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Volcano Corp. (NASDAQ:VOLC)

Q1 2009 Earnings Call

May 05, 2009 05:00 PM ET

Executives

John Dahldorf - Chief Financial Officer and Secretary

Scott Huennekens - President and Chief Executive Officer

Analysts

Mike Weinstein - JPMorgan

Jamar Ismail - Canaccord Adams

Matt Dolan - Roth Capital Partners

Jose Haresco - Brean Murray Carret

Raj Denhoy - Thomas Weisel Partners

Operator

Good afternoon, and welcome to Volcano Corporation's First Quarter 2009 Earnings Conference Call. During the presentation, all participants will be in listen-only mode. Following the formal comments, we will conduct the question-and-answer session. (Operator Instructions). As a reminder, this conference call is being recorded Tuesday, May, 5th. A replay of this call will be available through May 12th, by dialing 719-457-0820 with the pass code 5095234 or via the company's website at www.volcanocorp.com.

I would now like to introduce Mr. John Dahldorf, Volcano's Chief Financial Officer. Please go ahead, sir.

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 quarter's highlights, which included over all revenue growth of 34%. In addition, we continue our strong console placement activities, and, as Scott and I will discuss later today, we are accelerating our direct sales initiatives in Japan. I will also provide a review of our financial results and an update on our guidance for the year. We will then open the call up to your questions.

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, sales and growth strategies, product development and clinical trial programs, market acceptance in adoption of our product offering and those of our competitors, the functionality and capabilities of our products, expanded sales programs, any strategic activities, the impact of global economic and U.S. capital equipment environments on 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, 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 obligations 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

Thank you, John. And good afternoon everyone. As John indicated, Volcano started off 2009 very strongly with excellent growth across our IVUS and FM businesses and key geographies as well.

In addition, to continuing our execution of market penetration programs to generate revenue growth, we also drove our growth initiatives including technology innovation, sales force expansion, and the development of a product pipeline that will further our multimodality platform and enable our entry in the new markets.

There were also important developments recently related to our direct sales initiatives in Japan, in the Axsun acquisition that we completed at the end of last year. I'll speak to both of these in more detail shortly.

Our revenues of 49 million represents a 12th consecutive quarter in which we have exceeded Wall Street consensus hence going public. On an apples-to-apples basis excluding the contributions from Axsun in the first quarter of this year, we grew revenues 24% year-over-year.

Our ability to achieve these results came despite a difficult U.S. capital equipment market environment. And while we continue to be cautious in that regard, we also believe that our technology leadership, expanded sales efforts, market development initiative and clinical programs are helping to mitigate the impact of that environment.

As John will discuss, our IVUS business grew 19%, driven by very strong console placements, system sales and disposables. We placed 210 IVUS consoles during the quarter, all of them doubled now 121 consoles placements a year ago. And have now placed our 2,000 s5 console. Helping to fuel this growth was the availability of FFR on our s5 family of console.

As it's been the case in the past couple of quarters, our FM disposable business continued to gain an importance as FM disposable revenues grew 82% year-over-year.

Despite the difficult economic environment globally, we continued to believe that our IVUS and FM markets which today are more than 400 million can grow for the foreseeable future driven by enhanced functionality of IVUS and FM offerings and continued favorable clinical data such as that from the same study. As a result, we believe that our previously stated growth projective sort of businesses to grow revenues 20% or more are achievable.

In addition, we are focused on achieving improved margin and operating expense leverage to create long-term profitability.

As we have discussed with you in the past, we believe Volcano is addressing a significant market opportunity given the relatively low cath lab penetration rates for integrated IVUS and FM.

Also there are several important points to keep in mind, particularly in the current environment. First, for the moment, the capital equipment concern is primarily a U.S. issue, and we generate half of our revenues outside the U.S., with U.S. system sales accounting for about 10% of our total revenues.

Second, implementation of integrated IVUS, FM is not dependent on the construction of new cath lab as it can be retrofitted into existing facilities that are being upgraded.

Third, there is a replacement cycle for these IVUS systems that are roll around today to necessitate replacement in every seven to eight years, and the cost of the equipment is below $100,000 per integrated room.

So far, hospitals had continued to replace outdated or worn out equipment. Finally, in addition to direct purchases, we have several options such as leasing, renting, and catheter utilization programs. They provide hospitals the ability to procure IVUS and FM integrated consoles.

With all this said, we continued to remain conservative in our outlook and monitor the economic environment very closely.

Additionally based on our internal data and information published by Boston Scientific, we believe we continued to win greater than 70% of new console placements in the U.S.

We also continued to benefit from the PCI environment. PCI's volume in the U.S. was up 1% year-over-year, although down 2% versus the fourth quarter. We estimate IVUS penetration of PCI activity of 14% in the U.S. The perspectives, the major stand companies are provided during their conference call this quarter indicate that the outlook is for continued growth during 2009.

Based on our results and those reported by Boston Scientific, we estimate that the IVUS catheter market grew approximately 10% in the first quarter. And that our catheter revenues suggest that Volcano now represents a little more than half of the U.S. coronary IVUS market.

