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Executives

JJ Pellegrino - Chief Financial Officer

George LeMaitre - Chairman and CEO

Analysts

Jason Mills - Canaccord Genuity

Charley Jones - Barrington Research

Joe Munda - Sidoti & Company

Jason Zhang - Edison Investment Research

Larry Hemowich - HMPC

LeMaitre Vascular Inc (LMAT) 2Q 2013 Results - Earnings Call Transcript July 30, 2013 5:00 PM ET

Operator

Welcome to the LeMaitre Vascular Q2 2013 Financial Results Conference Call. As a reminder, today's call is being recorded. At this time, I would like to turn the call over to Mr. JJ Pellegrino, Chief Financial Officer of LeMaitre Vascular. Please proceed, sir.

JJ Pellegrino

Thank you, Jason. Good afternoon and thank you for joining us for our Q2, 2013 conference call. Joining me on today’s call is our Chairman and CEO, George LeMaitre. Before we begin, I would like to read our Safe Harbor statement. Today, we will make some forward-looking statements, the accuracy of which is subject to risks and uncertainties. Wherever possible, we will try to identify those forward-looking statements by using words such as belief, expect, anticipate, forecast and similar expressions. Our forward-looking statements are based on our estimates and assumptions as of today July 30, 2013 and should not be relied upon as representing our estimates or views on any subsequent date.

Please refer to the cautionary statement regarding forward-looking information and the risk factors in our 2012 10-K and subsequent SEC filings including disclosure of the factors that could cause actual results to differ materially from those expressed or implied. During this call, we will discuss non-GAAP financial measures which include organic sales and growth numbers. A reconciliation of GAAP to non-GAAP measures is contained in our press release announcing these quarter’s results as available in the Investor Relations section of our website at www.lemaitre.com.

I'll now turn the call over to George LeMaitre.

George LeMaitre

Thanks, JJ. Q2 2013 was an excellent quarter. I would like to focus my remarks on three headlines. Number one, Q2 sales grew 12% to a record $16 million, our third straight double-digit quarter. Q2 XenoSure sales grew 56% to a record 2 million. XenoSure is primarily responsible for LeMaitre double-digit growth and we expect it to post 2013 revenues of $7.3 million, a 43% year-over-year increase and finally number three. On July 5, we acquired the assets at Clinical Instruments International. We bought Clinical to improve our share in the shunts and catheters, our second and third largest products.

As to our first headline, we posted record sales of $16 million in Q2 2013, a 12% organic improvement over Q2, 2012 and our third straight double-digit quarter. Our sales growth over the last three quarters is primarily due to XenoSure, a refocusing of our enlarged European sales force, increased export competitiveness and a continued go direct strategy in new countries.

Europe was up 25% in Q2 and our new Canadian and Swiss subsidiaries posted 42% and 34% growth respectively. Indeed, we are now direct to hospital in 16 countries and are currently evaluating go direct options in Australia, which could happen in January 2014. Our export business is also doing quite well, up 60% in Q2 as we become more price competitive in vascular commodity markets such as grafts and catheters.

JJ's sales guidance at the end of this call projects a fourth straight quarter of double-digit growth. As to our second headline XenoSure has become the growth engine of LeMaitre and had powered ahead again in Q2 posting 56% year-over-year growth and a record $2 million in sales. For 2013 we project XenoSure will grow 43% to $7.3 million. XenoSure is our first sizable product line to exhibit such high growth rates, we estimate the worldwide 2012 vascular patch market was $30 million to $40 million and XenoSure had 15% share.

Here are three reasons for this product success. Number one, XenoSure is primarily used in carotid endarterectomy, we already sale $9 million of Pruitt Carotid Shunts each year. So these two products enjoy significant intra-procedure synergy.

Number two, vascular surgeons increasingly prefer biological graphs, as opposed to inner patching material such as Dacron and EPTFE and they believe that biologics cause less infection. And finally number three, our business plan is to marry high quality vascular products to a direct vascular sales force.

As you know, we are currently transferring XenoSure manufacturing from Vancouver to Burlington. In-house manufacturing should enable us to further develop our bovine platform adding shapes and sizes should provide growth. As to our third headline on July 5th, we acquired certain assets of Clinical Instruments International located in Southbridge, Massachusetts, clinical posted 2012 revenues of $635,000 and has 12 employees. Clinical shunts and catheters are quite similar to LeMaitre's, so this acquisition should allow us to increase share.

Clinical typically sold products through distributors, so there maybe pricing upside as we transition from distributor level pricing to hospital level pricing. Also clinical Southbridge factory is just 58 miles from Burlington right down the Mass Pike, which should make the manufacturing integration easier.

