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Volcano Corp. (NASDAQ:VOLC)

Q4 2008 Earnings Call

February 17, 2009; 5:00 am ET

Executives

Scott Huennekens - President and Chief Executive Officer

John Dahldorf - Chief Financial Officer

Analysts

Chris Pasquale - JP Morgan

Thom Gunderson - Piper Jaffray

Raj Denhoy - Thomas Weisel Partners

Jason Mills - Canaccord Adams

Jose Haresco - Brean Murray

Operator

Welcome the Volcano Corporation’s fourth quarter 2008 earnings conference call. (Operator Instructions) As a reminder this conference call is being recorded Tuesday, February 17. A replay of this call will be available through February 24, by dialing 719-457-820 pass code 8404715 or via the company’s Web site at www.volcanocorp.com.

I’d now like to introduce Mr. John Dahldorf, Volcano’s Chief Financial Officer.

John Dahldorf

Thank you and good afternoon, everyone. With me today is Scott Huennekens, Volcano’s President and Chief Executive Officer. Scott will begin today’s call with a review of the factors contributing to a highly productive end to fiscal 2008, with strong revenue growth, GAAP profitability and important progress on our product pipeline.

I’ll then follow with a review of our financial results and our guidance for fiscal 2009. Before turning the call over to Scott, let me remind you that our prepared remarks contain forward-looking statements as defined under the Private Securities Litigation Reform Act of 1995.

These include statements related to the guidance about financial and operational results, growth strategies, product development and clinical trial programs, market acceptance and adoption of our product offering and those of our competitors, the functionality and capabilities of our products, any strategic activities, the impact of global economic and capital equipment environments in our business as well as forward-looking statements that we may make in response to your questions.

Factors that could cause Volcano’s actual results to differ materially from these forward-looking statements are described in our filings with the SEC, including our 10-K for the year ended December 31, 2007 and our 10-Q for the quarter ended September 30, 2008. Volcano cautions you not to place undue reliance on forward-looking statements that speak only as of the date that they are made.

Volcano undertakes no obligation to update publicly any forward-looking statements to reflect new information with events or circumstances as of the date that they are made. Scott.

Scott Huennekens

Volcano ended 2008 in very solid fashion, continued to deliver on the important growth factors as we have since going public. Execution of market penetration programs to increase revenues, technology innovation and the development of a product pipeline to serve our future growth. In the quarter, we achieved record revenues, the 11 consecutive quarters that revenues have exceeded Wall Street consensus, with quarterly revenue growth of 23% year-over-year and total year revenue growth of 31%.

We experienced growth throughout our product portfolio and maintained our roughly 50/50 revenue split between the U.S. and international markets. In addition, we were profitable on a GAAP basis for the second consecutive quarter, as we continue to leverage our operating structure to improve gross margin and operating income.

While John will discuss our outlook for 2009 in detail, we are providing guidance for 2009 revenues of approximately $218 million to $223 million, including the contributions from Axsun, which represents year-over-year growth of approximately 27% to 30% and 18% to 21% for our core medical businesses. We also completed two important acquisitions during the year including Novelis and its forward-looking IVUS Technology in May and Axsun Technologies, a developer of optical and laser technologies at the end of December.

Additionally, we made a third small acquisition in November, Impact Medical which has innovative catheter technologies that will enable us to improve the capabilities of our existing products and develop other unique offerings to support of future efforts in PTOs and AMI and ACS cases. Our overall IVUS business in the fourth quarter of 2008 grew 20% year-over-year as IVUS systems sales increased 28% and IVUS disposables increased 18% in the quarter.

Keep in mind that in the fourth quarter of 2007, we recorded $1.1 million of revolution catheter revenue related to stocking orders in Japan. Excluding, those catheter stocking orders our IVUS disposal revenues in the fourth quarter of 2008 increased 23% versus a year ago. Facilitating our growth was the continued success of our IVUS and FM multimodality console placement programs as we placed 330 consoles during the quarter versus 177 in the fourth quarter a year ago and 238 in the third quarter of 2008, or an increase of 86% year-over-year.

Before discussing some key events in the quarter and providing our perspectives for 2009, I want to reiterate the components of our strategy that have contributed to our success today and will continue to drive our future success.

We have been able to grow market share and increase overall market penetration of our core IVUS and FM businesses by being an innovation leader in executing impactful sales, distribution and market development programs. At the same time, we have created a platform that enables us to move beyond IVUS and FM multimodality system that will serve our hub and spoke strategy by accommodating our current pipeline of new products as well as offerings that we may have in the future.

We estimate that the size of our core IVUS and FM market today is more than $400 million, but has the potential to continue to grow in excess of 20% annually for the foreseeable future. As I’ll discuss shortly, we believe that factors such as improved functionality and favorable clinical data will help contribute to our growth.

We estimate that the IVUS market grew approximately 15% year-over-year in 2008; functional measurement is currently greater than $60 million market and grew close to 30% during 2008 and we believe that it will replicate or exceed that growth in 2009 as a result of the data from the FAME study, and given that the FM penetration rate is still low to mid single digits in many key geographies.

