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Volcano Corporation (NASDAQ:VOLC)

Barclays Global Healthcare Conference

March 12, 2013 8:00 am ET

Executives

John T. Dahldorf - Chief Finance Officer and Principal Accounting Officer

Unknown Analyst

Good morning. Thanks for joining us here. We have Volcano here to kick off the conference, and really pleased to have John Dahldorf, CFO.

Volcano had its Analyst Day last week and laid out some really positive drivers across a number of its businesses, including new products in IVUS and FFR and also strategic initiatives to move more into the peripheral space. So we think that really received a pretty nice reception, and we're going to talk a lot about that this morning.

Also wanted to mention that this year we have -- you see these blinking little handheld devices in front of you. We have audience response questions and participation this year. So we're going to try this out. It's a way to get some feedback in terms of what people are thinking with some key questions for the companies, and so it could be a valuable tool to get some knowledge about what folks want to see in terms of use of capital and other things like that. So I'll ask some questions during the presentation. We'll show the results kind of on the screen and maybe create some dialogue between us in terms of how that works with the company's current plans.

Question-and-Answer Session

Unknown Analyst

So maybe just to kick off, do you want to talk a little bit about some of the core messages from the Analyst Day last week? You talked about base revenue growth of 11% to 13% over the next couple of years and a lot of new things in the pipeline that are going to help to drive to higher growth. So do you want to start with an overview? Then, maybe we'll delve into some of the specifics there.

John T. Dahldorf

Yes, so I think the biggest takeaway that we try to leave investors with is that, that Volcano is a growth story and we continue to be a growth story. And so one of the things that we've laid out over our strategic plan horizon, which is really kind of through 2017, is a base business growth of 11% to 13%, and we feel that, that's actually a very conservative growth number. And when we talk about the base business, just so everybody's really clear, what we're really kind of talking about is intravascular imaging, FM and our Axsun businesses. And so what we kind of laid out, as far as the base business is concerned, is that the coronaries or the IVI market will grow about 3% to 4%, and within that IVI business, we believe the coronaries will grow about 1% to 3% over the strategic plan horizon. And then peripherals, which have been growing in the mid-teens for the last couple of years, will continue to grow in the mid-teens as well. From an FM perspective, we believe that market is going to grow in the mid- to high-teens, and we'll grow faster than that. We'll grow in the 20% to 25% range. And then, from a systems perspective, we believe over the StrAP plan period, our systems will grow 2% to 3%. And the systems growth will really be driven by kind of upgrade cycles as we start to introduce some of our new technologies, and then we'll also get into a replacement cycle. Our s5 family of consoles, we introduced those in 2006, and we normally believe that the replacement cycle on those is about 6 or 7 years, so we're just kind of getting into that replacement cycle as well. And then, to augment that, we've talked about the products in our pipeline, and our pipeline products, we describe basically as our OCT development program, Forward Looking IVUS for CTOs, Forward Looking Intra-Cardiac Echo or FL.ICE for structural heart and then the revenues that will be driven by Sync-Rx and Crux, which are 2 recent acquisitions that we made. And so we believe that, that revenue, when it starts contributing over the next 18 to 24 months in a more material way, will augment our revenue growth and will grow at a compounded annual growth rate, again, conservatively of 13% to 15%, and we believe that these new products can be contributing up to 15% of total revenues by 2017.

Unknown Analyst

Great. So maybe we can delve into a couple of those pieces specifically and talk about the dynamics. First on FFR, that market's been growing really rapidly. You've been gaining a lot of share. Can you talk a little bit about how you're going to continue to do that and what your view is on the market growth there over the next couple of years?

