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AngioDynamics, Inc. (NASDAQ:ANGO)

F4Q10 (Qtr End 05/31/10) Earnings Call

July 15, 2010 02:30 p.m. ET

Executives

Doug Sherk - IR

Jan Keltjens - President & CEO

Joe Gersuk - EVP & CFO

Analysts

Jayson Bedford - Raymond James

Jamar Ismail - Canaccord

Brooks West - Craig-Hallum Capital

Robert Goldman - C.L. King

Thomas Kouchoukos - Stifel Nicolaus

Larry Haimovitch - HMTC

Operator

Ladies and gentlemen, thank you for standing by and welcome to the AngioDynamics Fourth Quarter 2010 Financial Results Conference Call. During today's presentation all parties will placed in a listen only mode. Following the presentation the conference will open for questions. (Operator instructions). This conference is being recorded today, Thursday, July 15th of 2010.

And I would now like to turn the conference over to Doug Sherk. Please go ahead, sir.

Doug Sherk

Thank you for joining us today for the AngioDynamics conference call to review the results of the fiscal fourth quarter and full year which ended on May 31, 2010.

The news release announcing the fourth quarter earnings crossed the wire this afternoon after the market closed and is available on the AngioDynamics website. The call is being broadcast live on the web at www.angiodynamics.com. A replay of the call will also be archived on the AngioDynamics website.

Before we get started, during the course of this conference call the company will make projections or forward-looking statements regarding future events including the statements about revenue and earnings for fiscal 2011. We encourage you to review the company’s past and future filings with the SEC, including without limitation the company’s Forms 10-Q and 10-K, which identify specific factors that may cause actual results or events to differ materially from those described in the forward-looking statements.

In addition, today’s presentation includes certain financial measures used to better understand our business that have not been prepared in accordance with the Generally Accepted Accounting Principles, better known as GAAP. An explanation and reconciliation of these non-GAAP measures has been provided in today’s news release issued by AngioDynamics and is available on the website at www.angiodynamics.com.

AngioDynamics uses non-GAAP measures to establish operational goals and believes that non-GAAP measures may assist investors in analyzing the underlying trends of the company’s business overtime. Investors should consider these non-GAAP measures in addition to, not as a substitute for or superior to financial reporting measures prepared in accordance with GAAP.

In today's call, the company has reported non-GAAP EBITDA and EBITDA per share and has reviewed these measures as an internal analysis and review of operation performance.

Finally, during the question-and-answer period today we’d like to request each caller to limit themselves to two questions and encourage callers to re-queue to ask additional questions. We appreciate everyone’s cooperation with this procedure.

And now, I’d like to turn the call over to Jan Keltjens, President and Chief Executive Officer of AngioDynamics.

Jan Keltjens

Thanks, Doug, and good afternoon everyone. Thank you for joining us in our fourth quarter conference call. With me today is Joe Gersuk, our CFO.

There's a lot we like about our fourth quarter financial performance. Top line growth of 14% and operating income growth excluding items of 17%, combined with a rock solid cash flow provided a very strong finish to fiscal 2010. With this performance, we delivered on one of our key objectives for the year which was profitable growth.

The drivers for our fourth quarter was strong revenue growth paired with strong operating expense leverage. These drivers have proven to be more than sufficient to offset the impact of an on-going price environment as well as unfavorable sales mix on our gross margin. Our fourth quarter revenue growth was broad based as all three businesses contributed at 14% our organic growth rate is as strongest as it has been in the last two years.

Engines of growth in Q4 were Varicose Vein products, Micro-introducer kits, LC Beads and last but not least our RF and NanoKnife ablation products. LC Beads still benefited from the competitive product entitled been out of the market this quarter.

We believe the LC Bead growth rate will slowdown from the fourth quarter because this competitive product has returned to the market. However, we also believe that LC Bead should generate positive growth during fiscal 2011.

The partnership at Biocompatibles, the manufacturer of LC Beads continuous to be mutually beneficial and we will be exploring ways to continue this beyond January 1, 2012.

At the same time our shareholder should know that we believe there are a number of scenarios that will allow us to be able to achieve continued profitable growth into calendar year 2010 and beyond.

We are very pleased with the strong performance of a very varicose vein in a healthy market environment which we continue to target about 15% annual growth rate. We continue to gain market share. The combination of a NeverTouch laser fiber platform which was launched a little over 1 year ago and our strong sales force supported by a revamp and broad practice development program is driving solid sales growth.

We believe that through ongoing innovation international expansion and increasing U.S. penetration our VenaCure EVLT franchise will continue to be an engine of growth. We also manage to stabilize our Access revenue in the fourth quarter, this despite the competitive pricing environment.

Our results were aided by launch of both the central split-tip dialysis catheters and a Triple Lumen Smart PICC. Our strategic goal is to obtain a number two position in key segments of the excess market, how we plan to use innovation, corporate accounts and international expansion to drive revenue growth and create economy of scale.

We believe the Access business will contribute to growth in fiscal 2011. Innovation is a key factor in driving future revenue growth. During fiscal 2010, we launched 11 new products in addition to smaller products as well as international releases.

These launches include important products like NeverTouch and Delta Lasers, new RF ablation electrodes, the NanoKnife commercial release with software version and hardware version 2.07, Micro-introducer kit and nephrostomy drain catheter and in the last quarter is specific NeverTouch kit for the international market the Triple Lumen Smart PICC and the central split-tip dialysis catheter.

