Synovis Life Technologies, Inc. F4Q08 (Qtr End 10/31/08) Earnings Call Transcript

Synovis Life Technologies, Inc. (SYNO)

F4Q08 Earnings Call

December 3, 2008 11:00 am ET

Executives

Richard W. Kramp - President and Chief Executive Officer

Brett A. Reynolds - Chief Financial Officer

Analysts

Matt Dolan – Roth Capital

Greg Brash – Sidoti & Company

Jay Roseman - Westpark Capital

Presentation

Operator

Welcome to the fourth quarter 2008 Synovis Life Technologies, Inc. earnings conference call. My name is Erica and I will be your coordinator for today. (Operator Instructions) I would now like to turn the presentation over to your host for today’s call, Mr. Richard Kramp, President and CEO.

Richard W. Kramp

Good morning. Welcome to Synovis Life Technologies’ 2008 fourth quarter conference call. Brett Reynolds, our CFO, and I will present the highlights of this quarter and this record year. As we bring you the latest news about the company’s performance and talk a little bit about the future, please keep in mind that forward-looking statements made in the course of this phone conference are made pursuant to the Safe Harbor provisions of the Private Securities Litigation Reform Act of 1995. These statements can be identified by words such as should, could, will, may, expect, believe, anticipate, estimate, continue, or other similar expressions.

There are certain important factors that could cause results to differ materially from those anticipated by the forward-looking statements made during the course of this conference, and the company has no obligation to update its forward-looking statements, references made to the company's annual report on Form 10-K for the year ended October 31, 2007, and all public filings made by the company thereafter.

Results presented today are for continuing operations of the company and for the current quarter unless otherwise identified. Comparisons are always to the same period of the prior fiscal year unless specified differently. As always, Brett will begin by providing the financial overview of the quarter.

Brett A. Reynolds

We are pleased to report our fourth quarter and fiscal 2008 results this morning. Fiscal 2008 has been a very successful year, a year in which we became focused exclusively on the soft-tissue repair and reconstruction market, a year in which we successfully grew the business, and a year in which we leveraged the growth to the bottom line.

The growth we realized in fiscal 2008 reflects the many significant contributions made by our employees to grow the company and the high demand from our customers for our products.

Our full year fiscal 2008 financial results from continuing operations include the following highlights. Our revenue for the year was $49.8 million, reflecting growth of 32% over fiscal 2007 and nearly 80% growth over fiscal 2006.

Our gross margin for the year was 69%, our highest annual gross margin ever and an increase of 4% over fiscal 2007. Fiscal 2008 operating income was $7.2 million, nearly tripling our operating income from a year earlier.

Our operating margin was 14.4%, our highest operating margin in five years, and earnings per diluted share from continuing operations totaled $0.48 for the year, our highest ever annual EPS.

Also of note during fiscal 2008, each quarter showed significant revenue and operating income growth over the same quarter of the prior year. Our revenue growth by quarter ranged from 24% to 37% while the growth in our operating income by quarter ranged from $800,000 to nearly $1.4 million.

I will now go into more detail on our Q4 financial results. Overall we are pleased with the results of the quarter. While we did not achieve our tenth consecutive quarter with record revenue, our fourth quarter revenue nonetheless grew 24% over the same period of the prior year.

Our gross margin in the fourth quarter was 70.2%, slightly exceeding our goal of 69% to 70% that we set at the beginning of the year. And our fourth quarter operating income increased 145% over Q4 of last year to $2.2 million, reflecting an operating margin of 17.6%.

Revenue totaled $12.7 million in the fourth quarter. Again, this is an increase of 24%, or $2.4 million, when compared to Q4 of last year. All of our major product categories had increased revenues. Approximately $2.0 million of the revenue gain came from growth in unit volumes sold while the remaining $400,000 was due to higher pricing on various products.

From a product line perspective Q4 revenue can be summarized as follows. Peri-Strip revenues reached $4.7 million in the current quarter, an increase of $1.1 million, or 32%, from the year-ago period. All of this increase was due to higher unit volumes with increased penetration of our existing accounts as well as an increase in the number of new customers.

Internationally PSD revenue grew nearly 100% over Q4 of last year as our international distributors have been very effective in communicating the benefits of PSD Veritas since receiving clearance to market for this product in the second half of 2007.

Revenue from our tissue-patch products, which included Tissue Guard and Veritas, totaled $4.8 million in the fourth quarter. This represents an increase of nearly $1.0 million, or 25%, when compared to the fourth quarter of last year.