John T. Dahldorf

Yes, FFR, we're really excited about it. And what's not hard to be excited about? Product line that grew at 45% in 2012 on a constant-currency basis, and we believe that it's still a very underpenetrated market. Penetration in the U.S. is about 14% today; in Japan, it's about 9%; and Europe, it's 7%. And if you kind of take a step back and look at the data and the guidelines that are supported by the data, we believe that approximately 33% of all PCIs could be benefited by FFR, and that equates to about 1 million procedures a year on a global basis. And then, when you think about the technology advances that we've talked about, you think about the guideline changes that we believe are in the near future, if you think about the opportunity to take the technology to adjacent markets like the peripherals, to ACS, patients of the PCI patient population, diagnostic angiograms, we believe, over the StrAP plan period, that, that $1 million opportunity in terms of procedures can grow to as many as 4 million procedures. And when you think about $600 a wire, that's a pretty big addressable market, and with our over 6,000 consoles placed that can run FFR and our direct distribution channel in Japan, in Europe and the U.S., we believe that we're positioned very well to be able to take advantage of that

Unknown Analyst

And then, what about on the IVUS side? So the growth there is a little bit slower, but you have some plans with new products to be able to boost that a little bit. I think also, there's some clinical data coming in and perhaps ADAPT that could help to stimulate growth there. So how do you see the base business growing and then the additional layers from some of the new products?

John T. Dahldorf

Yes, so I think that between 2012 and 2013, I think the coronary market is really just growing about 1% to 2%, and we're kind of growing with it. Our real emphasis right now from -- as we're kind of out with our customers, is really focusing on less mains and bifurcation, so the more complicated cases in terms of using imaging. But as we kind of look a little bit further, we're really excited about coming out with FACT, which is our next IVUS transducer technology, which gives you an OCT-like image, but you also maintain the benefits of IVUS. We will also be introducing OCT in the 2014 time frame, and so we're really excited about getting that technology out there as a complementary technology to IVUS. And then, if you go to the peripherals side of the intravascular imaging market, again, it's about a $45 million to $50 million business for us today. I think that it will grow in the mid- to high-teens to over $200 million by the end of 2017, and that'll be a combination of our diagnostic technology, which is basically our imaging, as well as devices like IVC filters and those types of things. So when you kind of put it together, we're really excited about it. And then kind of just to augment that, you talked about ADAPT, which was presented at TCT, kind of the first wave of ADAPT as far as data is concerned. But again, what ADAPT, for us, was -- is that it's a -- it was the largest IVUS study that's ever been conducted over 3,300 patients. And basically, what it showed -- and it was a study of IVUS versus angiography alone, and so what it showed was that when you use IVUS versus angiography, you can reduce MI by 33%. You can reduce stent thrombosis by over 50%. And the real takeaway, if you don't want to remember all the numbers and everything, is that, basically, the sicker the patient, okay, the better your outcomes using imaging versus angiography alone. And then on the horizon, what I think you're going to see coming out of the ADAPT study, which is going to be presented most likely at PCR down the road and TCT, is you're going to see the benefits of using imaging in ACS patients, which a lot of imaging isn't used today, but we believe that there's some real opportunities there for us.

Unknown Analyst

Just as a backdrop, can you talk a little about your expectations for PCI volumes in different geographies over the next couple of years and how that impacts you?

John T. Dahldorf

Yes, yes. It -- 2012 was a pretty rough year, as far as PCIs were concerned, especially in the U.S. I think a year ago, if I was sitting here, I would have said that we thought that PCIs were going to be down slightly in the first half of the year, but based on easier comps, we thought that we'd have a chance to be at least flat to maybe have a little bit of growth in the second half. That didn't happen. PCIs were pretty consistently down in the mid-single digits throughout the whole year, and that's something that we're going to continue to forecast into 2013. The next natural question that I've gotten from a lot of people was, "Well, why are PCIs down in the U.S. mid-single digits?" And I think it's one of these -- the answer is, is not -- there's not one answer that's going to give it to you. I mean, it's kind of like death by a thousand cuts, so to speak. So I think that, obviously, appropriateness criteria that's being applied comes into play. I think that there's less revascularizations because stents are doing a better job today. The drug-eluting stents are much more effective today. I think that cardiologists are keeping their patients on medical therapy longer than they have in the past. So I think it's a number of these factors that are kind of leading to it, and so we don't really see a further decline as far as the slope of the curve is concerned, but we're conservatively forecasting that PCIs in the U.S. will be down about 3% to 5% in 2013. In Japan, PCIs were basically flat in 2012, when you take into consideration the adjustment for the tsunami the year before. And in Europe, it's really kind of hard to talk about pan-Europe anymore because of just the macro environment and some of the issues that some of the economies in Europe have had. But we have seen growth in areas like Germany, the U.K., France, Benelux countries, so the more northern, industrialized countries, where there's less unemployment. The southern, more Mediterranean types of countries, like Spain, Italy, south of France, we have seen some dropoff, as far as procedures are concerned, and it's really due to just tightening budgets based on what's going on in those economies.

