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Executives

Larry Betterley - CFO

Dave Martin - President and CEO

Analysts

Matthew O'Brien - William Blair

Ernest Andberg - Feltl & Company

Cardiovascular Systems Inc. (CSII) F3Q10 (Qtr End 03/31/10) Earnings Call May 5, 2010 4:45 PM ET

Operator

Good day ladies and gentlemen and welcome to the Quarter 1, 2010 Cardiovascular Systems earnings conference call. I will be your operator for today. At this time all participants are in a listen only mode. Later we will conduct a question and answer session. (Operator Instructions) I would now like to turn the conference over to your host for today, Larry Betterley, Chief Financial Officer. Please proceed.

Larry Betterley

Good afternoon and welcome to our fiscal 2010, third quarter conference call. Before we begin I would like to remind you that during the course of this call we would make forward looking statements.

These forward looking statements are covered under the Safe Harbor Provisions of the Private Securities Litigation Reform Act of 1995 and include statements regarding CSI’s future financial and operating results or other statements that are not historical facts.

Please be advised that actual results could differ materially from those stated or implied by our forward looking statements due to certain risks and uncertainties including those described in our most recent Form 10-K and subsequent quarterly reports on form 10-Q. We suggest that you read these and other future filings that we may make with the SEC.

CSI disclaims any duty to update or revise our forward-looking statements as a result of new information future events developments or otherwise. We will also refer to non-GAAP measures because we believe they provide useful information for our investors.

Today’s news contains a reconciliation table to GAAP results. I will now turn the call over to Dave Martin CSI’s President and CEO for comments.

Dave Martin

Thanks Larry and hello everyone. In fiscal 2010 we have five priorities, they are first, driving adoption in our existing accounts through customer education on the optimal protocol for the Diamondback 360 and increasing volumes in patient procedures below the knee.

Second, launching ORBIT II our pivotal clinical trial to evaluate our technology for using calcified coronary lesions this is a new market opportunity for CSI.

Third building a foundation of quality evidence staged data to confirm the clinical utility of the Diamondback 360 intruding peripheral arterial disease including advancing COMPLIANCE 360, CALCIUM 360 and additional clinical trials.

Fourth introducing new versions of the Diamondback 360 to improve EBIT use for physicians and enhance the price effectiveness throughout the patient’s leg.

And finally balancing revenue growth and operating expenses to achieve profitability and positive cash flow. We will operate out amounts on these areas later in the call.

Turning now to CSI’s fiscal third quarter financial performance. Revenue of $16.5 million was up 9% over both the year ago period and sequentially from the second quarter of this fiscal year.

This was in line with our expectations balancing revenue growth with expense management resulted in a reduction in our loss compared to last years third quarter. The net loss improved 11% excluding income for preferred stock warrants and auction rate securities valuation changes a year ago.

During the third quarter, we made significant headway in educating our physician customer base in the optimal protocol for using the Diamondback 360 to safely change lesion compliance by removing hardened plaque while minimizing damage to the arterial wall and therefore preserving medial integrity.

As a result, we are seeing improved patient outcomes in greater product usage of targeted accounts. Newly targeted accounts this quarter grew 13% sequentially over the fiscal second quarter.

While targeted accounts we focused on the second quarter continue to go as well. We're expanding this effort to additional accounts going forward by focusing on superior outcomes and increased usage of our current accounts base rather than broader account penetration we’re building on little customer base at sustainable revenue growth for the future.

Diamondback 360 treats plaque throughout the leg and addresses many limitations of other treatments. In just over two and half years since the commercial launch the Diamondback system has been used in more than 25,000 cases.

At this early stage, we’ve captured the number one or the number two share in the above the knee atherectomy market in each region of the United States. And we have a leading number one share in the below the knee market and across the country.

Our unprecedented safety profile means more patients upon the release and improved long-term outcomes with significant economic benefits. Traditions are adopting our technology as evidenced by increases of both hospital accounts and usage. We sold 4,870 Diamondback devices up from 4,559 in the third quarter last fiscal year, bringing the total number of devices sold nearly to 38,000 since the initial product launch.

