ZOLL Medical Corporation F4Q09 (Qtr End 27/09/09) Earnings Call Transcript

| About: Zoll Medical (ZOLL)

ZOLL Medical Corporation (NASDAQ:ZOLL)

F4Q09 Earnings Call

November 11, 2009; 10:30 am ET


Rick Packer - Chief Executive Officer

Jon Rennert - President

Ernie Whiton - Chief Financial Officer


Stephen Simpson - Northland Securities

Joshua Zable - Natixis

Jonathan Block - SunTrust

Greg Brash - Sidoti & Co.

Ross Sandler - RBC Capital Markets


Thank you for holding for the ZOLL Medical Corporation fourth quarter results. Today’s call is being recorded at the request of ZOLL Medical Corporation. If anyone has any objections, you may disconnect now. At this time, all participants are in a listen-only mode. Later, we will have a question-and-answer session following today’s speaker.

At this time, I’d like to introduce your host, Mr. Rick Packer, Chief Executive Officer. Sir, you may begin.

Rick Packer

Good morning and thank you for joining us this morning. Jon Rennert, our President; and Ernie Whiton, our CFO are with me this morning to help provide some inside on our business and answer your questions.

As this tradition, Ernie will start with our Safe Harbor.

Ernie Whiton

The matters we will be discussing today, which are not historical information consist of forward-looking statements. Reliance should not be placed on forward-looking statements because they involve risks and uncertainties, which may cause actual results, performance and achievements of the company to differ materially from the anticipated future results, performance and achievements expressed or implied in such forward-looking statements.

Forward-looking statements may contain estimates and the actual results may vary materially from estimates. Factors such as overall economic conditions, the demand for the company’s products and services, availability of raw materials and manufacturing capacity, risks of non-payment of accounts receivable, risks associated with foreign operations, risks involved in litigation.

Other risks and uncertainties described from time-to-time in the companies filings with the Securities and Exchange Commission may cause actual results to differ materially from management’s current estimates and expectations. The company disclaims any current intention to update forward-looking statements in the event of any changes in the facts, circumstances or expectations that underlie those statements.

Rick Packer

Thanks, Ernie. Turning to the business, we’re proud to end fiscal year 2009 on a high note with our revenues once again growing and we’re obviously happy to get ‘09 with its unprecedented market conditions behind us.

As we have stated throughout the year, our mission in ‘09 was to get through this period with the company squarely in the black, our people intact, having made continued large investments to push the LifeVest and Temperature Management forward, and continuing to have a very strong balance sheet. In fiscal 2009 we accomplished all of that and more.

So, as we look forward with the market in North America showing some although very small, signs of life, we believe we are poised for another period of good revenue growth and a rebound in our profitability and while our official outlook will remain unchanged and conservative, we certainly feel more confident in our short term prospects than we have in a few quarters.

This confidence springs mainly from our robust backlog, which is at a level we have not enjoyed since 2007. Continued sustainable growth from the LifeVest, new growth from Temperature Management, and a number of strong elements from the military business allowed us to grow revenues while at the same time adding significant backlog.

So, while we are reporting revenue growth of only 2%, our overall order growth was obviously much higher around 12% and on a sequential basis was over 20%. So, some signs of recovery, but still a ways to go until the North American capital equipment markets recover.

Now turning to the hospital market in North America, we are still experiencing decline over last year’s record numbers, but much like the U.S. unemployment picture, the rate of deterioration is slowing. In fact, Q4 was our second quarter in a row with sequential growth and while that growth was only about 4% on a shipment basis, accounting for backlog, order growth was much stronger in the U.S. hospital market.

We believe the U.S. hospital market is stabilized, and as we now start easier comps compared to the prior year, we will see continued progress and the pipeline of good sized deals looks much better than last year. We continue to believe, based on wins and losses that we have picked up some market share in this market during 2009.

Going forward, our product offering has been further enhanced by the addition of non-invasive blood pressure and entitle CO2 monitoring as new features on the R Series platform. Combined with the basic life support version of the R Series, which was introduced last spring this completes the major elements of the R Series platform. We shipped these new monitoring parameters in September, and we will now be able to move customers more rapidly from our M series to our higher margin R Series product. Our sales force is very happy to have this added capability.

As mentioned earlier, we had good military business this quarter. We had an expected lift from the completion of one contingency contract and it was pleased to win the follow on contingency contract. In addition, we had additional strong order flow from various parts of the military. For all of 2009, we were just over $25 million for U.S. military, which obviously helped a lot. As always, this business remains lumpy and unpredictable.

