Lifecell Corporation Q4 2007 Earnings Call Transcript

Lifecell Corporation (LIFC)

Q4 2007 Earnings Call

February 27, 2008 10:00 am ET

Executives

Paul Thomas – Chairman, Chief Executive Officer and President

Steven Sobieski – Chief Financial Officer and Vice President of Finance and Administration

Analysts

Matt Miksic - Morgan Stanley

Ed Shenkan - Needham & Co

Michael Matson - Wachovia Capital Markets

Matt Dolan - Roth Capital

Caroline Corner - Pacific Growth Equities

Jayson Bedford - Raymond James

Steven Lichtman - Banc of America Securities

Greg Brash - Sidoti & Company

Mark Mullikin - Piper Jaffray.

Presentation

Operator

Good morning everyone, and welcome to the LifeCell Corporation Fourth Quarter 2007 conference call. As a reminder, today’s call is being recorded. At this time, I would like to turn the call over to Mr. Steven Sobieski, Chief Financial Officer of LifeCell Corporation.

Steven T. Sobieski

Thanks, Michael. Good morning, and thank you for joining us on LifeCell’s fourth quarter 2007 financial results conference call. I want to remind you that certain statements made during this conference call, such as our financial outlook for 2008, are forward-looking statements made pursuant to the Safe Harbor provisions of the Private Securities Litigation Reform Act.

Although we believe that the expectations reflected in such statements are reasonable, we give no assurance that such expectations will prove to be correct since they involve risks and uncertainties that may be beyond our control and could cause future results or performance to be materially different from our expectations.

Please refer to our SEC fillings for more information regarding the risk factors that could impact our future results. As a reminder, all of our SEC fillings are available through our website.

I’ll now turn the call over to Paul Thomas, President and CEO of LifeCell.

Paul G. Thomas

Thanks Steve, and good morning everyone. I’ll begin this morning by reviewing our fourth quarter operating results. We achieved record product revenues of $52.6 million this quarter, which was 34% above the $39.3 million we recorded in the fourth quarter of 2006.

Our product revenues grew 11% sequentially from the third quarter of this year. Consistent with the trend throughout 2007, the increase resulted primarily from higher demand for AlloDerm, which increased 38% to $46.9 million in the quarter, compared to $33.9 million in the fourth quarter of 2006.

AlloDerm, which is marketed through our direct sales organization, represented 89% of our total product revenues in the quarter. We recently expanded our direct sales organization by 20%, bringing the total in the field to 87 folks.

Our orthopedic product revenues, which include GraftJacket and AlloCraft DBM, increased 13% to $3.1 million in the quarter, from $2.8 million in the fourth quarter of 2006. GraftJacket revenues were $2.7 million, up 17%, compared to $2.3 million in the prior-year same quarter. Our Repliform revenues were $1.9 million in the current quarter, versus $2.1 million in the fourth quarter of 2006.

Our product gross margin was 70% in the quarter, which is in line with the third quarter and full year. Our operating income declined 1% to $9.3 million, compared to $9.4 million in the fourth quarter of 2006.

Operating income in the quarter was negatively impacted by higher legal fees associated with the contract arbitration with Wright Medical and the previously announced settlement of a non-product related claim.

Net income for the fourth quarter was $5.5 million, or $0.16 per fully diluted share, compared to net income of $6.2 million, or $0.18 per diluted share in fourth quarter of 2006. As noted in the press release, the per-share impact of the settlement charge was approximately $0.03.

Also, net income in the fourth quarter of 2006 was favorably impacted by the recognition of research tax credits, which lowered our tax expense by $480,000 or approximately added $0.01 per share in the quarter.

Turning now to our operating results for the full year: Product revenues increased 35% to $190.5 million, compared to $140.6 million in 2006. The increase was driven by a 40% increase in AlloDerm revenues, which grew to $167.1 million in 2007, compared to $119.4 million in 2006.

Our orthopedic revenues increased 27% to $12.3 million, from $9.7 million in 2006. Our GraftJacket revenues were $10.3 million in 2007, up 28% from $8 million in 2006. Repliform revenues for the year were $7.8 million, compared to $8.1 million in 2006.

Our product gross margin for the year was 71% in 2007 as well as in 2006. Our operating income increased 30% to $43.4 million in 2007 compared to $33.3 million in 2006.

Operating margin declined slightly to 22.7% in 2007, compared to 23.5% in the prior year. As previously discussed, our 2007 was impacted by higher legal fees and a non-product related settlement charge.

Full-year net income for 2007 was $26.9 million, or $0.78 per diluted share, compared to net income of $20.5 million, or $0.60 per diluted share in 2006. We ended the year with $97.9 million in cash and investments, up from $77.8 million at the end of 2006.

In 2007, we generated $29.2 million in operating cash flow, and received $3.9 million in cash from the exercise of stock options. During the year, we used $12.4 million of cash to fund capital expenditures required to support the growth in our business.

Turning now to 2008. As we previously communicated in January, we anticipate full-year product revenues in the range of $233 million to $243 million, which represents annualized growth between 22% and 28% compared with 2007. We expect our product mix to be approximately 90% recon, 7% ortho, and 3% urogynecology.

We estimate operating income for 2007 in the range of $57 to $62 million, representing an operating margin of approximately 25%.