Unknown Analyst

Great. Let's try our first question here and -- one on capital, then maybe you can talk a little bit about your plan. So here's some instructions on how to use the device. I think you input the number of the answer that you like, and then we'll see it on the screen and talk a little bit about it.

So here's the first question. What do you believe Volcano should do with excess cash? We have a few choices here.

[Voting]

Unknown Analyst

And we have the music.

John T. Dahldorf

Yes, I like that.

Unknown Analyst

All right. So it seems like a lot of folks are looking for you to do some more bolt-on M&A. And then, the second biggest option here is buyback. You want to talk a little bit about your capital deployment plan?

John T. Dahldorf

Yes. So we have about $516 million of cash in the bank. For those of you that do follow the company, you know we did a $460 million convert in December, and the real idea behind that was put some dry powder in the bank for us to go out and be opportunistic as far as acquisitions are concerned. And so we do have a very active business development program. We're not looking to kind of stray too far from what we know best, and so as we look at acquisitions, we look at markets. Obviously, we look at coronary types of technologies, but we're also looking at technologies in the peripherals, CTOs and structural heart. And so as we kind of map out our criteria, as far as acquisitions are concerned, I think we're looking at sizable, addressable markets. We're looking at opportunities where the technology -- where we can be the #1 or #2 player in those particular markets. As far as dilution is concerned, I get asked a lot about dilution. Theoretically, it's possible for us to make an acquisition and it be accretive, but most likely, just due to the size of Volcano right now and where we are from a profitability perspective, I think that there is going to be some dilution. So the idea kind of our -- our kind of test point is that we don't want extended dilution, so to speak, so we don't want to see dilution over a 2-, 3-, 4-year period. We really like to see dilution less than 2 years. And we're also very sensitive to revenue growth dilution, as well as gross margin expansion dilution. So as we're kind of looking at the deals today, a lot of what we're looking at is very similar to our recent Sync-Rx and Crux acquisitions, where, as you look, these are the products that were just starting to be commercialized, where there's limited technology risk, there's limited regulatory risk. This is something that we can really just go out and leverage one of our key strengths with this, which is our distribution channel. So that's kind of where we're focusing, so I think that Volcano's kind of internal thinking is very consistent with the group here.

Unknown Analyst

Great. Can we queue up our next question? It's a question on performance and how you can potentially improve. So what is Volcano's most significant opportunity to improve performance: core growth, margin improvement, capital deployment, execution, strategy or pipeline opportunities?

[Voting]

Unknown Analyst

So a little bit of a mix there. It looks like a lot of folks are looking for more core growth as the primary opportunity and then some improvement on the margin side, so certainly 2 areas that you were talking a lot about at the Investor Day. Maybe you want to talk a little bit -- you talked about growth a lot already, but maybe a little bit on the margin improvement.