As I mentioned earlier, two other important factors are driving our growth. The first is the continued expansion of our sales force. We entered the quarter with a total of a 161 direct sales reps versus a 152 at the end of 2008, and a 27% increase over the past four quarters. This scores a 106 sales people in the U.S., 25 in Japan and 30 in the rest of world.

In addition, we continued to leverage our strong partnerships with industry leaders such as GE, Philips, Medtronic, J&J Cordis and Abbot guidance, as well as our programs with major pharmaceutical companies that are using Volcano IVUS in their clinical studies.

Second factor is the ongoing release of data that demonstrate the value of IVUS and FM, such as the FAME study that we've discussed in the past couple of calls. This study continues to have a highly positive impact on our FM business. The FFR option for s5 family of consoles was included in nearly all of our new orders during the quarter. And we've started to see the positive effect of this data on our FM business in 2009 as we anticipated.

We also announced during the quarter the availability of our integrated FFR technology on all major cardiovascular Q&A-ray system, the likes of GE, Siemens and Phillips.

As we have discussed with you in the past, we believe we are well positioned for this growth in the FM market as we offer the broadest FM product portfolio in a view of our initiatives this year to update approximately 1,500 s5 IVUS consoles, two FFR functionality which is on schedule.

IVUS and FM were prominent at the recent American College of Cardiology meeting, where... there were there among 50 presentations. Case reviews and abstracts addressing IVUS, FFR, OCT and forward-looking IVUS.

We also had a higher level of traffic at our booth. In addition, we will have a strong presence of the PCR meeting to recapture next in Barcelona, which is the largest interventional cardiology meeting in Europe each year. Activities there including number of live cases each in our core IVUS and FFR technologies.

We're also seeing a very positive enrollment activity in our adapt or assessment of dual anti-platelet therapy with drug-eluting stents study. This study is enrolling faster than we had projected and budgeted. This is great news as we believe the data will demonstrate the benefits of IVUS in PCI with drug-eluting stents. As a reminder, we initiated enrollment in this study a little more than a year ago. It is now 11,000 patient, multi-registry of patients with coronary artery disease undergoing stent assistance PCI using drug-eluting stents with a 3,000 patient IVUS sub-study.

The objectives are to determine the frequency in correlation of DES thrombosis and the relationship of aspirin and/or clopidogrel, hyporesponsiveness, and general platelet reactivity to early and late DES thrombosis.

There is a great deal of interest in this study. And we believe the findings will help advance the field of interventional cardiology in patient care and confirm on a significant scale the findings of the stellar study and work by other clinicians in other trials.

I also wanted to mention the JSAP study, JSAP, which we discussed during our Analyst Day in New York City, and demonstrated the value of IVUS guided stenting. This is study similar to the U.S. COURAGE study. And we believe the data suggests that the use of IVUS and JSAP in the Japan study resulted in better patient outcomes than were experienced in the COURAGE trial. As David had demonstrated a significant benefit of IVUS guided PCI versus medical therapy alone, although the patients in JSAP were not as complex as those in the COURAGE trial.

The separation of the survival curves between IVUS guided PCI and medical therapy alone is quite compelling of the IVUS guided core had very few events in the first 30 days, and those improved outcomes were sustained for more than three years. These findings demonstrate not only the value of PCI and the treatment of cardiovascular disease, but also support the use of IVUS as a standard of care in Japan with nearly 70% IVUS penetration.

We believe that an addition to this ongoing flow of favorable data that the healthcare reform initiatives now being discussed lead to further adoption of our technologies.

As a company, we've engaged in the healthcare reform debate and has advocated strongly for President Obama's proposed investments in comparative effectiveness research.

As they pointed out in the recent Op-Ed piece by author for The Washington Times, we believe it is important that the healthcare industry reduce its reliance on procedures that have become standard practice regardless of their cost and efficacy. We clearly need to be focused on treating the right patient at the right time and with the right methods to lower healthcare costs, improve patient outcomes and faster research and development.

We believe that the industry will ultimately need to face the issue of allocating limited resources and how best to utilize reimbursement to facilitate changes in practice patterns and treatment regimens. A prime example is the use of our pressure wires to significantly improve patient care and reduced cost.

With respect to our initiative to move to a direct sales force model in Japan, as I mentioned a moment ago, we had 25 sales reps at the end of the quarter, but have 37 today. This compares with 20 at the end of last quarter.

As a reminder, we currently have a multi-distributor arrangement in Japan, as well as selling direct. Currently, our Japan sales by channel are Goodman 52%, Fakuda 22%, direct 17%, and J&J Endovascular for the peripheral market 9%.

Since our last call, the process to implement our direct selling program in Japan has been accelerated. This is based on an anticipated and to our Goodman relationship over the next two quarters. There will be no changes to our distributor relationships with Fakuda or J&J Endovascular. We feel very positive about this process as we have strong momentum in Japan as evidenced by the continued success of Fakuda and J&J Endovascular, and the rapid growth of our sales force in the related direct sales revenue.