Diluted net income per share is expected to be in the range of $0.98 to a $1.06, based on estimated fully diluted shares of approximately 36 million.

Turning now to some non-financial feedback. Last week, I attended our national sales meeting, and I have share with you that I’m actually very excited about the enthusiasm that I witnessed in our sales organization.

Not only are our reps excited about the potential for increasing their AlloDerm revenue this year, but I also sense the growing excitement about Strattice. We had several surgeons presenting at the meeting who have used Strattice in our early-experience program, and we are very encouraged by their comments.

To date, Strattice has been used or implanted in approximately 90 patients, with the earliest procedure done more than four months ago. Now that our expanded sales organization is fully trained, we are officially commencing our launch of Strattice this week.

In closing, I want to assure you that we are very excited about our future prospects. This is actually quite an exciting time for the company, and we remain focused on building shareholder value, through increasing our product revenues, managing our operating expenses, and making investments that we consider vital for the company’s future.

I’d now be glad to take any questions from the audience, Michael.

Question-and-Answer Session

Operator

(Operator Instructions). And our first question today will come from Mark Mullikin - Piper Jaffray.

Mark Mullikin - Piper Jaffray.

Thank you. Paul, can you give us an update on progress in signing an OUS distribution agreement for Strattice?

Paul Thomas

Sure, Mark. As I’ve stated several times, our internal target is to conclude this agreement by the end of the first quarter. And, I can tell you that we are looking to partner with a company that has a shared vision with respect to biologic soft-tissue repair, and has the appropriate infrastructure in place with respect to sales and distribution, regulatory and reimbursement capabilities, to facilitate a successful launch.

We are currently in advance discussions with several interested parties, and as I said, our internal target for completion continues to be the end of the first quarter. And, I’m very confident that we will be able to select a partner that will enable us to realize the full potential of Strattice in OUS markets.

Mark Mullikin - Piper Jaffray.

How confident are you that that happens by the end of the first quarter?

Paul Thomas

I feel very good that we have all the programs in place to advance those discussions. I don’t see anything derailing it at this point. So, our internal target remains the end of the first quarter. So, obviously we’re a month away and, as you can imagine, we’re making significant progress towards finalizing an agreement

Mark Mullikin - Piper Jaffray.

Okay. On the orthopedic indication for Strattice, you prevailed in the arbitration with Wright Medical. What are your plans for Strattice in orthopedics at this point?

Paul Thomas

As you noted, we prevailed in the arbitration proceeding with Wright Medical and our intention is to explore distribution options with folks who have capability in the sports-medicine market. Those discussions have been ongoing for some time, and hopefully we can conclude a distribution partnership in the relatively near-term.

Mark Mullikin - Piper Jaffray.

And what about Strattice and diabetic foot ulcers? Are you looking for a partner for that indication, or are you leaving that for AlloDerm through Wright Medical?

Paul Thomas

Actually, if you recall, Wright Medical retains all rights to GraftJacket including its use in diabetic foot ulcers or chronic wounds that are dealt with by podiatrists. So, nothing has changed with respect to Wright Medical’s product rights on GraftJacket.

What we’re talking about is what we choose to do with Strattice in orthopedics, and the primary focus is on sports-medicine application, rotator cuff, and ligament and tendon repair. Of course, we will also look at opportunities in diabetic foot ulcer with the right partner as well.

Mark Mullikin - Piper Jaffray.

Okay and Steve, can you just break out the impact of the legal settlement on the fourth quarter both pre-tax and post-tax? And also, how much unusual legal expense did you have in the quarter in addition to the settlement?

Steven Sobieski

The settlement was approximately $2 million pre-tax, and after-tax about $1.2 million, which is the $0.03 per share. Additionally, the legal, although we anticipated it in our original guidance, but I wanted to highlight it because it was higher than normal, and to try and give investors a sense of what our ongoing run rate is, and that amount was about probably another $0.02 per share, after-tax.

Mark Mullikin - Piper Jaffray.

And just incremental legal fees?

Steven Sobieski

Roughly, $700,000 to $800,000.

Mark Mullikin - Piper Jaffray.

Okay, very good. Thank you.

Operator

We will have a question from Greg Brash - Sidoti & Company.

Greg Brash - Sidoti & Company

Hi, thanks for taking my call. Can you just talk a little bit more about the opportunity outside the U.S, the size of the market and just maybe your expectations for long term? Is there something you believe, say 3 or 4 years down the road, can generate as much revenues as your U.S business?

Paul Thomas

When I speak of OUS markets, Greg, I’m really going to limit my comments to the E.U. because that’s really where we’ve done most of our work to this point. We’ve actually done a quite a bit of primary market research and if you look at the procedural basis, or the market opportunity based on number of surgeries, it’s actually quite similar to the market potential in the U.S. on a surgical basis.

I think that the reality is that reimbursement and pricing will be less robust in the E.U. compared to the pricing we’re able to get in the U.S. So, while it varies by country, a reasonable walking-around number is probably about two-thirds of the pricing levels of the U.S. So, as you can appreciate, the E.U. becomes a fairly significant opportunity for us, and one that is essentially untapped.

What is interesting as well, looking at Europe, is that there is really no successful history, on use of biologics. Obviously AlloDerm has not been used to any great extent in Europe, and other biologics have a very weak footing in that market.