While most of the clinical products overlap LeMaitre products, the acquisition does bring latex free carotid shunts and latex free irrigation occlusion catheters, products that we had on the drawing board in Burlington.

In summary it was an excellent quarter, we posted our third state double digit quarter, international sales were up 19% and our new Canadian subsidiary delivered 42% growth. In addition in July we made a tuck-in acquisition which should boost our market share in shunts and catheters. At this point, I'd like to hand the call over to JJ Pellegrino, our CFO.

JJ Pellegrino

Thanks, George. For getting into our Q2, 2013 results there's a caveat for today’s earnings call. Our Q2, 2013 financial results are preliminary as we are currently evaluating historical inventory evaluations related to mid classified manufacturing hours which impact financial results to 2011, 2012 and the first six months of 2013 and where the prior period financial statements need to be revised.

Based on the current status of our review, which is preliminary and subject to change, the Q2, 2013 financials reflect the correction of this hour, which increased net income during Q2, 2013 by approximately $300,000. Any potential revisions to 2011 and 2012 financial statements would increase reported net income in those periods by approximately $400,000 and decrease Q2, 2013 net income by approximately $300,000.

We expect that on a cumulative basis that some of our potential period adjustments would be negligible to net income. Cash would remain unaffected by any adjustment and we are working to complete our evaluation as soon as practical.

That said, I would like to take a few minutes to comment on our Q2 2013 gross margins, operating results, dividend programs, stock ownership and liquidity and Q3, 2013 and full year 2013 guidance.

Gross margin in Q2 2013 was 70.4% versus 73.4% in the prior year period. The gross margin decline was driven by manufacturing inefficiencies, XenoSure start up costs, underlying inventory write-offs and a shift towards faster growing lower margin XenoSure and international sales. With regard to the XenoSure manufacturing transition our clean room build out was completed in Q2. We currently have 12 employees building product and we are manufacturing devices that we hope will be available for sale to U.S. hospitals in Q4 of this year. While we expect highest cost product initially, we believe that we will be able to improve XenoSure margins as we move into 2014 and beyond.

With respect to UnBalloon, we wrote off $350,000 of inventory in the second quarter, in response of sluggish sales and an impending next-generation launch. We are hopeful that the launch of a new device with stronger nitinol cage will enhance the appeal of the UnBalloon going forward. As George discussed previously, we have been having significant success selling our devices to faster growing lower margin geographies outside of the United States.

Gains in places like Egypt, Brazil and Taiwan contributed nicely to the top line, but tend to be at lower average selling price that to put pressure on margins. We think the trade off is rationale as it boosts sales growth and increases manufacturing efficiency and we expect to continue to pursue these and similar opportunities.

Moving down to P&L, total operating expenses in Q2, 2013 were $9.8 million versus $9.1 million in the year earlier quarter. This 8% increase was driven by higher administrative costs including expenses from our new Canadian subsidiary, higher selling costs and the Affordable Care Act tax. The company ended Q2 2013 with 85 sales representatives, up from 83 in the prior year period. As a result, operating income in Q2 2013 was $1.4 million, a 9% operating margin.

Cash and marketable securities of $14.9 million at June 30, 2013, a $400,000 decrease in the quarter largely driven by two quarterly dividend payments totaling $915,000 and XenoSure clean room construction cost of approximately $700,000 offset by cash from operations. Our Board of Directors recently approved a quarterly cash dividend of $0.03 per share of common stock to be paid on September 4, 2013 shareholders of record on August 21, 2013.

Future declarations of quarterly dividends on the establishment of future record and payment dates are subject to the determination of the Board of Directors. For the year-to-date 2013, we have paid $915,000 in dividend and have repurchased $85,000 worth of our shares of common stock. It’s interesting to note that the average trading volume of LeMaitre shares in Q1 and Q2 2013 was up more than 15% over 2012.

With respect to guidance, we expect Q3 2013 sales of $15.2 million, up 10% organically versus Q3 2012 and operating income of $1.1 million, 7% operating margin. We increased our 2013 full year sales guidance to $62.3 million, up 10% organically versus 2012 and maintained our operating income guidance of $5 million and 8% operating margin. We also increased our 2013 XenoSure sales guidance to $7.3 million. All guidance excludes the effect of changes in the foreign currency exchange rate as well as future acquisitions and divestitures.

In closing, I would like to welcome Jason Zhang of Barrington Research to our growing list of covering analyst. We look forward to working with a professional of Jason’s caliber and the company with the European exposure of Edison. We now have four analysts covering the company.

