merck collaboration revenue versus what you had forecasted for the third quarter. Could that same durability occur in the fourth quarter?

Pat Spangler

No. Basically, what it was is that we entered in to wind down negotiations with Merck within the quarter in terms of the number of things that we had to do to close up the project. And essentially, as I indicated in the script, we have about $800,000 to recognize in the fourth quarter.

Chris Warren - Caris

Okay, thanks very much. I appreciate it.

Operator

And the next question comes from the line of Charles Chon with Goldman Sachs. Please proceed.

Charles Chon - Goldman Sachs

Yes, good morning. Thanks for taking the question. Just a quick follow-up to the question from before. So Pat, as we think about the contribution from FX to the operating line, what was that in the third quarter?

Pat Spangler

Well as I indicated, we had about [1.07] million favorable on the revenue side, and on the cost side we actually had an increased cost obviously because of the FX.

Now, what's happened is as the dollar continues to strengthen your cost structure comes down but then so does your revenue in terms of the overall.

But on average what we've said is that for every $3 you have an FX in your revenue line, it impacts us about a $1. So it's kind of a 1/3 impact around the net income line.

Charles Chon - Goldman Sachs

Okay. So as we anticipate the fourth quarter to experience a drag from FX, should we think that the same formula would apply just to get a direction in the fourth quarter?

Pat Spangler

Yeah, I think that that's fair. As we indicated earlier, Bob said we were going to have about a $4 million impact on revenue from kind of where we are so you can kind of do the math through the net income side.

Charles Chon - Goldman Sachs

Great, thanks for that clarity. Just a quick question on neurovascular growth. How much of that was driven by stocking patterns? Because if I remember correctly, I believe that the flat sequential growth that we saw in this segment during the second quarter was attributed to some de-stocking after the first quarter.

Bob Palmisano

We don't think it has much to do with stocking, Charlie. I think that business grew nicely, grew in the US and even accelerated outside the US. And I was just overseas and visited doctors there that are very enthusiastic about the product and are using it more. So I think that's just, I really don't think it has anything to do with stocking.

Charles Chon - Goldman Sachs

Okay. So going into the fourth quarter, should we anticipate that neurovascular could grow from these levels that we saw in the third quarter? I'm just trying to understand some of the seasonality in this business.

Bob Palmisano

Well, yeah, it should grow. I mean even though we did have some nice growth in Q3, Q3 is typically a low quarter because fiscally in Europe because of the vacation schedule. So I think that we should see some nice growth in neuro in Q4.

Charles Chon - Goldman Sachs

Okay, fantastic. Thanks very much.

Bob Palmisano

Okay.

Operator

And the next question comes from the line of Joshua Zable with Natixis. Please proceed.

Joshua Zable - Natixis

Hi, guys, thanks for taking my question. Most of my stuff has been answered, but I'm just trying to get some clarity here. So on atherectomy, related to the competitive landscape, I mean, CSI obviously was out a while ago, there was a level of trialing to the extent the reorder rates.

Can you just kind of give us a little bit more color? I know Pathway is obviously out there. Is it more Pathway than CSI or are docs reordering the CSI? That's part one of the question I guess.

Bob Palmisano

No, I think that is still, it's both companies and Pathway is more of a new entrant, just got into the market in Q3, and it's trialing and stocking of orders.

And I think I still think CSI is still doing the same thing. They have built a very large sales organization similar in a move that's close to the way FoxHollow kind of operated.

A very large sales organization that would have some effects, but as I indicated earlier, it had two effects on us. One is the new competitors are certainly doing some cases, and secondly is that it has an effect, it has had an effect on our organization.

We had in Q3, I think we exited Q3 with about 11 sales territories that we really didn't have reps in. Now we're rectifying that, but that had an effect on us.

Joshua Zable - Natixis

I mean, are you seeing docs that trialed CSI now a couple quarters ago come back to you guys?

Bob Palmisano

Well it depends on the indication. CSI is basically for calcified lesions below the knee. Now we have our RockHawk device is indicated for surgical [crack] down, not endovascular. That's one of the reasons we're doing the study on that. So that's a little bit less convenient for doctors to use.