So, I think that Europe will require a reasonable amount of investment to build the market, and demonstrate to folks the value of biologic tissue regeneration approach to wound repair. And that’s why we’re looking very closely at partnerships, and partners that share that vision with us, because it will require investment in clinical trials as well as dedicated medical-education and sales-force programs to fully capitalize on the opportunity available to us in Europe.

Greg Brash - Sidoti & Company

Do you have any ideas on how long it would take, as far as making those investments, before international would generate a significant portion of your revenues?

Paul Thomas

We have indicated that international will not be a significant portion of our revenues in 2008, and we’ve really not given any guidance beyond 2008. But I do anticipate that you’d begin to see some ramp-up in 2009, with acceleration going into 2010.

Greg Brash - Sidoti & Company

Okay that’s very helpful. And then just on the gross-margin side: Last year during the fourth quarter you were around 72%, and 71% in the beginning half of this year. And now you’re down near the 70%, 70.5%. Any reason for that? I know I thought there was going to be some manufacturing efficiencies, and what should we look for in ‘08?

Steven Sobieski

I commented earlier in January when we talked about margins for 2008, and said that we were anticipating margins to be flat. And you are right, although they were 72% a year ago, we saw them trending down slightly and actually, in the third quarter, they we’re just about the same, or maybe slightly above where we are. And the full year is about 71%, and actually last year’s full year was − meaning ‘06 − was about the same.

As I mentioned in our call in January, as our business over the last several years has shifted towards much larger size pieces of AlloDerm, the cost associated with recovering and processing those larger sizes is higher than for smaller pieces. And although part of the costs have been offset by volume-related efficiencies, the gross margin at least over the last year or so has been fairly neutral, maybe down just slightly. And we anticipate a similar performance in terms of gross margin at least in the near term in 2008.

Obviously, on a go-forward basis, we’ve stated that we believe there are opportunities with Strattice to improve gross margin. However, in 2008, since we’re just in a start-up mode really, and will not have our full commercial capacity online, that you probably you will not see any net impact in 2008 on margins as a result of Strattice.

Greg Brash - Sidoti & Company

Okay. Is there a certain volume level or sales level for Strattice where we’ll begin to see gross-margin improvement?

Steven Sobieski

There are lot of moving pieces to it, right? It’s sales mix, it’s also, and as Paul was just talking about OUS and pricing on OUS, and the way we structure that relationship could impact the amount we book; it may have a comparable product contribution but it could be at lower initial gross margin. So, there are a lot of moving pieces but I would say that, beyond 2008 − and again we haven’t given any guidance for 2009 − I would expect as we move into 2009 and beyond, we would be able to show improvement in our corporate gross margin.

Greg Brash - Sidoti & Company

Okay thanks for taking my questions. I’ll hop back in queue.

Operator

We’ll go to Steven Lichtman - Banc of America Securities.

Steven Lichtman - Banc of America Securities

Thank you, good morning. Just had a follow up on data presentations this year. Any latest thoughts in terms of timing? Are we still on target for primate data this quarter? And if you could talk about what you think the relative impact that the primate data will have on the physician community?

Paul Thomas

There’s a couple of questions there. We have submitted the primate data for publication. It’s under review, so I anticipate that that will be published shortly.

With respect to your question, Steve, I think is, what is the impact that primate data or other data will have on clinicians? I can tell you that about three weeks ago I attended a meeting with 25 key opinion leaders where we shared the existing data on Strattice, primate data, as well as early clinical experience with surgeons, and the surgeons reacted very positively both to the primate data as well as to hearing the early clinical experience from their peers.

So, I actually anticipate that the market of surgeons will receive the available information on Strattice very positively, and I also believe that as we continue to build the data base behind the use of Strattice, that people will gain more and more confidence in its use.

We’ve also spoken in the past that we’re making quite a large investment in clinical studies in 2008 and beyond. We will tee up something on the order of 12 or 13 studies either currently ongoing, or to be initiated in 2008, and that will certainly add to a wealth of information on Strattice.

Steven Lichtman - Banc of America Securities

And the interim human data, you would expect still in the second half of this year?

Paul Thomas

I think so. It’s a little bit difficult to predict exactly where and how that information will get presented. I am sure some of it is being presented right now in grand rounds and speaker programs that we sponsor. I am sure that it will get presented at meetings that take place throughout the year. So I think there’s going to be a lot of different forums where that information get shared.

Steven Lichtman - Banc of America Securities

And I apologize if I missed this, but could you provide an update on your expectations for sales force expansion in 2008?

Steven Sobieski

Yes, we have not given specific numbers. We did put into our guidance an expectation that we would have an expansion of our sales force probably similar in size to what we did at the end of 2007. And we finalize that as we move into the second quarter and third quarter.

Steven Lichtman - Banc of America Securities

And, so the pace of hires will be similar in terms of the timing?

Steven Sobieski

Yes. It would be a fourth-quarter hire. We’ll make that decision in the third quarter, typically.

Paul Thomas

Steve, just to expand a little further on my last set of comments. We are actually, this weekend, moving forward with our first surgeons’ forum, and we have 200 surgeons attending this first event. And at that event, we will be able to share primate, other pre-clinical data as well as the early experience.