Already in fiscal 2011 we have launched three new products, these include two new port, the Smart Port CT Mini and low profile models and these port further expand our family of successful smart ports with our Vortex technology positioning us for growth in this segment.

We also launched a unique 16 gauge non-coring high flow needle for use with implantable ports. But a full fiscal year 2011 we expect to continue a healthy flow of new products coming out of our R&D organization. We expect to launch approximately 10 new products into the market place.

The plan includes importing new products to strengthen our NeverTouch platform in a number of new products in our Smart PICC, dialysis, smart port franchises as well as an upgrade to our NanoKnife platform and a new RF ablation product. We're also making good progress on longer term R&D programs that will lead the new products that we anticipate the launch in the fiscal 2012 supporting long term and accelerating growth for our company.

Our most significant innovation program obviously is the NanoKnife IRE System. We are pleased with the success of the commercial program we launched in the second quarter of the fiscal year which resulted in our first $1 million NanoKnife sales quarter. Our customers are actively using the system to successfully treat patients. In addition to the revenue stream being generated the system's use is building the body of clinical evidence that we believe will drive the long adaption of the technology.

For the months of April, May and June a total of 76 additional soft tissue ablation procedures have been performed using the NanoKnife System for a cumulative total of 230 procedures in 14 centers around the world. This represents an increase of nearly 50% over Q3, both in revenue as well as the number of procedures. As we have shared before, we have proposed two IDE trials to the FDA, focused on respectively the treatment of prostate and pancreatic tumors.

We held a pre IDE meeting with the FDA on the pancreatic study. Following this meeting we are working on conducting some additional pre-clinical work to answer the FDA's questions. We have also received questions from the FDA on the prostate study IDE we have submitted and again answering these questions requires additional pre-clinical work. Both files will be complimented with our growing body of clinical data and based on these developments we now expect the IDE for the prostate study to be resubmitted and the IDE for the pancreas study to be submitted towards the end of the fiscal year.

While this delay is disappointing, we do remain confident we will be able to eventually obtain a positive response from the FDA on these IDE proposals and this confidence is based on the fact that we feel that the additional pre-clinical work will satisfy the FDA's questions and our confidence is further enhanced by the rapidly growing body of clinical outcome data following the use of NanoKnife.

The number of pancreatic tumors that have been treated continues to grow and patients continue to do well. The first whole gland prostate ablation was performed and again the procedure was completed successfully. The number of procedures continues to rise, the safety profile remains favorable and clinical outcomes are generally positive.

The HCC primary liver cancer trial in Europe is progressing well. If those patients had been treated by Doctor Ricardo Lencioni of the University of Piza and additional patients are scheduled for treatment over the next few weeks. A number of additional samples have obtained, require approvals and will be initiated after the European holiday. We expect the majority of the seven participating centers will be enrolling patients by this fall and we anticipate completing enrollment in this study including acute results before the end of this fiscal year.

There are a number of significant additional clinical studies planned. We expect these to focus on pancreas as well as liver tumors. These studies as well as other studies and physician experiences are expected to lead to peer review publications. As an example, there was a recent article titled, Irreversible Electroporation: A New Challenge in “Out of Operating Theater” Anesthesia, which was published in a peer review journal of Anesthesia & Analgesia.

As we said before, we fully expect that sales of NanoKnife would continue to grow independently of the IDE trials. Other studies, publications and presentations at international conferences will raise awareness and help drive utilization. As a result of all this, we expect sales this fiscal year to be substantially above fiscal 2010 sales.

We remain bullish about the potential market opportunity for IRE technology. Let's take pancreatic tumor treatment as an example. Between patients with non-metastatic disease and palliative treatment, we see a potential global market opportunity of several hundreds of millions of dollars. Opportunities in liver, prostate and lung could each exceed this potential market. In aggregate, NanoKnife provides a very large growth opportunity for many years to come.

Moving now to our focus on operational excellence, as mentioned, price erosion in certain segments of our business continues. This along with an unfavorable mix impact due to strong sales of LC Beads resulted in a fourth quarter gross margin below our guidance. We have however been able to successfully offset the margin decline through solid expense management.

Important to notice that this OpEx management is sustainable and is and will not be at the expense of our strategically important R&D investments. We believe through a slowing of price erosion, driven by a steady stream of new products and a number of manufacturing initiatives, our efforts to build gross margin should start yielding results during the second half of the year.

We recently also completed an organizational realignment. The goal was to create the right balance between strategic focus and operational leverage. As a result of this, we have combined the U.S. Peripherals, Vascular and Access sales teams into one vascular sales force. Our U.S. oncology sales force remains dedicated and will see a modest expansion this year. With the new U.S. vascular team, we have substantially improved coverage as well as penetration in the U.S. and created a strong commercial team, which will be able to rapidly convert new products into revenue, as well as better leverage customer relationships.

The product marketing and product development teams have been aligned with key disease states such as, venous intervention, access and oncology and this creates multifunctional co-located teams with a single minded strategic focus to drive us to a leadership position in those respective disease state areas. Our executive management team has also been further strengthened with the addition of Lynda Wallace as our new Senior Vice President of Business Development and Shawn McCarthy, now providing leadership to both the Oncology and Vascular Businesses.