Approximately 2/3 of the growth in the quarter was due to increased revenue from Veritas in the hernia and chest wall repair markets, with the remainder of the increase driven by a combination of price and unit volume increases for our tissue-guard products.

Revenue from our microsurgery product line was $2.0 million in the quarter, an increase of $350,000, or 21%, over the prior year. Approximately 2/3 of this increase is due to higher unit volumes with the remainder due to pricing. The revenue growth was led by Coupler, which increased 26%.

On a sequential quarter basis our Q4 revenue of $12.7 million represented a decrease of approximately 5% from our third quarter with sequential decreases across all of our product categories as follows.

Peri-Strips revenue decreased 2% in the fourth quarter compared to Q3. Tissue-patch revenue decreased 4%, microsurgical revenue decreased 8%, and our surgical tools and other decreased 12%. In addition, sequential quarter revenue was down both domestically and internationally, although international saw a more pronounced decrease at 15%.

While we have not seen any meaningful seasonality over the past three years in which we have been direct domestically, if we look at the five years prior to us becoming direct, our fourth quarter typically did have lower revenue than the third quarter and we believe seasonality did play a role in the revenue decrease in Q4 compared to Q3.

In addition, while medical procedures and products used in those procedures are generally immune to the general economic swings, we believe the significant negative change in the economy in our fourth quarter may have impacted our revenues. Rich will comment on this more later.

Our gross margin was 70% in the fourth quarter, up 3% from Q4 of last year. This improvement is due to increased sales of higher margin Veritas and Peri-Strips, improved labor and material utilization, as well as higher average net selling prices.

SG&A expense during the fourth quarter totaled $5.0 million, an increase of $660,000, or 13%, from the same period of a year ago. The increase in SG&A was driven by higher sales and marketing costs, as well as increased new business development costs, and professional fees. As a percent of revenue SG&A costs were 45% in the current quarter compared to 50% in the same period of last year. On a sequential quarter basis, Q4 SG&A costs were down approximately 5% from Q3, primarily due to lower sales commissions in line with the lower revenues as well as lower convention and related marketing spend.

R&D expense totaled $912,000 in the quarter, an increase of 9% from Q4 of last year, driven by increased project activity in the current quarter. Higher costs related to developing the flow coupler along with increased expenditures on activities focused on expanding the indications for our Veritas technologies were the reason for the increase.

Again, operating income in the fourth quarter was $2.2 million with an operating margin of 17.6%. This is a significant improvement over operating income of $914,000 and an operating margin of 8.9% in Q4 last year.

Interest income was $487,000 in the fourth quarter compared to $625,000 a year ago. While we have higher investment balances due to the proceeds from the sale of our Interventional business, two items have resulted in lower interest income in the quarter. First, we are experiencing lower overall market interest rates. Our money market accounts were yielding almost 5% a year ago compared to just over 2% at present.

Second, we have a higher proportion of our investments in tax exempt securities. At the end of the year, about 50% of our investments are in tax exempts compared with 35% a year ago.

Our year-to-date effective tax rate is 33.5%, lower than our statutory rate primarily due to tax exempt interest income and R&D credits. In our fourth quarter the law governing the federal R&D credit was reenacted by Congress which allowed us to book a tax benefit of approximately $120,000, or $0.01 per share.

Looking forward to fiscal 2009 we currently expect our effective tax rate to be approximately 36%.

Q4 net income from continuing operations was $1.9 million, or $0.15 per share, as compared to net income of $1.1 million, or $0.08 per share, reported in the fourth quarter of last year.

And now the balance sheet and cash flows. Our balance sheet remains very strong. We have total assets of over $97.0 million, net working capital of $62.0 million, and no debt as of October 31, 2008.

Of our total assets we had $46.9 million in cash and equivalents, as well as $3.0 million in restricted cash and $24.9 million in investments. These total to $74.8 million in cash and investments, or $6.22 per share, up from $53.7 million at the end of fiscal 2007.

Four significant items impacted the net increase in our cash and investments during fiscal 2008. One, we received $30.2 million in gross proceeds from the sale of the Interventional business; two, we paid taxes of approximately $6.0 million on the gain from the sale of Interventional; three, we spent $8.5 million during fiscal 2008 to repurchase 504,000 shares; and four, our operating activities from continuing ops generated cash of $5.7 million in fiscal 2008.

