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Executives

Paul Thomas - Chairman, Chief Executive Officer & President

Steven Sobieski - Chief Financial Officer & Vice President of Finance and Administration

Analysts

Jayson Bedford - Raymond James

Greg Brash - Sidoti & Company

Ed Shenkan - Needham & Company

Spencer Mann - Summer Street Research

Michael Matson - Wachovia Capital Markets, LLC

Caroline Corner - Pacific Growth Equities

Christopher Warren - Friedman, Billings, Ramsey & Co.

Lifecell Corporation (LIFC) Q1 2008 Earnings Call April 24, 2008 10:00 AM ET

Operator

Good morning and welcome to the LifeCell Corporation First Quarter 2008 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. Please go ahead sir.

Steven Sobieski

Thanks Stacey. Good morning, and thank you for joining us on LifeCell’s first quarter 2008 financial results conference call this morning. Certain statements made during this conference call are forward-looking statements that are 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. Future results or performance could be materially different from our expectations.

Please refer to our SEC fillings for more information regarding the risk factors that may impact our future results. All of our SEC fillings are available through our web site.

I’ll now turn the call over to Paul Thomas, President and CEO of LifeCell, who will review our first quarter operating results.

Paul Thomas

Thanks Steve and good morning everyone. Our first quarter results were in line with our expectations. Our product revenues grew 27% in the quarter, the $54.3 million compared to $42.7 million recorded in the first quarter of 2007. The increase resulted primarily from higher demand for AlloDerm, which increased 30% to $47.8 million in the quarter compared to $36.8 million in the first quarter of 2007.

AlloDerm which is marketed through our direct sales organization represented 88% of our total product revenues in the quarter. Revenues from Strattice, our new reconstructive tissue matrix totaled $1.1 million in the quarter. The commercial launch for Strattice commenced towards the end of February following our national sales meeting. We are very pleased with the early results and we remain optimistic about the possibilities for Strattice going forward.

Our Orthopedic product revenues, which include GraftJacket and AlloCraft DBM, increased 14% to $3.4 million in the quarter from $3.0 million in the first quarter of 2007. The growth was driven by higher GraftJacket revenues. Our Repliform revenues decreased to $1.5 million from $2.1 million in the prior year as a result of increased competitive activity in the urogynecology market.

Our product gross margin was 69% in the quarter, down from 71% in the first quarter of last year. Consistent with the trend we experienced over the past several quarter the decrease in gross margin was due to increases in cost associated with the procurement and processing of larger sizes of AlloDerm, and to a lesser degree, inefficiencies of producing Strattice in a pilot facility versus a full-scale commercial facility.

As previously communicated we are planning to have our commercial manufacturing for Strattice built-out by the end of the year. Operating expense for the quarter excluding the cost of products sold was $6.0 million with 30% compared to the same period in 2007. The increase in operating expense was primarily associated with Strattice. Some of the areas of increased spending included the initiation of clinical studies, process development initiatives, and commercial launch activities.

Additionally, selling expense increased as a result of 19% increase in our direct sales force headcount. Our total field sales organization headcount is now at 87. Operating income for the first quarter of 2008 increased 8% to $11.3 million compared to an operating income of $10.4 million in the first quarter of 2007.

Our net income was $6.8 million or $0.19 per diluted share compared to $6.4 million or $0.19 per diluted share in the first quarter of 2007. Our financial position remains strong. We ended the quarter with approximately $93.4 million in cash and investment and no debt. We are off to a good start in 2008. Inn addition to the commercial launch of Strattice we also entered into a distribution agreement with Tornier focussed on orthopedic and podiatric application for our new porcine-derived tissue matrix.

Tornier is a global leader in extremity orthopedics and this agreement provides for collaboration and the development of certain orthopedic soft tissue repair applications for which Tornier will distribute our products to its surgeon customer base under the product name ‘Conexa’. We are very excited to have the opportunity to partner with Tornier to extend the availability of tissue matrix technology to their surgeons and customers.

On Monday, KCI commenced the previously announced cash tender offer to purchase all of the issued and outstanding shares of LifeCell common stock for $51 per share. Our Board of Directors and management team believe this transaction makes strategic sense for our company, offers a premium to our stockholders, and creates opportunities for our employees. We expect the combination of our leadership position in regenerative medicine and KCI’s innovative therapeutic approach to wound healing will present opportunities for both organizations to expand the markets we serve.