Beyond this we hired strong and high potential VPs for HR and the Venous Intervention Disease state team. We provided our current outlook for fiscal 2011 in our press release this afternoon. We anticipate revenue growth in the range of 6 to 9%. The low end of this guidance is in line with the estimated growth rate of the markets we operate in. The high end assumes ongoing gain in market share. We are committed to delivering profitable growth as reflected in our operating income growth range of 8 to 13%, which is higher than our revenue growth guidance.

Looking ahead, we remain confident about the outlook for AngioDynamics. We are increasingly vested in high growth markets with leading products in Venous Intervention and Interventional oncology markets. We are aggressively pursuing opportunities to accelerate growth through international expansion and increasingly exiting R&D pipeline for 2011 and the years beyond and the continuing successful commercialization of NanoKnife. Beyond this our strong balance sheet allows us to create additional growth opportunities. We are making good progress on executing our strategic plan and realizing our vision of building a fast growing and profitable leader in our space.

We have a profitable business model, we generate significant cash, and we have a strong balance sheet. We are exiting fiscal 2010 stronger than we ended it with higher growth, a stronger organization, a stronger financial position as well as a clear strategic vision. We're well positioned to continue growth and enhance profitability in fiscal 2011.

Before I turn the call over to Joe for a more detailed review of the fiscal fourth quarter and full year financial results, I'd like to thank once again our global AngioDynamics team for the hard work in delivering these strong results and the dedication and commitment in building our future. I'd also like to thank our shareholders and our Board of Directors for their on-going support and confidence. Joe?

Joe Gersuk

Thank you, Jan, and good afternoon ladies and gentlemen. We ended fiscal 2010 with a very solid quarter, reporting fourth quarter sales of 60.3 million, a 14% growth on last year's fourth quarter. The 14% growth rate was entirely organic and is the highest rate of organic sales growth for AngioDynamics in eight quarters. We note however that there was one additional business day this year, which means the growth rate on a daily sales basis was still an impressive 12% for the quarter.

For the fiscal year, sales grew 11% to $216 million. Organic sales growth was 10% which is a substantial improvement on the 6% organic growth rate reported in fiscal 2009. We achieved two important milestones this quarter. The first was crossing the $60 million threshold in quarterly sales and the second was exceeding $1 million in quarterly sales of IRE products for the first time.

Our growth this quarter was again led by our oncology surgery unit, which grew 35% to 16.8 million. We saw strong sales of LCDs and RF ablation products in addition to $1 million in NanoKnife system sales. This is our third consecutive quarter of solid NanoKnife system sales and brings IRE sales for the fiscal year to $2.5 million. Four hospitals acquired systems in the fourth quarter and we continue to be pleased with both the commercial and the clinical response to the technology.

The list of 14 hospitals that are actively using NanoKnife today on a commercial basis is available on our website. As Jan mentioned, the withdrawal of ethiodol from the U.S. market resulted in an increased demand for LCD. Using the more normal growth rate relatively that we saw in the first half of the fiscal year prior to the withdrawal of the ethiodol, we consider a normalized or adjusted fourth quarter growth rate for our oncology surgery unit would be 27%.

Our Peripheral Vascular unit also enjoyed a strong quarter with 13% growth in sales to $25.5 million. This was the highest organic growth rate achieved by this Peripheral Vascular unit in eight quarters and was led by very strong sales of disposable procedure kits in our EVLT business. While we continue to see pricing pressure in the procedure kit market, we were more than able to offset it with very strong unit volume growth. The balance of the growth in PV sales was primarily in introducer step and the benefit of Renal Infusion Systems.

We returned to growth in our Access business in the fourth quarter, albeit modest with sales increasing 1% to 18 million. We continue to see strong price, strongly price competitive markets for PICCs, Ports and Dialysis products and we experienced 6% lower average selling prices across the business unit this quarter in comparison to price levels a year ago. This offset 7 to 8% growth in unit volumes for our major Access products.

Hospitals and other buyers of these products continue to aggressively seek to lower their purchase cost. While we are not expecting the pricing environment to improve anytime soon, the regionally introduced Centros dialysis catheter and Triple Lumen PICC and two new Port products just entered FDA clearance and should contribute to incremental growth in fiscal 2011.

From a geographic perspective 90% of fourth quarter sales were in the U.S. and 10% or 6.1 million came from international markets. International sales grew 1% -- grew 8% rather from the prior year. Continuing down the income statement, gross profit totaled 35 million in the quarter or 58% of sales compared with 58% in the preceding quarter and 61.9% a year ago.

The 3.9% margin decline from the year ago reflects the decline in average selling prices on Access and Peripheral Vascular products mentioned earlier. Product cost increases on certain access products and the effects of sales mix. The pricing pressure accounts for about two thirds of the year-over-year margin decline. Operating expenses totaled 28.6 million in the fourth quarter, a 2% increase from the prior year expense level.

We achieved excellent operating expense leverage by reducing operating costs to 47.4% of sales in the quarter, more than a 4 percentage point improvement from the 51.5% a year ago excluding last years one time item. This is reflected of our effort to lower our operating expenses to mitigate the reduction in gross margin and these efforts are focused on sales, marketing and administrative costs and have not been achieved at the expense of new product development activities.

For the full year operating expenses totaled a 106.1 million or 49.1% of sales. The total operating cost investment in the IRE program for the quarter was 3.2 million and 11.1 million for the fiscal year. Including a sales revenue on our operating cost, the net loss impact to the IRE program amounted to $0.06 per share in the fourth quarter and $0.23 per share in the year.