During the fourth quarter our cash and investment balances decreased by $5.0 million as most of the stock repurchases occurred in the fourth quarter. We spent $7.0 million to repurchase 417,000 shares in the fourth quarter.

Operating activities from continuing operations generated cash of $1.5 million in the fourth quarter.

Our accounts receivables continue to be in very good shape with our days sales outstanding as of the end of the year at 46 days compared to 47 days last year.

Inventory increased about $800,000, or 17%, during fiscal 2008, all in support of higher revenue levels.

As I mentioned previously, through year end we have repurchased 504,000 shares at a total cost of $8.5 million. In May our Board approved a program for the company to repurchase up to 1.0 million shares of our common stock and we expect to ultimately repurchase the approved limit of shares.

Given our strong cash position, we feel the stock buyback will enable us to increase shareholder value without compromising our ability to make investments in our current business and to pursue acquisition opportunities.

The timing and extent to which we buy back shares will depend on market conditions and other corporate considerations.

And now an update on our auction rate securities. Included in our total investments of $24.9 million are six auction rate securities, which at the end of the year were recorded at their estimated fair value of $6.6 million. This fair value was estimated based on both an external valuation by a third-party valuation firm, and various internal valuations.

The par value of these securities is $9.0 million and as such we have recorded an impairment of $2.4 million. We have classified this impairment as temporary with the impairment being recorded as accumulated other comprehensive loss in the equity section of our balance sheet. As such, this impairment has no impact on net income or earnings per share in the fourth quarter or fiscal 2008.

This impairment is primarily due to the lack of liquidity for these securities. We have continued to receive all the interest payments when due and we believe that we will ultimately be able to liquidate these investments without significant loss primarily due to the underlying collateral of the securities and the third-party insurance.

However, market conditions as well as other facts and circumstances could change in the future and may significantly change estimated fair value of our securities as well as the determination that any impairment of the securities is temporary.

Since August a number of issuing and distribution auction dealers have announced settlements with various government regulators whereby these firms have agreed to buy back certain of their clients’ auction rate securities at par over the next several years.

Our broker/dealer has not publicly stated their intentions, if any, to repurchase any of their clients’ auction rate securities, however, they have acknowledged that they are currently working with various state agencies regarding their customers’ auction rate securities.

I would like to now turn to our thoughts for fiscal 2009. While we do not provide formal guidance, we have typically provided our high-level thoughts about the upcoming fiscal year. Our current expectations for fiscal 2009 include revenue to grow between 20% and 25% over fiscal 2008. We expect all product categories to participate in this growth with the highest expectation of percentage growth being from Veritas.

Gross margin is expected to be slightly above 70% for the full year, dependent upon product and geographic sales mix.

Operating expenses are expenses are expected to grow in fiscal 2009 at a rate similar to the revenue growth. However, the growth of these expenses is expected to be weighted toward the beginning of the year due to the ramp of clinical trials and the hiring of sales professionals in the first half of the year.

Interest in the quarter is expected to be similar to Q3 results, subject to change in the overall interest rate environment.

We expect the use of cash to repurchase additional shares to be offset by cash generated from operations. Of course, this expectation is based on the status quo and any cash deployed in an acquisition will impact our interest income.

As previously noted, we expect our tax rate to be approximately 36% in 2009.

As we have stated before, growing our top line is, and will remain, the top strategic priority for the company and the above expectations reflect that strategy. Our fiscal 2009 will focus on investing in our technologies and in our sales force with the end goal of increasing our share in each of the main product markets.

A variety of investments is necessary in the short term but should continue to position Synovis very well for the future.

Now I will turn the call back to Rich.

Richard W. Kramp

Fiscal 2008 has been quite a year for Synovis, a year of very strong growth with three record revenue quarters and a fourth quarter in which revenue grew 24% and operating earnings were up 145% over the same quarter last year. All product lines contributed to this growth and the markets in which we are mainly focused showed the greatest growth, both for the year and the quarter.

In the fourth quarter our PSD products were consumed by the market at a rate much higher than procedural growth. We achieved unit growth greater than 32% in a market whose annual procedural growth is in the range of 6% to 8%. Our additional 24% to 26% growth indicates that our sales force continues to convert non-buttressers as well as capture market share from our competitors.

Peri-Strips users increased their preference for our Veritas technology versus our cross-linked Apex buttresses from 71% to 82% compared to the same quarter last year. In Europe, with the long-term results of gastric banding show that weight loss is not fully sustainable and complications increase with time, the reason why gastric by-pass procedure continues to gain acceptance.

