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Executives

Joseph Kaufmann - President and CEO

Mike Celano - CFO

Doug Evans - COO

Analysts

Dave Turkaly - SIG

James Sidoti - Sidoti & Company

Josh Jennings - Jefferies & Company

Bill Plovanic - Canaccord

Kensey Nash Corp. (KNSY) F4Q10 (Qtr End 06/30/2010) Earnings Call August 23, 2010 9:00 AM ET

Operator

Welcome to the Kensey Nash fourth quarter and fiscal year earnings release. (Operator Instructions) I'll turn the conference over to the President and CEO, Mr. Joseph Kaufmann.

Joseph Kaufmann

Thank you. Good morning, everyone. Welcome to the Kensey Nash fiscal fourth quarter 2010 conference call. Joining me today are Doug Evans, our Chief Operating Officer; and Mike Celano, our CFO. First, we can get started with the Safe Harbor.

Mike Celano

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

Please see today's press release and Kensey Nash's SEC filings, including our Annual Report on Form 10-K for the year ended June 30, 2009, and other fiscal year Form 10-Qs, particularly the information under the caption "Risk Factors" for the discussion of risks, uncertainties and other factors that could cause actual results in fiscal year '11 and beyond to differ materially from those expressed in or implied by our forward-looking statements.

Joseph Kaufmann

Thank you, Mike. Well, I'm very pleased to report excellent financial results for our fourth quarter today, a quarter in which we achieved record sales of $15.1 million and record adjusted EPS of $0.54 per share. I would like to thank our employees for another great job in not only the current quarter, but throughout our fiscal year 2010.

My remarks today regarding EPS will be referencing the adjusted EPS of $0.54 for the quarter and $0.85 for the fiscal year 2010. Details of the reconciliation from adjusted EPS to reported EPS are available in the press release.

Our total revenue for the quarter of $21.9 million exceeded prior year by 7% and increased 10% sequentially. Total net sales of $15.1 million exceeded prior year by 12% and increased 14% sequentially. This growth was due to sports medicine, which increased 58% year-over-year and 9% sequentially; and our cardiology products, which are primarily Angio-Seal components, also increased 14% year-over-year and 3% sequentially.

In addition, we shipped our initial XCM Biologic products to our new partner Synthes for their initial launch in the U.S., which is taking place in the first quarter of fiscal year '11. So all these items contributed to an outstanding quarter for Kensey Nash.

Partially offsetting this growth year-over-year was a 9% decline in our spine products; however, these products did increase 37% sequentially from the very weak third quarter. The spine business reflects an overall weakness in this market, as I'm sure most of you are aware of by the reporting of other companies in this space. And in particular, it has impacted one of our key strategic partners.

As you may know, Orthovita, our partner, with the VITOSS products and the VITOSS Bone, has announced recently they will be refocusing their sales efforts on our co-developed products. And we are hopeful this will result in an improvement in sales in the second half of our fiscal year 2011.

Royalty income of $6.8 million was 3% below prior year and increased 1% sequentially. Angio-Seal royalties of $5.3 million were essentially flat year-over-year and sequentially. And Orthovita royalties of $1.4 million decreased 10% year-over-year, but were flat sequentially.

Earnings per share of 54% increased 32% year-over-year and 17% sequentially. And for the total year, EPS of $1.85 increased 9%. This reflects not only the improvements that we've made throughout the year in our cost structure, but also the growth of our new businesses in the regenerative medicine space and the fact that this gets the company in a position for outstanding growth looking out over the next five years within our organization.

We have refocused the company in this biologic space, and we're very happy with the progress our teams have made in R&D and clinical area and in the manufacturing space, as we're in a great situation today not only for fiscal year 2011, but certainly beyond with all the products that we have in the pipeline and the strategic partnerships that we currently have in place, but also some new ones that we anticipate will happen in fiscal year 2011.

If you look at our balance sheet, the operating cash flow for the quarter was $10.9 million and for the year was a little bit over $30 million. CapEx was approximately $3 million for the year. And free cash flow prior to our stock repurchase program was approximately $27 million. As of June 30, 2010, cash and investments totaled $65 million, and this is after stock repurchases for the year of $41 million.