So when Ernie provides forward guidance in a moment you will hear our typical view that next year will not be as high as we planned conservatively. This in spite of the fact that in 2010, we should have the benefit of a new military defib that we inherited from Welch Allyn.

This defib was essential tailored for the military by Welch Allyn, using some R&D grants from the military to get the research and development going and is built on the market leading pro pack monitor, which adds key resuscitation features. This product has been submitted to FDA for 510(k) clearance, and we look forward to telling you more about its status in January.

Turning to U.S. EMS; as expected, results were down from last year, as the buying environment slows and while we experienced sequential growth, we are not expecting much from that market in the next couple of quarters, as we face some difficult comps. We expect to launch carbon monoxide monitoring parameter on the E Series at the end of Q1.

This will line our features up directly with Physio-Control’s, White Pack 15 and give us an added advantage over Phillips’s MRx product. So our product offering remains very strong in EMS and it is simply a matter of grinding it out in a smaller market and seeing if we can continue to take small bits of market share in the U.S. EMS market.

In international, our results bounced back nicely from a weak Q3. The economies are not as much affected internationally as they are in North America. So we continue to make good process in Asia, Latin America, and the Middle East. In fact, our biggest AutoPulse sale this quarter went to Brazil, 30 units.

Our international results have been depressed all year due to foreign exchange headwinds, but now that the U.S. government has fixed that problem with a nice weak US dollar. We look for a tailwind in 2010 that will certainly make things easier.

A couple of quick updates on some product before I finish with the LifeVest, obviously our AutoPulse results were the one real disappointment in Q4. Clearly U.S. EMS sales of the AutoPulse are being affected by the economy and we can’t do much about that. However, equally important, our sales efforts in 2009 suffered on the AutoPulse as our sales forces struggled with buying uncertainty and gravitated back to their tried and true defib customers.

The AutoPulse is still a missionary sale and it is natural that when times get tough, sales people will pullback from the harder sale to maximize their results in larger product categories like defibs. We can do something about that and we will work hard with our sales forces to put effort into AutoPulse and regain its momentum.

Additional clinical data will help and the CIRC trial continues on track. We are up to 1300 patients and the first dataset, which is part of that 1300, goes to the DSMB in December. We don’t expect any results from that smaller dataset, but we continue to be hopeful that we will hit our targeted 2500 patients in 2010 and that the data will then be compelling. Very briefly, on the Welch Allyn transaction, we shipped our first AED’s to Welch Allyn for resale internationally. We continue to work with the FDA to get the product cleared in the United States.

As I am sure you are hearing from all points in the industry, the FDA has become very conservative in their approach to everything and 510(k) product approvals are taking much longer, but at least we have the AED internationally to add to the service business, providing some contribution to support the Chicago R&D facility that we inherited from Welch Allyn. As all the pieces ramp up during the course of the next year, we expelled Welch Allyn elements to contribute positively in the back half of 2010.

On Temperature Management, results were outstanding in Q4, as we got through the transition from Altheus and probably benefited from pent up demand. We added to our U.S. sales force and put a ZOLL person in Europe in-charge of our European efforts. We will add a few more selling resources this year, but our prime focus will be on the factory and costs, so that we can get our gross margins above 50% by the end of 2010, so far so good on Temperature Management.

Additionally, we continue preliminary discussions with the FDA on the shape and scope of trial work needed to get a label on our products for used with sudden cardiac arrest. We anticipate this negotiation will take many months, but we would like to get a trial started before 2010 is finished. Last but not least, turning to the LifeVest, great progress continues with this product and this marketplace. Sales growth is strong, and again this quarter the business was mildly profitable on a stand-alone basis in spite of adding many new sales people over the last six months.

Hiring progress was very good here in the United States, as we were aiming to be at 85 by the end of the year and ended up at 89. So we’re well along to our goal of 125 or so sales people to cover the U.S. market. We plan on adding at least 15 or so in 2010, maybe more if we can support it with other elements of the company, and still hit our financial goals. We are making good progress with key opinion leaders and at the AHA this weekend; we will have more clinical data presented to add to our growing stack of evidence.

Also of significance, with the LifeVest, we recently completed a negotiation with our current distributor in Germany to allow ZOLL to takeover the Vest business in Germany and do it on a direct basis. We believe Germany, where reimbursement already exists, is another major opportunity for the LifeVest. We currently sell only about a $1.5 million in Germany due to a lack of focus by our current distributor and we believe we can grow this significantly.

As reimbursement is essentially equal to the U.S., we expect this to be equally profitable, once we have sales coverage. We intend to reevaluate the LifeVest business model in Germany for the international markets and then, expand the LifeVest internationally to other developed countries. Overtime, we believe the international markets represent another $1 billion of opportunity for the LifeVest. I continue to encourage anyone interested in ZOLL to closely monitor our rapid progress with the LifeVest, while they patiently wait for the North American capital equipment markets to return to normal.