So that reinforces the point I was making, that over the course of the year we are going to have more and more opportunities for surgeons to see the data that’s available on Strattice.

Steven Lichtman - Banc of America Securities

That makes sense. Great, thanks.

Operator

We have a question from Jayson Bedford - Raymond James.

Jayson Bedford - Raymond James

Hi, good morning. Just a couple of quick questions. First, on Strattice, is your expectation that you’ll get deeper penetration into existing accounts, or do you think that it will open up new accounts that previously haven’t used AlloDerm. And, is your sales force actively courting potential new accounts?

Paul Thomas

Yes. Such a good question. I expect both to happen, Jayson. And from a targeting perspective, obviously our first-tier target accounts are those that are not using AlloDerm, or not using AlloDerm to any appreciable level.

The second tier would be those accounts where we feel there’s competitive pressure that we want to respond to. And the third tier would be accounts that we would describe as the loyal AlloDerm users.

Having said that, while that’s great marketing theory and that is the way we’re going to approach the market in terms of targeting, I fully anticipate that there are going to be customers across all three sets of accounts that are going to want use Strattice based on what I’ve heard at the KOL meeting as well as our national sales meeting. And we will obviously respond to that in an appropriate way.

Jayson Bedford - Raymond James

Okay, that’s helpful. Have you with AlloDerm been constrained at all by the size of the tissue? Meaning, do you think you would have been able to sell more with larger sizes and that for Strattice doesn’t seem like that would be a gating factor at all?

Paul Thomas

That’s a good question. It’s running real hard with AlloDerm all the time. And, as we fully satisfy demand with one larger SKU, the demand then seems to shift to the next larger SKU. So it always feels like you’re chasing your tail a little bit.

We have been able to always supply our customers’ needs, but we might have been a little bit behind the curve in terms of chasing the next largest SKU. That issue essentially disappears with Strattice, certainly as we get into full commercial-production capability by the end of the year.

Jayson Bedford - Raymond James

Okay, that’s fair. And just, last couple questions here. You’re coming on a $100 million in cash, you’ve talked about kind of new product opportunities in the past. My guess is most of those are internal. Can we assume that you’re looking externally for other product opportunities as well?

Paul Thomas

Yes, absolutely. Obviously we don’t speak to what we’re looking at externally. But I can tell you we have a very active screening program and we look at lots of things. But we’re actually fairly rigorous in how we approach that. And what we’re looking to do is add products or technology that are complementary, and reinforce the strong organic growth that we believe we have in the business.

Jayson Bedford - Raymond James

Okay, that’s fair. And then Steve, the fourth-quarter share count was a little lower than we expected, down from the September quarter. How come?

Steven Sobieski

Yes, actually our actual shares are the same, but the fully diluted is impacted by the stock price. And so it’s a calculated number. I don’t want to get too technical, but you can assume a different buyback level in terms of your calculations.

You can follow up, if you want to call me back on that calculation.

Jayson Bedford - Raymond James

Sure, that will be great.

Operator

We’ll go to Caroline Corner - Pacific Growth Equities.

Caroline Corner - Pacific Growth Equities

Hi, thanks for taking my call. First question: Two versions of Strattice, one for hernia, one for breast reconstruction, is the sales force rolling out both of those products simultaneously starting now?

Paul Thomas

Yes, that’s a good question, Caroline. We have what we refer to as a firm version of Strattice for hernia repair, and a pliable version for breast reconstruction. Both products are available to sales force, and they will be marketing both versions.

Caroline Corner - Pacific Growth Equities

And then just go back to the gross margin in the fourth quarter again. You mentioned that part of the reason that gross margin was down at just over 70% was that large pieces were involved in the inventory. Is that just because it’s more expensive to make, to process these large pieces, is that what’s going on there?

Steven Sobieski

Not only the processing, but also the recovery cost as well, Caroline.

Caroline Corner - Pacific Growth Equities

Okay. But then the fact that you have those large pieces actually is good, because then you can make large pieces of AlloDerm for hernia repair?

Paul Thomas

Exactly.

Caroline Corner - Pacific Growth Equities

Okay. And then just to follow up about some of your comments about how you are targeting physicians on the Strattice launch. You said the first tier was the non-users of AlloDerm, or the light users of AlloDerm, and the third tier was the loyal AlloDerm users.

Should we expect, as we look forward, at some point, for Strattice to start cannibalizing AlloDerm sales? Can you talk a little bit about when we realistically should expect to see some significant cannibalization?

Paul Thomas

First of all, LifeCell hasn’t provided any guidance on the level of Strattice sales in 2008, although we have indicated that we would report our Strattice revenues on a quarterly basis. I think the street estimates on Strattice are in the $10 to $12 million range. And although we have not provided any guidance, I would certainly hope that we could do a lot better than that.

But having said that, I don’t anticipate that 2008 is going to be the year when you see a significant erosion of the AlloDerm business. And in fact we’ve stated many times that we think, yes, there is the potential for Strattice to cannibalize AlloDerm sales to some extent, but it’s also very much an incremental opportunity.

Quite frankly we’re just going to have to see how that plays out over the year. And we’ll be able to then track the extent to which we see a tradeoff between AlloDerm and Strattice versus incremental growth. And our focus internally is, we want to make sure that we continue to grow the top line of total business. That will include both AlloDerm and Strattice for the foreseeable future.