As we have discussed with you in the past, our growth objective of our core businesses is to grow revenues 20% or more while achieving margin and operating expense leverage to increase profitability. This strategy is predicated upon creating product differentiation, technology innovation and expansion of our sales and distribution programs. Our s5 family of consoles is a highly integrated solution that is easier and faster to use and delivers a higher level of information that prior IVUS technology. In addition, with our phased array and rotational catheters we are the only IVUS Company offering clinicians a choice of catheters.

At the same time, we are looking to generate additional revenues and profitability by broadening our offerings of high-margin disposables and adding complementary therapeutic solutions directed to a broad number of indications through acquisitions and in-licensing of technologies. As we have indicated previously, we estimated that there are more than 6000 cath labs in the U.S., Japan and Europe with just about 15% of them currently having integrated IVUS technology.

As we have indicated previously, we believe that IVUS and FM, cath lab penetration can potentially reach 90%, including 80% plus with integrated systems within the next several years. I should note that the implementation of integrated IVUS FM is not dependent on new cath lab construction as it can be retrofitted into existing facilities.

We believe that we now have a 40% share of the global IVUS and FM market and won more than 70% of new IVUS and FM placements in the US in the fourth quarter. Additionally, the growth of our FM business is outpacing that of the overall FM market as we are taking market share.

It is also important to remember that based on current market penetration levels, it doesn’t take a major wave of adoption for the market to achieve meaningful growth of 20%. We believe that our market growth projections can be achieved based on the continued favorable trends of PCI volume and stenting activity accompanied by nominal increased penetration in the US, Japan and Europe. We have seen a resurgence of PCI volume in stenting activity, both of which have been trending upward for most of 2008 and showed meaningful growth in the fourth quarter.

Fourth-quarter PCI activity in the US was up about 4% year-over-year and 2% versus the third quarter. In Europe, PCI activity increased in the low teens and PCI volume on a worldwide basis increased 10% year-over-year. This was the fourth consecutive quarter that PCI volume has increased. IVUS penetration of PCI activity is now estimated at 14% in the US and 67% in Japan.

Based on the outlook provided by the major stent companies, they expect stenting activity to experience continued solid growth in 2009 as well. Based on the 6% IVUS growth globally reported by Boston Scientifics and our results for the fourth quarter, we estimate that the IVUS market grew approximately 15% in the fourth quarter and that our catheter revenues suggest that Volcano now represents in excess of 50% of the US coronary IVUS catheter market.

Also helping to fell adoption of IVUS and FM is the increasing volume of data demonstrating the value of these technologies and addressing concerns around Drug Eluting and bare-metal stance. We will review this data in more detail during our analyst day in New York on February 25. As we have discussed during the course of 2008, clinicians are increasingly using IVUS and FM to determine if the patient is best served by stenting, which lesions to stent, how best to place the stent.

Increasingly, the data suggest that the use of IVUS and FM not only leads to better patient outcomes, but in the long run can often reduce the costs associated with PCIs. For example, we are continuing to see an increasingly positive response to the FAME data that was presented at TCT in October.

As you may recall, FAME looked at the use of FFR or fractional flow reserve versus angiography for multi-vessel evaluation. The results of this randomized controlled study, which involved just over 1000 patients at 20 US and European centers, has greatly heightened the interest in FFR pressure guide wires such as those that we offer. Helping faster awareness of the FAME study and the value of SFR was the publication of the study’s findings a few weeks ago in the prestigious New England Journal of Medicine.

The data showed that using FFR guidance in addition to angiography can reduce mortality and myocardial infarction by 34% at one year. The study also demonstrates that these improved clinical outcomes would complement it by reduce costs.

FAME further demonstrated that FFR guidance in routine multi vessel PCIs result in clinically superior outcomes and reduce the composite death, documented myocardial infarction and repeat revascularization by 30% that one year. I should note that Medicare data for 2007 showed that 35% of PCI procedures bill were multi-vessel disease.

Currently, FFR is used in only about 5% of U.S., PCI procedures, but the FAME data could justify its use in more than 30% of those procedures. While John will discuss the performance of our FM offerings in more detail, we believe that we started to see the impact of the FAME study on our FM business during the fourth quarter.

The FFR option for our s5 family of consoles was included in more than 90% of all orders during the quarter, demonstrating the growing interest in receptivity to the use of FFR. We believe that there will be an even greater impact during the course of 2009 as this data becomes more pervasive within the clinical community. We also believe that St. Jude’s acquisition of variety, our only competitor in the FM market signals the market potential for FM.

In fact, we note that St. Jude commented during their recent analyst day that they expect the FAME data to provide a tailwind for significant growth for FFR. We are well positioned for the FM opportunity as we offer the broadest FM product portfolio, particularly with the launch during the fourth quarter of our new PrimeWire PressureGuidewire, which is compatible with the s5 family of integrated consoles.

This device represents a significant improvement to our FFR product line. During the year, we will implement a major initiative involving the updating of approximately 1500 s5, IVUS consoles to incorporate FFR capability.