Now, let me turn the call over to Ernie for brief comments on Q4 and our 2010 outlook and then we will take your questions.

Ernie Whiton

Thanks, Rick. Let me start with a couple of observations on the P&L. I’ll review our balance sheet, then discuss our forward outlook. We covered our revenue in detail in our press release, so I will not repeat that here. As we indicated in our press release, our Q4 gross margin decreased from 55% year ago to 50%. Part of this was related to reduced factory absorption as we reduced defibrillator production levels, adjusting for the lower levels of defib orders that we received over the past year.

A second part of this was related to foreign exchange and foreign mix of products. The third element related to starting up of our Temperature Management business, which currently is lower than corporate average margins. Another element related to North America incentives and promotions that we’re in the pipeline as we tried to get capital equipment customers to move forward with purchase orders that had been delayed.

So this quarter, we had a bundle of things that pushed gross margin down, all of which are addressable, and we believe do not represent long term trends. This was partially offset by an improvement in the mix of LifeVest sales as these margins are higher than corporate average, and these sales are growing faster than our corporate average. Again, all of these elements I’ve just described provide gross margin opportunity as we move through 2010, which I will cover later in my forward guidance.

Q4 operating expenses increased four points as a percentage of sales from 42% to 46% reflecting our investments in the LifeVest and Temperature Management businesses as well as the R&D associated with the Welch Allyn transaction. R&D increased from 7% to 10% of sales reflecting the acquisition of Welch Allyn Chicago, R&D facility and other defib focused spending increased spending on Temperature Management and increased clinical affairs spending.

G&A increased roughly one point as a percentage of sales reflecting increased Temperature Management costs, accrued sales tax and professional services. Selling and marketing increased $1 million in Q4 ‘09 versus Q4 ‘08 reflecting increased spending on the LifeVest and Temperature Management sales forces, partially offset by selling and marketing related to the core defib business.

The improvement in other income in Q4 and the year reflex a favorable foreign exchange impact or Q4, ‘09 effective tax rate decreased to 28% from 30% in Q4 of ‘08, our effective tax rate for fiscal ‘09 was 29% versus 34% for fiscal ‘08. Our reduced tax rates for the quarter and the year are the result of the expansion of the R&D tax credit through the end of the calendar year 2009 by the U.S. Congress in October of 2008.

The expansion allowed us to book seven quarters worth of R&D credits in 2009 versus only one quarter of credits during fiscal 2008. We expect our tax rate for 2010 to look something like 34% to 35%. Our balance sheet remains in excellent shape our cash and short term investments totaled approximately $59 million as of the end of Q4. During Q4 we generated approximately $6 million in positive cash flow from operations.

During the year we generated approximately $32 million in positive cash flow from operations. Our DSO in account receivable decreased to approximately 67 days at the end of Q4 as compared to 74 days and 72 days at the end of Q3 and the end of Q4 of ‘08 respectively.

As a result of the expiration of the military contingency contract our DSOs fell just over three days as we had $5 million in revenues and no corresponding receivable at the end of Q4. Consequently in Q1 of ‘10 expect DSOs to move back into the low ‘70s. Our inventory turns increased from 2.4 times at the end of Q3 to 3.1 times at the end of Q4 reflecting a $9 million decrease in our core defibrillator related inventory, they were flat with Q4 of ‘08.

The increase in accrued expenses and other liabilities in Q4 of ‘09 versus Q4 of ‘08, primarily related to earn out payments owed on the Lifecor acquisition, partially offset by a reduction in the obligation to the U.S. Government under the military contingency contract. Capital expenditures during Q4 approximated $4 million while depreciation and amortization totaled approximately $5 million. CapEx and depreciation and amortization each approximated $19 million for fiscal 2009.

So now let me turn to our forward outlook. From an overall perspective, our view of 2010 has not changed since our last call, although Q4 was pretty good from an orders perspective as evidenced by the strong backlog build we believe it is prudent to remain conservative until we see a number of data points showing recovery in hospital spending. We anticipate revenue in the vicinity of $440 million and EPS in the range of $0.80 in 2010.

Our view of the details is a little different so let me walk you through these. With respect to the North American hospital customer class, we see overall growth of low teens. With respect to the individual components, this might imply the following; core North American hospital organic defibrillator growth of about 7%. We believe this is pretty conservative given the comps and pent-up demand.