Steven Sobieski

Maybe just to add to Paul’s comment, as you look at our guidance for 2008 we anticipate growing top-line product revenue by $50 million. So obviously there’s AlloDerm growth included in that number.

Paul Thomas

Right.

Caroline Corner - Pacific Growth Equities

Great. Thanks for taking my call.

Operator

Our next question today will come from Matt Dolan - Roth Capital.

Matt Dolan - Roth Capital

Steve, a follow-up on the settlement and legal cost in the quarter, how much of that was wrapped up or concluded in Q4? And what you would expect for legal spend in ‘08? Is that all said and done, or is there more going forward?

Steven Sobieski

Actually, all of that was contained in Q4, the amounts I talked about.

Matt Dolan - Roth Capital

Okay. So, normalized G&A number somewhere around $6 million?

Steven Sobieski

On a quarterly basis?

Matt Dolan - Roth Capital

Yes.

Steven Sobieski

Yes.

Matt Dolan - Roth Capital

Okay, great. Paul, with the sales force being out of the field last week a little later than normal, and probably getting excited about Strattice, how should we look at seasonality here quarter-to-quarter?

Is there any potential for a little bit of disruption in Q1 as they shift their focus and come out of the field for a week, or should it be pretty normal relative to historical patterns?

Paul Thomas

Ideally we like to hold the sales meeting a little bit earlier. Usually we do that around the third week in January. But for obvious reasons we delayed the national sales meeting to the middle of February to allow us to get some more experience with Strattice.

I think we feel very good about the sales force being energized to sell both AlloDerm and Strattice. I wouldn’t expect any seasonality per se, other than the traditional seasonality that we see in Q3 as surgeries begin to drop off a bit in the summer months, Matt.

But other than that I wouldn’t expect much seasonality in Q1, Q2.

Matt Dolan - Roth Capital

Okay. That’s helpful. And finally, since we’ve got some timing updates here Paul, can you touch on potential launches into breast augmentation, and then also, some of the indications you mentioned at our recent conference, peristomal hernias and actually preventative hernia care?

Paul Thomas

So with respect to the use of Strattice in breast plastic surgery, which is looking at using Strattice to correct mal-position, or rippling or other complications associated with augmentation, we had a group of folks that actually were in Florida last week following the national sales meeting, meeting with KOLs to develop the procedures, and refine the procedures and marketing message for that particular application.

We anticipate launching that, I believe towards the end of the year, fourth quarter I believe. Correct me if I’m wrong, but I think it was towards the end of the year.

With respect to new indications, I indicated, we are doing 12 or 13 clinical trials with Strattice. One of those is with peristomal hernia as well as hernia prevention following laparotomies. I know the protocols have been developed and investigator meetings held.

I just don’t recall whether we are actively enrolling in those studies or not. I suspect we may not be yet, Matt. And some folks here are nodding your head, yes, that’s the case. But we have actually quite an aggressive program teed up, and over the course of the year we going to have more and more studies with more and more patients enrolled with Strattice.

Matt Dolan - Roth Capital

Okay, great. And one more if I can. With respect to the topic of cannibalization, and as you look at Strattice coming in at a 15% discount relative to your expectations for the year to simplify the concept down, it sounds like the incremental revenue-generating opportunity you see would at least offset that discount, at least in 2008 here?

Paul Thomas

Sure, because we’ve indicated that total product revenues will grow; we anticipate them to grow in 2008. The other thing that I’d be a little bit careful about, Matt, is while we have priced Strattice at a 15% discount to AlloDerm, the other thing we’re seeing is surgeons are tending to use larger sizes of Strattice. So on a revenue-per-procedure basis, which is really what we’re most concerned about, that might very well be a push.

Matt Dolan - Roth Capital

Okay, very good. That’s clear. Thank you.

Operator

We have a question from Michael Matson - Wachovia Capital Markets.

Michael Matson - Wachovia Capital Markets

Hi, thanks for taking my question. First of all, we noticed in an 8-K filing from Bard that they’re having some FDA issues with their hernia-related products. And we were wondering if you’d seen any disruption in the field, and is that anything that you may be able to take advantage of, particularly in getting into some of the lower end hernias?

Paul Thomas

Michael, I did not pick up on that 8-K filing, so I’m not familiar with what products it relates to. I can tell you that we do not generally regard synthetics, and certainly in grade 3 and 4, as our primary competitors. So, I’m not seeing any positive impact rather, from the challenge that Bard has on their product-quality issues.

With respect to less-severe types of hernias, if you refer to inguinal hernias, for example, which is actually a large part of the market, there are about 750,000 procedures, we do not participate in that market currently. I can tell you that one of the studies we have teed up for Strattice in 2008 is to look at its use in inguinal hernia repair.

Our folks believe that that’s actually quite a significant opportunity for the product. But I think that’s a significant opportunity for the product regardless of whether Bard, or Gore or Ethicon, or any of the other players in the synthetic-mesh market are, what they’re doing, quite frankly.

Michael Matson - Wachovia Capital Markets

Okay. And then, this is related to the cannibalization questions that you have already addressed. But I want to ask a little bit differently.

