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Executives

Joseph Kaufmann – President and Chief Executive Officer

Michael Celano – Chief Financial Officer

Douglas Evans – Chief Operating Officer

Analysts

James Sidoti – Sidoti & Company

Josh Jennings – Jefferies & Co.

David Turkaly – SIG Capital

John [Robo – Gaggin Securities]

Spencer Nam – Summer Street Research

Kensey Nash Corporation (KNSY) F4Q09 Earnings Call August 20, 2009 9:00 AM ET

Operator

Welcome to the fiscal year-end earnings release conference call. (Operator Instructions) I would now like to turn the conference over to our host, Mr. Joseph Kaufmann. Please go ahead.

Joseph Kaufmann

Thank you. Good morning, everyone. Welcome to the Kensey Nash fourth quarter and fiscal year end 2009 conference call. Joining me today are Doug Evans, our Chief Operating Officer, and Mike Celano, our CFO. Mike will start out with the Safe Harbor.

Michael Celano

Thanks, Joe. The statements made by Kensey Nash and its representatives in this conference call will contain certain forward-looking statements, including financial forecasts that are based on the current beliefs of management as well as assumptions made by information currently available to management. Wherever possible, we will try to identify those forward-looking statements by using words such as belief, expect, anticipate, forecast and similar expressions. Please note these words are not the exclusive means for identifying such statements.

Please see today’s news release and Kensey Nash’s SEC filings, including our Annual Report on Form 10-K for the year ended June 30, 2008, particularly the information under the caption “Risk Factors” for a discussion of risks, uncertainties and other factors that could cause actual results in the remainder of fiscal year 2010 and beyond to differ materially from those expressed in or implied by our forward-looking statements.

Joseph Kaufmann

Thank you. I would like to start off today with some comments and remarks related to our fourth quarter performance. Total revenues of $20.5 million were at the high end of our guidance. Compared to the prior year, revenues were down 7% as we expected. Our revenues consist of product sales and royalties. The product sales were $13.6 million which slightly exceeded the high end of our guidance for the quarter. Compared to the prior year, sales declined 9% or $1.4 million.

As expected, endovascular sales declined $400,000 and this is due to the shift from the direct sales model that we had in fiscal year 2008 to a strategic partnership in fiscal year 2009 which resulted in lower transfer prices to our partner.

Our biomaterial sales declined approximately $1 million from the prior year. Within biomaterials, sports medicine declined approximately $1.8 million as anticipated. One of our major customers accounted for about $1 million of this decline. This was due to a very difficult comp comparison relative to last year and also this customer is coming off of a very strong third quarter. For fiscal year 2009 the total year this customer was actually flat year-over-year and this performance for the year we think was actually relatively good due to the market conditions that exist today and the reduction I believe everyone is seeing in sports medicine because of the economic decline and the procedures taking place, the high unemployment rates that are out there. Overall, again we think this is a good performance for the sports medicine marketplace for our customers. However, they are feeling the impact of what is going on in the economic climate today.

The balance of the short fall in sports medicine of $800,000 was due to a reduction of inventory with another customer, a large order that was placed at the end of our fiscal year 2008. Again, because of what has taken place throughout the fiscal year in terms of procedures, the reduction and things I alluded to earlier caused us to show a decline in our fiscal year 2009.

In spine, however, our sales of $3.7 million increased 21% year-over-year. This was driven by our product sales to Orthovita which include the Vitoss bioactive foam and Vitoss foam products. Again, this partner Orthovita continues to do extraordinarily well in the marketplace. These products are performing exceptionally well and we are looking for this to continue in our fiscal year 2010.

Moving on to royalties for the quarter, royalties of $6.9 million were flat versus prior year. However, the current quarter was negatively impacted by approximately $300,000 due to unfavorable foreign exchange related to the Angio-Seal royalties. Our Angio-Seal royalties as reported were $5.3 million or $5.6 million excluding the negative effect of foreign currency. This was slightly below last year’s $5.7 million. Units for the Angio-Seal year-over-year increased slightly.

