Spectranetics Corporation (NASDAQ:SPNC)
Citi 2013 Global Healthcare Conference Call
February 26, 2013 11:05 AM ET
Scott Drake – CEO
Guy Childs – CFO
Amit Bhalla – Citi
I'm Amit Bhalla from Citi's Life Science Tools and Diagnostics Team and with me is Adam Darity, to my left from our team as well. We're very happy to have our next presenting company Spectranetics. With us from the company is Scott Drake, President and CEO and Guy Childs, Chief Financial Officer of Spectranetics Design Manufacturers in cell single use devices for use in minimally evasive coronary and peripheral vascular procedures.
Spectranetics has been in our conference for several years and we're very happy to have you with us again. Scott is going to take us through a few slides as an overview and then we'll have some time for Q&A.
Great. Amit, thank you and thanks for the opportunity here. Before I dig in, the usual Safe-Harbor Statement, and I just have a few slides that'll kind of frame our conversation here this morning and thank you all for being here. I appreciate the interest in our company.
As we go through the conversation, there's three areas I'd like to bring to your attention. Number one, the very attractive end-markets that we serve. There are two few spaces in the medical device world that are growing attractively and both of our end markets are growing in the 10% range and we're taking share in each of those markets. We'll touch on that in a second.
Number two, our growth drivers are very clearly defined in terms of what's going to take this business from where we are today going forward as we accelerate our growth rate. And as we accelerate our growth rate and expand our margins, this business sets up very well for leverage over time.
What we want to touch on here just a couple of things in the endovascular market, you see the procedural growth is in the 6% to 7% range. Our focus is in atherectomy, that's growing 8% or 9% and you see our growth pretty consistently in the 15% to 20% range over the past several quarters. We believe that this market will continue to grow and if anything, that growth overall will accelerate due to the clinical work that's being done in this space.
On the lead management side, the market is growing slightly faster -- we say about 10%. Frankly, given our growth rate over the past few quarters, it may be a bit higher than that. But here, too, this market growth is very attractive and if anything, over time, there's a bias to that growth rate increasing.
The overall kind of big picture of the company, we said 18 months ago that our goal was to be a viable, profitable, double digit growth company. Throughout 2012, in each quarter, we cleared that bar, driven by the growth in our focus areas of peripheral atherectomy and lead management. Those two spaces have grown from the mid teens to 30% range. Over the past four quarters, our margins have expanded very nicely and again, that picture sets up nicely for leverage over time.
We are asked frequently, what does this business look like, what is the model kind of portend out into the future. We see the opportunity to double our revenue organically in the next several years. Through the process of doing that, we see about 300 plus basis points of margin improvement, getting to 76% or beyond that. An operating margin is comfortably at the 15% range. That is not world class in our minds, that's not the final destination but we believe a reasonable goal for us here with the business.
So the big picture here is growth for us and if you look at what drove our growth in the 2012 timeframe, PAD awareness, office-based opportunity [inaudible] world class training and education, all of those, spillover very nicely here in the near term. We add to that a tuck-in acquisition that we did now about a month and a half ago. And then when you get into the mid and long term timeframe, we expect to get well beyond our current rate into the mid 10% and 20% by exploiting the ISR opportunity -- in-stent restinosis opportunity that we have, feeling more of the impact of our new product pipeline, the market development opportunities that we have in front of us and global expansion. So that's what you can expect to see from us here out into this timeframe.
And final slide, just to share with you how we do what we do, we think this is very important, is to keep business appropriately simple. We are maniacally focused on attracting, retaining and developing the best team on the planet. Number one, easy words to say, much harder to do. We actually measure ourselves on this, secondarily have perfect strategic clarity in terms of not only what you are doing but what you aren't doing. Very important for a company like ours not to dabble.
Number three, execute it as if life depends on it. In our case, indeed they do. And finally, if you want to be great at number one, be very thoughtful and purposeful about your culture and we strive to delight our teammates, our customers. And if we do those two things well, we will delight our shareholders.