This effort and our development of the PrimeWire reflect our commitment to the FM business and its representative of our strategy to offer the clinicians the leading intervascular imaging platform with a variety of tools built around it. We believe that the factors that we’ve discussed today, the growing number of PCI procedures, IVUS integration and ease of use, enhanced functionality with FM on the s5 system and the positive data coming out of a number of studies including FAME are all helping to mitigate the impact of the current economic environment.

As we had indicated in our last call and have reiterated since then, we have thus far seen only a minimal impact of our business with respect to the capital equipment environment as evidenced by our record number of 330 systems placed in the fourth quarter. Remember that, at this point in time the capital equipment issue has to date primarily been a U.S. phenomenon and that we generate roughly half of our revenues outside the U.S. and do not sell capital equipment directly to hospitals in Japan.

A couple of additional mitigating factors are that the IVUS and FM are established technologies that every hospital owns and they generally need to replace their existing IVUS and FM equipment every seven to eight years. So, there’s a natural replacement cycle and the cost of this equipment is below $100,000 per integrated room.

We’ve seen hospitals freezing capital budgets for new items while still replacing worn out equipment. I will add however, that we recognize this could change quickly and we continue to monitor the situation very closely. Additionally, as we have stated in the past, we have numerous options for hospitals to acquire our capital, go to purchasing, leasing, renting or catheter utilization programs.

As I mentioned earlier, another important element of our success is the ability to execute in the sales and marketing area. We have several strategies in this regard, including the continued expansion of our direct sales force. At the end of the year, we had 152 direct sales reps versus 137 at the end of the third quarter, as we added a total of 32 representatives during the year.

In addition, we are continuing to build out our program to go direct in Japan and had 24 sales reps in the market at the end of the year. Given the response in Japan as evidenced by the new console placements and the addition of new accounts, we plan to accelerate our efforts there during 2009. Our initiatives may include additional staffing, new market development programs and facility expansion.

We also make additional incremental additions to our sales teams in both the US and Europe and continue our proven market development education programs during 2009. At the same time we continue to have strong partnerships with other leaders in the field such as GE, Phillips, Medtronic, J&J Cordis and Abbott, as well as leading pharmaceuticals companies through the use of our IVUS technology in their clinical trial programs.

With respect to our product pipeline, our strategy is to grow beyond our current two cylinder car powered by IVUS and FM, to offer a broad product portfolio of products, again built around our platform hub. A principal area of focus for this year is the forward-looking IVUS opportunity that we are developing through our acquisition of Novelis in mid 2008.

This platform technology can be integrated into the S5 hub and addresses an estimated $1 billion or larger market opportunity, including chronic total occlusions and other coronary peripheral and structural heart indications. We currently have two forward-looking IVUS products under development. We expect the initial of these will have first in man in the first half of this year and we are targeting approval in the US and Europe for later this year.

The second device incorporates RF capabilities to provide a therapeutic solution. We expect first in man later the second half of this year, with commercial approval in the US and Europe by the fourth quarter of 2010.

A second major initiative is Image Guided Therapy, which combines IVUS and a balloon on the same catheter with both coronary and peripheral applications. We expect first in man use before the end of the year. We estimate that this is a market with potential in excess of $500 million for both coronary and peripheral applications, and our current timeline calls for commercialization in the US, Japan and Europe about mid 2010.

With respect to our optical coherence tomography or OCT program, we have followed the first in man use that occurred in Europe last May, with the recent initiation of a study for achieving regulatory approval in Japan and the US. OCT provides significantly higher resolution than IVUS and we feel that will be an important abject to our IVUS offerings.

OCT also provides faster imaging of the artery and easier to interpret images, borders and stent malpositioning can ultimately provide economic benefits by helping clinicians make appropriate diagnoses. Initial applications for our OCT technology include PCI guidance, thrombus identification and removal, as well as stent coverage. Our current timeline for OCT calls for commercial launch in the US and Europe by mid 2010 and in Japan about one year following.

Finally, of course, is a technology we acquired with our Axsun transaction at the end of the year. Axsun has a line of optical and laser systems that can be used in medical applications, as well as in the industrial and commercial markets they serve today. Its laser technology was the driver for this transaction and it represents a low-cost, high-performance alternative to current medical laser technologies.

In the medical arena, Axsun’s technology has potential market applications in intravascular imaging, ophthalmology, dental, cancer diagnosis, urology, endoscopy and blood glucose monitoring to mention a few. Axsun generated approximately $17 million in revenues in 2008 primarily from its industrial market. Axsun will operate as a wholly-owned subsidiary of Volcano and will continue to operate the entire business for the foreseeable future.

In closing, Volcano had a great fourth quarter in 2008, hitting on our key growth objectives and laying a foundation for continued growth in 2009 and beyond. Our key milestones for 2009 include continuing to grow revenues in our core business at 20% or more through greater IVUS and FM penetration and capitalizing on the momentum for the FM business provided by the FAME study; capturing growth available through a full year of availability for new offerings that were introduced during 2008 such as our revolution rotational catheter on the S5 platform, FFR functionality on the S5 and PrimeWire; growing our sales force in the US and Europe and accelerating the build-out of our direct capabilities in Japan with staffing, additional facilities and new market development initiatives; introducing new versions of the rotational and Phase III IVUS catheters in the second half of 2009 and launching our first forward-looking IVUS device late in the fourth quarter of this year; achieving improved gross margins in our core businesses and increased operating leverage; hitting key milestones in our development of our forward-looking IVUS device with therapy and our image-guided therapy and OCT offerings to support 2010 launches; generating additional data on the value of IVUS and FM, and lastly continuing to identify additional strategic opportunities that provide us new technology that is complementary to our current offerings.