John T. Dahldorf

Yes, so this kind of lines up with a lot of questions that I get, one of the ones -- what keeps me up at night. And I'll tell you that Volcano probably hasn't had the best track record in terms of bringing kind of new products to market. I think that in the past, when you go back and look at our OCT program, our Forward Looking IVUS program and even our Forward-Looking Intra-Cardiac Echo program, we kind took on science projects, and those projects have taken us longer and has cost us more money to kind of bring them to market. And so I would say that, that's the most significant opportunity in my mind for us to improve is to bring products to -- new products to the market and bring them faster, and it's something that we're very focused on. But again, we're also very focused on margin improvement, growth -- both gross margin improvement, as well as operating margin improvement. So from a gross margin perspective, I think that our Costa Rica initiative, where we're moving all of our disposable manufacturing from northern California to Costa Rica, has our focus. We spent about $45 million building the facility that we have in Costa Rica. We started manufacturing there in May. We're probably producing about 25% to 30% of our disposable -- disposables in Costa Rica today, it will be about 80% to 85% by the end of the year. We'll have gross margin improvement of about 65% to 66% today. We should be close to 70% by the end of 2014. And then, from an operating margin improvement perspective, we are committed to leveraging our SG&A. I think you saw that in 2012, and you're going to -- you're seeing it again in 2013, where our SG&A on an as-reported basis is only growing about 6% or 7%, and that includes about $3 million that we have embedded in there for the medical device tax here in the U.S. R&D this year is going to grow about 28% or 29%, but again a lot of that's driven by the $8.5 million of additional R&D that we're picking up from our Sync-Rx and our Crux deals. And then, we've also -- as we presented at our Analyst Day, we also have a number of initiatives, from a clinical development perspective, around intravascular imaging, FM, as well as peripheral in terms of really trying to expand our current technologies in the market. So we kind of redeployed about $6 million of additional R&D there this year. So -- but I think as you look at -- over the StrAP plan period, as I talked about a little bit earlier, I really kind of think that our operating expenses will only grow in the 10% range, and so we will get leverage kind of throughout that period. So those are areas that we very much are focused on, very consistent with the survey.

Unknown Analyst

And one thing you've mentioned a few times is the Sync-Rx and Crux acquisitions. You talked a little bit about this at your Analyst Day, but can you talk about the opportunity to fill in the bag a little bit more with some interventional devices and get some leverage there? It's kind of a new area for you, but how do you think you might be able to get some growth and leverage out of that?

John T. Dahldorf

Yes, so the Crux deal is really kind of our first kind of foray into kind of a therapeutic device in the peripheral space. And Crux is -- they have an inferior venous cava filter, and these filters are really to kind of protect against pulmonary embolisms or PEs. And this is about a $300 million market. It's grown about 2% to 3% a year. It's had a lot of kind of bigger players in it for a number of years, and the technology really hasn't been advanced very much. We saw the opportunity to go out and get a novel type of a filter that's just a lot different than what they have today and really kind of addresses some of the issues that those filters have today. But our real strategy is to get an IVUS indication at bedside, and by doing that, we believe that we can expand the potential patient population. We can reduce costs because you don't have to take the patient and schedule the patient into a cath lab and because you don't have to move the patient. A lot of these patients are high-trauma patients. Because you don't have move them, the risk of something else happening to them really kind of declines quite a bit. And so this is kind of a win-win, whereas we believe that we can kind of bring kind of the next generation of technology. We believe that we can get a bedside application, which is an economic benefit, as well as a clinical benefit to the hospital and the patient. And then, our vision is then to also then build a combo device, where you have the visualization just built right on to the IVC filter delivery device. And so it's something that we're really excited about and expect it to be a pretty significant revenue contributor by 2017. And then, real quick, the Sync-Rx acquisition. This was a software company -- is really a software company, and this company has been developing technology really to kind of enhance the reading of angiography and so just to kind of make it easier for them to be able to do measurements and those types of things. But really, the real diamond in the -- that they have is the ability to kind of co-register intravascular ultrasound with the angiography. So the physician knows kind of where they are in both places simultaneously, and it just kind of makes the user experience a lot more favorable. That's one of the strategies that we always are trying to accomplish in terms of our technology and what we're bringing to our patient is basically making it so it's always there, always on and easy to use. And we believe that Sync-Rx, over time, will make it a lot easier to use and that will pull through more usage.