We will now be able to more broadly control our sales and marketing efforts and it's important in growing market. And there is, of course, the revenue benefit of going direct versus selling through Goodman.

At the same time, we recognized that this accelerated process will likely cause short-term disruption to our business in Japan. And as John will discuss during his comments, we will be accelerating our spending to build out our infrastructure in Japan as we expect over the next six months or start to accomplish much of what we had originally anticipated will take place through the middle of 2010. Again, I want to reassure you that this short-term investment will add great long-term value for the company.

As most of you know, CMS issued their proposed reimbursement rates that would take effect in October. While these will not be finalized until August, the proposed reimbursement rates for the DRG's under which our products are most commonly used would remain essentially flat to moderately up with the current reimbursement rates. We are monitoring the process, and we will apprise you of updates as necessary.

While we believe offering features such as both phased array and rotational catheters, and FFR functionality provides us important competitive advantages that are enabling us to win greater than 70% or more of the integrated IVUS and FM system, we are looking to further our hub and pod strategy to new offerings of high margin disposable and complementary therapeutic solutions directed to a broader number of indications.

We continued to move forward on our strategy to expand our IVUS and FM offerings, with a broad portfolio of products built around our platform hub.

I'll begin with our Axsun acquisition that occurred at the end of 2008. First, the integration is going very well. The core Axsun business which consist of selling optical components to medical device companies in certain telecom and industrial markets is operating to plan. As we have discussed with you in the past, Axsun small form-factor OCT tunable laser technology together with its MEMS manufacturing capabilities provides us a rich pipeline of new product opportunities in cardiovascular imaging and beyond.

Given the breadth and scope of this technology, our biggest challenge will be prioritizing market development opportunities such as imaging and analytical devices for peripheral vascular, neuro, pulmonary, ophthalmology, cancer detection, blood glucose monitoring among others.

As we reported in 10-K for 2008, the Superior Court in Massachusetts in January issued a preliminary adjunction against Axsun and Volcano in response to a complaints filled by LightLab, a wholly owned subsidiary of Goodman. The initial injunction prohibited Volcano from using Axsun tunable lasers and Volcano's OCT products under development, but ordered a full hearing following a more complete discovery.

We are pleased to report that as a results of the full hearing that occurred in March, the trial court reconsider the broad injunction and issued a much more limited order to provide simply that a) Axsun not disclose confidential information of LightLab to Volcano for the agreement, and b) Axsun will not work with Volcano on any project involving those particular tunable lasers identified in Appendix A to the supply agreement between Axsun and LightLab.

In addition on April 2nd, the trial court denied LightLab subsequent motion to order a change of the laser specification in Appendix A to a new revision of the specifications. These core findings are consistent with Volcano's expectations and represent a very positive outcome for Volcano.

The court also said a trial date for the first week of January 2010. We fully expect to prevail a trial and have full and complete access to Axsun's extensive technology in lasers and MEMS excluding only Volcano's use of a laser design specified in the LightLab-Axsun supply agreement for cardiovascular imaging and the use of any LightLab confidential information.

Our forward-looking IVUS efforts which we acquired through the Novelis transaction last year are moving along nicely. We are developing a therapy guidance device that will have its first to man use this year and market introduction in the U.S. and Europe in 2010.

And a second for IVUS offering which incorporates RF capabilities to revive a therapeutic solution, which will have its first in man use in 2010, with commercial approval in the U.S. and Europe expected in early 2011.

Our image guided therapy products that combine IVUS in a balloon on the same catheter are on track for first in man later this year or in early 2010, with commercial approval and global launch expected in 2010. We believe this market is in excess of $500 million of both coronary and peripheral applications.

With respect to our Optical Coherence Tomography or OCT program, we're making good progress with all the components, including the consoles, software palm (ph) and catheter including our ongoing clinical trial work in Europe.

We are now focused on refining our system to ensure that it integrates extremely well with our existing IVUS FFR multimodality platform and provides a seamless work flow. We're also working on the integration of the Axsun technology to ensure that we have a best of three product at product launch, and believe that our initial launch of an OCT offering will take place in Europe in mid-to-late 2010.

Before some closing remarks, I want to acknowledge our two newest Directors who joined our Board at the end of April. Michael Coyle has served as President of the Cardiac Rhythm Management Division of St. Jude, which he joined in 1994. Before that, Michael held business in technical management positions in the device and pharmaceutical businesses of Eli Lilly.

Roy Tanaka stayed more than 10 years with Johnson & Johnson, serving as both U.S. and Worldwide President of their Bioscience Webster division. Before that, he held senior management positions with Sorin Biomedical and a division of Pfizer. Both of these Directors bring great experience and knowledge to Volcano, and we look forward to their contributions.

In closing, Volcano continues to meet or exceed its growth objective. And although we are conscious of the potential impact of the U.S. capital equipment environment, we feel we can continue to realize our growth strategies going forward.