Thank you for joining us today and I’ll now turn it over to John before we open the call to your questions.

John Dahldorf

Thank you, Scott. Revenues for the fourth quarter of 2008 were $49.3 million, a 23% increase over revenues of $40.0 million in the same period a year ago. Our fourth quarter revenues include a nominal contribution from Axsun, as that transaction closed about a week before the end of the year.

The total revenues for the fiscal 2008 were $171.5 million, a 31% increase over revenues of $130.6 million in fiscal 2007. As has been the case in prior quarters, our performance was driven by growth across both of our product lines and key geographies. Our revenues for the fourth quarter include a negative euro FX impact of approximately $1.1 million versus the prior year. For all of fiscal 2008, we recorded an FX benefit of approximately $1.8 million versus fiscal 2007.

With respect to the revenue breakout for the quarter, consolidated sales of IVUS systems and related equipment were $11.3 million, a 28% increase over sales of $8.8 million a year ago. In the US, IVUS system revenues were $6.8 million versus $5.8 million a year ago; in Japan, they were $823,000 versus $1.3 million ago and in Europe, they were $2.9 million, nearly double the $1.5 million a year ago.

We continue to significantly expand our installed base through console placements, a key element of our growth strategy. During the quarter, we placed 330 IVUS consoles versus 177 in the fourth quarter a year ago. This included 154 integrated consoles in the fourth quarter this year, versus 107 a year ago.

Our console placements for the fourth quarter this year include approximately 100 placements in Japan versus 15 a year ago, demonstrating the impact of our new direct initiatives in Japan. Even if you exclude the Japan placements in the quarter, our year-over-year growth in console placements was 41%. For the full year, we placed 867 consoles versus 597 in 2007, including 403 integrated consoles in 2008 versus 280 in 2007 and we now have more than 4000 IVUS and FM consoles placed worldwide.

As we have discussed with you in the past, another important element of our strategy to drive both revenue growth and profitability is sales of disposables and we ended the year well in this regard. On a consolidated basis, IVUS disposable revenues were $30.4 million, an 18% increase over $25.9 million in the fourth quarter a year ago.

In the US, IVUS disposable revenues were $14.3 million, a 26% increase over $11.4 million a year ago. In Japan, they were $11.3 million versus $10.1 million last year; although, as Scott mentioned, the results for last year include $1.1 million of stocking orders and in Europe; they were $4.1 million versus $3.8 million in the fourth quarter of 2007.

Scott mentioned the positive impact of the FAME study. While that data did not get presented until October and thus we wouldn’t have expected to see a significant impact on our business until the current quarter; our FM business had a very solid fourth quarter.

FM revenues were $5.6 million versus $4.1 million in the fourth quarter a year ago or a 36% increase. With the addition of FFR functionality to our S5 console, the FM business has increasingly shifted to become primarily a disposable business during the year and going forward, we expect FM system sales to be phenomenal. In the US, FM revenues were $3.1 million versus $1.8 million. In Japan, they were $392,000 versus $332,000 last year and in Europe, they were $1.9 million versus $1.7 million a year ago.

Gross margin in the quarter was 63% versus 60% a year ago and 62% in the most recent quarter. We’re continuing to benefit from the growth in sales volume and the favorable impact of our cost reduction programs implemented throughout the year.

Operating expenses in the quarter were $30.9 million. This compares with $50.4 million a year ago and $27.2 million in the prior quarter. Operating expenses in the fourth quarter of 2007 include $26.2 million of in-process research and development, related to our CardioSpectra acquisition which closed at the end of 2007.

In comparison to the third quarter this year, SG&A spending increased to $2.4 million due to headcount and commissions in sales, tradeshow activity and marketing and public company infrastructure costs in G&A. Our R&D expenses increased by approximately $1 million from the third quarter due to headcount additions and related costs and increased spending for our OCT forward-looking IVUS and image guided therapy projects.

In comparing operating expenses to the year-ago period, sales and marketing expenses reflect increased spending due to higher headcount and promotional costs across all geographies, especially Japan. R&D expenses increased due to our OCT forward-looking IVUS and image guided therapy programs and the increase in G&A reflects infrastructure growth and higher stock-based compensation expenses.

On a GAAP basis, we reported net income of $1.4 million or $0.03 per diluted share. This compares with a loss of $23.7 million or $0.53 per share a year ago, although the in-process R&D charge I mentioned a moment ago negatively impacted our earnings by share, by approximately $0.55 per diluted share.

Excluding stock-based compensation expenses of $2.5 million and in-process R&D of $274,000, Volcano reported net income of $4.2 million or $0.08 per diluted share in the fourth quarter of fiscal 2008. In the fourth quarter of fiscal 2007, excluding stock-based compensation of $2 million and in-process R&D of $26.2 million, we recorded net income of $4.4 million or $0.09 per diluted share.