Royalties from Orthovita of $1.6 million increased 30% year-over-year again reflecting the strong performance of these products in the marketplace and obviously that impacted our product sales as I mentioned earlier. We are very pleased with how these products continued to perform and again we are expecting to see similar performance in fiscal year 2010.

Looking at our EPS for the quarter we had earnings of $0.41 and again this was at the high end of our guidance. Compared to last year on a pro forma basis our EPS increased 17%. Operating cash flow for the quarter was $11.2 million and our cash and investments on our balance sheet at the end of June were approximately $80 million.

For the full year results our biomaterial sales increased 7%, endovascular sales declined 38% again because of the shift in the strategic model. Overall our sales increased 3%. Our royalty income increased 4%. That was primarily driven by the strong Orthovita performance and our total revenues increased 3%. We have had record EPS of $1.69 in the year and this represents a 71% increase from the pro forma $0.99 we reported in fiscal year 2008 and a 345% increase from the reported EPS from fiscal year 2008.

For the total year our cash increased $16 million or 26% during the year and this is after we had stock repurchases of $19.5 million in fiscal year 2009. For the guidance moving forward for fiscal year 2010 we expect revenues in the range of $86-89 million. Net sales $58-60 million which would represent a 7-9% increase and royalties of $28-29 million which would represent a 4-7% increase over the prior year. EPS in a range of $1.76 to $1.80 which also would represent a 4-7% increase.

Now the EPS includes, or our earnings and net income includes an additional $2 million of stock based compensation in our guidance for fiscal year 2010. This is the result of the acceleration that took place in 2008 for stock based awards which had a significant impact obviously on our EPS in fiscal year 2009; a positive impact but in looking at the comps year-over-year this has a negative impact in fiscal year 2010. I think everybody has to take that into consideration when you look at how this company is growing and the leverage we are experiencing today in terms of cost controls and improvements we are making throughout Kensey Nash.

In addition, our R&D expenditures will increase in fiscal year 2010 by about 13% or $2 million. This will be due to the anticipated clinical trial and initiation of our clinical trials in our cartilage program which we are very excited about for the future of Kensey Nash. Not only for the European market but also for the U.S. markets but the U.S. market obviously we don’t anticipate to actually have the product approved for several years.

A couple other items I would like to point out in the press release you will notice earlier this month we announced the repurchase of the OsseoFit product from Biomet. This was something we have been talking about with Biomet for several months. This is a deal that allows us to get the OsseoFit product back into Kensey Nash. This is part of our overall cartilage strategy and brings all the technology into our building. The entire platform now is controlled by Kensey Nash and we will give further guidance on how this will proceed and what we expect to do with the OsseoFit and our cartilage program in the call in the first quarter. We are very pleased we were able to get these rights back and keep this technology in one place.

In addition, we also did highlight in the press release we have completed a deal for the ECM technology, or a piece of our ECM technology we have been talking about for several quarters. We had told the street we had expected to have a new partner on board sometime this summer and I am pleased to announce we do have a new partner on board and that is Synthes. Synthes will be our first partner and we are very pleased to start this new relationship with these new products that have been developed at Kensey Nash. The deal that we put in place will include milestones. It will include royalties. Kensey Nash will be responsible for the manufacturing and Synthes will do the sales and marketing. So this is another example of the ongoing diversification that we have in place at Kensey Nash in terms of both partners and also products. We are very pleased to announce this new relationship.

With that I would like to turn it over for questions.

Question-and-Answer Session

Operator

(Operator Instructions) The first question comes from the line of James Sidoti – Sidoti & Company.

James Sidoti – Sidoti & Company

On the Synthes deal can you give us a little more detail on that and tell us what they will be using this for and if there is anything built into your fiscal 2010 revenue estimates for Synthes?