On top of this 7% we see approximately $4 million in Welch Allyn AED, $2 million of AutoPulse business, $12 million of Temperature Management business, and $20 million of military business. Given that we just did $25 million of military business, and as Rick said, we have a new military product on the horizon, we think our military view is also conservative. Given the unpredictable timing of military orders, this seems appropriate.

With respect to the North American pre-hospital customer class, we see overall growth of low double digit say, 12% with respect to the individual components we see core EMS defibrillators decreasing 20%. This is consistent with what we saw in the EMS in the second half of 2009 and reflects that we had some big Canadian business in 2009.

Regarding other components within pre-hospital, we might see mid teens AutoPulse growth, 10% Data Management growth, flat public access AEDs as we wait for signs that the AED market is growing again, and 60% to 65% LifeVest growth. With respect to the international customer class, we see mid teens constant currency growth, 4% growth from foreign exchange based upon today’s rates, and $7.5 million of Temperature Management business. This equates to overall growth in the low 20% range.

From a product perspective, this model would imply total AutoPulse revenue of around $20 million, or mid-to-high teens growth. Recall that AutoPulse is included in each major customer class as I have described. Adjusting for the transition, as Temperature Management started up, this essentially equates to about 30% inherent Temperature Management growth. Recall that Temperature Management is included in the North American hospital and international customer classes as I have described.

This view of the business would lead us to about $440 million of revenue in 2010. Another way of thinking about this view, is that it represents about $12 million in growth from total Temperature Management product sales companywide, $28 million in growth from LifeVest, and $17 million in growth from international excluding Temperature Management, with all other growth in the company essentially netting to zero in the aggregate.

So soft we think this is pretty conservative as all growth can be accounted for by LifeVest, Temperature Manage, and international, meaning all we have to do is repeat last year in North America overall marks to make our plan. Obviously, we believe there is some up side in our North American plans, but this seems a good conservative deal. We believe, we can pick up two percentage points improvement in gross margin in 2010 versus 2009, this comes primarily from the LifeVest foreign exchange and factory absorption.

We also believe, we can pick up a point or so of leverage in our operating expenses as a percentage of sales. This leverage would most likely come from selling and marketing expense. This view would imply our operating return on sales improves from 3% to 6%, pretty modest in our view. This model assumes the 35% tax rate. With respect to the quarters, we expect to see a significant ramp up over the course of the year as the economy improves.

This might look like double digit revenue growth in Q1 versus Q1 of ‘08, or ‘09, rather, low teens in Q2, mid-to-high teens in Q3 and Q4. One scenario might be $100 million in Q1, slightly better in Q2, $110 million or so in Q3, and $125 million or so in Q4. With respect to EPS, recognizing that any individual quarter could be plus or minus a few cents the quarters might look like $0.10 in Q1, $0.10 to 12 in Q 2, 20 to 25 in Q3, and $0.33 to $0.40 in Q4.

While this view might yield an annual range of $0.73 to $0.87, if you take the conservative end of the range for Q’s 1, 2, and 3, and the higher end of the range for Q4, you get to $0.80, this represents our current view. This model reflects our intent to continue to invest in our LifeVest business, Temperature Management business, and the AutoPulse as Rick described.

We continue to each of these areas as significant growth opportunities for ZOLL. This model also leaves intact, our core selling and marketing infrastructure, which we believe will allow us to take advantage of pent up demand in both hospital and EMS, as the economic outlook improves.

So with that, let me turn the discussion back to you, Rick.

Rick Packer

Thank you, Ernie. Jonathan, if you’d now like to conduct the question-and-answer for us.

Question-and-Answer Session


(Operator Instructions) Your first question comes from Stephen Simpson - Northland Securities.

Stephen Simpson - Northland Securities

Could you give us an idea of what the R&D priorities are going to be for the next fiscal year? Then as a partial follow-up, I guess actually the separate second question, could you give us an idea of how many LifeVest prescribers were first timers at this quarter? Thanks.

Rick Packer

I can’t give you any numbers on the last question of lifetime prescribers first timers. I just don’t have any data available. It’s not something that I’m tracking on a regular basis. On R&D priorities, I think it spreads across the company. We’ve mentioned a new military product coming as we finish up the Welch Allyn and Co on the E Series. I think those are our big defib pry or priorities.

On the Temperature Management, we will concentrate on costs and getting some engineering effort into reducing costs of the catheters primarily, so we can drive the gross margin there. On product wise, for the Vest, we have a new 4000 generation, which we brought out at the end of last year. So I don’t think that there’s anything that we’re really concentrating on in the Vest business right now and then of course, layering across all of the companies, continued push in clinical efforts have primarily the CIRC trial.