Peri-Strips unit consumption was up over 100% despite the August/September slowdown associated with the European vacation season.

For those of you who are not familiar with Peri-Strips, they are strips of pericardial tissue used to reinforce surgical staple lines to minimize fluid leakage and an increased burst strength. Our primary application is for the reduction of the size of the stomach in gastric by-pass surgery or sleeve gastrectomy.

Peri-Strips are also used in lung surgery for removal of cancerous or otherwise diseased lung tissue.

Looking now at another market of primary focus, our tissue-patch products grew 25%, led by Veritas collagen matrix, which more than doubled in sales this quarter versus the fourth quarter of 2007. Veritas patch products are used primarily to reinforce and regenerate supportive tissue in ventral and hiatal hernia repair or breast reconstruction.

Sequentially Veritas patch units were up slightly, although revenues were slightly down as fewer large patches were used. This may be the result of more component separation procedures being performed, due to the disappointing results experienced by many surgeons using human dermis in a bridge hernia repair.

Due to the high failure rate of dermis, which is approximately 80% in this challenging situation, many surgeons have become skeptical of the performance of any biologic patch for this procedure.

The surgical procedure known as a component separation can be done as an alternative to the bridge procedure. It consists of surgically separating the three layers of the lateral abdominal muscles on each side of the patient and then bringing them together, somewhat like sliding a three-panel door together, to close the gap caused by a large hernia. If this procedure is performed, a smaller patch is used to secure the joining of those muscle layers at the center line of the abdomen.

Because we firmly believe Veritas is capable of performing well in the bridge situation, Synovis is currently conducting medium- and long-term in vivo studies to increase our available performance data for Veritas in the bridge and other procedures.

We are likewise planning a clinical study to document the comparative strengths of Veritas versus its biological competitors to more fully understand the role of implant technique and other factors which might maximize patients’ outcomes.

To be effective, these studies will run over a two- to three-year period and are a necessary and worthwhile investment to meet our goal of establishing Veritas as a major player in the hernia and breast markets.

Now, let’s take a look at our third market of focus. Revenue growth produced by our MCA group, which serves micro and reconstructive surgeons was again very strong. Micro grew 21% in the fourth quarter compared to the same quarter last year, driven in great part by a 26% increase in coupler sales.

The coupler is used primarily to connect very small diameter vessels during a breast reconstruction procedure. The procedure involved is called a perforator flap procedure and it involves dissecting a section of the patient’s own tissue, consisting of the skin and subcutaneous fat with small perforated vessels from the abdominal area and transplanting it in place of the removed breast.

The critical function of the coupler is to facilitate connection of the perforated vessels to vessels in the implant area to successfully reestablish blood supply as quickly as possible, thereby keeping the transplanted tissue alive.

The coupler can actually reduce time required for reconnection to 25% of the time required for hand suturing. And just as important, the quality of the connection equals or exceeds that achieved by hand suturing.

As we look at the year from a broader scope, 2008 was also a very instructive year for Synovis. It is the first year since 2004 in which Synovis’ business has not been affected by significant, planned, internal changes.

In the fourth quarter of 2005 Synovis announced its intention to phase out our distributor-based sales force and to begin, in fiscal 2006, building a direct sales force. The transition was made in the first two quarters of 2006 and by the beginning of the third quarter we had 24 direct territories defined and staffed.

In 2007 we again introduced significant change by increasing the size of the sales force by 50% in the third and fourth quarters of the year.

So for the last three years we have not experienced any seasonal effect on fourth quarter sales levels. As Brett pointed out, however, in this fourth quarter we did see a decrease in sales across all of our product lines with a notable exception of Veritas hernia and breast, which grew slightly.

It is not possible to know whether this decrease is wholly attributable to the historic fourth quarter slowdown or if the effects of the current economy are also playing some minor role. We do not feel that the performance of our products or our sales team or competitive advances are the cause.

During 2008 we made no significant internal changes. Rather, we resolved to focus on refining our sales approach, getting closer to our customers, and building and enhancing mutually beneficial relationships with them.

We also made many improvements in the efficiency of our manufacturing processes and our quality systems. It is evident that in spite of the reemergence of the fourth quarter slowdown, which had been experienced in years prior to 2004, we have been very successful in realizing our goals.