And secondly is that, the below the knee business is smaller than above the knee. So I think that we are very keen on getting RockHawk on indication and approved and being able to promote it. And until then, I think that CSI probably has an ability to do a lot of cases there that we don't have the indication or that we can do.

Joshua Zable - Natixis

And I guess, so given you're seeing trialing out there. You talked about PAD procedures being up, atherectomy maybe not so much. Can you just kind of give us some level of comfort here, why you're confident these are trough levels for you guys?

Bob Palmisano

Well, yeah, I mean it's been fairly constant. If you kind of look at it and that where we have our organization, we are still the largest by far, we do the most cases, we have the majority of the cases we do are above the knee which is really where the market is.

So if we kind of extrapolate that out, I think that we feel pretty good that we know the US market pretty well with where we're going. Internationally is another case, it's that there are a lot of variables that play there.

We have great growth opportunities but we have to get the market going, there's also some missionary work, and secondly is we have to make sure that we have good reimbursement around the world.

So there are a lot of moving parts to this, but I think at the levels that we're at now are kind of the bottom, particularly the Q3 I think we should be able to see modest growth as we go forward until the point where we actually do get the clinical data that we're talking about.

Joshua Zable - Natixis

Great. And I know you've used the term modest growth and people asked about it. Is there any way you can give us some sort of ballpark? I know you don't want to talk about specifics and especially going forward for '09, but modest growth could be 1%, it could be 7%. Can you give us some sort of range of how to think about that?

Bob Palmisano

I think that when we do our Q4 call and we give you guidance we'll really enunciate that more clearly, Joshua. But as for now, I'd say that we see it as a low growth kind of an opportunity in the near term.

But the rest of the market; when you look at our business and I think that this is a good point. When you look at our business and divide it into four pieces, okay.

Let's look at US peripheral vascular. You have the atherectomy piece which we just talked about, modest growth, it needs this additional clinical series to really grow. But the other part of that business is growing very, very nicely and very rapidly.

If you look at our neuro business growing very nicely and very rapidly, and look at our international business is just gangbusters. So we have all of those moving pieces that indicate to us that this company has a lot of opportunities for growth on the top line, as well as being able to leverage that into being a real profitable company.

And I think that's where our focus is. That's why we're excited about. As you go forward, looking at the markets that we're in, how they're growing, our place in them and our opportunity to leverage our company is that I think that we're going to be in very, very good shape.

Joshua Zable - Natixis

Great, thanks. And then just a housekeeping item for Pat. Just on FX, as you look going forward from fourth quarter, how are you thinking about, is it sort of constant currency as of the end of the quarter, constant currency as of today? I know you guys can't predict currency, but just so we can have an ability to forecast where you guys are thinking at?

Pat Spangler

Yeah, obviously, Josh, the currency, the dollar has strengthened considerably even since the end of the third quarter in September. So right now, kind of we are viewing it is that we're in this 128-129 level, and that's kind of how we're analyzing the business for the fourth quarter.

Joshua Zable - Natixis

Okay, great. Thanks very much guys.

Operator

And our final question comes from the line of Bob Hopkins with Banc of America. Please proceed.

Bob Hopkins - Banc of America

Hi guys, thank you. I just have one really quick question. I was wondering if you could give us a rough timeframe for an FFA indication approval in the US in your view. Is that roughly early 2010, is that why you are thinking about it?

Bob Palmisano

You talking about stent?

Bob Hopkins - Banc of America

Yes, sorry for EverFlex.

Bob Palmisano

I think it's some time not early but some time in 2010. Does that answer your question, Bob? Hello?

Operator

Hello? And this concludes our question-and-answer session. I would now like to turn the conference over to Robert Palmisano for closing remarks.

Bob Palmisano

Well, thank you, Operator. In closing let me reiterate that our top priority is to make this company a profitable company, with clear focus on our vital two projects and continuing improvements in operational execution and efficiency.

I believe we can transform this company into a leading global endovascular business that delivers superior, long term value to our shareholders.

I want to thank the entire ev3 worldwide team for their efforts in the third quarter. I'd also like to thank you for listening today and for your interest in ev3.

And this concludes the call. Thank you.

Operator

Ladies and Gentlemen, thank you for your participation in today's conference. This concludes the presentation and you may now disconnect. Have a good day.

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Source: ev3 Inc. Q3 2008 Earnings Call Transcript

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