If there was really significant upside this year to your Strattice sales number, and it did end up cannibalizing AlloDerm a little more heavily, is there any risk that would put pressure on your gross margin given that this year at least Strattice’s margins, on a percentage basis, are consistent with AlloDerm but on a dollar basis would obviously be lower? So gross margin dollars would be lower from that product.

Paul Thomas

As you said the gross-margin percentage is the same, and so that gets back to this question on revenue per procedure, Mike. And I think that, although Strattice is priced at a discount to AlloDerm, the revenue per procedure might be quite similar due to the fact that surgeons are tending to use larger sizes of Strattice compared to AlloDerm.

So, I think the mix between AlloDerm and Strattice is not going to have any appreciable impact on our margin in 2008. Now, we have said as we go forward, we think there is significant opportunity for gross margin expansion on the Strattice product line. And that’s why, to the extent that product-mix move moves more towards Strattice in the future, that would have a positive impact on the business.

Michael Matson - Wachovia Capital Markets

All right. And then, does the upcoming hernia meeting, is there anything that we should be looking for there, papers presented or posters or anything, on Strattice, or AlloDerm for that matter?

Paul Thomas

Mike, the short answer is, I don’t know. I haven’t looked at the abstracts presented, and I just can’t comment. I just don’t have that information available. Sorry.

Michael Matson - Wachovia Capital Markets

That’s fair. And then, just one more question on the outside-U.S. markets. I know you had said you are focused, at least in your market-research efforts, on Europe, but is the intent that this distributor that you sign on going to be potentially selling the product in the other markets outside of Europe, so Asia in other words, as well?

Paul Thomas

Yes, that’s a very good question. My comments had focused on Europe, but both parties that we’re engaged in discussions with have global footprints. So, I would anticipate that we would move beyond Europe as we tee up those other markets.

Michael Matson - Wachovia Capital Markets

Okay. And then, just back to the diabetic foot-ulcer question that Mark had brought up. Are you actively looking for a partner to sell Strattice for diabetic foot ulcers, or is that something that you got on the back burner now, given all the other activity with Strattice?

Paul Thomas

Yes, let me make sure I clarify those remarks. In orthopedics, some of the orthopedic partners that have a sports-medicine presence also have a capability with a podiatrist. And so what they have done, similar to what we have done with Wright Medical, is requested product rights for Strattice in diabetic foot ulcers or chronic wounds that are treated by podiatrist.

As you are probably aware, a lot and most of the chronic wounds are treated by other physician specialties. So generals, plastics and a whole range of other folks. So, our discussions on chronic wounds is limited to those treated by a podiatrist.

At this point, we have not had any discussions on looking at partnership for non-podiatric-treated chronic wounds, if that’s clear. I know it’s a little bit complicated, but that’s how we are segmenting the market.

Michael Matson - Wachovia Capital Markets

I think that makes sense. I think what you are saying is basically that if you could potentially sign on an orthopedic partner that would have a podiatrist as the call point, and you would allow them to sell it for that use to the podiatrist market, is that correct?

Paul Thomas

Yes, that’s exactly right; that interest has been expressed by several parties who have a presence with a podiatrist, and we have been open for those conversations.

Michael Matson - Wachovia Capital Markets

All right, that’s all I have got. Thanks a lot.

Operator

Our next question comes from the line of Ed Shenkan - Needham & Co..

Ed Shenkan - Needham & Co

I was wondering if you have yet submitted for CE Mark for Strattice?

Paul Thomas

There’s a couple of elements to the CE Mark, Ed. One is getting yourself ISO-certified, and we have actually been through the first round of that and are now going through the second round of that. And so yes, we’ve initiated the process, and the current timeline is that we anticipate CE Mark in the first half of this year.

Ed Shenkan - Needham & Co

Why is it important to announce a partner before you get CE Mark?

Paul Thomas

We would consider a partnership to be a materially important event for the company. So, we anticipate announcing that as soon as it’s done.

Ed Shenkan - Needham & Co

That would make sense that you tell us about it right away, but you don’t have to sign the deal necessarily before you get the CE Mark. Shouldn’t make any difference as far as your revenues would be concerned, right?

Paul Thomas

No, of course not. But, the partners that we are talking to want to get engaged early, actually in advance to the CE Mark, because I said there is a lot of market-development work to do and coordination. So that’s why we want to finalize this, our internal target is to get it done by the end of March, and then move forward.

Ed Shenkan - Needham & Co

And you talked about 12 to 13 studies which you are going to be conducting in 2008. What type of R&D spend would you expect in 2008 associated with all that?

Steven Sobieski

We gave that guidance, we said during our January call that we expect to spend somewhere around 12% or 13% of revenue, so that puts you in a range of about $30 million in total, Ed, for research and development.

Ed Shenkan - Needham & Co

Would that be front-end loaded for the year, or evenly spread out as the trials progress?

Steven Sobieski

Typically, it’s spread out. You do have some cost associated with enrollment, but there are ongoing costs throughout the study. So no, we don’t expect front-loading on our R&D spend.

Ed Shenkan - Needham & Co

And, it’s been a while since we talked about size of the complex hernia market. We believe that that market is growing and continues to grow. Could you just give us an update on the size of market we have now, and where you are expect it to go?