In addition, I would also like to let you know that we will be presenting eight upcoming investor conferences Canaccord Genuity Conference in August, in Boston; Three Advisors Conference in August in Chicago, the Barrington Research Conference in September in Chicago. Stifel Nicolaus in September in Boston, Craig Hallum in September in New York. Bringing Capital in October in New York, Canaccord Genuity in November in New York and Sidoti & Co. in November in New York.

And finally, we will be holding our 2013 Analyst Day at our headquarters in Burlington, [Mas] on November 12 and also in San Francisco on November 13. We look forward to seeing some of you then. With that I'll turn it back over to Jason for Q&A.

Question-and-Answer Session

Operator

(Operator Instructions) The first question comes from the line of Jason Mills with Canaccord Genuity. Please proceed.

Jason Mills - Canaccord Genuity

So first of all, just a question on XenoSure and then JJ, a question on your guidance, I know it's a little bit too early to give full 2014 guidance but sort of your run rate it’s little over 7 million this year, what kind of growth prospects can you give us for next year often fairly strong 2013 for that product specifically and then JJ with respect to your guidance another quarter, double-digit quarter expected in Q3, but it would imply obviously against a little bit more difficult comp it would imply Q4 is actually a lower revenue quarter than what you just put up in June that’s typically not your pattern. So is that just conservatism in play or is there something else going on in Q4 that we should model?

George LeMaitre

So Jason maybe I start answering this and I know you direct to the back of it to JJ, but maybe I start with this initial thing, we are to be able to sort of out dissect out and give guidance on this thing for 2013, it’s such a big number inside the company and so we look at it so closely but I really don’t want to poke into 2014 guidance and I am sorry, I just don’t feel like doing that it’s a great product, it’s going great, may be one or two bit I can add to that is that in Q2 there was a 41% growth rate in the United States and the reason I pull that out it’s not true that this is just all because we are launching in Europe and in fact the European launch has been staggered a lot because we’ve got into different countries at different speed and right now I would classify it as generally just as Central European launch.

So I guess it’s a long winded way of saying we are still very bullish with the product it’s exciting to have such a big product and of course even if we had not a 43% growth rate next year, and it will something a little lower, a course of time, so much of a larger base that number is eating up more and more of what we owe well through in terms of growth in order to get to double-digits.

JJ Pellegrino

Yeah. And in terms of your second question Jason. I would say few things one is, if you look at the quarter sequentially each throughout the year where we did 15.4, 15.9 and 16, now we are saying 15.2, and back after 15.8 so sequentially you are going up $600,000 from Q3 to Q4 so that is a pretty healthy jump there and in addition that 58 implied is not too far below the 15.9 in Q2, and Q2 tends to be seasonally a nice quarter for us, so I would say it’s not a natural that the Q4 might be little bit below the Q2.

And I would agree with you that we have sort of tougher comp in Q4 so that get you to sort of 7% reported growth rate but I would say maybe there is some New England conservatism in that and we hope to certainly beat that number or at least put in a solid showing in Q4 in terms of the 15.8 or even better.

George LeMaitre

And Jason one last thing here, we are implying and we are getting a 10% organic growth rate for the year and so look at globally for the whole year, we did 8.3 in 2012 and we are giving you a 10.1 or 10.2 is the real number for 2013, so we are pretty excited that we have been able to accelerate growth from ‘12 to ‘13.

Jason Mills - Canaccord Genuity

That is very helpful, and I see where you are going with all that, we are getting answers, so just as a follow-up and I will get back in queue. Understanding that you're not ready to give 2014 but it will having the model and I am sure you sensitive to that, so tell me the way you think about this year phenomenal growth everyone wants to see double-digit growth but it is coming again somewhat of a difficult comp not to take away from the growth because the stock is still trading like one X time it’s not expensive by any means. So you're really not getting credit for that kind of growth rate, but if we look at next year with XenoSure comp being a little difficult and obviously just the full company comp being a little difficult, offset by the fact that you're actually participating in the markets that are growing compared to CRM for instance which aren't. Should we look at 2014 more similarly to your organic growth rate in 2012 which sort of at least a place to start George?

George LeMaitre

Well, I mean there is not that much to choose from I guess, it's 8.3 organic growth in 2012 and then I don't know what guiding 10.1, 10.2 for. So maybe you take those two numbers and you look at the difference between them although, honestly we just can't give guidance in 2014. We usually give guidance for that year in the February of that year. So and I realize you guys are modeling, you're just looking for a modeling number, but I think we're just not ready to give guidance and I wish I could. But we just don't feel comfortable.

Operator

(Operator Instructions) And our next question comes from the line of Charley Jones with Barrington Research. Please proceed.