KCI’s global infrastructure will provide the platform to expand the penetration of our products in the international markets. We also believe KCI’s experience and leadership position in advanced wound care will facilitate the adoption of LifeCell products into this market, and together we look forward to improving the lives of more patients around the world.

Upon successful completion of the merger transaction, our results of operations will be consolidated within those of KCI and although we have suspended our historic practice of providing financial guidance sue to the pending merger, we remain confident in our business fundamentals.

That concludes our prepared remarks, and we do have some time left over for a few questions, Stacey.

Question-and-Answer Session

Operator

(Operator Instructions)

We’ll go first to Jayson Bedford with Raymond James.

Jayson Bedford - Raymond James

Just wondering on Strattice, is it gaining acceptance in any one application over the other, either breast or hernia and then have you seen and I realize this is early but any stratification, meaning those folks using AlloDerm for some wounds and Strattice for another?

Paul Thomas

You know, it’s a little bit early in the game to comment fully, Jayson, my sense is the early feedback is that the product is being trialed in both hernia repair as well as breast reconstruction. With respect of stratification of Strattice into various grades of hernia or are we getting cases that we would not normally get with AlloDerm, it is just a little bit early in the game to make any real comments on that. I suspect over the next quarter or two we’ll get a little bit more visibility into exactly how that roll out is proceeding.

Jayson Bedford - Raymond James

Okay and those surgeons using Strattice, are they primarily current AlloDerm users or has it opened up new accounts at all?

Paul Thomas

It’s a mix of both current AlloDerm users as well as new surgeons. So there are some surgeons who have not in the past used a lot of AlloDerm and we are now beginning to see new additions to our surgeon base, which is very encouraging.

Jayson Bedford - Raymond James

Okay, and just lastly, on the gross margin number, I am wondering in terms of Strattice, did you have any trialing in the period where you were not so much giving it away at a very discounted price that could have had an impact on the gross margin?

Paul Thomas

No, we don’t discount Strattice.

Jayson Bedford - Raymond James

Okay, so the gross margin obviously is down a little bit here, that’s largely due to the higher cost of procuring these larger sizes, is that --?

Steven Sobieski

That’s correct. It’s primarily due to the higher cost associated with larger pieces of AlloDerm and to a certain extent there is a startup aspect of the Strattice production.

Jayson Bedford - Raymond James

Okay, fair enough, thank you.

Operator

And we’ll move next to Greg Brash with Sidoti & Company

Greg Brash - Sidoti & Company

I just wanted to follow up on the mix with Strattice being new users versus new surgeons, I mean are you seeing it heavily weighted in any direction?

Paul Thomas

It’s just a little early, Greg. At this point, we are really focused on how many accounts we are opening with Strattice as that gives us an idea of what the future demand curve may look like and as you can appreciate getting any new product into a hospital takes some time and effort and many times you have to go through various committees to do so, but the receptivity from the surgeon base and their willingness to champion our efforts to bring Strattice into their accounts is a very encouraging early sign.

And as I said over the next couple of quarters, we should get a much better handle on are we getting a lot of new surgeons to compliment the existing base of AlloDerm, to what extent do we think we are generating incremental revenue versus swapping out revenue that we might have otherwise achieved with AlloDerm?

It’s just a little bit early in the game quite frankly to make much of a call, and our initial focus certainly in Q1 and actually even in Q2, is sort of looking at the metrics in terms of how many new accounts are we able to open with Strattice, new accounts we are able to get the product on the shelf because that will be a good indicator of what future demand may look like.

Greg Brash - Sidoti & Company

Okay, and just one final question, just curious, if there have been any changes on the competitive front, if there have been any new entrants since your last conference call?

Paul Thomas

No, I don’t believe so. I can’t recall our last conference call but you are aware that Covidien purchased TSL, so that is not a new product, but it's a new competitor in the sense that you now have Covidien and their sales organization marketing that product. I think other than that, the competitive landscape is largely as we discussed in the past, there is a variety of both biologic and synthetic based materials with which we compete with.

Greg Brash - Sidoti & Company

Okay, well thank you and best of luck with the merger.

Operator

We’ll go next to Ed Shenkan with Needham.

Ed Shenkan - Needham & Co.

First, congratulations on building this company through the years; shareholders are obviously very pleased. Question on the Tornier agreement - could you tell us, as far as US versus international, when would you expect launch and any economics you could tell us about on that agreement?

Paul Thomas

Sure. So the Tornier agreement is very much right now focused on the US although we intend to expand that into global market since Tornier has a global footprint or at least a footprint outside of the US.