The percentage of revenue generated for the orders increased to 93% for the fiscal 2010 third quarter, that’s up 84% in the year ago period reflecting our emphasis and driving adoption in existing accounts.

Now Larry will provide more details of our financial results. Larry?

Larry Betterley

Thank you Dave. For the third quarter of fiscal 2010 compared to 2009 revenue grew to $16.5 million which was 9% increase over last year. Diamondback device sales continued to generate most of our revenue at 88% of the total.

Other products revenue grew more than $600,000 from sales of our vibrant product line and distribution partner products which have been introduced over the last year.

We added 52 new accounts down from 87 last year, as we’ve focused on driving adoption and existing accounts. Adding fewer new accounts reduced revenue by $1.2 million between previous. However this is more than offset by increasing revenue from reorders from $2.6 million to 93% of total revenue up from 84% of total revenue last year.

Gross margin improved to 77% from 74% last year due to product cost reductions manufacturing efficiencies and shipment of dealer controller units. Operating expenses rose 7% to $18.8 million, SG&A expenses increased 15% primarily due to larger sales organization, which includes more than 100 direct sales representatives as well as higher spending on education and training programs.

R&D expenses declined 28% from the prior year due to cost reductions as well as the completion and timing of development projects and clinical studies.

Net other expense was 349,000 for the quarter versus net other income of $2.7 million in the prior year period. Last year’s amount includes $2.5 million of income related to valuation changes in redeemable convertible preferred stock warrants, which were adjusted at the time of the merger in February 2009 and in auction rate securities.

Interest expenses also declined as a result of our debt refinancing in April 2009. The net loss was $6.5 million or $0.44 per diluted share this year compared to $3.8 million or $0.32 per share at last year.

However excluding the other income from valuation changes last year the net loss improved 11% and loss per diluted share improved 27%. The number of diluted weighted average shares outstanding rose to $14.9 million and $12 million last year. The increase is due to the effects of reverse merger which included conversion of all preferred stock to common stock as well as the issuance of new common shares.

Last years net income available to common share holders was increased by $25.8 in decretion of redeemable convertible preferred stock due to revaluation at the time of merger.

Adjusted EBITDA calculated as loss from operations, less depreciation and amortization and stock-based competition expense improved by 16% from last year to a loss of $3.9 million.

The improvement was greater than the adjusted net loss improvement of 11% due to the higher stock competition expenses this year. For the nine months ended March 31, revenue rose $46.8 million a 15% increased over last year.

The gross margin was 77% up from 71% last year for reasons similar to the quarter. Operating expenses declined 5% to $54.6 million, investments in sales expansion and education training program were more than offset by reduction in R&D, primarily due to the timing and completion of product development projects and the ORBIT I coronary trial. Also fiscal 2009 included a $1.7 million write off, of cost related to our IPO withdrawal.

Year-to-date net other expense was $896000 versus net other income of $2.4 million last year, which included net income of 3.8 million for valuation changes and redeemable convertible preferred stock warrants and auction rate securities including the put options with UBS related to our securities.

The first nine months net loss narrowed by 26% to $19.5 million, the improvement was 35%, excluding the net other income from valuation changes last year, net loss available to common share holders was favorably affected last year by $22.8 million of decretion in the preferred stock.

Resulting net loss for diluted common share was $1.33 this year versus $0.57 last year. The average shares outstanding grew to $14.7 million from $6.1 million a year ago primarily due to the merger transaction. Adjusted EBITDA improved 50%, to a loss of $11.7 million year-to-date.

Cash and cash equivalents at the end of this quarter remain consistent with the end of the fiscal 2010 second quarter at $23.6 million and included $4.4 million of proceeds received from a term debt refinancing at the end of the quarter.

As we previously announced at the March we completed a $25 million refinancing with Silicon Valley Bank consistent of a $10 million growth capital term loan and a $15 million working capital line of credit, the term loan was founded at the end of the quarter bringing $4.4 million of new proceeds into the company after consolidating existing term debt balances.

No drives had been made on the line of credit. In April we also completed a convertible debt agreement with partners to grow providing the ability then drive up to $4 million in debt over the next 12 months, in addition will announce over the next four years to the extent existing of that debt is converted to common stock.