Charley Jones - Barrington Research

So, how surprise were you by the XenoSure growth, I mean you guys definitely put your cards pretty close last quarter not line to give any guidance on that. But just wondering if this is kind of that deployment is surprising you and so maybe we can continue to see nice surprises like this in the future or else if the caps really do get tougher here and do you think there could, should be a slowdown in the growth rates here?

JJ Pellegrino

Okay, so how surprised were we? Yeah, right, well, so you can get a gauge on how surprised we were which is we had a 7.1 guidance for the year plugged in as of April 28th and here we are sitting three months later exactly and we are plugging it at a 7.3, so we've upped guidance a little bit and that to say, yeah, as of three months ago, we are kind of expecting a $7 million product line and now we are kind of expecting $7.3 million. So it means something good happened. It was a robust Q2 for XenoSure. There's no question, getting up to that $2 million number was a $400,000 sequential increase from Q1 that was pretty solid, we said about that. Some of that inside they are just temporary expectations a little bit, there was 50,000 worth of a one timer and equine XenoSure patch that was going on that carried very little margin. We don't expect that to continue. So maybe a pull down a little bit on that, but yeah, we were happy with the quarter and it shows up in our increased guidance.

George LeMaitre

I would say in Europe XenoSure has been on the market for a shorter period of time than in the U.S. and it still has a lot of room to run in their geographies in Europe where you can still sort of plug XenoSure and it get that nice early stage ramp, so there should be continued good things coming out of XenoSure on that front.

Charley Jones - Barrington Research

How are the launches going of some of these new products, maybe remind us what you launched last quarter and when do you expect to launch the new UnBalloon?

George LeMaitre

Sure. Okay. The UnBalloon answer is easy and clean, that's sort of a Q4 topic. We are just submitting our regulatory paper work here. So that's a Q4 topic. In terms of the launches so actually the high level headline is the quote big launches over the last year and a half or so contributed 50% more sales in Q2 than they did in Q1 of this year. It’s still not a giant number. They are running at about I think $1.5 million in annual sales in the Q2 quarter and they were running at something like, I know I get the number wrong but some like $900,000 in annual sales in Q1.

So you saw a nice ramping and a nice contribution of the new products. The new products are the 1.5 Valvulotome. They are the multi-task. We're still counting UnBalloon as a new product. It's over the wire LeMaitre Valvulotome. I think it's those four and then more recently about a month and half ago, we launched what's called AlboSure which is a corroded patch except it's made out of Dacron which goes with the AlboGraft product line. Those are the new products. It's going quite well. We're in the hospital. We're getting with the 1.4 LeMaitre Valvulotome with a [Mills] Valvultome inside of it and also as you mentioned, the next general UnBalloon.

Charley Jones - Barrington Research

Quick question on your sales force. I think maybe it was a year and half, two years ago, you started hiring some less experienced reps, some junior reps and I am curious how that strategy is gone, whether or not you had a lot of turnover or whether or not these guys have ramped at original pace to get to a profitability or whether or not maybe you need to go back to a more estranged rep. Obviously, you guys are doing well (inaudible.

George LeMaitre

Sure. Okay, so this is a big topic at LeMaitre. Actually we started program in November of 2008. So we're now in to year five, year six of this program and over this years, we had about 45 reps back then and we have 85 reps right now. Almost all of the reps have transitioned from we used to have higher paid and now we have lower paid [Tier-A] reps is what we call them. At the company’s level, the move has been tremendous in terms of allowing us to speed up the growth of our reach to get more geographic penetration going from call it 40 or 50 reps to 85 today.

And at the same time, you’ve seen that put leverage on the bottom line of this company. In 2007 we lost $5 million of op income, and in 2013 we are guiding for $5 million of op income. It’s a huge delta and I would say in general terms three quarters of that delta can be pulled out, because we are saving approximately $100,000 per sales rep times 80 reps.

So a big large chunk of the explanation LeMaitre leverage over that period has been above the sales force and you see on all the charts on our website, it really has a lot us to stick tightly at $35 million or $36 million of annual operating expenses even all the while we’ve been growing the sales force dramatically and you are hearing us go to places like Canada and Switzerland and now maybe Australia.

These new markets are not available to us unless we’re going with lower price reps. So it’s half of the question. The other half is well how they’re working, how the turnover, I would say a big part of that move was born out of the frustration that we found as a small device company that people are just going to leave, sales reps are going to leave in two or three or four years.

You should build your financial model and your pay model around the fact that they are going to leave and they are going to go to stuff like intuitive surgical, stuff like Medtronic and these bigger and/or really sexy companies until. I would say to you, in general the turnover has not really changed, although it’s still not a wonderful aspect of LeMaitre Vascular to still turnover in the sales force, but instead of we used to sort of pay in the hopes that they wouldn’t turnover, we are now paying knowing that they are going to turnover and just accepting as part of the model.