Operating income for the fourth quarter was 6.4 million or 10.6% of sales. This was a 70% increase on the prior year results as we adjust last years operating income for the 702,000 of non recurring costs. EBITDA was 9.6 million or $0.38 per share in the quarter compared with 7.8 million or $0.32 a year ago. For the fiscal year we reported 20.9 million in operating income compared with 16.1 million in the prior year, while EBITDA was 33.3 million or $1.34 per share compared with 27.9 million or a $1.14 per share in the prior fiscal year.

After other income and taxes are taken into account the result is 3.7 million in net income or $0.15 in diluted earnings per share compared with $0.12 per share a year ago. The non-recurring cost reduced to prior year fourth quarter earnings by $0.02 per share.

For the fiscal year, net income was $0.50 per share in 2010 compared with prior year earnings at $0.41 per share or $0.51 per share excluding item. The tax rate was 36% in the quarter and 35% a year ago.

While we recorded a tax provision in the income statement, we paid minimal federal income taxes in fiscal 2010 and save 7.6 million in tax payments through the use of NOL available as a result of the acquisition of RITA Medical.

This was a substantially contributor to our strong cash flow from operations for the year. Turning to the balance sheet in cash flow statement we ended the quarter with cash and liquid investments of 100.1 million compared with 68.2 million at the beginning of the year.

We enjoyed an extremely cash flow quarter as cash and investments increased by 14.3 million and we generated 16.1 million in cash flow from operations in the fourth quarter. For the fiscal year we generated a record 40 million cash flow from operations.

A significant contributor to the very strong cash flow performance was the 8.3 million reduction in inventories that we achieved this year. On a per share basis we generated a $1.60 per share in cash flow from operations and $1.40 per share in free cash flow after accounting for $5 million in capital expenditures. These metrics are a clear indication of the strength of our business model to generate cash flow in a difficult competitive environment while we invest substantially in our IRE technology.

Finally, as indicated in the release, we are providing guidance for fiscal 2011. We expect 69% organic growth in net sales, which is a range of 230 to 235 million, gross margin in the range of 58 to 59%, GAAP operating income to increase 8 to 13% to range of 22.5 to 23.5 million, EBITDA to increase by 5.8% to a range of 35 to 36 million and GAAP EPS of $0.53 or $0.56, inclusive of a $0.23 per share impact from the IRE program, of $0.04 is the non-cash intangible amortization cost. Additionally we expect a tax rate of 37.5% and to achieve cash tax savings of $3 million next fiscal year from the use of NOL

With that I'll now turn the call over to the operator to begin the Q&A session. Michaela?

Question-and-Answer Session

Operator

(Operator Instructions). And our first question comes from the line of Jayson Bedford with Raymond James. Please go ahead.

Jayson Bedford - Raymond James

Good afternoon guys and thanks for taking the question. Just to start off on the Access business, can you just maybe talk about some of the traction I guess on Centros Triple Lumen PICC. I guess we would have thought you would have seen a little more impact in the quarter. I'm wondering was a full launch in the quarter or was it partial or just maybe talk about the trends generally with those new introductions.

Jan Keltjens

Yeah Jayson, good afternoon. Good question. Actually you know, we typically don’t break up revenue on even product families, let alone product lines. The second thing I want to add is that we always set something for the PICC line in particular that the, those were halo effects or the absolute revenue for that individual SKU as one number by those who make the entire PICC family more competitive. Now Centros was released fairly early in the quarter, initially on a limited. I wanted to test mark a little bit and see what the user feedback was and then we release it more fully. Smart PICC I think was frankly at the very end of the quarter. I think in the last handful of weeks it does. So I say the impact of that has been very, very marginal as such.

Jayson Bedford - Raymond James

Okay, and when you look at the Access business, was there a specific sub segments, whether it be PICC, sports or dialysis that did better than another?

Jan Keltjens

I believe -- I'm opening up the page here while I speak and actually our PICC family was the best in that mix of three. So they above that average of 1%.

Jayson Bedford - Raymond James

Okay, and then lastly for me and I'll jump back in queue, in terms of the guidance, you just did 10% organic growth in 2010. The guidance is 6% to 9%. Just wondering what's the source of your caution there and then secondly is there a way you can maybe breakout the expected growth or contribution from each of the segments for 2011? Thanks.

Jan Keltjens

The basic methodology as we did last year Jayson was essentially quiet close to the industry growth rate and we essentially bracketed it, so we’ve taken the same methodology this year, but we don’t offer any guidance with respect to the individual segments as to how that, those might break down.

Jayson Bedford - Raymond James

Okay and maybe if you just comment on, again the guidance implies a deceleration in organic growth and I'm just wondering, is there a specific area of caution or is that just conservatism?

Jan Keltjens

What do you call that? Conversation or caution, I think in certain segments – I think in the overall Access market, apart from our own performers, I think we have seen the market slowing down a little bit. Although still volume growth is outweigh in the marketplace at least it is outweighing price erosion. So, maybe there is a little bit of guarding in there, how to say, but we want set us up well and we thought this was the right number.

Again as is said in my remarks, the 6% we think estimates that we are holding share, the 9% would be that we continue to gain share, I think we took down market growth at one point in the mix from 7 to 6% for this year and that’s how we came up with this math. I understand the flavor, I understand the background of your question but we believe it's the kind of guidance and sets us up right and creates the right expectation out there as well.