The stretch targets the company established for 2008 during our planning and budgeting work in the fourth quarter of 2007 were achieved or exceeded across the board in this past fiscal year.

Revenue from continuing operations reached nearly $50.0 million, up 32% from 2007, and operating earnings grew even more dramatically, up 191% year-over-year.

Less visible achievements, but no less important, were our production efficiency programs relating to improvements in gross margin, marketing and medical education programs to facilitate market penetration and improve the knowledge of our sales people, and our quality and IT initiatives to assure reliable delivery of high-quality products to our customers worldwide. We have improved our infrastructure in 2008 and will continue to do so in 2009.

While 2008 gave us a good taste of what the company can do relative to revenue growth, gross margin improvement, and increasing operating earnings, it also revealed the areas where we should invest to accelerate growth and improve our strength in the market place.

In 2009 we plan to hire 15 additional sales people with about seven of those hires occurring in the first quarter of the year. Our micro surgical sales force will take three of these people, increasing the micro sales team to 10, and surgical will add four, bringing the surgical sales teams to 40.

The surgical sales team now has five regions, led by five regional managers, each with about eight sales people reporting to them. In the latter half of the year we will add the remaining eight sales professionals to the surgical group, to end the year with a total of 58 professionals selling Synovis products in the United States.

We will also make significant investments during 2009 to enable our sales people to become more valuable to the surgeons they serve. This will be accomplished by conducting increasingly personalized sales training programs to get each sales person completely comfortable with the product and procedural knowledge they need to be an indispensible partner to the surgeons they call on.

In addition, we will be conducting more in vivo and clinical studies to generate the data needed by the sales team to be able to provide the answers to the scientific as well as clinical questions of their surgeons and to build lasting confidence in our products as well as our company.

We will also have a lot of work going on to advance several new products and product enhancements to the market. Yesterday we received 510(k) approval from the FDA for an improved method of securing our Veritas Peri-Strips to the jaws of a surgical stapler. This improvement will provide greater stability of our buttressed products on the jaws of the stapler during the introduction of the stapler into the abdominal cavity, especially during laparoscopic surgery. It will also provide greater ease of use for the surgeon and the operating room personnel.

We will first introduce our circular buttressed version of this product, followed later in the year with the linear version.

As you will recall, we are working with a surgeon who has some long-term follow-up data on use of Veritas patch material to repair arterial venous fistulas in dialysis-dependent renal patients. We hope to obtain that data soon and put it in a form acceptable for submission to the FDA in the first half of fiscal 2009. This is about a $25.0 million market in the US and the availability of a patch with remodel ability characteristics of Veritas promises to offer a unique solution to repair of degraded fistulas.

We also intend to introduce an enhanced version of the successful coupler product to the market in July of 2009. The product, called the flow coupler, is currently undergoing final validation studies in preparation for submission to the FDA for 510(k) approval. The flow coupler will allow immediate, real time confirmation of blood flow through the coupled vessel using an integrated but removable Doppler ultrasound probe.

I also want to bring you up to date on our studies of the application of Veritas as a myocardiac patch. We have concluded the eight-week and six-month studies that were ongoing for much of 2008 and feel we have demonstrated a proof of concept. Our initial studies were conducted in healthy hearts and we will next look into the performance of Veritas in infarcted hearts where the scar tissue in the heart will be replaced by the Veritas patch.

This will give us the opportunity to study the electrical recovery, as well as the mechanical recovery, of the heart. These studies will run for most of 2009.

As we announced earlier this week, Dr. Dan Meridian has joined Synovis as our Vice President of R&D. As you might imagine, one of my primary concerns when Dr. Nick Oray told me of his plans to retire, was how to find a person with the background and skill set necessary to fully understand Veritas and be able to move ahead with our studies with a minimum of delay. Nick made that easy by suggesting Dan, who had been a principle scientist and then Director of R&D at Synovis from 2001 to 2004.

Fortunately, we were able to bring him back to Synovis. Dan is uniquely positioned to hit the ground running because he knows our company, our products, and our technology so well, particularly our Veritas remodable biomaterial. Beyond that Dan brings strong academic credentials to Synovis having received a Ph.D. in experimental pathology from Wayne State University School of Medicine and a Bachelors Degree in the Biological Sciences from the University of Minnesota.