Operator

The next question comes from the line of Joe Munda with Sidoti & Company.

Joe Munda - Sidoti & Company

Real quick George keeping on the sales force front, I know you touched a little bit on a AA rep and acute system, but you did mention you refocused your sales force, is that what you are referencing in the last comment or is there something else going on in Europe that we should be aware about?

George LeMaitre

Right, in fact that’s something very different, glad you pulled that out. So in Europe we have now finally transitioned fully Tier-A but that is not what I was talking about. The refocusing is more, I hate to keep mentioning a word stent graft for you guys. We are trying to put that in the path but it is our move away from stent graft which happened in mid 2011 and we used to have our sales reps sort of half focus stent graft and sell the Endologix stent graft and have focus on the LeMaitre Vascular 12 product lines.

And so when we got cards to get rid of the Endologix stent graft in mid 2011, it’s really been like a renaissance over there for us, and it’s showing you always great growth numbers. Every time I get on the call these days, Europe is growing 20%, it’s 15% and it’s 25% and the reason that is because we have taken that thing out of their eye sight which was the old Endologix stent graft and we focused them squarely on all of our products.

Now inside of this also Joe we went directly in Switzerland and Spain and Denmark so you have a little bit geography, I would say that’s wrapped up and it’s a little bit and then also we’ve given the manager over there opportunity to expand the sales force roughly 25 reps or roughly 35 reps. So those three things going direct in those countries, getting on a stent graft and the expansion of the sales force over there have been added to the fact that they have now transitioned to Tier-A. And again in fact, when we move to Tier-A and it's a lower price model, it gives us room to do all these other things like go direct in these countries and increase the gross number of sales reps.

Joe Munda - Sidoti & Company

I'm sorry. And George the number of sales reps you had domestically and internationally you said 25 to 35 now?

George LeMaitre

I would say there is, I'm going to get the numbers wrong here, I'm sure they are here somewhere in front of me, hang on I'll get it. So right now we have 45 reps in North America, we have 32 in Europe, we have 8 in Japan for a total of 85.

Joe Munda - Sidoti & Company

Okay. So that, I think last quarter you guys said 83 if I am correct?

George LeMaitre

That's correct.

Joe Munda - Sidoti & Company

So you added two more. As far as the growth is concerned, I know on the last call, you touched on unit growth versus price increases, can you give us some sense of where that occur, was price hikes here more of a factor or is it consistent with the two-thirds, one-third?

George LeMaitre

It's exactly consistent with two-thirds, one-third. So we had a 12% organic growth and we are attributing 8% of that to unit and 4% of that to place Joe just like on the last call.

Joe Munda - Sidoti & Company

Okay, great. And then just two more and then I'll hop back in the queue. The acquisition you guys did, I know on the phase of it, it seems very small here, but your comment on the latex-free I know that people with latex allergy that could be a pretty big opportunity, was that the thinking in that acquisition?

George LeMaitre

No, it really was not, actually that was the late pick up, it was sort of a nice thing that came along. The thinking in this acquisition was this is sort of a medium priced competitor and we wouldn't mind getting a hold to this means of production to increase our market shares in shunts as well as embolectomy catheters. They've been nipping at us for a long time again as you know our shunt and catheter business is probably a $20 million business, all pooled and this is a $600,000 competitor and we just felt like hey one of our imperatives is to keep growing in the markets that we really like being in, we want to grow share and that's mostly what we were doing.

And I would also add that it really is 58 miles down the Massachusetts Turnpike and I know that sounds like a small thing on a conference call but in terms of ease of integration we're used to closing factories in France and Italy and California and it's just, It's horse in the mouth in terms of difference and integration ease and so we thought given those two factors its worth doing.

Joe Munda - Sidoti & Company

Okay and you said they did about $650,000 in revenue or that's the revenue run rate and mostly from distributors, right.

George LeMaitre

That's correct.

Joe Munda - Sidoti & Company

So can we assume that now this thing when it gets integrated into your operations you are technically going to capture all of that direct margin, is that the plan.

George LeMaitre

The plan is that I think it is a complex business running around buying out distributors so you'll see that take place over 18 months but that is generally where we're going with this.

Joe Munda - Sidoti & Company

Okay and then I guess my final question for JJ well and you George you guys upped the revenue guidance nicely here but the op income guidance and the op margin guidance stayed, you guys maintained that and I'm just trying to get a sense here are we going to see gross margin I guess that would assume gross margin in the low 70s for the rest of the year.