So with that Amit, thanks very much.
Thanks, Scott. Just to start, I remember years ago that whenever you would talk about the lead management business, investors say, yes, yes, let's talk about vascular business. And now, you have a balanced portfolio approach. And just to ground the discussion, can you give us a sense of the differences or similarities in the gross and operating margins between the two businesses.
Growth margins and operating margins actually are very similar. So 87% of our business today is single use disposable products. And those generate margins of 80% higher than our overall corporate average and it's very similar between the lead management.
Right. And ultimately, the purpose of the question is to make sure people understand that both of the businesses are critical, both of them are growing pretty nicely. So then, it brings me to the next question of sustainability. You've talked about this 10% growth in the near term, let's go through first the vascular business and why you think that's a sustainable growth number and then we'll go through lead management.
Yes, I would. From a high level perspective, obviously, with the comments I just made, I think not only are growth rate sustainable but I see room for acceleration. Starting with the vascular business, we are focused very clearly on the peripheral vascular space. Very, very attractive end markets that we serve. As I said, overall growth rate is roughly 10%. We're taking share pretty nicely. That's being driven today by our PAD awareness program and office base initiatives that we have that clearly has legs.
We place more lasers in Q4 than at any time prior as it relates to those programs. We just added a really nice acquisition to our bag, focusing on the same end customers that we continue to focus on. So we think that will be in the crossing solutions line as we report going forward. So we see an upward bias there.
And then you look at the in-stent restinosis opportunity -- this is a market that's 250,000 procedures worldwide versus an atherectomy served market today of about 125,000 procedures. So it's twice as big as the current served atherectomy market. We believe we'll be the only company to achieve an indication. We'll have compelling clinically superior data to go along with that and we just really like what that opportunity means to us over time, and especially so in the area of drug-coated balloon.
So we'll be the only company with the indication, compelling clinical data and you have big companies out there spending hundreds of millions of dollars developing the drug-coated balloon market. And you see the data that's coming out of Europe combining laser atherectomy with drug coated balloons compared to drug-coated balloons alone and you see great deferential between those two arms in different studies that are taking place over there. So the vascular business we believe sets up beautifully for growth and accelerated growth over time.
Similarly, on the lead management market, we grew Q2 18%, Q3 20%, Q4 30%. Fundamentally, what's driving the growth of this market is younger patients being implanted with devices. These patients are living longer, therefore the physician is being confronted more times in that individual patient life with the question of what do I do with this hardware that's left inside. And as these patients live longer, they have more co-morbidities, they're sicker and infection rates are going up.
Those are the two fundamental growth drivers of this business and that continues as far out as the eye can see. So the growth rate there, again, we believe is not only sustainable but we like what the future means. And a couple of things I point to -- one, we'll be launching a suite of mechanical tools in the 2014 timeframe to allow us to compete more head-to-head with our primary competitor in the space.
And number two, our research reveals that only about 40% of infected leads are currently extracted, and 100% should be. So there is enormous opportunity for us to help our customers deliver better patient care and have more extraction programs throughout the world.
So let's go back to vascular for a second. If we turn back time, the vascular market was one that was begging for clinical data and was highly promotion sensitive. So the more reps you threw out there, you saw a nice rise up in our revenue. It wasn't necessarily an ideal model because there is so many reps you can hire -- not you, but the market in general.
Today, the vascular business is growing at a more sustainable rate. Take us through what's changed from a clinical side as well as from a promotion side.
Yes. I think a lot has changed and I think you're really touching on the fundamental shift that has and is taking place in the peripheral vascular space, and that is that it's being more driven by really good clinic work. But frankly, I think Covidien is doing a pretty good job into noble lesions. And I think the work that we're doing in in-stent restenosis humbly but frankly is excellent and I think that will really drive the growth going forward.