Paul Thomas

Yes, we actually do have some updated information on that, Ed, and we will be communicating that very shortly. So for the time being, the current estimates we have out there stand, but I would agree with your observation or suggestion that the market is somewhat larger than our initial estimates. And we will update you. We are just fully vetting the market research right now, but that is the case.

Ed Shenkan - Needham & Co

Would you expect, as you launch Strattice, to see significant change in market growth with Strattice, or discontinued growth with that new product?

Paul Thomas

There is no growth profile on Strattice right now, right? I am not following your question, Ed.

Ed Shenkan - Needham & Co

I’m thinking, the overall market is growing for...

Paul Thomas

Oh, I see.

Ed Shenkan - Needham & Co

Now that they get another great product with Strattice, the market should grow a little bit faster, I would think?

Paul Thomas

No, I think the market is related to the types of patients that present with a need for a product like Strattice or AlloDerm. Strattice may allow us to capture a portion of that market more rapidly than we might otherwise, but I don’t think it will necessarily affect the size of the market, Ed.

Ed Shenkan - Needham & Co

Okay. Thank you.

Operator

We have a question coming from Matt Miksic - Morgan Stanley.

Matt Miksic - Morgan Stanley

Just a couple on the sales force. You talked about the excitement around Strattice, some of the early adopters presenting at the sales meeting. Can you relate to us maybe some of the things they’re highlighting as the advantages, and what is getting people excited about this the new product?

Paul Thomas

It’s a couple of things. It depends on the surgeon, whether he is a hernia surgeon or a plastic guy, a breast-recon guy. But starting with the hernia guys, there are a couple of things they like. They like, as you would anticipate, the ease-of-use factors. So they like the fact that they have large sizes, that it doesn’t require rehydration, it doesn’t require refrigeration, it’s readily available.

And they also like that when you implant it, the Strattice firm product, which is used in hernia repair, has a bit less elasticity, which makes it easier to deploy in the wound. And so, those are some of the ease-of-use factors if you will.

But some other things that really excite them are some of their clinical observations with Strattice, and I will give you an example of an anecdote that was shared with me by one of our investigators, and actually shared with the other KOLs down in Florida.

He had a hernia patient to grade, it was either grade 3 or 4. Typical difficult patient, contaminated wound site, obese patient, multiple previous operations, et cetera. And he put Strattice into the wound, closed the skin over, the skin necrosed, and you now had Strattice that became exposed and there was an infection that developed.

And what they did is they debrided the wound, they treated the Strattice with local antibiotics, they did a wet-to-dry dressing change, and the material granulated over, the skin closed and the patient is now out four-plus months and doing great.

Those are the exact same early observations that people had with AlloDerm and quite frankly, that is in marked contrast to other products, either synthetic products where if that happened, you’d be removing the material and having another procedure, or other biologics, where either material would fully resorb or you’d have to remove it because it became infected as well and you’re unable to treat that locally. So, those are the kinds of things that folks in the hernia-repair space were getting fairly excited over.

In the breast-recon space, where we use the pliable version of Strattice, the handling characteristics are great. They’re not having any complications that would be attributable to the Strattice material. So it looks in every way to be behaving the way AlloDerm does, and of course again, the same ease-of-use factors would apply in breast reconstruction.

So what’s really exciting is that all the feedback thus far is that, clinically in both breast and hernia, Strattice seems to be behaving as we had hoped and designed for, which is on a clinically equivalent basis to AlloDerm. And then on ease-of-use basis, it’s just easier to use than AlloDerm. So, that’s what has people genuinely excited about the prospects for Strattice in their practice.

Matt Miksic - Morgan Stanley

Okay, and on the hernia side, how much is the availability and cost of larger sizes a factor?

Paul Thomas

Availability of larger sizes is a real positive. The cost is somewhat less, but at least with regard to the surgeons, and those are the folks we’ve been talking to over the last couple of weeks, the 15% price discount is not a big deal in their mind, because they’re looking for clinical performance first, and ease-of-use next.

And price is down their list because, what they know is that by avoiding some of the complications − even though AlloDerm and Strattice are relatively expensive products, certainly compared to synthetic-based materials or for that matter other biologics – you are avoiding costly complications.

I think that the relative price discount to AlloDerm probably does play well with materials management, and portrays LifeCell as a responsible partner in healthcare. And so I think that’s a net-positive for the company, and probably a net-positive for the hospital as well.

Matt Miksic - Morgan Stanley

Understood. Any color you can give us on some of the new reps that you brought on, and maybe some idea of how long it takes to get these folks up and fully productive this year?

Paul Thomas

It’s really quite an impressive group of folks that we had at the national sales meeting. And I think we have 13 new folks, so I actually got to meet quite a few of the new folks. And I think it’s fair to say that we continue to raise the bar with respect to the quality of the representatives we’re bringing on board, the training programs that we have in place, the medical education tools that we have to support these folks and, as I just spoke to earlier, we’re very excited about what Strattice might mean in the future.

And so you just come away from that sales meeting very energized and very optimistic about what you can accomplish in the next year. So, as you can probably tell, we’re still on a little bit of national sales meeting high.

Matt Miksic - Morgan Stanley

Yes, that’s coming through. One question on SG&A. And you talked about the legal expenses, and I think in an earlier question, it sounds like they’ve already rolled down heading into Q1, is that right?