Net closing $1.5 million was drawn. This financing enhances our financial flexibility as we continued to grow the business and work towards profitability and positive cash flow. Finally our auction rate securities declined $3.4 million quarter due to redemption by issuers.

Proceeds were used to reduce the full part value loan UBS provided against those securities. The remaining $19.3 million par value of auction rate securities can be put back to UBS beginning on June 30, 2010. The remaining UBS loan will be paid off at that time. I will now turn it back to Dave for additional comments, Dave?

Dave Martin

Let me first recap our recent educational efforts. When we launched the Diamondback 360 it worked exceptionally well to treat lesions behind and bellow the knee. We delivered a tool with a specific protocol for predictable outcomes; however positions being using the product above the knee for which the optimal procedure protocol was not in place.

Customer satisfaction above the knee did not match the below knee results and usage suffered. We developed an optimal protocol for large vessels above the knee educated our sales organization on it and it focused on working with physicians and their staff to install this protocol, our efforts are paying off in key targeted accounts of higher usage rates and revenue.

We will continue to expand this effort while also placing greater emphasis going forward on increasing procedures below the knew, in order to improve outcomes to people inflicted with the slight limiting and threatening disease.

Next I would like to bring up the date on recent development in our clinical trails program. At CSI we believe that clinical evidence is the path to leading market share. We are committed to obtaining quality prospective data that will confirm the clinical benefits of the Diamondback 360 in treating both peripheral and coronary disease.

Our growing body of evidence puts us in a unique leadership position to provide physicians with the information that they need to optimize patient outcomes and favorably affect the cost of care, as well as standardize practice guidelines.

Based on known superior clinical outcomes in treating small vessels with the Diamondback 360, we intended to leverage the devices capabilities to expand into the interventional coronary market.

The coronary market is a large potential market opportunity for core technology. In April we announced unconditional FDA approval to begin the ORBIT II. A pivotal trial to evaluate the safety and effectiveness of the Diamondback 360 and treating calcified coronary lesions will initially enroll up to 100 patients at 50 US sites, with the potential to enroll up to 429 patients.

We are working right now in the internal review board submission that 15 initial hospitals across the United States expect to begin enrolling patients in the next few months.

During fiscal 2009 we complete at ORBIT I trail a 50 patient feasibility study which investigated device and safety in treating calcified coronary arterial lesions. The Diamondback was successful 98% of patients with calcified lesions and the acute procedural success rate including staff placement was 94%.

We are confident that we can repeat these favorable outcomes in ORBIT II, upon FDA clearance of our products of coronary use we will have one of few new coronary product introduction in the last decade.

Additionally in the third quarter CSI made significant progress related to peripheral clinical research programs. Last week we've announced the completion of patient enrollment in our CALCIUM 360 study this compares the effectiveness of Diamondback 360° to balloon inflation in treating heavily calcified lesions behind and below the knee. Calcified plaque exists in about 75% of these lesions.

In the fiscal fourth quarter we expect to complete enrollment in the COMPLIANCE 360 study. COMPLIANCE 360 evaluates the clinical benefit of removing hardened plaque while preserving medial integrity above the knee with the Diamondback 360. This study compares the performance of the Diamondback 360 plus low-pressure balloon inflation if desired with that at balloon inflation alone.

Both of these clinical trials are prospective randomized studies, that will be core lab adjudicated each will enroll 50 patients or have enrolled 50 patients and up to 10 US medical centers and follow up will be 12 months.

In addition we recently began a prospective multi-center registry called confirm to study more than 700 patients and their queue outcomes following the Diamondback procedure. With our continued commitments studying clinical and economic outcomes in conjunction with our landmark OASIS study coronary work and several physician initiated studies we have perspective data on more than 1100 patients.

Rigorous prospective evidence will accelerate market growth and enhance our leadership position.

Now I’d like to share our outlook for the fiscal 2010 fourth quarter ending June 30. We anticipate revenue in the range of $16.5 million to $17.5 million or growth of 5% to 11% over the fourth quarter of fiscal 2009.