Weighted average diluted shares in the fourth quarter of 2008 were $50.3 million versus $44.9 million a year ago, reflecting the impact of our equity offering that was completed in the fourth quarter of 2007.

Turning to the balance sheet, we ended fiscal 2008 with $149.9 million in cash, cash equivalents and short-term available for sale investments, versus $176.7 million at the end of the third quarter and $189.1 million at the end of fiscal 2007. The use of cash during the year primarily reflects our two acquisitions, including $12.3 million for Novelis in the second quarter and $21.5 million for Axsun at the end of the year.

With respect to guidance for 2009, due to the addition of Axsun as a wholly-owned subsidiary, I will first discuss our base IVUS and FM businesses so that you have a comparable comparison to 2008. I’ll then provide guidance for Axsun alone. Finally, I’ll present guidance on a consolidated basis for GAAP and non-GAAP results and discuss some of the key differences impacting our non-GAAP results in 2009 versus 2008.

For fiscal 2009, we expect our base IVUS and FM revenues to be in the range of $203 million to $207 million or an increase of 18% to 21% over 2008. In the past, we have not provided guidance with respect to console versus disposable revenues, but wanted to provide you with some direction, given the uncertain global economy and its impact on hospital capital spending.

Despite these concerns, we expect 2009 console revenue in the US and Europe to be relatively consistent with that of 2008. Console revenue in Japan will decline, reflecting our shift to going to direct and the increased placement of consoles directly with our customers versus selling consoles to our distributors.

Gross margins for our IVUS and FM business is expected to be in the 63% to 64% range and as we demonstrated over the past couple of years, we’re continuing to benefit from our manufacturing cost programs, in achieving our previously stated goal of generating improved gross margin year-over-year.

Operating expenses for our IVUS and FM business in fiscal 2009, including stock-based compensation expense and approximately $3.2 million of intangible amortization, are expected to be in the 63% to 64% of revenues. Our plans call for increased SG&A spending as we build out our sales force and infrastructure in Japan and strategically expand our sales and marketing programs in the US and Europe.

In addition, we’ll invest in G&A to support the growth of the business and an anticipated modest increase in research and development spending to fund product development programs, clinical trials and regulatory activities.

In terms of the Axsun business alone, we expect revenues to be the range of $15 million to $16 million, with approximately 85% of that generated by Axsun’s Industrial segment. We believe this is conservative but appropriate guidance based on the current economic environment. Gross margin at Axsun is expected to be the range of 24% to 25%, including a purchase accounting onetime step-up charge of approximately $600,000 related to the fair market value of on-hand inventory.

Operating expenses at Axsun are expected to be 44% to 45% of revenues, including stock-based compensation expense and approximately $900,000 of amortization expense related to the fair market valuation of certain intangibles resulting from the acquisition. Major spending initiatives at Axsun during 2009 will include research and development to develop lower-cost platforms, new devices and systems for medical imaging applications, as well as market development initiatives.

Turning now to our outlook on a consolidated basis, we expect total revenues in fiscal 2009 will be in the range of $218 million to $223 million, an increase of 27% to 30% of our revenues in 2008. Gross margin for the year is expected to be in the range of 60% to 62%, reflecting the dilutive effect of the Axsun business. Operating expenses, including stock-based compensation expense and approximately $4.1 million of intangible amortization, will be 62% to 63% of revenues.

On a GAAP basis, we expect to report a net loss of $0.05 to $0.08 per share. Because of the timing of planned investments in the business that I discussed earlier and the anticipated growth projection for revenues, we expect that as was the case in 2008, the company will show a loss on a GAAP basis in the first half of 2009, but return to profitability on a GAAP basis beginning in the second half of 2009.

Excluding stock-based compensation expense of approximately $13.3 million, we expect to report net income of $0.19 to $0.21 per diluted share. For the full year 2008, excluding stock-base compensation expense, due diligence costs and in-process R&D expenses, we realized operating income of $5.4 million. On a comparable basis, we expect operating income in 2009 to roughly double that amount.

The $0.23 per diluted share that we reported in 2008, excluding stock-based compensation, in-process research and development and acquisition due diligence costs, is favorable to our expectations in 2009 by roughly $0.02 to $0.04 per share due primarily to the contributions of interest income and a favorable exchange rate gain in 2008 that we don’t expect to repeat in 2009. Finally, weighted average shares outstanding at year end 2009 are expected to be approximately 48.2 million basic shares and 50.5 million shares on a diluted basis.

In closing, I want to remind you of our analyst day on Wednesday, February 25 at the NASDAQ market site in New York. Please contact us if you have not received information on the event or if you’d like to attend and have not RSVP’d. In addition, we will be presenting at the Roth Capital Conference at 9:30 AM tomorrow.

Thank you for joining us today and we’ll now open the call to your questions.

Questions-and-Answers Session

Operator

(Operator Instructions) Your first question comes from Mike Weinstein – JP Morgan.