Steven Sobieski

That’s correct.

Matt Miksic - Morgan Stanley

Beyond that, even putting that aside, there is a step down in operating expense that is implied in your guidance. What can you give us to help us be more comfortable with the fact that you will get that kind of leverage to hit the operating margin you talked about?

Steven Sobieski

Really two areas that we’d see leverage. The first is obviously the G&A. If you move aside what I would call the unusual items that occurred in Q4, we expect leverage there. And even without those items, we expect to see maybe a point or so trend down in terms of G&A as a percent to of revenue.

Then, I think the other area, again, where we continue to get leverage is by having our own direct sales organization. And again, that’s probably the other area where you potentially see a point or so in terms of leverage.

The area that I think we have stated that we will either continue at the same level or percent of revenue or increase slightly is our R&D. So, the two areas are really slight improvements in G&A, and also the selling and medical-education expenses.

Matt Miksic - Morgan Stanley

Okay. Paul, you mentioned that it sounds like you are pretty confident that your chances are good for beating what the consensus numbers are out there. How much conservatism is built into that top-line guidance you’ve given us for ‘08?

Paul Thomas

If you’re looking at total revenue, certainly in the second month of the year, that’s a reasonable guidance and the one that we’re still quite comfortable with. I do think that based on what we’ve heard right now and this is not guidance, but I do expect that we’ll do better on the consensus on Strattice, and hopefully significantly better.

So, at this point, I wouldn’t change total revenue, Matt, other than to say we’re still quite comfortable with it. But given the recent experience over the last couple of months, I have to say that I would anticipate that Strattice is probably going to be a more important piece of our product mix than perhaps what the investment community has in its consensus numbers.

Matt Miksic - Morgan Stanley

Okay. That’s helpful. On AlloDerm, one question on the production and technology that you are using there; any further improvements that you can put in place on the core business to improve efficiencies or margins on the core AlloDerm product?

Paul Thomas

It’s really hard to move the needle on gross margin there, because as we’ve talked about in the past I believe, each lot of AlloDerm is an individual donor. You can’t pool donor lots. So the opportunities for efficiency are limited, and what you are really getting is some improvements related to volume, you get better absorption.

And that’s partly offset by what Steve referred to earlier, in a bit more investment or cost associating with procuring the large grafts to produce these large sizes of AlloDerm. So, I don’t anticipate much improvement. We’re going to continue to look at whether we are missing some opportunities there, but I don’t think that’s where you’re going to see us move the needle much.

I think the opportunity to move the needle on gross margin is really in Strattice, where some of the inherent limitations of processing a human tissue don’t exist and you can provide more of an industrial process, if you will, towards the manufacturing of the product.

Matt Miksic - Morgan Stanley

Okay, so not much improvement, but maybe it would give and take some stability, at least in terms of AlloDerm?

Paul Thomas

Yes, I feel comfortable with that, yes.

Matt Miksic - Morgan Stanley

Okay. And finally just one question on Europe. You mulled it over pretty well on the call. But if you could help us understand specifically, are there any markets there based on the field work that you’ve done that look particularly attractive? Any way, without disclosing too much, that we can think about maybe prioritization of these markets?

And then secondly, given the product-filing registration, the reimbursement process that’s in place, is there just something you could tell us about the timeline, where you are in that timeline?

Paul Thomas

So, first of all I mentioned the primary market research. We’ve also held a meeting with European KOLs to discuss the types of studies that may be needed for Strattice and how we might begin doing those. But I think your question is, what markets first? Which are most attractive?

In part, I think that will depend on the partner that we choose, because each partner has slightly different capabilities. And they may be very strong in one or relatively strong in one market and relatively weaker in another market. And with respect to reimbursement, I don’t think we know quite enough at this point to say, is there a big difference between markets on reimbursement? Or I should just say that I’m not familiar enough to communicate that at this point.

Matt Miksic - Morgan Stanley

Okay. Just to push you little on that. Assuming that if there are large markets in challenging hernia repair in Europe, that you are talking to partners who have reasonably good presence in those markets.

Paul Thomas

So let me give you a little granularity on that.

Matt Miksic - Morgan Stanley

Maybe you can just educate us a little bit on the U.K., Germany and France?

Paul Thomas

So, obviously the market size is largely got to be related to the population of the country. So, let’s take two large markets, Italy and Germany for example. They might both be very attractive markets, but if one distributor has a stronger presence in Italy than Germany, that might tilt the needle at least in the near term to Italy being more important or a more rapid rollout. Or the reimbursement may be a little more attractive in one of those markets. So, it depends a little bit on the partner as to where we’ll have our first and greatest impact.

Matt Miksic - Morgan Stanley

Okay. That’s fair. Thanks for taking the questions.

Operator

Ladies and gentlemen, thank you. That does conclude the question and answer session. Mr. Thomas, I would like to turn the call back over to you for any additional or closing remarks.

Paul G. Thomas

Thanks, Michael. That actually concludes the remarks for this quarter, and we look forward to updating everyone on Q1 in April. Thank you.

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Comments

[Cburnette:]

Looking for information on Lifecell's purchase of body parts from New Jersey surgeion who robbed corpses in funeral homes and sold parts.
How is Lifecell dealing with this

2008 Apr 01 11:50 AM