You've heard us talk consistently about -- our model was not brute force marketing. It is clinical solutions that we're delivering to our customers with the right proof that these products matter and they're relevant. And as a result of that, you'll see our SG&A, a percent of revenue come down. We've called for that in 2013 and that indeed will happen. There are others that have more of a model that's based on growing SG&A and revenue kind of together with much higher percentages of SG&A. The percent of revenue -- that's not this model; it's not what we're doing. And hopefully, we've been really clear on that front.
So the approach, the strategic approach historically has been to make sure you have a full bag of tools to offer to the physician in peripheral vascular disease, do you feel like you have what you need at this point or does your PAD portfolio also need to expand?
Yes. I think it needs to expand. We would love to put more tools in that bag both organically. And you see the business development work that we did here recently with solutions that are really creative and meaningful to customers to shorten procedure times especially retrograde procedures and to help keep physician's hands out of [inaudible].
So we love the fact that we can put more in that bag and get more out of the sales team that we have. And we're by no means done.
So the ISR indication is going to be very nice one for you. Before we talk about that though, help us understand the various products that are there in the rest of the market -- drug eluting stents are coming to the peripheral space. Drug-eluting balloons you touched on, it's laser, [inaudible], how is your products going to interplay with the others that are out there.
Yes. In the ISR space, the reason this is such a precious opportunity for us and one that we spent a lot of time talking about is first the size of the market that I mentioned just a bit ago. 250,000 procedures and one of the big investigators in the definitive series who's now going to be an enroller on Excite [ph] made this comment to us that this is a huge, clear pool of water and we'll be only fish in it.
We loved the fact that the safety bar that's been set, others won't be able to clear. So we think we stack up really, really well on that front within the ISR space.
As it relates to the overall peripheral vascular space, we do believe drug-coated balloons are a very relevant part of the landscape going forward. I think the adoption in the US market frankly will be faster than it has been in Europe because of the clinical work that's being done now. That wasn't necessarily done prior to launch in the European market.
So we think there's a real play there. We just got back from Link recently, a very large conference that's based over in Germany and what that conference has been focused on for the past couple of years is leaving no metal behind. I think stents have a place in the market long term. I don't think there's any doubt about that. But it's being more clearly defined through clinical work that's being done again, kind of the foundational shift that's going on in the market.
So we're focused on the peripheral vascular space. We love the portfolio we have but there's an opportunity to add to it.
And just lastly, from a competitive standpoint, drug-coated stents for the legs, how are you thinking about that from a competitive dynamic?
We have heard good feedback. The clinical data look to be good on that front from that technology. It's unclear whether that will have change the competitive dynamics in ISR. I'm not aware of any trials they're doing in that area. So that's where our focus.
From everything I've read and heard, there's place for drug-eluting stents in the legs and we'll see how big of a market share they'll have over time.
So let's switch over to lead management. I mean, this is, over the last few years, has been a lot about awareness. We have some physicians in the US are keenly aware of the risk of infection and the need to take without and that's clearly growing. But there's this other dynamic on just faulty leads, recalls that are happening from some of the other big medical device manufactures. How much of that has actually played into growth if not all?
I think a small amount. It's very difficult to pars out and give a real data based answer to the question. I think the bigger impact with malfunctioning leads is the fact that it's really shined a spotlight on the space generally.
If you look back in the '07 to '09 timeframe, people thought that the growth of our business was based upon Fidelis if you will. And if you look at our revenue curve, there was no appreciable bump up or down as it's related to kind of the Fidelis bowels if you will coming through the market. And the same is true today on Riata.
So the bigger impact here is the spotlight that it shines on Lead Management and the fact that it hits kind of main stream media. I think patients are having very real conversations with their physicians based upon that dynamic. In Obama physician [ph] that exclusively caps leads, that's a conversation I don't think I want to have with my patients.
So that's why we invest so heavily in training and education on this front. We think it's paying off not only in terms of financially in the growth rate in the business. But also in terms of better patient care being delivered which really underpins everything that we do.
So part of this increasing awareness in the market has really come from you guys?