Stephen Simpson - Northland Securities

If I could try the LifeVest question a different way, maybe without specific numbers. Do you have a sense of what the reorder rates or same store sales if we want to pull that term out of retail? What same store sales might be like with the LifeVest because it pretty much matches the overall growth or what’s the case there?

Rick Packer

So I did analysis on this last time and we talked about this last time, because it was a question of is growth coming from simply new sales people or old sales people ramping up. We provided a bunch of data and that three months ago said that we’re getting as much growth from existing people that are in territories expanding their penetration as we are from adding new sales people. I have no reason to think that would have changed in the past three months.


Your next question comes from Joshua Zable - Natixis.

Joshua Zable - Natixis

Couple of questions here, just first of all for clarity’s sake, I know you’re talking about Welch Allyn. So we understand there’s a new AED, which is being sold internationally and there’s another product, which is a military product that’s being developed. So there are two separate Welch Allyn products. Am I correct on that?

Rick Packer

Yes, that is correct. The AED is into the agency for approval. So it can also be sold in United States market, but we don’t have approval on that, but there are two products.

Joshua Zable - Natixis

Then just on, I guess the hospital and the pre-hospital market, I know obviously you’re seeing much better momentum here at the end of the year than obviously the beginning of the year. I guess, I’m wondering, sort of is it a function of delayed orders or things really kind of improving, that’s on the hospital side?

On the EMS side, you guys actually held up pretty well through the toughest part of the year, so your comps get harder. So I understand where you’re coming from. You also made a point of how carbon monoxide, I know Physico’s out there, obviously much stronger than they were.

So I guess I’m just trying to understand from a market standpoint from both of them. EMS seems like it’s improving a little bit. Is that a more competitive thing, that you guys hopefully get back or is that really more of a market thing?

Rick Packer

We’ll have Jon Rennert to answer that question, as he’s a little closer to those businesses.

Jon Rennert

I would say, let me start with the hospital first. While it was certainly better in Q4 than it was in Q3 I mean we normalize see some seasonality in Q4 tends to be strong for us, but I would characterize, the run rate in hospital as still below where we would consider the norm to be, so your question about are we seeing pent-up demand come back, I would say we’re still not even at the point where, call a steady state replacement range.

So, we’re still below that I think pent-up demand is out there, it still out there building and, clear yet how strong in fast, the recovery phase of this will be, but we think it has bottom out at least. In EMS, I think this is really just this market really held up better than we expected in the first half, some of that was driven by the big win we had in Canada.

So we have a couple of tougher comps, as Rick said to overcome here in the first half, but again this marketplace is really driven a lot by state and local budgets and you all know where the state of the finance structure is within state and local governments today. So we think 2009 budgets that were set kind of in the middle of this year for into 2010 are going to be tighter than they were even in 2008.

Joshua Zable - Natixis

When I look back to your sort of historical revenue run rate and historical earnings and with respect to the fact that obviously you have a lot of R&D here going on, which I think is a great thing and you’re also reinvesting in the business, which clearly is paying dividends in those business you’re reinvesting, so with that said, not that we don’t understand it or criticize it, but just to be clear, is it safe to say that from a profitability or bottom line standpoint, some of this is going to sort of I guess at your discretion of reinvesting in the business, and could we theoretically squeeze about and this trying to reconcile the fact that did you $400 million in revs and you add a $10 now we’re at 4.40 and 80?

Rick Packer

I’m glad you asked it, because it is one of the harder parts to understand about ZOLL and it’s really just all goes from taking a company that was primarily Defibrillation Company and expanding our scope into these other areas. So you have a certain profitability in the defib business. You’re getting a lot of growth from some of these other businesses, like the vest, like temperature, but it’s not highly profitable growth at this point, because we’re investing in the sales force.

The gross margin in Temperature Management is still relatively low because we need top ramp up production and a lot of just things that time cures if you will and those businesses will build to models that are much, much higher profitability than our core business. So what’s happened is that’s the master plan and had not this economic meltdown occurred, the master plan would be masterful.

Alright what’s gotten in the way is while we’re still investing in these high growth areas were that don’t drive much profitability, our core business, which was supporting all that, has taken, a serious wrack here and because we’ve chosen to maintain most of the elements of it, because we think that that’s a temporary situation and it would be more expensive in the long term to rebuild distribution and rebuild R&D, we have very depressed profitability in the core business now.

So as a result of that, you see exactly what you’re asking about, which is higher revenue than we used to have and significantly lower profits and it’s because the revenue is coming from a different part of the business. Now, where does that leave us as we move forward the next couple of years? If we’re right, and if we get a capital spending environment that becomes more normal and we don’t even need high growth there any more.