In addition to driving growth with our core offerings, we have a significant opportunity through a continued product innovation and extended sales programs such as our direct sales initiative in Japan. We also have several product enhancement schedule for introduction later this year, the initial revenues from our pipeline of products starting to kick-in during 2010.

Finally, we will continue to look for strategic opportunities that can provide a complementary additions to our current offerings, while continuing to be judicious in our approach to these opportunities.

Thank you for joining us today. And I'll now turn the call over to John. John?

John Dahldorf

Thank you, Scott. Revenues for the first quarter of 2009 were 49 million, a 34% increase over revenues of 36.6 million in the same period a year ago.

Revenues from Axsun, which of course we did not have the year ago, were 3.7 million in the quarter, meaning our organic growth revenue growth was 24% year-over-year. Our first quarter revenues included an unfavorable euro FX impact of approximately 1.3 million versus the prior year.

With respect to the revenue breakout for the quarter, consolidated sales of IVUS systems and related equipment were 8.5 million, a 32% increase over sales of 6.4 million a year ago. In the U.S., IVUS system revenues were 5 million, a 33% increase over the 3.8 million a year ago. In Japan, they were 1.2 million versus 916,000 a year ago or 28% increase, and in Europe, they were 1.6 million, compared to 1.2 million a year ago or an increase of 35%.

Our console placement efforts continued to be very successful as we nearly doubled placements versus the first quarter a year ago. During the quarter, we placed 210 IVUS consoles versus a 121 consoles in the first quarter year ago. Our console placements included 54 in Japan this year versus eight a year ago. So, in spite of the global economic environment, our customers are continuing to adopt our systems. In total, we now have more then 4,200 IVUS and FM consoles placed worldwide.

As we have discussed with you in the past, our growth strategy consists not only expanding our installed base, but also driving utilization and we had a great quarter in this regard. On a consolidated basis, IVUS disposable revenues were 29.1 million, a 16% increase over 25.2 million in the first quarter of 2008.

In the U.S., IVUS disposable revenues were 14.3 million, a 23% increase over 11.6 million a year ago. In Japan, they were 10 million versus 8.8 million last year and in Europe, they were 4 million essentially flat versus the first quarter of last year despite disposable unit growth of 19%. Our European disposal revenues were impacted by unfavorable foreign currency exchange and geographic mix.

Our FM business continued to prosper as revenues were 6.3 million, a 68% increase over the 3.7 million in the first quarter a year ago. Nearly all of the FM revenues in the first quarter this year were disposables.

As we indicated in our last call, with the addition of FFR functionality to our s5 console, we expect that FM's system sale will be nominal. In the U.S., FM revenues were 3.6 million versus 1.9 million in the first quarter of last year, or a 93% increase in general. In Japan, they were 296,000 versus 223,000 last year, and in Europe they were 2.1 million versus 1.5 million a year ago, or an increase of 41%. Other revenues on a consolidated basis were 1.7 million versus 1.3 million a year ago.

Gross margin in the quarter was 58% versus 63% a year ago, and 63% in the most recent quarter. Our gross margin in the quarter reflects the impact of Axsun's lower margin business, including a purchase accounting onetime step-up charge of 600,000.

Other factors for the lower margin included our initiative to upgrade our legacy s5 family of consoles with FFR functionality and the increased contributions from FM disposables which carry a lower margin than the previous quarter's average.

Operating expenses in the quarter were 34.9 million. This compares with 28.6 million a year ago and 30.9 million in the prior quarter. Our operating expenses in the quarter reflect our build out in Japan to support our direct sales efforts, legal expenses related to the LightLab's litigation, and a full quarter of Axsun expenses.

On a GAAP basis, we reported a loss of 7.6 million or $0.16 per share versus a loss of 2.3 million or $0.05 per share in the same period a year ago. Excluding stock-based compensation expense of 2.7 million, Volcano reported a net loss of 4.9 million or $0.10 per share in the first quarter of 2009.

Excluding acquisition related cost of 2.9 million stock-based compensation expense of 2.1 million and in-process R&D of 175,000, we recorded non-GAAP net income 2.8 million or $0.06 per diluted share in the same period a year ago. Weighted average basic shares is in the first quarter of 2009 were 48 million.

We ended the first quarter of 2009 with a 144 million in cash, cash equivalents and short-term available for sale investment versus a 150 million at the end of fiscal 2008. Our use of cash during the quarter primarily reflects capital expenditures and increased working capital.

With respect to guidance as Scott mentioned in his remarks, we are currently in negotiation with Goodman, our primary distributor in Japan to accelerate our transition to a direct sales model over the next two quarters. Due to the complexity of the negotiations with Goodman at this point, it is very difficult to ascertain the timing and the impacts on our operating expenses and subsequent net income.

Consequently, we will provide guidance as we have in the past for revenue and gross margins and speak the trends in operating expenses without consideration of the Goodman negotiations. And we'll not provide guidance for total consolidated operating expense, operating income, or earnings per share at this time. We intend to provide updated guidance for operating expenses, operating income and earnings per share during our next earnings call.