Gross profit as a percentage of revenue at about the same as the third quarter of fiscal 2010 and a net loss ranging from $5.6 million to $6.2 million or $0.37 to $0.41 per share based on 15 million shares outstanding. We cannot exclude an expected stock compensation charge in the fourth quarter of about 80,000 or $0.05 per share related to the issuance or extension of stock option grants that had short original exercise terms.

And on an adjusted EBITDA basis, we anticipate a loss between $3 million and $3.6 million; we believe that net loss and adjusted EBITDA will improve as revenue grows in the future.

So recap on our five fiscal 2010 priorities first driving adoption in our existing accounts from customer education on the optimal protocol for the Diamondback 360 and to increase the volume and patient procedures below the knee, second launching ORBIT II our pivotal clinical trials to evaluate our technology for use in calcified coronary lesions this is a new market opportunity for CSI, third building foundation of quality, evidence based data to confirm the clinical utility of the Diamondback 360 and treating peripheral disease including advancing COMPLIANCE 360, CALCIUM 360 and additional clinical trials.

Fourth introducing new versions of the Diamondback 360 to improve ease of use for physicians and enhance the vice effectiveness throughout the patients leg.

And finally balancing revenue growth, and operating expenses to keep profitability and positive cash flow these initiatives position us well for significant profitable growth over the longer term as we continue to target fiscal 2011 to achieve our first profitable quarter.

Now we would like to open the call for questions.

Question and Answer Session

Operator

(Operator Instructions) Your first question comes from the line of Matthew O'Brien with William Blair. Please proceed.

Matthew O'Brien - William Blair

Good afternoon, guys. Thanks for taking the question. Just wanted to ask you a little bit about the training program that you have in place, I mean where are we at this point, are you 50% away through with your serving customer at 75%, where are you at this point?

David Martin

Yes, Matt, we’re about 50% through our target and installed the optimal protocol.

Matthew O'Brien - William Blair

Great. And then I'm looking at your unit performance in the quarter, it was up about almost 10% sequentially, was that really driven by the change to protocol in fiscal Q1 that now you are seeing the benefits of this?

David Martin

Yes, results are lagging activities for sure, we really focused on this in Q2 fiscal and we are seeing the result now.

Matthew O'Brien - William Blair

Okay. And so then what I look at extra Q4 guidance kind of a mid point of the range, it looks like unit sequential growth is about 5% and then that assumes flat other revenue, are you incorporating in some kind of competitive impact or it just seems like the guidance is a bit conservative looking into the next?

David Martin

It is conservative and no, we’re not expecting, we expect fierce competition as we always do, but nothing in particular.

Matthew O'Brien - William Blair

Great. And then question for Larry, in terms of the debt any sense for when you expect, you seem like you had a reasonable cash position at this point, but any sense for when you may start to?

Larry Betterley

I’m sorry Matt, you broke up right at the end, could you restate it.

Matthew O'Brien - William Blair

I apologize. Just any sense for when you might start taking down additional debt associated with the revolver or the other facilitated cap?

Larry Betterley

We don’t have additional plans in the near future to drive down additional amounts.

Matthew O'Brien - William Blair

And then one last quick one you are making great progress on the clinical product things and we going to get any kind of interim looks at CALCIUM 360 or ORBIT II before the full data is released?

Dave Martin

Yes, the CALCIUM 360 we would like to present acute results so we are planning on doing that the next six months and then we will have that critical one year follow up about this time next year. So we will come back at it with those results, clinical and economic.

Operator

Your next question comes from the line of Ernest Andberg with Feltl & Company. Please proceed.

Ernest Andberg - Feltl & Company

I guess address the ORBIT first, what are the primary end points that you guys are looking to meet in the ORBIT Dave?

Dave Martin

Yes, it’s a safety end point 30 days mace.

Ernest Andberg - Feltl & Company

Are there any what kind of procedural success or end points are they secondary kind of end points?

Dave Martin

Well, 30 day mace would be made up of cardiac debt, MI or QA and TLR and the ORBIT I we had a 6% rate for ORBIT II the target for approval is 13.6.

Ernest Andberg - Feltl & Company

How about in terms of any end points on opening the lumen or size of the lumen at 6 or 12 months in terms of success that way as opposed to add those cardiac events.