Joseph Kaufmann

Sure. I will start out and then I will turn it over to Doug. There should be a press release, a separate press release that we believe has just come out that was issued by Synthes talking about the deal. A joint press release and it goes into some further details. We do have some revenue built into the back half of our fiscal year relative to this program. I think Doug can highlight for you the technology and the regulatory path and where we are with these various products.

Douglas Evans

From a macro perspective I think our objective with the ECM technology was to give quarter-by-quarter for this fiscal year, in the current quarter we really established our partnership for the first products. Then looking in the second quarter we have the objective to get the products initially approved. Moving further in the year if we look out to the third quarter for our fiscal year we are going to look at getting the first clinical evaluations of this product. Some of the areas that we are looking at include abdominal wall repairs, head, neck and chest plastic reconstructive type kinds of procedures. Finally in the fourth quarter of the fiscal year we are going to be looking at trying to get these products launched. From a macro perspective that is sort of the timeline for these technologies.

James Sidoti – Sidoti & Company

Can you give us a little color what does the sales force look like and the size of the sales force they have for abdominal repair? Could this relationship be expanded so that Synthes would be selling this for rotator cuff repair and orthopedic applications as well?

Douglas Evans

We don’t want to give out too much information at this point in time. Synthes, as you know, is a very well respected company and is well known throughout the world. They dominate in trauma but we look at Synthes now as a partner that is looking into expanding into other markets. We have committed to Synthes what we are going to do is really handle the terms of any kind of information we are providing to the street and we are going to be very careful until we get these products ready to launch.

So I will kind of hold back on that. In terms of expanding the relationship with other products, sure it could happen in different areas. We have certainly over the years have continued to develop and will develop other applications, other indications and so we note this relationship is going to grow and expand. It will be a major customer for us and as it works out they are doing well and we are doing well. We would hope that it would expand.

James Sidoti – Sidoti & Company

Then if we switch over to the cartilage repair products, by buying the rights back from Biomet what did that do for Kensey Nash? Did that make it easier to shop the products around to other orthopedic companies to control the elements? What is the main motivation for doing that?

Joseph Kaufmann

The main motivation was that cartilage has always been our big focus. As you know the OsseoFit has an indication only as a bone void filler and Biomet has the rights as a bone void filler. There was a lot of technology within that product. The motivation was that we felt that if we had all the technology back together so that we were able to take out any uncertainty on who owned what rights, distribution, where the [IP] was it would make for a much easier way to put together a potential deal with other players. So this allows us to move forward very clearly in terms of our strategy in getting through clinical trials, various indications, the control over the trials and eliminates any kind of potential conflict down the road with the technology. So that was our motivation.

James Sidoti – Sidoti & Company

On the income statement the other income was negative in the quarter again. With such a big net cash position I understand you have some debt from maybe a loan on the facility, is there anything else going into that?

Michael Celano

In this quarter it was pure investment income and interest expense. On our cash we are earning on average approximately about 1% on the investments since we are keeping very liquid and safe at this time.

James Sidoti – Sidoti & Company

So unless interest rates change materially we should expect to see about this level in fiscal 2010?

Michael Celano

Yes.

Operator

The next question comes from the line of Josh Jennings – Jefferies & Co.

Josh Jennings – Jefferies & Co.

On the cartilage program to start off with can you give us an update in terms of clinical sites or when first moment will be and sort of gauge us in terms of CE mark timeline and then secondarily on the cartilage program where is the competition with products similar to the products you are developing out there in Europe?

Joseph Kaufmann

As far as the cartilage, we filed our IDE earlier this calendar year and we are communicating and working with the FDA in terms of filing additional data, answering questions. The protocol in place, as I think everyone is fully aware, the FDA over the last year or so has been increasing I would say the bar in terms of data, in terms of studies, end points and so this is a very important trial and we want to make sure that we are going down the right corners here and the right path to make sure when we come out of this several years down the road that there is not going to be any question about the data or the study.