Jayson Bedford - Raymond James

Fair enough. Thank you.

Operator

Thank you and our next question comes from the line of Jason Mills of Canaccord. Please go ahead.

Jamar Ismail - Canaccord

Hi guys this is Jamar Ismail for Jason. Congratulations on a good quarter.

Jan Keltjens

Thank you.

Joe Gersuk

Thank you.

Jamar Ismail – Canaccord

My first question is on oncology. Can you just give us a little bit more color on how you guys are gaining share and little bit about the competitive landscape and the sustainability of you guys share gain in oncology.

Jan Keltjens

The oncology market, Jamar, is probably the hardest one to frame in terms of market size and market growth, because there is frankly a lot of market creation going on and conversion from very, very different areas like brachytherapy, et cetera. So, in the RF side I think we're coming up with a good quarter. How to say whether we gain share or holding share market is hard to triangulate, but we did well and we think it's sustainable.

LC Beads, in a way you may argue that, that was a share gain, but at the expense of ethiodized oil that was pulled off the market in that quarter. We think that’s going to drop back a little bit but still year-over-year we will continue to show growth in that area, meaning that some of those customers that converted away from Ethiodized oil to LC Bead, we believe that we can retain and keep and like the benefits of a product of like LC Beads so much, that it will stick with us throughout the year.

Beyond that also with this market growth, the HCC prevalence is going up and there is a broadening use of the product, but we are gaining share, but we certainly see in Q4, begin in Q1, we're probably clipping in terms of, what we say close to a market separation, but again, on going growth.

NanoKnife, I'd say is entirely market creation and $1 million on the oncology business is a substantial number, $2.5 million for the year, Joe, is what about 4% - 5% of that growth number coming from NanoKnife, in the quarter, probably even a little bit even more than that.

And that is I would say, virtually, entirely creation. Those who are patients that went to other type of procedures, some of them maybe RF but I think the majority are coming frankly from either surgical resection or even counter indicated for that. And what else do we have -- I think those were the highlights, I guess.

Joe Gersuk

Yes, the only thing I just chime in on that Jamar to say that in the U.S. markets certainly we have an undisputed number one position in RF ablation. So, we've got the strength of market leadership. And secondly, I would just say that we have a very strong oncology sales force that’s been intact for a long time and is really excellent at establishing the physician relationships and selling the product. So, a very strong sales force is also part of our success there in oncology.

Jamar Ismail – Canaccord

Okay, let's move outside of IRE, did you see differences in growth rate in U.S. and OUS for oncology?

Jan Keltjens

Yes, I think you're following up on Joe's comments, so we got a very strong position in RF in the U.S. I'd say the flipside of that is frankly a good chunk of our RF growth is coming from international markets where we are arguably, I would say, we estimate a number three behind Covidien and Boston Scientific, but that's what we see about average growth and it goes up and down over the quarters a little bit.

NanoKnife has been heavily slated towards the U.S., thus far, Q4 a significant success for us, a first ever international commercial sales, and we like to believe that it’s the first of more to come. I think (inaudible) has frankly been performing outside the U.S. quite well better than in the U.S. and LC Beads of course is a domestic U.S. product, so we're not carrying that product outside the borders of the U.S. So, that gives you a bit more color, Jamar?

Jamar Ismail – Canaccord

Yes, it does, thanks. I'll get back in queue.

Jan Keltjens

Great.

Operator

Thank you. And our next question comes from the line of Brooks West with Craig-Hallum Capital. Please go ahead.

Brooks West - Craig-Hallum Capital

Hi, guys. Can you hear me?

Jan Keltjens

Very well, Brooks.

Brooks West - Craig-Hallum Capital

Great, congratulations on a good quarter.

Jan Keltjens

Thank you.

Brooks West - Craig-Hallum Capital

I wanted to ask in kind of follow-up question on guidance mirroring an earlier question on revenue but testing gross margins. Joe just wanted to understand the thought process there and also how we might see gross margins ramp throughout the year, kind of taking into consideration product launches, LC Bead contribution and also the sales force re-organization?

Joe Gersuk

Yes, essentially we've got a number of programs going on intending to target material costs which are a large element of the cost and goods, and we think those will begin to bear fruit heavily in the second half of the year. So, the improvement should all take place in the second half of the fiscal year in terms of getting towards that 59% range that we're talking about.

Brooks West - Craig-Hallum Capital

So, it's primarily coming from the manufacturing side versus the revenue driving side or in the mix side?

Joe Gersuk

Yes, it's going to be more on manufacturing activities, some vertical integration programs that we have going on, a number of things, but then mix should also help somewhat. IRE as well as will be an increasing element of our sales and that has an attractive gross margin in it as well. So, it really is a combination of all of those factors but in the aggregate the improvement is expected to be back loaded into the second half of the year.

Brooks West - Craig-Hallum Capital

Okay. And a couple of other quick ones. Our quick math, you got about a $1 million benefit from the LC Bead competitor being off the market in Q4, is that in the range?

Joe Gersuk

We calculated it little bit less than that.

Brooks West - Craig-Hallum Capital

A little less than that, okay. So still good performance in Q4 despite that competitor being off. And then Jan, lastly on OUS sales, only 10% in Q4. You have hired new management. What’s the opportunity or the plan you see for OUS in the following year or in this coming year, I guess the current year?