So heart rhythm side [ph] in few years ago, you added the first stimulators in the market and you guys are really pushing the message here. Can you balance that with the financial side of the investment that you need to make up front, obviously to measure the [ph] promotion?
Yes, I think so. I mean, couple of points there. Number one, I do. I think the team deserves credit for executing well. I think they're fundamentally driving this business in a really good and positive way for the benefit of shareholders and for customers.
Number two, I think our thought leading physicians that we partnered with our Medical Advisory Board specifically, I think they deserve credit in terms of using us in some ways as their vessel as we kind of deploy capital out in the market.
And third, as it relates to how do we balance that financially. We're focused on growing the business. We're unambiguous about that. Our focus is on accelerating the top line.
We will become a leverage in operating margin story over time. But given the opportunity that we have both on the Vascular and on the Lead Management side of the business, frankly we'd be doing shareholders and customers at the service to focus on driving profitability at this point in time.
So doing more simulation work, doing more training and education is absolutely right in terms of driving the top line, delivering better care and having a great sustainable profit model over time.
Yes. I don't disagree at all. On the Lead Management side, let's talk a little bit about GlideLight. That has provided a nice boost at the margins. And there's a conversion taking place in your existing portfolio on GlideLight. So yes, maybe explain the product and the dynamics that's taking place at the business.
Yes, happy to. Again, here both the team and customers deserve credit for this product. Our customers perceive a product that would have greater flexibility. So the difference, the primary difference in this product is that the rep rate of the laser goes up to 80Hertz before it would max out at 40Hertz.
So the premise behind that increase flexibility was it would reduce forces required in the procedure which would lead to more physician control which is a good thing. And the physician can dial up or dial down the rep rate of the laser.
So that's fundamentally what they perceived. It's what we deliver to the market. The product has a great pull to it. And so, we're not stressed at all about the rate of conversion. We're more than happy to let the field and customers determine at what rate that happens.
As we've said, I think it's roughly in the mid '13 timeframe that we'll convert the vast majority of our volume from SLS II, the predecessor product II; GlideLight that has a really nice impact on our ASPs, a 15% price premium is what we have charged every single customer.
So that is sticking very nicely and there's no turning back because we went to our largest accounts first. And our customers are speaking loudly on this that we've delivered enough value to charge to that premium.
So somewhere in the midyear timeframe, we'll have to convert the vast majority of our business. And then we'll have the choice to make in terms of whether we want to completely obsolete the old product line or leave that out there. Frankly today, I'm not sure what our answer is going to be there. I think it's more likely the knot that will obsolete the previous products but not calling for that quite yet.
So from the competitive standpoint that you guys and Cook in the Lead Management markets, what are you seeing from them in terms of helping develop the market or even from a new product standpoint? And when do you expect other players in this space if not all?
Yes. We have a lot of respect for Cook. They're a great company and they're a much bigger, more diverse player than we are obviously. So we have a lot of respect for them. We know they're team well and have a lot of respect for what they do.
I think there are areas that they're more focused in than Lead Management to be candid. And they are coming out with what I would call derivative improvements in their product as supposed to what I would call more platform or breakthrough kinds of technologies. We're focused across the water front year.
In terms of developing the market, I think by and large that's what we're doing. I don't see a lot of kind of formal market development work from them in terms of what they're doing there. So a lot of that heavy lifting is on us.
If there's any questions in the audience, raise your hand and we'll make sure we can get a mike over to you.
All right, just on gross margins. I know guidance for this year is at least 50 basis points of expansion. Can you maybe just talk about what the mix looks like between product mix and optimization versus manufacturing efficiencies? And then how you bring in the decision on how much to let flow through the bottom line versus being reinvested in the business?
Sure. So there's really good balance when you look at the margin expansion that we've driven for example in 2012, there's nice impact from price increase GlideLight specifically. There's really nice overhead absorption in terms of more products flowing through the same footprint. And we can about double our manufacturing output with the exact same footprint that we have today.