We have initially expected we would start the trial this summer or early fall. Now I don’t think we will start it until the earliest at the end of this calendar year. Maybe a little bit beyond that. I think the delay and getting it right is well worth it in the long run. So we will continue to talk with the FDA and continue to give them the data that they need to get the protocol in place. We have approximately 12-15 sites that have committed to the study. We expect it to go up to 20-25 and we are interviewing sites on a regular basis. As far as the CE mark approval we are hoping that we have that by the end of this calendar year. Regarding the competition in this space, you have the procedure; the micro fracture procedure is one that we would compete against. In terms of other products that are used Smith and Nephew, the TRUFIT was approved in Europe but not in the U.S. for the cartilage indication. You have Genzyme Carticel product. You have a lot of other companies that are out there, relatively small companies that are in various stages of clinical trials or pre-clinical.

Those are the major elements of answering your question.

Josh Jennings – Jefferies & Co.

In terms of your contract agreement with St. Jude I’m not sure if you have made any comments on continuing that contract and maybe if you can just help us think about timelines about when you would potentially have a contract in place to extend that? My understanding is that it ends in December 2010.

Joseph Kaufmann

It does end in December 2010. I don’t have any updates to provide to anyone at this time. I would hope there would be more information and update over the next…I don’t expect to have anything certainly before the end of this calendar year but I would expect we would have something in early 2010 so that we can move forward with the contract any way it turns out. We do have some certainly planning to do beyond December 2010. We are working with St. Jude and we will see how it turns out.

Josh Jennings – Jefferies & Co.

You mentioned on the call that units Angio-Seal year-over-year increased slightly but royalties came down. Should we assume that pricing is what would cause the royalties to come down despite larger unit sales?

Joseph Kaufmann

I think you have to look at two things. One the foreign exchange negative impact was about $300,000 so if you factor that in the royalties were down very slightly. The difference in the whole units is actually just a mix of heavier international versus domestic and the international pricing is lower than the U.S. pricing. I don’t think it has anything to do with price deterioration.

Josh Jennings – Jefferies & Co.

On the endovascular side can you give us any sort of timeline for launch trajectories for the next generation of endovascular products sold through Spectranetics? Have you received any update from them on the investigation that is ongoing? What is the potential worst case and best case scenarios for Kensey with this FDA investigation?

Joseph Kaufmann

I don’t have any information whatsoever with the ongoing investigation either way. As far as the second generation products, the second generation ThromCat is in the soft launch in Europe right now. We are waiting to see how that does and how Spectranetics performs.

Josh Jennings – Jefferies & Co.

In terms of your guidance on the top line, products $50-60 million, in terms of your different product lines are you expecting a deceleration in sports medicine and growth in the spine and in cardiovascular products? How are you, I don’t know if you can delineate some of these line items, but in terms of how you got to that $50-60 million in product sales for the guidance. Where are you expecting the growth in the specific divisions or across the board?

Joseph Kaufmann

I think what we expect to see for next year is that the sports medicine will be relatively flat, 2010 versus 2009. I think we definitely expect to see the spine products continue to grow and double digit growth in that space. In terms of Angio-Seal and the cardiology products we provide we expect to see in the low single digit growth. Then of course we would hope to see growth in the new products we are talking about towards the latter half of the year which would be in the ECM products.

Josh Jennings – Jefferies & Co.

Will we see market approval for the cartilage product expected at the end of this year and in 2010, are sales from that product internationally included in the guidance?

Joseph Kaufmann

No they are not.

Operator

The next question comes from the line of David Turkaly – SIG Capital.

David Turkaly – SIG Capital

On the ECM agreement do you need approvals for the processing of the tissue you are providing or is it just a straight 510K?

Joseph Kaufmann

It is a 510K on the final product.

David Turkaly – SIG Capital

In terms of your processing is there anything you can tell us about other companies out there that have I guess processes in place for treating the tissue? Do you have any, I imagine you have one in place, but have you commented at all on exactly what that entails and what other kinds of materials you may be able to process with that?

Joseph Kaufmann

Well the process we have developed is called the [inaudible] process and what we believe is proprietary technology which is based upon our years of work and processing biomaterial tissues. We feel it is fairly unique and it offers a wide variety of applications not only for processing porcine tissues but also other tissues as well. So we do explore those applications of that process for other devices over the next couple of years.