Chris Pasquale - JP Morgan

Hey guys, Chris Pasquale here for Mike. Scott, maybe to start off with obviously a very impressive system placement number this quarter, can you spend another minute on the situation in Japan? In the past, we’ve seen boluses of system demand there, especially around new product launches. It sounds like you’re attributing this recent increase more to a shift in your selling strategy which could be a longer term driver. So, given that, how sustainable is the momentum that you see in there in the back half of ‘08?

Scott Huennekens

Yes, just to walk you through exactly how the direct business works in Japan; we basically place the systems in the hospital for free like we do in the US under catheter utilization programs.

So as we’ve converted accounts to our direct model, these are accounts that would’ve been previously Goodman or Fukuda accounts, we’ve gone into the hospital. You sell them on the benefits of your product. They indicate they want to use it, so you place an S5 system in there, then it goes onto our balance sheet and we appreciate that as an asset.

For example, at an exchange rate of 90, today in Japan, reimbursement for an IVUS catheter is JPY1 41,000. You convert that to dollars at 90 and it’s about $1,566. The hospital pays 75% of that or about $1200, but you don’t have to sell a lot of IVUS catheters or wires which correspondingly would be around $1300 per wire, our FM wires, in order to justify putting the capital there for free.

So that’s how it works. As we open up new accounts, we put our S5 our S5I system into the account and John we placed how many systems in Japan in the fourth quarter?

John Dahldorf

Approximately 100.

Scott Huennekens

So, approximately 100 systems were placed there and I think you’ll see that trend continuing throughout 2009, as we win new accounts and as we move accounts to our direct business model.

Chris Pasquale - JP Morgan

How much of that market do you think you’re covering on a direct basis now with your 24 reps?

Scott Huennekens

Very, very small, 5%, 10%.

Chris Pasquale - JP Morgan

On the Axsun side, you’re guiding to a little bit of a step-down in revenue relative to what they’ve been doing as a stand-alone company. What’s the driver there? Are you weeding out some prior business that either was unprofitable or you don’t want to pursue any more and how should we think about that segment’s top-line growth profile longer-term?

Scott Huennekens

Yes, as John said we’re just trying to be conservative, under-promise, over-deliver. Given the uncertainty in the economic environment with telecommunications companies and their capital budgets, we wanted to take a little bit of a conservative approach as well as being conservative on our projections on new revenue in the medical imaging area as we integrate the business and ramp it up.

So we feel like we’ll exceed that, but at the same time we want to be conservative given a little bit of uncertainty out there in the marketplace. John, do you have anything to add there?

John Dahldorf

No, to again just reiterate Scott’s point, a large part of Axsun’s current business is actually outside the United States and as we have watched and followed very closely to what is going on globally from an economic perspective, we felt it best to kind of look at it from a conservative perspective.

Chris Pasquale - JP Morgan

Okay, so not a change in the strategy of what that company was doing, just taking out a conservative stance on it initially?

John Dahldorf

That’s correct.

Operator

Your next question comes from Thom Gunderson - Piper Jaffray.

Thom Gunderson - Piper Jaffray

Following-up a little bit more on Japan, you’ve got 24 reps at the end of ‘08. It sounds like a little bit more aggressive, still in the ballpark. Where would you think you’d be either in mid ‘09 or by the end of ‘09?

Scott Huennekens

It was 20 Tom at the end of the year and our objective is to be at about 45 by the end of the year.

Chris Pasquale - JP Morgan

Okay and then Scott, in the US our rule of thumb for a cardiology rep is about somewhere between $200,000 and $250,000 a year fully loaded. Is it comparable, less; what should we look for in Japan?

Scott Huennekens

Much less. It’s fully loaded, about $120,000.

Thom Gunderson - Piper Jaffray

Then John, on the operating income, twice in ‘09 what it was in ‘08 in apples-to-apples, are you planning on being operating income positive in each of the four quarters and also cash flow from operations positive in each of the four quarters?

John Dahldorf

Normally we have not given quarterly guidance and we’re not going to give quarterly guidance, but I can tell you that our profitability, both at the operating income level as well as the cash flow level will follow the net income guidance that we gave earlier in the scripted remarks. The second half will be much more profitable than the first half.

Thom Gunderson - Piper Jaffray

Sorry, just to be clear, I get the second half, first half, but I thought the scripted remarks were second half positive, first half negative. It’s not necessarily true on op income or cash flow from operations in the first half. Is that right?

John Dahldorf

No, no, no, the operating income and the cash flow will really kind of mirror the net income.

Operator

Your next question comes from Raj Denhoy - Thomas Weisel Partners.

Raj Denhoy - Thomas Weisel Partners

I know you’re not to give quarterly guidance, but as you are laying out the trajectory of a weaker first half and a stronger second half of the year, does that incorporate some capital spending softness in the first half of the year that may be recovery in the second half or have you baked some of that into your guidance at this point?

Scott Huennekens

No, it really reflects the continued ramp of revenue, but expense is being more consistent. So, the investments we’re making in R&D, the investments we’re making in building the Japanese direct sales force that occur in the first half, you start seeing the revenue from them in the second half. The R&D programs on image-guided therapy, forward-looking IVUS, OCT are consistent programs for the whole year. So, you’re growing into your infrastructure and the step-up in operating expenses.