There's a nice impact in terms of the mix of the business as we grow the disposables products specially the laser based products that we're talking about here on the peripheral space and in the Lead Management side, you get a benefit there. And then the team is doing excellent work in terms of efficiencies that we're driving.
So it's really across the Board. We expect that to continue here kind of as far as I can see we've call for it [ph] as you said, 50 basis points of improvement in '13 and you can expect that in '14 and in '15 as well. There's just a lot of opportunity to expand margins nicely in the business.
In terms of the second part of your question in how do we look at the incremental gross margin and investing that back in the business? We are very focused on our vitality index in improving that. We measure that with new products introduced in the last three years as the percentage of total revenue.
In 2011, that number was in a mid-single digit. In 2012, it was 13%. And we anticipate doubling that again in 2013.
So to get there we are enhancing our capabilities from our product development perspective, bringing in new talent, doing more projects there. So R&D as the percentage of revenue will go up in '13 versus '12. To be specific there we spent 12% of revenue in 2012 that will go to 13, 13.5 in 2013. And we also said that there will be a slightly lower SG&A spend as the percentage of revenue in '13 versus '12.
So that's how we're looking at it. We are anticipating profits for the full year, very modest. Likely net losses in the first half of the year as we absorb the medical device tax, accelerate R&D spending, and seasonal expenses, as well as acquisition and related cost for upstream, but looking for breakeven to $0.5 million of profit in 2013 on a GAAP basis including all those things.
Let’s go back to ISR for a minute. Do you feel like your existing sales infrastructure is going to be able to handle when that indication comes and the added procedure volume that you think you’re going to be getting from.
Yes, I think the big point here is, SG&A as a percent of revenue, we anticipate will go down over time. And I think that includes the ’14, ’15 timeframe that we’ll be capitalizing on that opportunity.
We’re actually in the process right now of taking a look at our overall sales organization, the vascular and lead management side, and looking to see what would be optimal. Are we kind of in our own way here in terms of gaiting our growth? Or is there a way that we can accelerate growth such that what I said at the very front is still true, that SG&A as a percent of revenue will go down.
So we’re looking at that, we’re looking at, do we put more people against the PAD awareness and of this space, opportunity, can we leverage clinical across the business, these are all open questions that we need to answer. So I would anticipate that our number of reps will continue to go up as it has, but again, overall SG&A will come down as a percent of revenue.
Okay. As you think about the business over the next three to five years, is this going to continue to just be a vascular lead management story? Or are there adjacent legs you can add to the business to continue to target this cardio space?
Yes. I think for the foreseeable future, I’ll just define that in the next couple of years, there’s absolutely no reason, and we have no desire and need given the size of these end markets and their growth to go outside of that.
There clearly are adjacencies that are there, that are leverageable, but we are first going to win in those two spaces, and have a model that shows leverage and then we’ll earn the right to take on some of those adjacencies.
So I wouldn’t say never by any means, but I think it’s really important again, that a company like ours, $150sh million in revenue is wickedly focused strategically. And we have two great end markets, we’re competing favorably in them and don’t see any reason here, near-term to go outside of that.
How’s your coronary business from a stand point of, there you want to aggressively pursue?
Yes, it’s a great example, right? I mean there are people both internally and there’s customers externally that hate it when I say this, but we are not focused on the coronary. And we’ve got to be really overt on that because there are both people internally and customers that want us to focus in the coronary space.
We may earn the right over time to compete there, it’s a huge market, it’s very attractive from that perspective, but we’re going to focus and win in the periphery first.
And whether or not we ultimately choose to take on the coronary space, time will tell. How that business is doing? Our coronary business is declining. So it’s got a negative growth rate coming out of Q4, and we’re very comfortable with that, and it’s being overcome by other areas that are growing.
But what’s somewhat gratifying from my perspective is, we said what we’re going to do 18 months ago, we’ve done it, and not only have we done it, but we’ve done it in the areas that we said we were going to focus on.