JJ Pellegrino

Yeah, I think generally speaking at a high level yes, the sales increase is being offset somewhat by lower margins and I think the XenoSure start up piece is with us for a little while longer. We're going to keep ramping up that group, we've got 12 or 13 folks manufacturing XenoSure hopefully ready to put on the shelves in Q4 and so the hospitals and so that will keep coming through the P&L and hampering gross margin.

We're going to continue probably the South of geographies that tend to be faster growing but have lower ASPs and therefore and lower margins and that keeps the lid on the gross margin piece as well and so those negative trends have basically I think yes, going to keep the gross margin suppressed for a while in the low 70 and the 70% range what you've seen and that is in fact the main driver between not getting more leverage on the P&L in their subsequent quarter.

George LeMaitre

And Joe, I would say, and I hate to go back to this Obamacare thing but just I promised after the end of this year I won't keep bringing this up but we did lose $750,000 of op income, apples and oranges versus last year. So if you can allow me to extract Obamacare this year only, we're going from op income of 4.2 last year to op income guidance of 5.75 and I know you'd agree that's decent leverage on a business of our size. It doesn't look so great because the real guidance is $5 million but hiding under that is an extra $750,000 that we got to pay to Obamacare.

Joe Munda - Sidoti & Company

Oh, George you're very patriotic, so we appreciate it.

George LeMaitre

No problem.

Joe Munda - Sidoti & Company

Thank you.

Operator

The next question comes from the line of Jason Zhang from Edison Group. Please proceed.

Jason Zhang - Edison Investment Research

Okay, can you hear me well?

JJ Pellegrino

Yeah, we can hear you, Jason.

George LeMaitre

Hi, Jason.

Jason Zhang - Edison Investment Research

Okay, thanks. Okay I wanted to start with the gross margin, the first quarter was around 72, now 70, JJ, you mentioned that will be staying at that level probably for this year, I understand that manufacturing transition of XenoSure is probably the biggest impact factor for that I'm still wondering from a timeline point of view when do you think this transition will be in place and it you will be coming back to enjoy in a better gross margin and I have one questions related to that?

JJ Pellegrino

Yeah. It’s a good question, Jason thank you. So we're starting to manufacture product now. We hope to have it available for sale in the hospitals in Q4, but we will continue to ramp production as we go assuming that we feel comfortable that the products going to be validated and available for sale. So your initial product that you sell is probably sometime in substantially in Q4, Q1 that product is probably going to be pretty expensive, because you're just starting up the process, and when your first transition to manufacturing facility, you don’t have all the efficiencies in place that you'd like to and you start ringing those out pretty aggressively typically that’s what we've done with integrations in any case and I expect that we will in this case as well.

Over the next few quarters, so I would say into Q2 and beyond of next year hopefully you'll start to see significant cost reductions in the price of XenoSure manufacturing here in Burlington.

George LeMaitre

And I'd add to that Jason that a big piece of the Q2 gross margin issue was the UnBalloon write-off $350,000 and so you won't have those coming back to bite you all the time, that's getting pretty deep into that topic of how much is written off that should be a nice 2.2% non-event generally speaking going forward so you get off the hook on that.

Jason Zhang - Edison Investment Research

Okay, with regard to the inventory flexible readjustment (inaudible) the number one how does that affect your net income is because of the cost of goods sold impact and also you said accumulates to be, it won’t have much impact what’s the period in two or three quarters aggregate, or I just want to get it from the comparison point of view what does that impact, I guess on the quarter-for-quarter basis?

JJ Pellegrino

Yeah, I think the way to think about it Jason is in 2011 and then in 2012 we have the lower net income then we would have if do this adjustment and in Q2, it’s the reverse and so if we went back and restated, we would unwind those and then we would have higher net income in 2011 and 2012 and we would lower in 2013 and that’s the general dynamics that would happen. We are talking about $300,000 to $400,000 amongst the periods and it basically next to zero because you are fixing in current periods what was not correcting prior periods and so they essentially next to zero overtime. Does that answer your question?

Jason Zhang - Edison Investment Research

I understand that part but I guess for me, how will that impact net income and I guess which line of the P&L back?

JJ Pellegrino

Yes, you are right, so this is all in the cost of goods sold line Jason, and it was basically related to the calculation of manufacturing cost based on data input from direct labor hours. And so on that's all in cost of goods sold and then and none in operating expenses. But then that obviously does flow through the operating income and net income.

Jason Zhang - Edison Investment Research

Okay, that's great. The recent acquisition that clinical, I know you mentioned George you said the [Shunt], the balloon business the 20 million this is only a 600,000 at a current level. Do you expect this to be a material impact on your revenue sometimes on a row may not be in the first, second quarter from now but down the road, what do you expect it would we expect to see this as material at all?