We just need a more normal level of buying, the profitability in that core business, will pop right back. Meanwhile, quarter-after-quarter, which you really can’t see, the profitability of the LifeVest business is getting better and the Temperature Management business will get better, that’s all hidden right now, due to the core business being weak.

Those things are happening, I think are going to happen as the exact same time, so we’re going to get tremendous leverage out of our existing core business when that pops back, and we’re building very strong profitability models in businesses like the LifeVest; and over the next couple of years, that will move our profitability to levels that we’ve never been able to achieve at ZOLL.

It’s hard to understand, and it’s, like I say, people are just so focused on capital equipment within ZOLL, which I don’t worry too much about, because I know that will come back. People have to buy defibs, the market is not going away. I think what many people miss is the strong growth of the LifeVest, the strong potential of Temperature Management, and the fact that, both of those businesses have profit models that are much, much greater than anything we’re used to here at ZOLL. Does that help?


Your next question comes from Jonathan Block - SunTrust.

Jonathan Block - SunTrust

First question maybe Ernie just on gross margins, was down roughly 500 bips year-over-year. Can you give us some color on what was mix shift, what was FX, maybe what was attributable to the discount that Rick alluded to in the press release? Then do you think that the discounts need to persist for most of FY10?

Ernie Whiton

So we are articulated about four things, factory overhead, absorption, international FX, and mix, Temperature Management start-up, and incentives and promotions. Each just in terms of the rough order of magnitude, each of those elements I would say, had equipped us for one to two points relative to Q4 of ‘08. I think looking forward, each of those elements represents an opportunity for improvement, as our factory production readjusts to the increase in orders we should get improved absorption there.

With the foreign exchange headwinds now behind us, we believe, and based upon today’s rates, as I articulated in forward marrow, we should get a little bit of the pickup there. Certainly, there’s an opportunity to get some mix shift back as we move through 2010 as well internationally. Then our Temperature Management business as that ramps up, the gross margins should improve as we get better absorption in that factory.

Given what we anticipate to be a high rate of growth there could be a temporary offset there due to mix, but in the long run that we should see improvement. Finally, I think in the incentives and promotions, I think what we saw in Q4 was a manifestation of stuff that was in the pipeline, and I think looking forward is the economy stabilizes, and as the capital spending environment stabilizes, we should see less of that as well.

Jonathan Block - SunTrust

Then maybe on Germany, Rick, just some color there. You alluded to going direct. What will that take in terms of the size of the sales force? How do you expect to build that out throughout fiscal year ‘10?

Rick Packer

Yes, so we’ll start relatively slow. This business has to bootstrap. We’re not going to throw any losses. It’s making a little bit of money through the existing distributor right now. So the rules are, of engagement, for our international leader is you got to build from here, and you can only invest as you grow, because clearly we know there’s a huge opportunity in the United States. If we are going to invest, i.e., lose any money, I’d rather put another sales person into the United States.

So he’s going to start slow. There are three sales people that currently work for the distributor over next six months there is a transition plan with the distributor, and hopefully we will move those three people from the distributor team to a ZOLL team. He probably needs seven or eight people to really get started in Germany on a credible basis, and those people then need to be backed up with some part time patient services representatives, just like with the model that we have in the United States, and then there is the whole billing of the insurance component that we also have in the United States.

They’ll probably use some distributors in very localized areas, very specialized areas, so that we’re not leaving territory uncovered. Again, all of this is part of the bootstrap strategy. I don’t think that we have a terrific handle on where the marketplace, how many people we need in total to cover Germany exceedingly well. It’s probably a fifth or a sixth of what we ultimately end up here in the United States, but it will be a slow ramp up, but we’re really excited to get started and to find a good cooperative relationship with this distributor.

So that they will stand aside and we can get going direct, because I certainly believe that if we can validate our usage internationally, the reimbursement internationally, then the services delivery system internationally in Germany, that will give us a model that we can pickup and move to the other developed countries around the world.

Jonathan Block - SunTrust

Then just a quick one on the gross margins instead of waiting for the queue, could you breakout the gross margin specific to LifeVest for thus quarter?

Rick Packer

I’m turning to Ernie. Do you remember exactly, what that number is?

Ernie Whiton

77%, 78% some where in there.

Jonathan Block - SunTrust

Then just two more, maybe the first one just thinking, how longer term on Temperature Management. Rick, how should we think of this in terms of the mix between sort of the razor and razor blade? I mean when this gets more mature? What’s the capital, what’s the razor? What’s the razor blade and then maybe if you can describe a rough gross margin to each one of those?