So I’ve been a part of accidental growth before, this isn’t one of those times, and it’s nice.
So a lot of the discussion we’re having right now is US market based.
There’s a big portion of patients outside the US that has very similar type issues. How has that factor in, into the growth rates that you put out for us?
Yes. Our international business will be more robust in ’13 than it was even in ’12. And our growth rate, I think has been pretty consistent there internationally.
What’ll drive that, is continued strong performance in the big five countries in Europe, we have added feet on the street in the UK, in France, in Germany, we went direct in Austria.
So we’ll continue to have strength in the major European markets. We expect that Japan will continue to be a really strong part of our story going forward.
Our growth rate was very rapid in 2012. It will actually increase off of a bigger base in ’13. We’ve had a lot of success. They are getting products both approved and reimbursed.
We started with the lead management line being approved then. Our coronary products then, our crossing solutions products, and now we’re working on the peripheral vascular products to be approved and reimbursed. And we just expect Japan will be a brighter and brighter star for us going forward.
We just shared on our call that we’ll be entering India and China in the 2014 timeframe, so there’s a lot of focus on the brick markets unlocking that opportunity which is just really beautiful for us.
So I think it’s fair to expect that our international business will grow and grow pretty nicely here for the foreseeable future.
So just playing, or continuing on internationally, how do you weigh the decision of going out of the loan and into these countries versus potentially looking at partnership opportunities?
Yes, we debate that all the time. And sometimes the answer that you come to today isn’t the answer that you have tomorrow. Like I said, in Austria as an example, we went direct and we’re growing more rapidly generally speaking where we’re direct versus distribution markets.
With the exception of Japan, we have a great distribution partner there, called DBX, they do really nice work, and we value that partnership. So that would be the notable exception in my mind, but generally speaking, you want to control your channel, and you want to have real focus and excellent training there.
So that served us well, and I anticipate that that kind of model will continue to serve as well.
Let’s talk about risks and how you’re thinking about risks in both the business segment over the next few years. Looks like there’s a lot of runway. If everything goes well, you’re going to be hitting some very nice numbers.
What are your contingency plans around risk and what are those things that you’re worried about?
Yes. I think our risks are best described as being more time based than whether or not certain things happen. For example, you can have a product delay, we’re talking about delivering a suite of mechanical tools in the 2014 timeframe.
It’s possible that we hit a bump that we don’t anticipate, and that pushes out, but there’s nothing in the way of us being successful developing those products.
Similarly, with the In-Stent Restenosis claim, I wish EXCITE was enrolling faster than it is. And we’ve got a whole bunch of stuff going on including a bunch of physicians that are enrolling in the study, coming to my house on Thursday night to talk about how we can increase the enrollment rate.
So it’s more time based than it is success based. We will get the indication, we’re highly confident of that because of the work that’s been done in the Payton Study and other kind of precursor studies. So our confidence level is very high there, but the risk really on both sides of the business would be more time based.
Okay. All right. Let’s talk a little bit about reimbursement. Reimbursement, pressure is downward but for you PAD business, the move to office based procedures has been actually a positive for you. How do you think about reimbursement as a risk for the businesses?
Yes, it’s been a positive impact thus far generally speaking to us, and we believe that the government, very intentionally wants to have more procedures done out of hospital.
And it’s absolutely unambiguous that that’s their attempt and they’re having success with that, and they’re driving those procedures to a lower cost setting. I think that’s generally good for taxpayers. And we don’t see that changing any time in the near future.
Also on the lead management side, we feel good there as well. The economics are aligned with great patient care, and we think that’s a sustainable model.
So we feel like there’s slight benefit from a reimbursement perspective, but we’re not calling for modeling anything significantly better than is out there, but I think we’re in a pretty stable place right now.
Okay. Any questions in the audience? If not, we’ll end it there. Thanks a lot, Scott. Thanks a lot, guys.
Thank you, guys. Appreciate it.
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