George LeMaitre

No, I don't expect, we bought a company that was 160 of our size. So I don't expect this to be material, I feel like this is just a small tuck-in one that you probably should do. We made a small press release it's in the even show up to the bottom of this press release this time. So it's pretty small for us, but we thought like we should do it anyway.

Jason Zhang - Edison Investment Research

Okay. And then just quickly, I know you talked to some degree about the emerging market, I know certainly we have to be careful on one hand there was potential, on another hand there was a lot of cost concern and that's difficult to business in some of the emerging countries, what can you tell us in next year or probably in couple of years, where you believe your business will be in those countries and how much do we, should we pay attention to there. And of course with regard to some of the recent I guess news from the industry, you realized how difficult to the business in countries such as China. Does that affect your thinking or your plans going forward looking at the market that is growing but also realizing the challenges that may lay ahead?

George LeMaitre

Right. Okay. So my sense is we talked about Australia in this call. My sense is we are going to go to Australia in the next six to seven months and obviously none of us would call that an emerging market but it will be a new piece of the geographic footprint. So that seems like that's going to happen. I also feel like we've been talking about Brazil and China inside this building a lot lately and we keep on sort of trying to figure out what’s the next best move is. It feels to me like China after Australia for us and whether we want to classify them as emerging market I don't know but that feels like another place where we will go.

And then the question you said how much if we are talking about emerging markets now and we are staying away from China and Australia and just if you are looking at places like Vietnam maybe for Brazil in there, it’s still a small piece of what we do but we are finding a lot of success in it. So it’s still small for us. I think 93% of our sales are sold in markets where we are direct to the hospital and so by deduction only 7% is elsewhere and not all of those are emerging markets but some of them are. So it’s still pretty small for us but its growing rapidly. We are finding some good things that had, some really good things happened in H1 where I think everyone around a company felt this. I don't know what happened but all of a sudden things were just clicking or hitting on all cylinders. The brand is making sense in a lot of markets.

We have a very aggressive export effort going out of our European office and so there's some plenty of good things in the water in H1 about export and people recognizing our brand and I believe that's going to continue. It’s sort of on the back of us recognizing that we have a really nice commodity portfolio inside of our company and I think we always sort of used to not look so closely at it but the catheters, the shunts, the XenoSure to a certain extent and maybe the ramps. These are commodity products and the emerging markets really want these products. They don’t want our fancier products as much and all of a sudden we are discovering that and we're playing aggressively with pricing, winning a lot of orders and contracts.

So the good side of this is you can see our sales growth rate tick upwards and the negative might be, you feel it in the gross margin a little bit although this quarter’s gross margin add a lot of different things in it right now. So it is not all that but you can feel as a negative but also I think we all agree. We keep talking about unit growth rates of 8%, 7%. It starts to get exciting and allows us so we can do some things in manufacturing that we never used to be because we're accessing these emerging markets.

Operator

The next question comes from the line of Larry Hemowich with HMPC. Please proceed.

Larry Hemowich - HMPC

So many of my questions have been answered and there were a lot of good questions. Just a couple, one, the organic growth was 12 but the unit growth was seven. I am assuming that the obvious is price increase or is that currency?

George LeMaitre

That’s right, Larry. It was price increase. We're quoting. I think, Joe asked this question. We're quoting two-thirds unit and one-third price for this quarter.

Larry Hemowich - HMPC

On the buyback, JJ. You mentioned there was, I didn’t get the number of shared but there was some buyback. What was the number share buyback?

JJ Pellegrino

We bought back about $85,000 worth of stock in Q1 Larry but we didn’t by any in Q2.

Larry Hemowich - HMPC

Not lately my question, which is I am assuming at this prices you are not that anxious to be buying the stock back?

JJ Pellegrino

Well, its two things, the stock has had a nice run up recently and that’s nice to see and we have been opportunistic buyers historically and we will pick and choose our spots as we go forward by, in addition the bank balance is down around $14 million to $15 million. We would like to say its power for acquisitions that are in the pipeline and this is one place you can go to do that. So its seems to make sense to slowdown the share repurchase for now, Larry.

Larry Hemowich - HMPC

It does. And finally your comment someone mentioned, the George is patriotic and had a good laugh about that. I will see you guys in Boston in a couple of weeks.

Operator

Next question comes from the line of Raymond Myers with [Lear]. Please proceed.

Unidentified Analyst

Yeah. Thank you, my question is for George, George can you discuss the margin and strategic support related to the transitions to direct distribution? You’d mentioned that potential transition to a direct distribution in Australia and also direct sales supported by the Clinical Instruments acquisition?