We are reconfirming our revenue guidance for fiscal 2009 that we provided on our last call, of revenues in the range of 218 to 223 million, an increase of 27 to 30% over revenues in 2008. We are also reconfirming our guidance for gross margin of 60 to 62%. These expectations for both revenues and gross margins also reflect the contributions from Axsun.

On our last call, we shared with you our plans for increase SG&A spending as we built out our sales force infrastructure in Japan and strategically expand our sales and marketing programs in the U.S. and Europe.

At this time, we are planning on a further increase in spending in sales, marketing and G&A in anticipation of an accelerated transition with Goodman.

In addition, we expect a modest increase in G&A resulting from legal expenses associated with the LightLab litigation and a slight increase in R&D spending through the balance of the year versus the first quarter due primarily to enrollment rates in the adapt trial, which are exceeding our earlier expectations.

Finally, we will be presenting at the Banc of America and Merrill Lynch Health Care Conference in New York next Thursday, and at the JMP Health Care Conference in San Francisco, on Monday, May 18th.

Thank you again for joining us today. And we'll now open the call to your questions.

Question-and-Answer Session

Operator

Thank you. (Operator Instructions). We'll take our first question from Mike Weinstein with JPMorgan.

Mike Weinstein - JPMorgan

Thanks. Thanks for taking the question guys. Could you start on the gross margin line and just maybe flush out for us a couple of different items that were impacting that, particularly the FFR upgrades that we have been assuming that would be more spread out over the first half of, in fact it was more in the first quarter than we had modeled?

John Dahldorf

Yeah, the impacts, we planning on doing about 1,500. We're running a little bit ahead of plan as far as the actual number, which is a good thing. Because as soon as that we can get those units upgraded, obviously as soon as our customer has the ability to run the FFR. And so, I could say we are running a little bit ahead there.

As we mentioned, the Axsun business and the step-up charge from accounting is impacted the margin. And the margin actually is really kind of within the plans that we had setout, when we setout our original guidance of 60 to 62%. So, as far as management is concerned, there is really no surprises. Probably, the only other thing that did affect margin that it was really kind of outside of our control and initial guidance was the $1.3 million of unfavorable FX that we had on the euro that drops down to the margin line. But in spite of that we still believe that we can hit 60 to 62%.

Mike Weinstein - JPMorgan

Okay. Just to make sure we're clear onto the... obviously, it's the onetime inventory step-up. The FFR impact I guess will be relatively minimal in the second quarter than non-exist in the third. Am I assuming that right?

John Dahldorf

Yeah. I mean it will be less in the second quarter, and it will be non-existed in the third and fourth quarters.

Mike Weinstein - JPMorgan

Is there any thoughts on where you exit the year with gross margins?

John Dahldorf

Yeah. I believe we'll be in the 60 to 62% range. And so, I expect gross margin to specially in the second half of the year once we get beyond the FFR upgrade and once we start to get some traction from the direct sales initiatives in Japan. I expect margin to grow and I expect us to be exiting the year probably in access of 62%.

Mike Weinstein - JPMorgan

Okay. That's helpful. And let me switch to Japan and the transition there. First, maybe it will be helpful to spend a minute on what accelerated the timeline there? Was it the build out here in sales force, was it request from the Goodman side to accelerate that?

And then, I want to just understand what happened to the installed based systems in Japan that were placed by Goodman as well as the other distributors, and do you need to anything there to buy them out? Thanks.

Scott Huennekens

Yeah Mike, this is Scott. So, as I stated, Goodman represents currently about 52% of our revenue. So about a half of the revenue in Japan, just to put it into perspective. And I don't really want to go into the details of the negotiation. But it's fair to say that the companies have agreed to move up the date based on a number of factors and we are currently in negotiation relative to a number of different parameters not includes everything from equipments, they will be bought back; disposables that are in inventory, they will be bought back ; and any other payments that will be part of the negotiated settlement. And so that's part of our issue relative to giving forecasting on a income statement side. As we buyback disposables obviously, then that's a contract to the revenue and gross margin impacts and those kinds of things.

So, we don't know. At this point in time we're in negotiation. It will be one or two things. We'll either put brand new equipment into Japan, which we build the inventory in order to do that. So we won't be held hostage by Goodman for lack of better term if they wanted to try and force us to buy equipment at an elevated price or anything like that. We build the equipment after little bit for the reasons for our inventory levels going up.

And so those units have started actually to be shipped to Japan and we've planned to start placing them into accounts that are Goodman accounts starting here in the second half of May to prepare for the transition in the third quarter.

Mike Weinstein - JPMorgan

For me something in now, all the different pieces here. So as you places those systems in Japan to replace the existing systems that are there, what impact does that have on your gross margins over the back half of the year? Are you assuming... what are you assuming in order to accelerate to hit to that 50, 52%?

Scott Huennekens

John, do you want to talk about the --

Mike Weinstein - JPMorgan

Or the top patterns are that meaningful?