Raj Denhoy - Thomas Weisel Partners

Sure, sure, I appreciate that on the expense line. I was trying to get at whether you would bake any conservatives into the top-line if there is additional slowing either in the US or even potentially internationally in capital spending and it doesn’t sound like you have.

Scott Huennekens

I was answering you question, a different question, but we feel like we have been conservative relative to our US capital number, to take into consideration the economic conditions currently.

Raj Denhoy - Thomas Weisel Partners

Okay, and then the second piece of that is in the international markets. I guess, in your comments you mentioned that you’d seen some or potentially would see some in the US but so far oversees everything has remained relatively strong. Do you expect that to continue?

Scott Huennekens

Well, I also said that we don’t sell capital in Japan, so there is therefore no capital effect in Japan, so your question really is Europe. The percentage of revenue that’s capital in Europe is pretty consistent with the US. We sell through distributors as well as selling direct in Europe. So far so good, we haven’t seen much of an effect, but again we’ve tried to remain fairly conservative in our capital numbers in the US and in Europe in our projections.

Raj Denhoy - Thomas Weisel Partners

Okay, that’s fair enough. That’s exactly what I was trying to get at, whether it had been baked. It sounds like it has, which is all I was trying to get at. Then maybe I could ask a little bit about the FFR business. Clearly it’s doing well and it will be a driver here in ‘09. Do you have any estimates as to what your share of that market is right now, overall?

Scott Huennekens

Yes, I think overall I believe we’re at about 30% to 35% market share.

Raj Denhoy - Thomas Weisel Partners

Okay and any expectations for what you expect that to grow towards over the course of the year or as we’re exiting ‘09 here?

John Dahldorf

I believe that we will grow our FM business in excess of 30% and we believe the market will probably grow at about 20%. So the growth will come at market and also take in market share.

Operator

Your next question comes from Jason Mills - Canaccord Adams.

Jason Mills - Canaccord Adams

I wanted to go back to go back to Japan just one more time. Last quarter Scott, you talked about seeing some momentum in revolution in Japan. That combined with an exhilarating movement to go direct, understanding you don’t cover much of the market, yet direct but are getting bigger.

I’m wondering what is your sort of upside potential in Japan in ‘09 and how much of that potential is reflected in your current guidance? What could it be given that you’ve got both chocolate and vanilla catheters if you will in Japan? Everyone else has chocolate and chocolate has been preferred and now you have both and are really driving direct.

Scott Huennekens

As you know Jason, we try to find a middle ground where we’re not overly ambitious with our projections and not under from an ambition standpoint. So, we feel good that we’ve got a middle of the road projection for Japan that involves our direct business growing, our work with our distributors Goodman and Fukuda are growing, and at the same time us continuing to transition more accounts to our direct channel in placements of a large number of consoles with the latest and greatest technology into Japan.

So there’s uncertainty also in Japan. It’s been announced the last couple of days that their economy was down 3.3% on a GDP basis. We don’t see that really affecting our business, we’ve got a reimbursed product, reimbursement levels are set. Sp, we feel like we have just got to execute.

We’ve got to execute the transition to direct which we’ve been doing effectively and we can get this step-up in price as I walk through with Chris where we go from selling for the mid $600 range to a distributor to if it’s direct, selling at a 90 exchange rate or a 95 exchange rate, somewhere between $1100 and $1200 per catheter.

Jason Mills - Canaccord Adams

Are Boston Scientific or TrueMode doing anything different from a sale and marketing perspective in Japan or is it status quo as far as you can see?

Scott Huennekens

It’s pretty much status quo. I think Abbott introducing their stent into Japan this year will also potentially help us, relative to increasing the competitiveness against Boston and given our ability to work with Cordis, Abbott and Medtronic to place systems and deal with Boston.

Jason Mills - Canaccord Adams

In other words, it will increase the differentiation among the drug leading stents.

Scott Huennekens

Yes.

Jason Mills - Canaccord Adams

Okay, just a couple of quick follow-ups here. In Europe, I’m struck by the significant console placement revenue growth in the fourth quarter. It piggybacks over 50% year-over-year console growth in the third quarter, however disposable growth is yet to catch up, either on the IVUS side or the FM side, perhaps not surprisingly, but are you perhaps on the cusp of a relatively decent breakout on the disposable side in Europe?

Scott Huennekens

Yes, I think so. I think that’s a great observation. It’s that we’ve been winning the new placements of systems the last two quarters in Japan and our expectation is we’re going to see good catheter growth during 2009 out of Europe as a result. Additionally, they will continue to do a good job on the console placements.

Jason Mills - Canaccord Adams

Great and last question, will the Novelis technology that you’re planning to launch here in the second half of the year, will it be integrated into the S5I upon launch? I missed that full sentence in your prepared remarks.

Also, on the image guided therapy side, how close are you to the product that you believe will meet your clinician expectations, on both the balloon side and the IVUS performance side? I noticed just a modest flip in the timeline there, not much but just modest. I’m wondering, are you getting close to the product that you think you’re going to like?

The first question was Novelis technology. Will it be launched, integrated or not?