As a founding member and assistant professor in the Department of Biomedical Engineering at the University of Minnesota, Dan established successful research programs in biomaterials and tissue engineering. He was Founder and Director of the Blood and Bio Compatibility Research Laboratory, Co-Director of Industry Interactions in the Biomedical Engineering Institute, and held teaching and research positions both at the Department of Laboratory Medicine and Pathology and the Department of Biomedical Engineering. We are happy to have Dan with us.

We have just completed a great year and are excited by the year ahead. We look forward to keeping you updated on our progress and thank you for your support of Synovis. That concludes our update for the fourth quarter of 2008 and we would be happy to take your questions now.

Question-and-Answer Session

Operator

(Operator Instructions) Your first question comes from Matt Dolan – Roth Capital.

Matt Dolan – Roth Capital

Broadly, you mentioned a little bit, maybe an impact of the economy on surgical volumes here in the October quarter. Can you give us an idea how things tracked throughout the quarter into October, on a sequential basis.

And then secondly, how are you factoring in this kind of unknown variable into your growth guidance for fiscal 2009?

Richard W. Kramp

Great question and a little bit hard to answer. It was clear that August was our weakest month and then we continued to gain back in September and October, which is more of a seasonal vacation sort of period thing, both in the United States and Europe.

Most of our procedures, both with respect to hernia repair, breast repair, or even the bariatric surgery, are reimbursed procedures, isolated or insulated. And I say most because there are a few states yet that don’t fully cover these procedures. But there are other impacts when a person decides to go in for these surgeries because they are usually not emergent, they are somewhat elective and can be put off for a period of months. The person takes into account the additional financial burden of being in the recovery period or not being at work, things like that, and we think those could have a mild effect.

We don’t know how much and we don’t know whether it is going to be significant or get more significant. Certainly if a lot more lay-offs occur and people lose their insurance, that could affect our sales a bit. But again, I think this will be small. We don’t see this as a big effect.

The fourth quarter seasonal effect I think we did see in 2008 because we didn’t have any major additions of sales people or changes internally, as I mentioned. In 2009, again, we will be making internal changes, adding more sales people, and so even though I am sure that slowdown might be in the market, we might now see it because it will get swamped out in the growth caused by our additional people.

So I hope I answered your question. The biggest month was August in terms of the slowdown and then we saw the recovery already happening during the course of the quarter, which would tend, as I said, to put a heavier weight on the seasonality than on the economy.

Matt Dolan – Roth Capital

And just to clarify, it looks like, from the numbers we have pulled out of the announcement, that no one surgical indication saw a particularly larger slowdown, like bariatric or something like that?

Richard W. Kramp

No, that’s kind of a clear signal, it was across the board, so I know it’s not some market or some product that impacted or some aggressive competitor or new technology coming into the market because it was every one of our products.

Matt Dolan – Roth Capital

Regarding the sales force expansion, specifically the micro surgery group, that’s on a relative basis that is a pretty big increase you are seeing there. Is that anticipation of new product launches, or maybe just walk us through the concept there. Where are you lacking in terms of sales coverage and what is the opportunity for growth there in the next couple of quarters?

Richard W. Kramp

It’s a couple of things. We have seven direct sales people now and included in that seven are a couple of people that are kind of our major product trainer, who also has a territory as well as our national sales manager, so they are kind of doing double duty. So two of these people will help free up more of their time so the national sales manager can actually manage and the trainer can do more training and new product development work.

But we are also light in the sense of our coverage, even with seven direct sales people, that is light to cover the whole U.S. because of the growing popularity, particularly of the flap procedure, and the fact that it has been a procedure that started out a lot in the academic institutions, it is going out much more into the more community hospitals. And by the way, that’s not only the United States, there was the first meeting for this procedure in India and I think in China recently. So it is happening around the world.

But also the introduction of our flow coupler, which is coming in July and we want to have all the people in place and trained before that happens because we think not only will it be a bit of an educational thing but it will be a big improvement and probably expand our penetration into that market.

Matt Dolan – Roth Capital

On the acquisition side of things, I know with respect to your cash that it sounds like the buyback will go to completion. In this market, as valuations come in and maybe offset by the uncertainty created in the economy, maybe just update us on how you feel that positions you to make acquisitions strategically. Is it more opportunistic now that the valuations have come in or does the uncertainty offset that in some way, or almost entirely?

Richard W. Kramp

Obviously there is no way to know the exact answer to that but our program continues to go. We are still continuing to look. From the people we have talked to and contacts we have, we don’t see people that have technology out there or have companies willing to take lesser price yet. They seem to be holding on to what they think their stuff is worth. So we haven’t seen a big break in that area yet. I suspect that could change if this goes on.