David Turkaly – SIG Capital

Does it render the tissue sterile or can you comment on that?

Joseph Kaufmann

No. Our process basically is used to remove cells from the tissue but to preserve essentially the extracellular matrix of those original tissues and also to maximize the strength of those tissues. It does not sterilize the product. What we do is we use a terminal sterilization method after we process with Optrex to prepare the product for use in the clinical setting.

David Turkaly – SIG Capital

On the Angio-Seal front, are there any newer versions that are coming? I think somebody asked this, from St. Jude this year. Any comment on just overall the competitive landscape you are seeing out there?

Joseph Kaufmann

I don’t believe there are any new versions this year. Last year, as you know, they launched the new version at TCT. The competitive landscape, I am not aware of anything that is new as far as products. The big hype over the Minx product is kind of in my view has subsided somewhat. That has been about it. There is always again many products in this space over the years but the Angio-Seal I think has proven to be an extraordinarily resilient product in the marketplace.

David Turkaly – SIG Capital

Any plans for new developments there in 2010?

Joseph Kaufmann

Well we have an excellent relationship with Vita and our teams are always working together with new products and new ideas. I think there could be some opportunities in fiscal year 2010 between the two companies to expand the product offerings, yes.

Operator

The next question comes from the line of John [Robo – Gaggin Securities].

John [Robo – Gaggin Securities]

I apologize up front I got on the call late. The ECM product you said that is porcine material, is that correct?

Joseph Kaufmann

That is correct.

John [Robo – Gaggin Securities]

You say your process is capable of processing other materials like allograft or bovine?

Joseph Kaufmann

Yes that is correct.

John [Robo – Gaggin Securities]

The Synthes contract you have today, what are the initial target markets again?

Joseph Kaufmann

We are evaluating a number of different markets as we mentioned earlier which start with the area of abdominal repairs and then we are looking at head, neck and chest plastic reconstructive types of procedures.

Operator

The next question comes from the line of Spencer Nam – Summer Street Research.

Spencer Nam – Summer Street Research

I was wondering what the current competitive dynamic and landscape is in the vascular closure space? Are you seeing any competitive activities and if so to what extent are you seeing that and how is Angio-Seal Evolution faring against the alternative options?

Joseph Kaufmann

Well as I mentioned earlier I haven’t seen anything recently that would be considered a new product. The previous product I think in the last year or so that I commented on earlier, the Minx has been out for some time now. But it certainly hasn’t impacted the market share of St. Jude. St. Jude continues to have by far the dominant market share and continues to the best of my knowledge has not lost any market share. What was the second part of the question?

Spencer Nam – Summer Street Research

Angio-Seal Evolution and how it is being received by physicians.

Joseph Kaufmann

Evolution product was launched at TCT last year and it appears to be doing very well. I haven’t heard anything but positive statements on the Evolution. Nothing on our end as far as I know in terms of any issues or problems.

Spencer Nam – Summer Street Research

Is there any presentation/data being released at TCT this year related to Angio-Seal?

Joseph Kaufmann

I don’t know. I can’t answer that question. I don’t know.

Operator

There are no further questions at this time.

Joseph Kaufmann

Again, I would like to thank everyone for listening to the call. I think the performance for Kensey Nash, again to all our employees, was outstanding in fiscal year 2009. We expect we will have a very strong fiscal year 2010. We will be back in the end of September with an update for the first quarter. Thank you.

Operator

Ladies and gentlemen this conference will be available for replay after 11:00 a.m. ET today until August 27th at midnight. You may access the AT&T executive playback service at any time by dialing 800-475-6701 and entering the access code 109060. That does conclude our conference for today. Thank you for your participation and for using AT&T executive teleconference service. You may now disconnect.

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Source: Kensey Nash Corporation F4Q09 (Qtr End 06/30/09) Earnings Call Transcript
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