John Dahldorf

Yes, it will be launched only integrated. So there’s an upgrade path for the current S5 that allows you to update the system to run the forward-looking. We’re feeling much, much better about where we are on the IGT side Image Guided Therapy. We’d hired a director of catheter engineering out of Abbott Guidant who has been with us for some time and we’ve built up the team in San Diego and the testing has been going very well on the balloon design.

So we’re making very good progress and feeling a lot more comfortable. There are more significant regulatory hurdles as you get into therapeutic products, but the timeframes we announced, we’re feeling much more comfortable with.

Operator

Your next question comes from Jose Haresco - Brean Murray.

Jose Haresco - Brean Murray

I have a couple of questions here just on the housekeeping side. You placed over 330 IVUS systems in the second quarter, 100 of those in Japan, of the remainder can we just assume that most of those are US or what is the US/Europe breakout there?

Scott Huennekens

John will give you the exact break out.

John Dahldorf

Jose, ask your next question. Let me…?

Jose Haresco - Brean Murray

Sure. Were there any changes in the US ASPs on the IVUS side between the third and fourth quarter that we should be aware of?

Scott Huennekens

No. Pricing around the globe has been very consistent. Joes, so the numbers are US, 164; Japan, 102; Europe, 51; rest of the world, 13; total 330.

Jose Haresco - Brean Murray

All right, thanks very much. In Japan, of the total number of catheters sold, what’s your sense of how many of those were placed through distributors versus placed directly, so I guess we can see the delta, since we know the delta and ASPs and what is your ballpark expectation for when you can recognize essentially all the catheter sales in Japan at the direct level?

Scott Huennekens

So our current arrangement with Goodman is to separate the middle of next year, so the middle of 2010. June 30 is what we’ve been running to with them, but with an increasing number of accounts being direct, meaning they only do business at roughly 300 accounts, Fukuda does business at roughly 150 accounts.

So you have got 550 accounts plus that are available for us to go do business at. So we have 20 reps. I think we have 24 as of today. I told Tom our goal is to have 45 by the end of the year and we have a game plan, roughly that’s kind of 100 or so per quarter growing out. So, we expect to be at 300 plus direct customers in that range as we move out of the year.

So you’ve got Goodman revenue that will be distributed and Fukuda revenue distributed; you’ve got a portion that’s direct and then you have by the middle of next year, everything will be moved to direct. So John, do you have an answer to his question on percentages?

John Dahldorf

Yes, in the fourth quarter, our direct business only really accounted, for total Japan business that we shipped as far as catheter units are concerned, less than 5% were attributed to direct.

Jose Haresco - Brean Murray

Scott, you mentioned something interesting earlier regarding the FAME study and the impact on the quarter. You said that 90% of all IVUS systems shipped had the FM or the FFR option installed on it. What is the baseline comparison to the pre-FAME?

Scott Huennekens

Well, we made a strategic decision that we announced towards the beginning of last year that we were going include it in all systems. So once we started having that capability, that’s been the number.

Jose Haresco - Brean Murray

Okay and when you guys think about the impact of FAME on a global basis, are there any particular regions, whether it’s the US or Europe, where you see the data being most impactful in terms of the growth of FM and FFR?

Scott Huennekens

Yes, definitely Europe and the USA and minimal impact in Japan until next year when we are direct, because our distributor Goodman just doesn’t have the capital to buy the equipment and so we’ve got to figure out a way to distribute the product direct. Right now it’s kind of in limbo, as well as Jose, we have got to get regulatory approval for the FM product on the S5 platform in Japan which takes place this year.

Jose Haresco - Brean Murray

Sure. I guess this is kind of a segue to that here in the US. We all know it takes a hell of a lot of time to get reimbursement for anything these days, but what momentum are you seeing at the society level to push for reimbursement, now that this very strong data is out there?

Scott Huennekens

Yes, so we’ve seen that the European Society of Cardiology has changed their standards based upon the data. We’ve also seen reimbursement movement in Europe in countries and in the Benelux and France and Germany, there’s been advanced discussions. So, we’re seeing traction there which could turn out to be very positive.

In the US, it’s a process that takes years, relative to presenting data working through things. I think you can see the level of data by ACC standards change from level 2 to 1 and the standards based upon the randomized trial published in the New England Journal of Medicine; but again we fundamentally have a DRG based system that pays for a procedure, it doesn’t pay for product.

So to have something where you would have two procedures, the diagnostic FFR procedure and a therapeutic procedure, one procedure is a little bit unprecedented. So these are the kind of discussions we’re having and there is an interest from St. Jude to work with us and that’s part of the positive I think since the acquisition because Rabi maybe didn’t have the marketing muscle contacts, relationships in Washington that St. Jude obviously does.

So it’s something we’re working on but I don’t expect any changes in the next two years, even though we could save quite a bit of money in the system and the data shows that every 24th time the products used, you save a life.

Operator

It appears there are no more questions at this time. I’d like to turn the conference back over for any additional or closing remarks.

Scott Huennekens

Yes, this is Scott. Thank you all for participating. We greatly appreciate the support of Volcano and we’re looking forward to a great 2009. Thanks.

Operator

This concludes today’s conference. We thank you for your participation. You may now disconnect. Have a wonderful day.

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