Scott Huennekens

It's not that meaningful because if you are placing 350 systems they get depreciated over five years. So John, I don't know if you want to --

John Dahldorf

Yeah. Mike, you kind of answered your own question. The incremental depreciation really is de minimis versus the margin pick up that we'll get.

Mike Weinstein - JPMorgan

Okay. And the sales impact in Japan just this year and the back half for this year for making the transition?

John Dahldorf

Yeah. You've got a couple of moving factors. Whenever you have a handoff like this, there is normally going to be minor disruption as we had mentioned in our scripted comments. We believe that that we'll be able to come back from that minor disruption and really kind of make up for the loss revenue by doing it to get sooner. But that's why in light of the increase or in the acceleration of the transition of the business, we don't feel like we need to make any significant adjustments to our revenue guidance, once kind of, some revenue kind of replacing other.

Scott Huennekens

Yeah, you're going to have, you can buck it under four categories. You're going to have some short-term, maybe market share losses we believe than we gain that back. You're going to have gross-up of revenue instead of selling it at distributor pricing or selling at a end-user pricing. We will have a little more FX effect based upon where the yen is versus the dollar. And then if we end up buying back disposables, we'll have some effects from that.

But to John's point, those kind of our ins and outs and we feel good with our overall guidance even though if Japan revenue per se maybe, would be a little lower than what we had originally projected, Europe and the U.S. we're feeling a little bit better overall.

Mike Weinstein - JPMorgan

Okay. The final question, I'll jump back queue. Let's fast forward, you get to this period in 2009, which will be a transition in Japan for you. If we think about the profitability of the company in 2010, 2011, how do we think about the gross margin profile and how do we think about the levels of OpEx spending?

John Dahldorf

Yeah, and I think as we've kind of disclosed the past, in 2010 we expect to see, I would say almost at least a 200 basis point year-over-year margin improvement. And, I think that with the profitability and the revenue that will be adding due to the transition, I think that you'll start to see some material operating expense leverage starting in 2010.

Scott Huennekens

And on the top line we've consistently talked about revenue growth of 20%.

Mike Weinstein - JPMorgan

Okay. Great. Thank you guys.

Operator

Next, we'll move to Jason Mills with Canaccord Adams.

Jamar Ismail - Canaccord Adams

Good afternoon. This is Jamar Ismail for Jason.

John Dahldorf

Hey Jamar.

Jamar Ismail - Canaccord Adams

Yeah, just one more question on Japan. I mean from the current, I think there is 40 reps in Japan. And I know you initially were thinking about going to 45 by the end of this year. What's the number now and the breakout between quarter carrying reps and clinical specialists?

John Dahldorf

Yeah, in Japan, they kind of serve a dual function. And so, a rep kind of, is a rep. So the model, the sales rep model in Japan is different than the U.S. And we have somewhere between 37 and almost 40 today by July 1st. We'll have almost 50, and I would say that probably by the end of the year, we'll probably be close to somewhere between 55 and 60.

Jamar Ismail - Canaccord Adams

Great. Second question is in Europe, when you're looking at consoles sales, this is... there has been several quarters of pretty strong console growth and we haven't really seen the pod through in disposables, and when do you think we're going to start seeing that?

John Dahldorf

I, Europe, the first quarter in Europe is always kind of funny because it's really kind of a function of when the distributors are ordering. And so it can kind of knock-off the utilization to some degree. And, but when we've looked at the disposable unit growth and that's what I tried to incorporate into our comments, our disposable unit growth in Europe was 19% for IVUS, and much higher for FM disposables. And so we believe that the pull through was there. And as Scott mentioned just a little bit earlier, we're looking forward to a pretty significant growth in Europe again year-over-year this year.

Jamar Ismail - Canaccord Adams

So, units are there, getting muted a little bit by FX changes?

John Dahldorf

It's getting muted a little bit by FX and it's getting muted a little bit by what I call geographic price mix as you go from country-to-country, and then as you look at the direct mix versus the distributor mix.

Jamar Ismail - Canaccord Adams

Okay. And one last one, just FM in the U.S. was up over 90%. And is that utilization or the stocking orders including in that?

John Dahldorf

No, there is no stocking orders included in that.

Jamar Ismail - Canaccord Adams

And the other geographies as well?

John Dahldorf

Correct.

Jamar Ismail - Canaccord Adams

Okay. Thanks a lot.

Operator

And we'll next move to Matt Dolan with Roth Capital.

John Dahldorf

Hey, Matt.

Operator

And Mr. Dolan your line is open. (Operator Instructions).

Matt Dolan - Roth Capital Partners

Hey guys. Can you hear me?

John Dahldorf

Yep. Yeah, we can hear you now.

Matt Dolan - Roth Capital Partners

Sorry about that. Just a couple of follow-ups. First on the U.S, you mentioned CapEx and the risks associated with that. Has that changed in your view over the past couple of months as you've seen changes in any hospitals behavior relative to what you thought before and maybe numerically you can help us with how you shifted in terms of the absolute placements versus direct sales there?