Jan Keltjens

Yeah, the quarter was a little softer international, nothing systemic. The overall number was -- currency didn’t play a major rule in case that question comes up, that actually was virtually a wash. The growth is coming by and large right now from RF, but in general I think the plans going forward are strong and again we don’t give guidance by region and all that. But we would expect the international division to grow above our average growth rate for the fiscal year and certainly our hope would be that it grows substantially faster. So, we were looking forward to those results coming through and being able to report those, Brooks.

Brooks West - Craig-Hallum Capital

Great. Okay I'll jump back in queue. Thanks guys.

Operator

Thank you. And our next question comes from the line of Robert Goldman with C.L. King. Please go ahead.

Robert Goldman - C.L. King

Okay. Thank you. Good afternoon guys. Couple questions on NanoKnife. First, if you could just help me through some of the vocabulary. On the hepatocellular trial, that is characterized as a pilot study, could you just help me understand what a pilot study is and what additional clinical data if any the FDA would be requiring to render a judgment on the use of NanoKnife for that indication?

Jan Keltjens

Bob, that’s a good question. The name pilot study for the international HCC study is somewhat arbitrary because the study is not designed to drive any indication, nor in the U.S., nor in Europe, where we frankly don’t need is because we have a very broad indication that works well. We don’t have the regulatory shackles in the international market or at least in the European market we have here. The reason we called it pilot, and we could have called it many things, but the reason we called it pilot is because the pool of 25 patients that will be enrolled in this trial is somewhat on the smaller side. We wanted to do a first high quality study, a top notch protocol using all the right parameters for end points, et cetera, with some real big names, some movers and shakers, say, frankly on the global field of liver ablation involved in the trial, creative base line. And we do anticipate that following this trial we will set up more levered efforts that could lead to indications in the U.S. but that has not been a decided upon strategy.

Robert Goldman - C.L. King

Okay. And relative to the IDEs, you mentioned prostate and pancreatic cancer. Is there anything that you could share with us as far as what the issues are with the FDA, what generally their questions are or concerns that resulted in a bit of a time delay here?

Jan Keltjens

Yeah, I can’t go into details for obvious reasons but the way to frame it, because I could imagine that the bystander would think by now we have a substantial body of clinical data, what can animal trials and preclinical data add to that? But there is a couple of safety points that you cannot really test in humans and don’t want to test in humans. You really go beyond the normal use of the device and make sure that even in extreme situations there is no collateral damage, et cetera, et cetera. And that kind of stuff you can typically only do in a preclinical setting.

So it’s questions of that kind of a nature that we're trying to address here, it’s fairly straightforward animal trials followed up by histology and pathology and then get a report in adding that. But in this environment between contract negotiations, setting up the animals, doing the work, doing the follow-up, doing the histology and pathology, it chews up time. And it’s a little disappointing but again very important to note here as well that we do not make revenue growth contingent on getting those IDE trials started or let alone finished anytime soon. It's decoupled at this point in time.

Robert Goldman - C.L. King

One more question if I could. It's not on NanoKnife but it's on acquisitions. I think, Jan, you mentioned on the last quarterly call that you did have some interest to the exploring acquisitions and there's actually been a number of medical device acquisitions since that time. Given what we're seeing in the marketplace as far as the valuation of medical device acquisitions, things like ev3 and Micrus and even Bard made one or two. Is their appetite increased or decreased over the last few months?

Jan Keltjens

Well Bob, I've never been accused of not having a healthy appetite. I think what we said last time is we purposely held back on acquisitions. We've been accumulating cash. We did not plan on buying back shares or paying dividend. We didn’t like the interest we got on banks. So we think we can actually invest it in the business. We are somewhat picky. We are looking for synergy. We're looking for strategy. We're looking for leverage. We're looking for bottom line contributions. We're looking for growth. I've said in smaller circles that stuff that’s cheap is cheap for a reason. I think the prices that recently have been paid for the companies you mentioned are not necessarily all that much higher than some of the other transactions that were done in the, let’s say, the two years before that. Good stuff that is worthwhile always expects a solid price. And a final thing I'd say is, yes, we forked [ph] the Senior VP of Business Development function with Lynda Wallace. We're in a strong position. Very important also to mention, I kind of slipped it in there in my remarks, we have a much more articulate [ph] strategy than we had 12 months ago and yet I would imagine that we get more and more active in that whole space.

Robert Goldman - C.L. King

Great, okay. Thank you, Jan.

Jan Keltjens

Welcome.

Operator

Thank you. And our next question comes from the line of Thomas Kouchoukos with Stifel Nicolaus. Please go ahead.

Thomas Kouchoukos - Stifel Nicolaus

Hi, good afternoon guys. Thanks for taking my questions.

Jan Keltjens

Hey Tom.

Thomas Kouchoukos - Stifel Nicolaus

I guess on the gross margin side, I know you've talked a lot about this already but just looking kind of back to the beginning part of last year, one of the things you talked about was bringing – I think you had 30% of products manufactured outside the company at that point, and one the goals like with DuraMax and then bringing the Benephit product manufacturing in house in Queensbury. We thought we'd see this kind of push upward with gross margin. I realize that your prices are a factor there but I'm wondering, if you take price out of the equation, how much progress are you making with the initiative to bring more product in house and then as you have your new PICC's and Ports and Access products, is that going to help bolster that as we go through next year.