Dave Martin

Yes there are primary efficacy end points but no 6 month or 12 month it is the last patient enrolled plus 30 days. It is a true safety trial. For procedural success we are looking for achievement of 20% residuals stenosis of the target lesion after stenting without an in hospital mace.

Ernest Andberg - Feltl & Company

Okay, so the FDA is primarily looking at safety in the coronary arteries and at 30 days?

Dave Martin

You bet with a really difficult patient population so on of the 1.2 to 1.3 million catheter based procedures in the US and 0.5 million cardiac surgeries. We estimate 15% to really benefit from a device that could take the classified plaque out in preparation for stent placement and I want to correct something too I just, quoted you the less than 20% residual stenosis that was the ORBIT I trail for the ORBIT II in the US procedural success will be defined as facilitating stent delivery with less than 50% residual stenosis and without in hospital mace.

Ernest Andberg - Feltl & Company

Okay, have you got any further insight as to whether your trail sites will be able to be reimburse for this because there is a atherectomy code out there that is general not specific to another device.

Dave Martin

Yeah, you bet we do believe that it will reimbursed and throughout the trial we worked with our sights we have done a lot free work with our sites. We’ve identified the first 15, we got a list of 50 plus that we pre-qualified so we’re excited to start reimbursements part of that package.

Ernest Andberg - Feltl & Company

Okay. Last on ORBIT II, how long you said a few months to get the trial up and going, any better idea what that might mean Dave, it’s few three?

David Martin

Yes, we think that we will have the first patients enrolled next quarter. We’ve done every the free work to make that happen, so that’s the expectation.

Ernest Andberg - Feltl & Company

Okay. And then if the FDA allows you to go ahead with the whole trial, can we look at that as a milestone that the FDA thinks this thing is working?

David Martin

Yes, you bet. We have worked closely with them with all of our trial, the ORBIT I. We really do believe any of that we would know the answer in advance of this based on the ORBIT I. And we think that ORBIT II will confirm that we will work closely with them and I think that would be a great endorsement for them to allow us to go from 50 to 429.

Ernest Andberg - Feltl & Company

All right. Dave you made some comments about above the knees success in targeted accounts that in the first quarter and the second quarter, I wasn’t quite sure what you’re referencing there. Can you go over that again please?

David Martin

Yes, the set quarters of fiscal we took a small number of accounts and we are really focused on installing the proper protocol and the number of touches in specific education with that set it worked and I think we reported in the last call that those accounts that we targeted in fiscal Q2 grew well over 50% sequential basis so we stand with that program we expanded that program into another large group of targeted accounts and got a similar great result.

Ernest Andberg - Feltl & Company

Okay, but did you say something about plus 13%, in targeted accounts did I miss it, what did that mean?

Dave Martin

It means that sequentially the accounts that we targeted grew 13% from fiscal Q2, to.

Ernest Andberg - Feltl & Company

Alright I understand, last question Larry, how is the interest income and the interest expense line going to change as we have added $6 million of additional debt into the balance sheet and you’re going to presumably have the interest you are earning, on the pardon me lets leave it there, how is that going to change the interest expense line?

Larry Betterley

Yeah the interest expense just on those pieces of debt would increase about $100,000 per quarter though we have some interest expense that is declining on a couple of other things including long term lease obligations so the net impact for fourth quarter would be fairly mutual to where we are in the third quarter.

Operator

(Operator Instructions), it appears there are no further questions at this time.

Dave Martin

The Diamondback 360 is raising the standard care for patients with peripheral disease which is an underserved market. We believe minimal evasive peripheral market is growing driven by the need for effective new treatments to remove plaque and modify compliance and lesions above and below the knee. We see an opportunity also for this technology to apply to the small vessels in the coronary arteries that is a new opportunity for CSI.

In fiscal 2010 we’re making great progress towards our goal and are optimistic about our future we look forward to updating you on our progress next quarter. Thank you everybody.

Operator

Ladies and gentlemen that concludes today's conference. Thank you for your participation. You may now disconnect. Have a great day.

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Source: Cardiovascular Systems Inc. F3Q10 (Qtr End 03/31/10) Earnings Call Transcript
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