John Dahldorf

Yeah, in the U.S., every month that goes by, I mean we learn more and more. I would say that hospitals are still continuing to act very conservatively. And they are watching very closely their spending and they are continuing to kind of ratchet things down. And so that just means that it makes us work harder because the customer is motivated to adopt the technology or to integrate the technology into their lab. And I mean, so this quarter in the U.S I think our sale consoles versus our either rentals or leases or cuts, I think our ratio was 60% sales and 40% kind of company owned placed. And that's kind of the percentage that we see evolving over the rest of the year.

And so, I would say that we're not terribly surprised of what's going on in, and to be quite honest we're meeting or exceeding our expectations in terms of the placements that we're making.

Scott Huennekens

And we tried to be conservative going forward. And feel that by doing that and having a growth on the FM side, we're being conservative. And like John said we'll continue to learn month-to-month and hopefully we'll see a little bit of a change here as more positive news starts to evolve and develop.

Matt Dolan - Roth Capital Partners

Okay, great. And then on the Japanese side as we think about the disruption potentially this year with respect to revenue. John, you've given us kind of a seasonal progression in the past of how you expect things to track throughout the year. Are there any updates for that? It sounds like overall you're comfortable with U.S. maybe offsetting any issues in Japan. But maybe walk us through how the year could possibly progress with maybe a little bit of the unit slowdown in Japan.

John Dahldorf

Yeah, I think that as I've discussed in the past, we've normally seen an uptick in Q2, versus historical. I think that as we kind of proceed through Q2 of this year and actually beginning of Q3 next year, Japan will probably depress our revenue more than it has historically to some degree. And then, as we kind of come out Q3 and roll into Q4, I think you'll see a faster acceleration or a greater contribution from those months than we've historically seen in the past.

So, we'll definitely see a more prominent trough in Q2 and again, in the beginning of Q3 of this year. But again like I said I think we'll be coming back very, very strong and entering 2010 with a lot of momentum.

Matt Dolan - Roth Capital Partners

Okay. If we think of Goodman owning about 52% of your Japanese business today, how much of on a unit basis is reasonable to convert by next year?

John Dahldorf

It will all be converted by next year.

Matt Dolan - Roth Capital Partners

Okay, great.

Scott Huennekens

What do you mean by convert Matt?

Matt Dolan - Roth Capital Partners

Converted to Volcano direct versus Goodman distribution.

Scott Huennekens

Yes. It will all be converted in the next two quarters.

Matt Dolan - Roth Capital Partners

Or I guess the other one would be lost to Goodman through maybe another source. And final on the legal spend, is that... have your expectations for that dollar number to go, has that gone up given any development with LightLab?

John Dahldorf

Well, the cost of litigation is all surprising to me.

Matt Dolan - Roth Capital Partners

Yeah.

John Dahldorf

But, so we've put a range on what we believe it will be as we prepare. As Scott had mentioned in his remarks as we've prepared in the event that we do go to court in January 2010. And so we've got, I think we've got a pretty good handle on what activities we'll be doing internally with our console to get us ready for and that's what we scoped into our operating expenses.

Scott Huennekens

The good thing is that this is whole preliminary in junction process was exhaustive. And so we spend a considerable amount of money in the first quarter in discovery and evaluation of all of the information. So and investments already have been made relative to what's going to be needed for a trial.

Matt Dolan - Roth Capital Partners

Okay, great. Thank you guys.

Operator

Next we have Jose Haresco with Brean Murray.

Jose Haresco - Brean Murray Carret

Hi guys.

John Dahldorf

Hey Jose.

Jose Haresco - Brean Murray Carret

A couple of questions, here just housekeeping things. How many units did we place in the U.S. in the first quarter, you had 54 in Japan?

John Dahldorf

Yeah, in the first quarter, we placed 41 in the U.S.

Jose Haresco - Brean Murray Carret

41 in the U.S. and that's, and 60% of those are kind of cash sales and rates in are not, is that the way to interpret that?

John Dahldorf

That's correct.

Jose Haresco - Brean Murray Carret

Okay. And on ASPs for IVUS capital --

John Dahldorf

Jose, Jose, hang out a second. I'm sorry. I gave you a wrong number. We placed a 112 consoles in the U.S.

Jose Haresco - Brean Murray Carret

Well, okay, a 112 in the U.S.

John Dahldorf

And 60% of those were sold.

Jose Haresco - Brean Murray Carret

Okay. On the catheter side, given that you have really a blend of inflations in the U.S. that are now under a catheter leasing program or variation there are versus the cath sale, is that... what ASP, I wish you could blend that all in the first quarter, and what were the ASP on the catheters be? Has that started to come up because you are charging a premium to the catheter utilization programs and then what should we think about its rate?

John Dahldorf

Yeah, because of the number of catheters that we actually have for a total business on a consolidated basis, all you need is it kind of picks up in decimal points, but contributes quite nicely to the revenue line. And so, I think that over the last few quarters, our catheter pricing has picked up modestly. But when you're kind of multiplying across the total number of catheters that we have, it has contributed pretty significantly.