Jan Keltjens

Yeah, it’s a great question, Tom. I'll make two comments and, Joe, I'm not sure you want to chime in here. But two comments I will make is, as I said a couple of times before, moving a significant product in house, and it depends a little bit whether the product of course is owned by the supplier, it gets a little harder because then you have to redesign the product versus we have contract manufacturing going on, if we move it in house it’s a little easier. But in the medical device world in 2010, things take a little bit of time, I mean we started executing on this kind of a strategy about a year ago I guess and Benephit is an example of that. There is a few other, I would say, relatively small examples, but I think the bigger initiatives wouldn’t come on stream until let say deeper into fiscal '11 and they will contribute to what Joe was signaling, a bit of a starting an upward trend in gross margins deeper in the year.

The margin, the contribution of excellently produced products as a portion of a total revenue, it's coming down a little bit. Some of the reasons for that is, that our high growth products are actually internally manufactured products, I mean NeverTouch. So, our Laser Fiber business is growing, is growing very, very healthy. Within that our NeverTouch product line which we manufacturer internally gets a bigger share of that volume. And in those product lines, we can't share those details with you, if you will appreciate, we do see healthy steps forwards in gross margin. So volume really helps and it’s a part of our strategy and we want to load up the factories and we want to create more volume and we're committed to that strategy.

So again major -- more major and more substantial initiatives of moving external products in house will happen over the next couple of months and quarters. And top of that, maintaining volume growth will do very well for us.

Thomas Kouchoukos - Stifel Nicolaus

Okay, thanks. And then Joe, a couple of financial questions here, looking at next year, just in terms of the R&D line and your expenses there, I would assume if you’re pushing the IDE studies, approvals kind of towards the back half of the year, should we assume that R&D would come down until you start enrolling patients in earnest or is there -- will you focus those dollars towards internal projects as an offset?

Joe Gersuk

Yeah, it won't come down; it will rise over the course of the year, and still be heavier though in the second half of the year than in the first, but it will rise in absolute dollar terms throughout the year. In fiscal '10, we spent 8.9% of sales on R&D and our expectation for next year is to spend slightly more than 9%.

Thomas Kouchoukos - Stifel Nicolaus

Okay, and then last one, Joe, on the tax rate, came in little bit below what we're looking for this quarter, was there anything going on there? And I think you said 37.5 for next year, is that correct?

Joe Gersuk

No, it's just that the final analysis of the taxes brought it down a little bit in the fourth quarter, but nothing really special and as we said 37.5% next year.

Thomas Kouchoukos - Stifel Nicolaus

Okay great. Thanks a lot guys.

Operator

Thank you. And our next question comes from the line of Larry Haimovitch with HMTC. Please go ahead.

Larry Haimovitch - HMTC

Good afternoon and two questions Jan, one tremendous progress and congratulations on the all the cash flow you have generated. You are facing what appears to be the loss of a key product at the end of next year. Is it possible that, that cash in some way could be used to solve that problem either with some sort of deal with Biocompatibles or some other manufacturer that would have fill the hole that the loss might occur with Biocompatibles.

Jan Keltjens

And what's the second question Larry?

Larry Haimovitch - HMTC

I'm saying, you have lots of cash, you got the potential loss of the Biocompatibles and second question is you want me to give you that now?

Jan Keltjens

I was wondering whether it was related or not.

Larry Haimovitch - HMTC

No, it's not. It's completely a different question so let's --

Jan Keltjens

Okay, fair enough. We'll do this one first, Larry. And thanks for the question profusely I would say. I said -- what I said in my remarks, we got a very healthy business, it's a win-win scenario. This relationship has been and continues to work well for both parties and the first and foremost, our energy is focused on just continuing a very successful mutually beneficial relationship.

Secondly, I had said very strongly that we believe that regardless of the outcome, we can manage the company through that period and that we can continue to show profitable growth going into 2012 in either the scenario. Now you also will appreciate I cannot or will not elaborate on the potential of both of the scenarios. As such some of them may require use of cash funds, some of them can be done differently. And you know what, it also maybe more than one solution and maybe at the end of the day, two-three things coming together that clearly seamless transition into a new reality from that point of view.

So we're not dazed by it. Nor Joe nor I, not the management team here is incentified to be naïve and sit on their hands. So we're trying to deal with all eventualities, project a vision of the future and deal with that. But again, the energy right now is focused on just continuing what has been a great run.

Larry Haimovitch - HMTC

Okay, great. And second question and I guess will it just preference my question but saying I am a major believer in IRE but I look at what you're spending now which was 11 million I think you expended in this current fiscal year that just ended. I don’t know if you projected a number. I joined the call a tad late. I don’t know if you projected a specific number for IRE. Your sales are growing but are very modest. Do you have unlimited faith Jan that this is going to ultimately payoff because with this loan as of with the FDA, it appears that you maybe facing many more quarters when this continues to be a significant drag on the company. I just want to understand your real commitment to this business and is warranted because it's just so difficult to get FDA approvals even to begin clinical trials.

Jan Keltjens

Yes, great question Larry and it is my first of all black and white and you know I have an engineering background so ask me if I believe unlimited I have to say no. And we are in a certain ways as interested in making certain milestones as the investment community as in as you are. We of course have the advantage of seeing a little bit more detail. I certainly personally also have the advantage of spending a lot of face time with customers that use their system in front of the FDA, work with the big thought leaders. I had dinner two weeks ago with Lencioni. I am going to be at the ECIO meeting next week. So spending a good chunk of my time there.