Rick Packer

So this is definitely crystal ball time Jonathan, because it really depends on how the indications evolve and five years out, who is using what for whatever, but I mean right now, half the business is the consoles or the system, and half the business is the catheters. I would certainly like to see that move to 80% is the catheters and only 20% is the equipment. I think that’s likely and logical, and could be a little bit higher. It really depends on how rapidly the technology evolves.

From a gross margin perspective, gross margins are relatively low right now, as we inherited it from Alsius and you could see what Alsius was doing kind of in the 30 range. Alsius really took a engineering approach and put it into production and we just need to productionize it. So we need to get some automated tools of this year. Some simple fixturing try and move away from some of the handcrafted stuff.

We need to smooth out the whole logistics pipeline. There’s stuff that’s being done inside that probably is better done outside, and there’s stuff being done outside that really needs to be moved inside. In all of that, I think we’ll move comfortably into the 50 range this year and I think our targets are to move that catheter business into the 60 range overtime.

Jonathan Block - SunTrust

Last one. I just love to hear you speculate a little, Rick. What’s going on in DC and the tax and what that means for you guys? I think in its current format, you guys would take a little bit of a disproportional hit, because it’s based on revenues and with a lot margin. So how do you think it gets through? Is this a 2010 thing or ‘13, any comments there?

Rick Packer

It is obviously a very fair question. It’s really hard to say, the Senate bill is very different than the House bill. The House bill is a much more sane approach to the problem with a more modest tax that phases in overtime and gives us the ability to digest it. I think the Senate bill is just lunacy in terms of how that it is crafted, it absolutely no logical sense.

Primarily, because it is fairly onerous and it’s a one size fits all kind of business that doesn’t recognize the differences in the device industry. Some devices are reimbursed, such as our LifeVests and it’s a fair assumption that if everybody has insurance there’s going to be more LifeVest business, and therefore we could afford tax there, and chip into making this affordable for the country.

However, on capital equipment defib business, there’s no incremental business that comes from defibs as a result of it. So it’s just lunacy to think that the company is going to be able to absorb a significant tax. Obviously, we will pass that cost directly through to our customers.

I would expect most people in the industry that are in the capital equipment business, where prices are not fixed by fee schedules or reimbursement schedules, we will just pass that through and our customers will deal with that by absorbing that in their overhead. So it certainly is not a done deal, it’s shifting every single day.

I don’t like it politically, I just do think that it’s just on its very face; it’s insulting the way that they’re thinking about it, but I think practically, from a business perspective, it is something that we can deal with, if it gets no worse than what’s written right now, and certainly the house version is something that I think we could easily absorb over the years would it face in.


Your next question comes from Greg Brash - Sidoti & Co.

Greg Brash - Sidoti & Co.

Like to start off with just the core defib business, I think we were talking about a year ago the thought was many of your customers, whether it be a hospital or M.S, wouldn’t be able to delay some of these large replacement orders for much over a year and looks like that’s still not coming back. What do you think needs to happen for that part of your business to come back and regarding the backlog, obviously some nice sequential growth there? Have you historically seen those orders still in the first quarter or two? Thanks.

Rick Packer

So I would like to break apart the pieces on the defib business. John can chip in here, but I don’t think that you can characterize the EMS business and the hospital business as one lump. Clearly the fact on the hospital business started right away. We are seeing some change in the hospital trajectory; sequentially we are seeing some growth and while we’re not ready declare victory, and I think John was saying that a real up side we haven’t yet seen that, I think we are seeing things start to loosen up in the hospital business.

So we may not have been too far off in our assessment of how long these folks could go before we’d start seeing something. I think on the EMS side, as John talked about, EMS was pretty much unaffected for the first chunk of time. They were living off budgets that were put in place before any financial meltdown, so to speak. It was really only in the back half of the year that we saw that effect.

So I think what we’re saying is, our guess that it’s a year or so is still in place for EMS. So we’ll have some tough comps. The first half of the year I think will be tougher EMS and then the latter part I think when these guys start having to delay their purchases more than a year, the pressure will build, and hopefully we’ll see some things come back there.

Greg Brash - Sidoti & Co.

Do you still feel the delays about a year still hold in the hospital market and if that’s the case, are you just trying to be ultraconservative on your expectations that in market?

Ernie Whiton

Well, I would prefer to under promise and over deliver than the alternative. So, I would say yes, our nature is to be conservative, and I think in this environment, ultraconservative I think is as good a label to put on it as anything, but we do I mean to answer the second part of your question, seasonality wise, our sales force usually humps that our in the fourth quarter and we usually get an up tick in fourth quarter and hospital for sure.