Jose Haresco - Brean Murray Carret

Okay. I believe in this first quarter call, in terms of thinking about the U.S. IVUS hardware sales, I believe that the guides was that it would be a flat sequentially for '09, given the split between kind of cut versus cash sale, should we expect that to come down and then will it be offset by FM increased catheter volume and so forth?

John Dahldorf

Yeah, it could fluctuate in the range of 5 to 10% down potentially. But as we've mentioned earlier, we believe that any softness in that number, we can make up in other areas of the business.

Jose Haresco - Brean Murray Carret

And if we had a kind of rank order where the offset is, is that FM driving the business? Is that the utilization rate?

John Dahldorf

Yeah, I would say it would be FM driving the business. Yes.

Jose Haresco - Brean Murray Carret

Okay. And kind of going back to the refurbishing, the installed base for FFR, can you give us an exact number of how much you spent during the quarter and how much... I think you mentioned like 3 million in the first half and did we spent all of that in Q1, was that going to be carryover in Q2?

John Dahldorf

No, there will be some carryover in Q2. And I would say that we spent approximately 60% of that in Q1.

Jose Haresco - Brean Murray Carret

Okay. All right. I think that's pretty much it. Thank you very much.

Operator

And we'll move on to our last question from Raj Denhoy with Thomas Weisel Partners.

Raj Denhoy - Thomas Weisel Partners

Hi, good afternoon. Wonder if I could just ask kind of a broader question. I mean just looking back at your model, I think in this quarter the disposable revenue, your average disposable revenue, the growth there was almost half of what it was on the system side. And I think it's, third or fourth quarter where you're seeing the growth on the disposables lag the system placements by a fair amount.

I'm curious, can you remind when you think that catches up? I mean is there a point where the box placements so just kind of have to start throwing off a significant number of disposables and we just see that disposable numbers start to really ramp?

John Dahldorf

That's kind of hard question to answer. Because a lot of it has to do with, I mean because if you're just looking at pure revenue, you're not capturing the FX impact. You're not capturing some of the geographic mix that like we've seen in Europe. And I mean we have had quarters in the past where we've had this kind of disparity between console growth and disposable growth, just based on the timing of placements and the like. And in the first quarter, traditionally has always been a little bit of a slower disposable quarter for us than previous quarters as well. So --

Raj Denhoy - Thomas Weisel Partners

Okay. But I guess, over time this should even now out I guess broadly speaking?

John Dahldorf

Yeah, we would expect over time for it to even out.

Raj Denhoy - Thomas Weisel Partners

Okay. And then just sort a housekeeping item. Could you give us the number of those catheters you sold in the quarter on the IVUS side?

John Dahldorf

No, we don't disclose that information, Raj.

Raj Denhoy - Thomas Weisel Partners

Okay. Okay. That's very helpful. Thanks.

Operator

And we have Dave Onqist (ph) with Wells Fargo Advisors.

Unidentified Analyst

Hi guys. How are you doing?

Scott Huennekens

Great.

Unidentified Analyst

I just want to commend you all on your continued and successful execution of your business plan in a really challenging environment. I do have one concern. And I guess I could paraphrase this is, all this what is this consistent stock option exercise is the sale of company shares. Any sense kind of question mark to investors of your confidence in the potential future value to this company? Would you all consider maybe encouraging more direct ownership of 84 shares and maybe longer retention periods?

Scott Huennekens

We have a stock option plan that is seven years and ten years depending on when you got them. The company, for example, in my case, this is Scott, the CEO, I have options that end up expiring at seven years. And I have the requirement to basically exercise them given my own personal situation. I'm forced to sell to pay taxes.

So, I think all of us from the options we have been granted own 75 to 80% or more of any options that we've been granted and have been at the company; most of us five, six, seven years as a management team. And so there is a small trick clean out and selling in diversification that I think most of the management team has done that it's not a very small level relative to their overall ownership.

Unidentified Analyst

I get a little concern when I see you, whenever we have news item, here it's always followed by someone exercising an option and basically liquidating shares. So it's just more of psychological --

Scott Huennekens

All of our management team only are allowed to sell and only sales on 10-B51 filings as well. So, there is no correlation of events and selling everything is done on 10-B51s.

Unidentified Analyst

Okay. I'm okay with that. Thanks a lot.

Scott Huennekens

Okay. I appreciate it. Good questions.

Unidentified Analyst

Bye.

Operator

And we have no further time for any further questions. I'll turn it back over to Mr. Dahldorf for any final or additional remarks.

Scott Huennekens

Well, it is Mr. Huennekens. Thanks again every one for your time today. It's been a great first quarter,, great start in a generally tough economic environment around the world. And we're real happy with our results, and are excited about the rest of the years and continue to meet the expectations that we've laid out. So thank you.

Operator

This does conclude our conference call for today. Thank you every one for your participation.

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