As you know, we have been focusing on trying to find companies that have existing sales and their products already developed or near FDA approval. Companies with earlier technologies that are depending on trying to get additional cash, they are willing to talk more, but that’s not our primary focus at all.

Operator

Your next question comes from Greg Brash – Sidoti & Company.

Greg Brash – Sidoti & Company

You mentioned some of the seasonality that you saw in August. Is it fair to assume that your sales into the hernia space and take that in the September/October time frame? Is it fair to assume that your sales into the hernia space picked up in the September/October time frame?

Richard W. Kramp

They did. And we would expect that to be a good harbinger for the first quarter but we have to see how that evolves.

Greg Brash – Sidoti & Company

And when can we expect to see results from some of the in vitro studies?

Richard W. Kramp

Those are long-term. The in vitro studies on hernia are in pigs and they are year-long studies. We will be intervening earlier on some of the animals and that will tell us certain things about the remodeling characteristics of Veritas but in terms of answering how good the product is performing over time, the real results of a bridge procedure when it starts to fail, and we saw it clinically starting to fail with a human dermis has been at the year time frame so those studies, all the implants were completed in late fall. It will be about late fall of 2009 before we have the first intervention and probably a month or so before we have a report on that. After the explants.

Greg Brash – Sidoti & Company

On the Peri-Strips side, obviously you are doing very well. I know, not a direct competitor of yours, but in the gastric banding side, reported a sharp procedural slowdown in the summer months. Just curious, I know you are seeing some seasonality, but are you seeing a sharp drop-off from the economy and maybe you are able to avoid that through your strength overseas or gaining market share. Just something a little more in-depth in what you are seeing in the market.

Richard W. Kramp

I would say the seasonality aspect occurs internationally as well as domestically. Our growth internationally has been high because as you might know, Europe started with banding seven years ago as their major procedure whereas in the United States we were gastric bypass and for the first three or four years, I must say the results were fairly comparable in terms of weight loss and complications. It’s in these latter years that we have seen a switch, or a beginning of a switch, away from banding to gastric by-pass because people have been gaining some of the weight back and complications have not been going down over time, they have been going up, which is the opposite from gastric by-pass.

So we expect to see continued growth in Europe. Whether it will actually swamp out all of the growth, again next year, although the seasonality next year is hard to tell, although we have high hopes it will continue to grow for quite a while yet. In the U.S., again, I think there is going to be some impact on the seasonality getting swamped out just by our adding these additional sales people. So as we do quarter-over-quarter comparisons we will have more sales people on the street and it won’t eliminate it, it will still be underlying, but our growth might make it less visible.

Greg Brash – Sidoti & Company

On new products, you mentioned the flow coupler and entering into av fistula or at least submitting a 510(k). Curious as to what your plans are as far as converting some of the tissue-guard products from Apex to Veritas and any update on the foreclosure product.

Richard W. Kramp

In terms of the fistula, I think I have reported everything we can. We hope to get the data. This data exists already so it was a very opportune thing for us to do, however, getting access to the data because it was not done under a formal study, had taken a little bit longer. We make baby steps in getting the approvals but I think we are now very close. We have one more hurdle we have to overcome and we are communicating about that hurdle right now. Once we have access to the data we think one, it will be under our control, and two, it will go a whole lot faster. It does look like an interesting market to us, though.

With respect to the conversion of tissue-guard products to the Veritas, we are looking at that. It is not the highest priority right now just because the tissue-guard products have such a spectacular performance record so we will go cautiously as we think of replacing it. On the other hand, we do think there are some benefits to Veritas that are even greater than the benefits we see from the tissue-guard products. And they might relate to the same place where the tissue-guard products are being used, or elsewhere in the body, but we will learn as we do these studies of replacement of tissue-guard with Veritas. But it is not the highest priority we have.

As to the foreclosure, it is an interesting product for us. We have been bogged down for a period of time in problems with it. We converted from machining these rods to making a die, to injection molding them, and we have had some setback with that with respect of the availability of the tool steel at first and then most recently the finish. Because as we molded them we got a much better finish on the product and that finish actually reflected a lot more light in the abdominal cavity which made it harder for the surgeon to see what they were doing so we are dealing with issue now.

Some of these things are really hard to predict, but we continue to sell it under the old version but we are waiting for a relaunch of the product once we get these final things worked out.