We didn’t see that last year in fourth quarter really. We did see that this year is that related to the sales force humping it at the end and making stuff happen or is that related to the buying environment getting some what better. It’s really hard for us depress that out right now. Jon, do you have anything to add?

Jon Rennert

Just one thing I would say the one factor, if would you ask what do we need to see turnaround, I’d say its general level of uncertainty that doubt their both in the hospital market around, a lot of the dynamics of healthcare reform weigh on that customer base and again in the EMS market, the uncertainty around state budgets and how that plays out in a lot of the big marketplace here over the next year is in clear, and I think that really is hanging over both of those core markets for us.

Greg Brash - Sidoti & Co.

Just a follow-up on the EMS market, looking for down 20% for defib, but looking for growth in AutoPulse and data management, why is there disconnect there?

Rick Packer

So our data business has somewhat slightly different dynamics. It’s more private ambulance-oriented, which is not affected by the state budgets and really has been unaffected during this whole period of time, actually, more people are calling their ambulance service for service now than previously. So the data business that just runs somewhat different. Different mix of customers than the core defib business does.

I mean, AutoPulse, I think were significantly down and I believe that part of that is focus, and that comes from international as well as hospital as well as EMS and I think, EMS may continue to struggle, but I think we can get some growth that we didn’t really achieve in international and hospital this year as our sales people are less twitchy about environment and more willing to make the investment pushing the AutoPulse agenda general forward.

Greg Brash - Sidoti & Co.

One final one from me, I missed the LCS expectations are that exceeding the Temperature Management expectations outside U.S. in fiscal ‘10, and how much did it contribute in the fourth quarter? Then just on top of that, overseas, I know a lot of cap equipment companies have been seeing some weakness in delayed orders in Europe. You guys are still putting up at least overall very strong growth in the quarter. Are you not seeing any weakness or is there just enough opportunity outside of mainstream Europe that makes you still feel very good about international?

Ernie Whiton

I’ll hit the front part of your questions. Temperature Management international in the fourth quarter was just over $2 million. Our expectations for Temperature Management in international for 2010 are just over $7 million. So I would bring total Temperature Management companywide to somewhere in the $19 million, $20 million range for 2010.

Rick Packer

Then on the international piece, I would say the growth is pretty broad based including Europe. I mean, I think we had a pretty good quarter in main line Europe and I can’t speak to other companies’ struggles there, but we seem to be doing pretty well.


Your next question comes from Ross Sandler - RBC Capital Markets.

Ross Sandler - RBC Capital Markets

You guys have obviously weathered a difficult environment in 2009 and continue to produce a lot of cash flow. I just wanted to get your sense for using the balance sheet in 2010. Do you see the opportunity to do any more additional deals, or should we think of 2010 more as an execution year as you grow out the LifeVest and the Temperature Management franchises?

Rick Packer

Well, I think that we have within ZOLL, with Temperature Management, with the LifeVest, with ability to take market share in defibrillation, with the AutoPulse, just enormous opportunities. I think if you look at that time resuscitation, the chain of survival, weary in every piece that we need to be in. Ventilation, we could still use something there, but it’s not super critical. So we are happy to just really focus on what we have in the portfolio and get that leverage that I talked about with answering Josh’s question out of the core business, and grow the profitability in these other areas.

Having said that, if there is opportunity out there, because we manage conservatively and we have a strong balance sheet to take advantage and to do some things that are wise for the long term we’re not against that, but it isn’t something that we’re compelled to do. I think we’re in an enviable position that within our existing company there is tremendous growth opportunity. We’re not feeling pressure to supplement that with other areas.


Your final question comes from Joshua Zable - Natixis.

Joshua Zable - Natixis

Most of my questions have been answered, here just one quick one. I know you started shipping Welch Allyn this quarter, that’s correct. Can you just give us any color on what it was or if it contributed at all?

Rick Packer

It’s more in principal than in quantity as we just got started, Josh. So let me wrap up here.

I thank everybody for their time this morning. As you heard, we’re seeing some positive signs in the core business, but as importantly we’re making huge progress with the LifeVest and now with temperature management and I think this has a tendency to be overlooked as I mentioned in Joshua question.

I continue to encourage folks to look beyond the temporary market conditions for capital equipment purchasing here in the United States and see the tremendous growth and profit potential that exists across the whole wide spectrum of ZOLL product. As outlined by Ernie we expect 2010 to see renewed strong growth at the top line and a strong recovery in our profitability still after ways to go.

So, with all of that we look forward to speaking with you again in January. Thank you very much.


Thank you, ladies and gentlemen for your participation in today’s conference. This does conclude the program. You may now disconnect. Good day.

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