Unknown Analyst

Okay. Let's queue up our next question. I think we have one on health care trend. So this one is, "What kind of impact do you believe the current health care trends, including the need for documentation and proof of necessity, will have on Volcano's business?"

[Voting]

Unknown Analyst

No surprise here, it's a significant impact. But maybe you want to talk about how that really impact FFR and your other businesses?

John T. Dahldorf

Yes, so I mean, I think that, one of the things that people asked me was, "What is the kind of the least understood part of the Volcano story?" And I believe that it's this right here. I think where health care is going, especially in the U.S., and we're seeing it kind of globally, but in the U.S. is that you're going to see a lot more risk sharing between the payer and the provider, okay? And so when you start getting the payer and provider and you put them together, what they're going to really be focused on is taking cost out of the total system. And when you think about Volcano and you think about our FFR technology, our FM technology, which includes iFR, and you think about our imaging technology, we are kind of lined up very well to do that. From an FM perspective, basically, what you want to do is you just want to treat the patients that need to be treated. So in other words, what our FM technology does is it can go out and diagnose those lesions that need to be stented. And for those of you that are familiar with FAME and FAME II, I mean, that's really what those studies were all about. And then, when you think about these more complicated cases in terms of stent strategy, stent placement and our ability to kind of reduce 30-day readmits and those types of things, which hospitals are being penalized today, again, our technology really is the only technology that is provided that can really do that. And so as we move towards these more risk sharing kind of models, whether it be ACOs or whatever they've got out there, I think that you're going to see Volcano become a much bigger player, not only from a clinical side but also from kind of the C-Suite side of the hospital as well.

Unknown Analyst

We can do the next question. It's a product-specific one, regarding your adenosine-free iFR technology. So the question is, "What do you see is the potential impact of the company's adenosine-free iFR FFR on penetration and growth over the FFR business over the next 5 years?"

[Voting]

Unknown Analyst

So "don't know", so maybe it's a good opportunity to educate.

John T. Dahldorf

Yes, okay. That's great, DK, "don't know". So what iFR really is, is that if we're doing an FFR case, what you have to do is you have to inject the drug that's called adenosine, and what adenosine does is it stresses the heart, okay? And then, based on that stressed heart, it kind of releases some waves that we're able to kind of measure. And so -- but the problem that you have with adenosine is that there's a certain amount of patients, and it's quite a few patients, ACS patients, they're contraindicated to adenosine. So in other words, you don't want to stress somebody with a very kind of sick heart. And so what adenosine -- or what iFR does is it eliminates adenosine. It's really just an algorithm change, and what you're able to do is really kind of reduce costs, reduce time and then, over time, we believe that you'll be able to kind of expand the patient population to enter this ACS patient population, who can benefit quite a bit from FM.

Unknown Analyst

Great. I think we need to wrap up or maybe one final question. Can you just talk about 2013 guidance and the things that kind of get you to the top and the bottom ends and a little bit of a wrap-up in terms of the outlook for the year?

John T. Dahldorf

Yes, so on a constant-currency basis, our revenue guidance is $422 million to $428 million, which is kind of in that 11% to 12% growth. On an as-reported basis, you basically take $16 million off of that, so it's $406 million to $412 million, which is about a 6% to 8% growth. I think the things that will be somewhat tailwinds for us this year, which we've been very conservative about, is that we're going to annualize the Japan 10% price reduction that we took on April 1 of last year so that will get annualized by the second quarter. And then, as we went direct in Spain last year, we probably left about EUR 4 million of revenue on the table, as we work through the inventory that was in the pipeline. So I think we'll have those behind us this year. And I mean, as far as upside is concerned, I think that we have opportunities on the peripheral side, as we talked about, continued penetration into the more complicated cases and really trying to leverage the ADAPT data that we'll be kind of rolling out throughout the year. And then, I think, FM, we'll be a 25% to 30% grower in FM as well.

Unknown Analyst

Great. Thank you so much. Thanks for your time.

John T. Dahldorf

All right, great.

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