Tell you what I wish sometime that I could share the enthusiasm of individual positions that have used this and their belief in how big this is going to be in the future. Some of the patient's testimony they are in the public domain because of being disseminated by our customers. I had said before also Larry you and in perfect compositions and one on one composition’s that it takes a think a couple of things to build a great business.

One is a big unmet clinical need. I think we all easily agree that we have one in certain tumors in pancreas, prostate, liver and other organs. The second thing it takes is a viable solution for that and I absolutely believe NanoKnife is it. Now I also add as a third dimension which is an ability to execute which is determined by capabilities of the company, a reimbursement situation, a regulatory environment et cetera, et cetera and yet it's more difficult and than it used to be and yet therefore takes more time probably little more money than it used to be and yet therefore it takes more time, probably lot more money than people anticipated certainly a few years ago when we moved into Oncobionic’s and all that but I do believe that we will get through this and I do believe it's going to be a world wide investment. Final point I will make is, it is a big world. Already in the interventional oncology space current technologies are there. The bulk of the revenue opportunities set out at the U.S. and I do believe for NanoKnife it's not going to be different and we were not as strong from an infrastructure point of view in Europe and certainly not in Asia-Pacific.

We are building that failure aggressively and I want to, as a little side comment state, all of that is funded while we are leveraging SG&A expenses aggressively. So we're making the right bet from that point of view and I do believe that the international traction we're going to get in interventional oncology in general and NanoKnife in particular in itself is certainly Europe has less hurdles, has less of burden and yeah I think there is going to be a great opportunity. So, in short I am not sayings it's infinite but there is enough belief here right now to continue to spend this kind of money on this program.

Though one thing I will say is a lot of, a good chunk of these investments are sunk investments, amortization of historic investments, and not all cash and I think the cash flow we get from ongoing sales is increasingly offsetting the cash gain we make through R&D investments et cetera.

Larry Haimovitch - HMTC

That’s a great answer. Let me just ask one more quick question and I'll jump back in queue. What would you say was your most pleasant surprise in the past fiscal year and what would you say you were disappointed with in the past fiscal year?

Jan Keltjens

Do you want me to lie in the couch before I answer that question?

Larry Haimovitch - HMTC

Yeah that will be good. I am from California, we have lot of couches. So if you want to come along we can…

Jan Keltjens

I have a road, this gold part of the Northern Western European area and so (inaudible). Listen, what I am excited about is, two things -- I knew oncology was really something I was intrigued by when I look at this opportunity and I'm very excited about the potential of interventional oncology. It's a complicated market, it's a fragmented market, but by Joe's, and I understand we're here to make profits and deliver returns on investments and all that kind of stuff, but one rewarding opportunity is, I found it a privilege and I find the VenaCure's vein market, the Venous Intervention market quite intriguing, very different dynamics in many ways, in certain ways much more a consumer kind of a market, much more commercial market for sure. Tremendous opportunities. So definitely from a business point of view, I think we got a tremendous team. I have said a couple of times; this has been the easiest leadership assimilation program.

I have gone through great people willing to do the right thing, capable people. Disappointments, although probably could escape by not answering the question, but disappointments, I think margin erosion in Access took the shine off what otherwise has been a very, very strong fiscal year I think. We are not one of could have, should have, but if Access would have hung in there, if only the margins would have hung in there we could have added that to top-line growth and we could have added that to bottom-line.

I think it would have made a solid year, a great year.

Larry Haimovitch - HMTC

Very good. Thanks very much.

Jan Keltjens

Thanks. Michaela, anything else there or? Hello?

Larry Haimovitch - HMTC

I'm sorry. We lost the operator.

Jan Keltjens

Is that you Larry?

Larry Haimovitch - HMTC

Yes it's me. I guess that they have lost the operator. Well, you and I can have a private conversation then.

Jan Keltjens

I'm not sure it's private. I wouldn’t bet on that. I would pull rig in one here but then.

Larry Haimovitch - HMTC

No, no, no yeah. I suppose maybe a disappointment this year has been that it's been a little bit slower with the FDA as far as IRE and that has, none of us thought it was going to be this slow to get some of these approvals moving.

Jan Keltjens

Michaela? Larry, do you have to hit a button? No, I don’t think so?

Larry Haimovitch - HMTC

No, no. I wonder if anyone else is on.

Jan Keltjens

Well they can't talk.

Larry Haimovitch - HMTC

Never had this happen before. I've had other strange things on the calls but this is a new one.

Jan Keltjens

Let me put you on mute for one second there Larry. I'm going to check via the web here.

Larry Haimovitch - HMTC

Yeah, I'm sorry. Go ahead.

Jan Keltjens

Michaela, I don’t think your back on? No. Larry, and I assume the rest can hear us as well. It sounds like they locked the bridge but also our systems tell us there was nobody else in queue. So go out on a limp and we just assume that. So I want to thank everybody for their interest in AngioDynamics. We will obviously continue to provide updates on our progress and very much look forward to talking with all of you again on our first quarter fiscal 2011 conference call which should take place in October. Thank you all very much and talk to you soon. Bye.

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Source: AngioDynamics, Inc. F4Q10 (Qtr End 05/31/10) Earnings Call Transcript
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