Moving on to our guidance for the first quarter and fiscal year 2011, we expect total revenues for fiscal year 2011 within a range of $81 million to $83 million. Net sales and royalties are expected to be in the ranges of $54 million to $55.5 million and $27 million and $27.5 million respectively.

The company expects the combination of new product launches of its ECM products in the U.S. and E.U. along with the launch of the cartilage repair device in the E.U. later this year and overall growth in our core biomaterials business will more than offset the expected reduction in the Angio-Seal components sales in fiscal 2011.

As you all know, we announced earlier this summer the new supply agreement with St. Jude Medical, and our guidance now reflects this new agreement which will go into effect January 1, 2011.

In terms of looking at the EPS for fiscal year 2011, we expect that will be in the range of $1.86 to $1.90. Fiscal year 2011 will include a significant investment in R&D, as always with our company, with total spending for fiscal '11 estimated to be approximately $20 million. This will include an increase of clinical activities for our cartilage and ECM technologies, both in the U.S. and in Europe.

We also expect that our operating margins will be approximately 33% to 35% in 2011 and the balance sheet will continue to be strengthened by adding cash from operations in excess of $25 million.

For the first quarter of 2011, total revenues we expect will be in the range of $17 million to $17.3 million. Net sales are expected to be in the range of $10.8 million to $11 million and royalties in the range of $6.2 million to $6.3 million. The company expects first quarter fiscal 2011 earnings per share of $0.41 to $0.43.

The first quarter revenue estimates reflect the continued weakness in the overall spine market, which is negatively impacting near-term orders, and we also expect a decrease in our sports medicine product sales and Angio-Seal collagen sales due to variations in ordering patterns in the quarter.

Now, in the last two quarters, our sports medicine products have been extraordinarily strong, reflecting the high demand in the marketplace and also what we believe is just a continuing strong performance by one of our key customers. However, in the summer months it's typically lower procedure volume that takes place, but we also are looking at the comparisons year-over-year and coming off two very strong quarters, we expect that our first quarter will be weak but it will rebound in the second quarter, and for the balance of the fiscal year, we will see sports medicine again continue to be strong and improved and actually increase year-over-year in fiscal year 2011.

As far as the Angio-Seal collagen sales, again, our third and fourth quarter collagen sales to St. Jude were very good. And we look at the comp compared to last year and our first quarter, it's primarily again due to timing. We expect our second quarter sales to St. Jude will reflect this and will show the improvement.

So the first quarter message is one of basically just timing relative to two significant customers, which will improve in the second quarter and throughout the year as regarding the sports medicine, but certainly not on the Angio-Seal as it will impact the new agreement.

The spine products will continue to be weak in the first half of the year, but we do expect a pick-up in the back half of the year with our partner, not only because of the sales refocusing efforts but also some new products that we hope to launch with this partner in fiscal year 2011.

So with that, I would like to turn it over for questions and open it up to the audience.

Question-and-Answer Session

Operator

(Operator Instructions) And we'll line up with Dave Turkaly with SIG.

Dave Turkaly - SIG

Thanks for all the detail in the release. We look at the fiscal '11 guidance and then how it starts in the year, just to reconcile it and how quick you think some of those other business might come back. I was wondering if you could just give us a little comment in terms of, from $17 million, are we going to be looking kind of back in that $20 million range pretty quickly.

And then how much, if you could give us sort of like, maybe even a range for what you think these ECM products could do this year?

Joseph Kaufmann

Well, in the second quarter Dave, we do expect the $17 million will grow substantially in the second quarter. And we do expect that the number will be around that $20 million number in the second quarter. So we feel pretty good about that.

So, again, I think that should give everyone confidence that this is more of a timing situation, which we run into occasionally. And again, reflecting the strong third and fourth quarter that we have with a couple of our partners.

As far as the new products, we don't want to give out specifics in terms of our expectations for the new products on ECM, but Synthes is launching the product in the U.S. in this quarter. It's a soft launch; it will get stronger as the year goes on.

We expect, in Europe that we're going to be launching later on this calendar year, early part of the third quarter for the E.U. launch. So that's certainly going to impact the back half of the year, those two items.

In addition, we expect to have at least two more approvals of our ECM technology in the U.S. and two more in Europe in fiscal year 2011. And we also expect that our new program with the sports medicine with ECM with Arthrex, that product is going to be launched in the second, third quarter of our fiscal year. That's also going to have an impact to drive sales from where the current levels are.