Greg Brash – Sidoti & Company

Do you think that will happen in fiscal 2009?

Richard W. Kramp

It will happen in fiscal 2009. I think it will be a little bit later in fiscal 2009 but it will happen in fiscal 2009 for sure.

Operator

Your next question comes from Jay Roseman - Westpark Capital.

Jay Roseman - Westpark Capital

This quarter you had some of the best gross margins you have had in the history of the company. Could you give some more details, is it product specific or economy to scale or what is allowing your gross margins to stay so high.

Brett A. Reynolds

Primarily it is product mix with Veritas and Peri-Strips growing over the year-ago period. Those products have higher than average margins so to the extent they become proportionally more of our revenue we will see the margin move up.

In the year we have had some manufacturing efficiency improvements, which have helped, and some slight price increases.

As we look forward, what we have said for 2009 is we would expect margins to be slightly above 70% and that is what we expect. In the fourth quarter we had some benefit with international being down 15%, international, we typically have a lower gross margin there so it will depend on mix going forward. But somewhere in that 70% to 71% range.

Jay Roseman - Westpark Capital

As I look at SG&A for 2008 it ranged anywhere from 50% of revenues down to 45.5% of revenues and if you add more sales people, how should we look for that percentage to be in 2009?

Brett A. Reynolds

It was about 50% and in each quarter we are around $6.0 million, we are at $24.0 million for the year. As we look forward to 2009, we have said for the full year expect that number to grow in line with revenue, 20% to 25%, but those costs will come earlier in the year as we add seven sales people in the first quarter, as some of the costs for our clinical studies come in.

And our clinical studies, we expect those to be accounted for as SG&A not in R&D because the product is already available for sale.

So that would be front-ended as a percent of revenue, most likely it would be a little higher in the early part of 2009 but less in the latter part of 2009.

Operator

Your next question is a follow-up from Matt Dolan – Roth Capital.

Matt Dolan – Roth Capital

On hernia, Rich you mentioned that there is a perception or a number out there, 80% failure of dermis-based tissue products. Where is that number coming from? It seems pretty high and if it is becoming the broader perception out there among surgeons, and it sounds like you figured out the size question relative to your own business in terms of Veritas patches, are you expecting some pretty significant competitive conversions on the hernia side of the business because of that number out there?

Richard W. Kramp

Clarifying now, that is with the bridge procedure. The source of the number were two papers, one that came out in January of 2008, one came out in March of 2008. This relates to the human dermis product. One had exactly 80% failure rate at 14 months. The other was in the range of 14 months but at about 79%.

I will tell you, and this is anecdotally, at the recent meeting of plastic surgery, plastic surgeons get involved a lot in these very complex hernias because sometimes it is a rebuilding more than it is just a repair, and one of the surgeons came up to me and we were talking about that and I mentioned the 80%. He said he was just at a meeting where in two different panels they said eventually it has been 100%, so you wait long enough they all fail.

I haven’t seen that in print yet. But 80% is bad enough. Our experience had been, and this is not published yet, we hope to get it published but it has been with one surgeon but he had a very large number, in fact as large as the numbers that were in the papers that were reported, where he had only about a 15% failure rate.

Now on the other hand, the other product, the human dermis is much more widely used so many more surgeons were having these problems and what we have been hearing is doctors, because over a period of time they have been told there are a lot of people selling biological products out there and everyone that comes along says theirs works.

So do we expect to have a large conversion of competitive products? I would say yes, with the exception, it will have to wait until we get this clinical data done. That’s why we have launched this clinical study. The doctors are at the point they want to see hard published clinical data that our products work in this position, followed up for a period of a year and a half or so.

We have launched this study, we are also working on doing retrospective studies, retrospective gathering of the data, such as the one I mentioned to try to get that published so we can have our sales people go in with other than what we know internally, have it in a peer-reviewed published paper so they can say they understand. The others failed, but look, ours did not fail.

Operator

This concludes the Q&A portion of the call.

Richard W. Kramp

Thank you. I just want to let you know our mission is very clear and our focus remains on growth. Our technology and our products continue to perform well, the markets we are in are dynamic and growing. We have a solid plan and worthy goals for 2009 and maybe most importantly, we believe increasingly that our Veritas technology is extraordinary and that we have a lot more to learn about it and a lot more rewards to reap from it. So with that, thank you.

Operator

This concludes today’s conference call.

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