George LeMaitre

Okay. So Ray I am hoping an answer to this question right for you, but so LeMaitre has made a cost slab over the last 10 years of not working with distributors in general and sort of trying to go direct as quickly as possible. The reason why we’ve done that is our product seem to be so niche that usually refine distributors don’t pay as much attention to our products, as we’ve like them to, as a kicker here it helps our gross margin obviously when 93% of our goods are sold directly to hospital rather than the 7% that are sold to us, through distributors; most companies of our size might be 50% direct in the US and letting the European distributors to care of the rest.

So we’ve had better margins over the years because of that. I will say it adds to the expense on our income statement to have 85 sales reps at a $62 million company, and it’s fairly expensive to go the route we are going from the selling and marketing perspective but maybe we give back some of what we earn in the extra gross margin by having more sales reps on the payroll.

Unidentified Analyst

So the transition to direct in Australia that you are contemplating, what kind of support would be expected to gross margins from the move like that?

George LeMaitre

I think Australia is small enough, you are not going to feel it, and I think it’s about a $400,000 business at the hospital level down there. So right now to do the math here in front of you maybe we are selling 200,000 to distributor at a 50% gross margin and maybe next year or the year after whenever we decided to do this and you are selling 500 or 400 at a hospital pricing and sort of 65% to 75% gross margin.

So you will pick up gross margin but of course in the early years in these go direct efforts it’s definitely not a financial windfall from an operating income perspective, you are definitely giving back everything that you get in the gross margin pick up would be operating income thing or the operating income losses I should say, and what we found though is that over three years over seven years, the growth rates are phenomenal, you can see this we are making a case here about Canada we grew sales 42% in Q2, we really just set up our office in January of 2013 in Canada and in Switzerland, I think our H1 growth was either 80% or 90% in Switzerland. And it was because we opened up our own direct selling efforts in Switzerland in January of this year. So you'll get flashy exciting growth rates in these new markets, but you do have to deal with patience to wait for the profits to show up.

Unidentified Analyst

Right. And I always thought that there was a lot of strategic benefit to having your own employees rather than distributors selling your products. What benefit is there to having the clinical instruments direct sales people, are they duplicative of your own sales force or do they add extra power?

George LeMaitre

Right, sorry, I probably misspoke or mislead somehow, but we didn't get any sales reps from these guys, it's strictly a 12 person manufacturing facility in Southbridge. They sold all of their products through distributors, sorry third party distributors. And so the advantage here over 18 months, over 24 months as we switch to direct to hospital sales, we'll be that we will cut off the middle man that they have necessarily associated with their products and the math might be something like what I described to you about our products in Australia.

Unidentified Analyst

Right. So it's your strategic power of having your own direct sales force over a product line that previously only had a distributor sales force?

George LeMaitre

That's right. Our acquisitions are almost always centered around the hypothesis. We're trying to marry a vascular sales force which is ours with a product line which has lost its way and is no longer associated with a good solid vascular sales force in house.

Unidentified Analyst

Very good. And George you'll be happy to know that when I first started looking at intuitive surgical they were smaller than they?

George LeMaitre

Well, it's been a good success. So I guess recently they went into a little problems, but I'm sure they will work their way out of it.

Operator

We have a follow-up question from the line of Joe Munda.

Joe Munda - Sidoti & Company

George, I don't mean to put you on the spot like this, but the question I consistently get hit with from investors is you know the comp to Vascular Solutions and the leverage that there is in their model as far as op margins are concerned. I know it’s a little preliminary here, but is there in your mind do you think you can get to that double digit op margin in two to three years, I mean you guys have been trending here 9 to 8.5 range and what will take it to that next level do you think that you would have to do an acquisition to get to that level.

George LeMaitre

Okay, great question and you know I do like being compared to Vascular Solutions because I would love to have their multiple on our revenue so the more you talk of us and Vascular Solutions the happier I get Joe so thanks. So at a very high level generally speaking from ’10 to ’11 to ’12 to ’13 and this is from memory here I believe our annual op margin has sort of drifted up from 6% to 7%ish and now our guidance here is for 8%. And again this year if not for ObamaCare and I apologize for doing this again we would have had a 9.5% op margin, the one you are wanting us to get to is 10%. So it does feel like it’s drifting upwards, I think it’s never been as fast as we had always wanted it to be, but it is pushing upwards and you do have an 8% keyed in for guidance this year and I think it’s coming off of a 7% last year, 4 million divided by 57, yes so something like 7% and 6% the year before. So there's a little bit of leverage being created and it’s not for ObamaCare, you would have seen a lot of leverage and it would have been a growth of, I don’t know almost 25% to 30% op income and I think you would have been satisfied with that.

Operator

At this time, there are no further questions in the queue. Ladies and gentlemen, that concludes today’s conference. I would like to thank you for your participation and you may now disconnect and hope you have a great day.

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