And we also expect that we're going to have a distribution partner for our cartilage product before the end of certainly the first half of fiscal year 2011.

So all those factors, when you look at it, as we talked about in our last conference call will all contribute to driving the sales growth of Kensey Nash throughout the fiscal year. And improving sequentially, we think every single quarter that we're going to see another strong year for Kensey Nash and another one that's going to have us well positioned for growth beyond 2011.

Dave Turkaly - SIG

And just to follow up with one, the approvals that you're looking for the ECM products in the U.S. too and then two in Europe, are those currently like, with the partners you have, or will those be opportunities to even add more?

Joseph Kaufmann

One will be with the partner that we have. The others, partner that we have, or could be with new partners. All depends on the indication and also depends on the type of deal that we're talking about.

So this opens it up for, certainly extending our existing relationships, but also growing and bringing in new partners for Kensey Nash.

Operator

And next, we'll go to the line of James Sidoti with Sidoti & Company.

James Sidoti - Sidoti & Company

Can you remind me on the Synthes agreement, is there a royalty component?

Mike Celano

Yes.

James Sidoti - Sidoti & Company

So because the launch is just starting, we didn't see that this quarter. But you expect that would start to contribute by year second or third quarter?

Mike Celano

Yes, I think more so in the second quarter. And then hopefully, certainly our expectations are that it's going to become more important as the year goes on, absolutely.

James Sidoti - Sidoti & Company

And then as far as the quarterly guidance; it's pretty easy to understand that the Orthovita sales should pick up towards the end of the year when they start launching some new versions of their product, but do you have any indication from Arthrex that what gives you the confidence that you think those sales will bounce back towards this second and third quarter of the year?

Joseph Kaufmann

Well, we have in our interaction or people talking with Arthrex, we certainly don't think that this should be interoperated as anything slowing down in the end-user market that actually things are going quite well. And they are doing, from what I understand, very well, and we think the sports medicine market is going to continue to be strong. They are obviously one of the dominant players in this space.

So this again, Jim, is nothing more than a timing situation that you will have with our business. But looking at forecast, looking at new products, looking at potentially some other business we may have with this partner, we feel very confident that our numbers in the sports medicine field are going to do very well in fiscal year 2011. So this is not something that should be interpreted as any kind of weakness in that market, it's timing.

James Sidoti - Sidoti & Company

And then when you talk about potential other business with Arthrex, is that the ECM product or those other products on top of that?

Mike Celano

Well, certainly, the ECM one we announced earlier this year, that was one, but there are other things. We have a lot of respect for that organization and what they have accomplished in sports medicine. And they are a tremendous force. So there could be other opportunities with Arthrex and with other players in this space. But they are certainly at the top of the list.

Operator

And we'll go to Josh Jennings with Jefferies & Company.

Josh Jennings - Jefferies & Company

I guess looking at guidance and how it sort of took a sequential step down in fiscal Q1 and then more strength in the back half. From your comments, it sound like a lot of that strength is going to be driven by the ECM mesh product in the official launch and then driving that out in the U.S. and in Europe.

Can you just comment on the competitive landscape that you guys are up against for one? And then my understanding is that the penetration really is relying more and more upon clinical data for one and just your strategy to accumulate clinical data? And then two, the price point, what your pricing strategy is in terms of whether you're coming in at a discount or sort of in line with where the markets at?

Joseph Kaufmann

Well, we feel that the product that has developed here at Kensey Nash is certainly going to be very competitive in terms of the clinical performance. And the expectation is that we will be conducting various clinicals associated with our products. And obviously they have a headstart, and that's why they have the $125 million may $150 million in sales right now.

But again, we're starting from zero. So we have a lot of opportunity for growth. We have a great partner with Synthes who has very strong reputation in their sales and marketing organization and education.

So that's a real strong point from that organization. So we think that we'll be able to get our fair share of the marketplace over a certain period of time. As far as pricing, we certainly don't expect that we're going to be competing on price. We're going to be competing the value of our product. And we think will be very competitive.

Josh Jennings - Jefferies & Company

Just to circle back on the strength of sports medicine business, you're seeing that it's big and expect in the last three quarter of fiscal '11. Looking at some of the unemployment numbers and population level and some expectations for moderation in elective procedures, how have you guys been able to grow that business? Is it really, sort of, more demand for your biologic products or for the products that Arthrex is kicking out there with some of the other partners? How have you guys been able to grow that so nicely over the last three quarters?

Joseph Kaufmann

Well, we like to think that it's a combination of all those things you just said. It's a combination of certainly, obviously Arthrex is a very strong player in sports medicine and they continue to drive the products in the marketplace. We also like to think that Kensey Nash with the reputation that we have in delivering high-quality products innovation helps to provide those products to Arthrex.

So we believe that certainly the market has been impacted by the high unemployment, not just that market, I think we're seeing it throughout healthcare more and more. But it's a strong marketing company, Arthrex.

It's products, it's quality, it's all that things that you think of every day, and that we think with hopefully some of the new products that we're brining to the marketplace, the biologic products, we believe are going to be a major factor in all of healthcare going forward. And Kensey Nash is going to be a major player in this space, not only in sports medicine, but also in general surgery and in other areas that we're very well positioned with the technology we have built here over the last five to 10 years or so within our organization.

Josh Jennings - Jefferies & Company

Just in terms of cartilage program, what needs to be done, what are the next steps that you need to take to get a partner for international distribution? And then I believe you guys had spoken historically about a 30-patient pilot trial that was going to start, and if you could just comment on where you're there?

Joseph Kaufmann

On the pilot trial, that's getting underway. So we did get the approval by the FDA to move forward. So I don't have any updates to provide to anybody at this time, but it's something that we expect to move forward with and hopefully have a good outcome there.

As far as the partnership with cartilage, quite honestly we've had a lot of interest in partnering for the cartilage product from a whole variety of companies, big and small, everywhere. And it's very important for Kensey Nash strategically where we're going with this product not only for Europe, but also in the U.S. and the long-term impact of any deal that we do and how that impacts us down the road in the U.S. and in other markets.

So it's not a question of us not being able to find a partner or any of those situations. We have to make sure that we're going to put together a distribution deal that works for Kensey Nash long term. So that's really been the only delay.

Josh Jennings - Jefferies & Company

And then just last one just on the St. Jude supply agreement. Anymore color you could provide in terms of what happens? I know that's a tiered supply agreement for the component parts, but after 2011, it seems that that minimum 25% does that end in 2011 and you could renegotiate for 2012? And then lastly, is there any risk of the Angio-Seal royalty rate going away at some point?

Joseph Kaufmann

On the supply agreement, it's a two-year deal that starts at January 2011, so it goes out for '11 and '12. And then after that it will be determined whether it will be expanded, increased, decreased, or renewed, I don't know at this time.

As far as royalties are concerned, we are a royalty on Angio-Seal sales. As long as there is at least one claim on any patent, we're entitled to the full 6% royalty, there aren't any step-downs. So as long as there is patents in place that are being utilized, then that's when we continue to receive the royalty.

Operator

Our next question is from the line of Bill Plovanic with Canaccord.

Bill Plovanic - Canaccord

Just curious, on the ECM product, what approvals do you need and what type of clinical studies do you need to perform to gather those approvals prior to launch, your commercialization with the different partners.

Doug Evans

Currently, for the launch of the product with our partner Synthes, this will be the XCM biologic product. At this time, to sell the product in the U.S., we do not need any further clinical studies. However, to help prepare the marketing literature and training programs, we will be coordinating some small, focused clinical studies on specific indications which are already within our approval to help with the marketing and sales efforts.

With the approvals that we have for the product in place in the sports medicine area, Arthrex is also able to sell the product as it stands today. So from a marketing perspective, we'll be doing some clinical trials, but it's not necessary to launch the specific products initially.

Bill Plovanic - Canaccord Adams

So basically, you have the 510(k) clearances. Any trials or studies you're doing is purely for marketing support for these products, for Synthes and Arthrex? Is that correct?

Doug Evans

That's correct.

Operator

(Operator Instructions) And to the presenters, there are no further questions in queue.

Joseph Kaufmann

In that case, we'll end the call. I appreciate everyone calling in today and listening, and look forward to a conference call again in October with our first quarter results. Thank you very much.

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