The initial launch is focused on training their sales network, initiating clinical trials. They have some techniques that we believe can be developed to deploy Conexa arthroscopically, especially for rotator cuff repair, which we think would be very exciting over time.

So it’s really the early stage, Ed, of sort of planning the longterm success for the products, so we are moving forward on several different fronts and we think that they will be an excellent partner, and we think their strong presence in the shoulder as well as the extremities markets really bodes well for Conexa.

Ed Shenkan - Needham & Company

You had several other partners that you could have chosen, you picked Tornier. Tell us what makes them stand out as an ideal partner for Conexa.

Paul Thomas

Well, we were very impressed with the management team and the product portfolio that they are assembling. They have brought in several new product lines in the extremities area, including Nexa. They have a strong backing, and we anticipate they will continue to develop a leadership position in the shoulder and in the extremities, and perhaps most importantly, we felt that they understood and were committed and shared a common vision with us in terms of what Conexa might do to improve patient outcomes in these significant rotator cuff tears or Achilles tendons repairs or other sort of procedures where we think there is great value to be offered with our reconstructive tissue matrix, and I think that shared vision and commitment is combined with their capabilities is what compelled us to move in the direction of Tornier.

Ed Shenkan - Needham & Company

Are there any economics that you could tell us about where minimums or what kind of revenues you might expect through Tornier?

Paul Thomas

We don’t go in to the details on our distribution agreements. It's a revenue sharing agreement and it’s probably in the range of what you would have expected from Boston Scientific and Stryker and others and beyond that, Ed, we are not going to comment on the specifics.

Operator

And we’ll go next to Spencer Mann with Summer Street Research

Spencer Mann - Summer Street Research

Just one quick question about the Strattice data and the clinical experience; I know the data is early, but any thought so far based on the experience that you have had in the clinical settings? What is the feedback from the physicians right now?

Paul Thomas

Yeah, the feedback has been actually quite positive, Spencer, and as I think I indicated in previous calls, we have something in the order for 13 clinical trials either initiated or planned for this year, and we are beginning to enroll patients and collect data, and obviously, we will be looking at time points well beyond the initial implantation.

What I can tell you is that, anecdotally, some of things that are encouraging and we think is quite unique with Strattice is in some of our open bellies or situations where Strattice is exposed, we are actually able to see granulation tissue form that becomes revascularized and this is very much what the early uses of the AlloDerm, going back five or so years ago saw and we think is quite unique in the biologic space.

So like I said the early feedback’s, all very positive, we’ll continue to build the data set over time, but we are very, very encouraged by the early evidence and the early anecdotal feedback that we are receiving.

Operator

And we’ll go next to Michael Matson with Wachovia Capital Markets, LLC.

Michael Matson - Wachovia Capital Markets, LLC

A question on the firm version of Strattice, when that is implanted during a hernia repair, does that have to be stretched as its being implanted ala AlloDerm?

Paul Thomas

Yeah. As you noted we have two versions of Strattice and the firm version is what we use in hernia repair, Mike, and that version of Strattice actually has a lot less elasticity than AlloDerm.

Having said that, one of the things that we sort of advocate and educate our surgeons to think about in these complex hernia repairs, is first reduce the size of the defect. You can do that with a variety of techniques - using component separation, in certain cases using a vac, making sure when you put the Strattice material in, use an underlay technique, you can go back three to five centimeters if possible, and putting the appropriate tension on Strattice.

It’s a lot easier to put the appropriate tension on Strattice, as this has less elasticity. So the technique is a little bit easier than with AlloDerm and several surgeons have commented on that, but you still want to put it in under tension; it is not the way they taught in the old days, a tension-free repair with synthetic materials.

Michael Matson - Wachovia Capital Markets, LLC

Okay and since it’s not going to be probably stretched to the degree that AlloDerm would and while it does have a price discount -- I know you had answered one of my questions on the last call about revenue per case being similar to AlloDerm, is that why?

Paul Thomas

I think revenue per procedure will be similar to AlloDerm and I think that is in part because of there is a difference in elasticity, but I think in part, we are also seeing surgeons use larger sizes and getting more underlay in their defect rather than just trying to bridge the gap. So there are probably a couple of reasons, but if your basic premise or question is will the Strattice revenue per procedure be similar to AlloDerm despite a discount in a per centimeter cost; I think that the answer to that is yes.

Michael Matson - Wachovia Capital Markets, LLC

I think you made some comments about this, but I just wanted to ask you again, with regards to the acquisition of TSL, Tissue Science Laboratories by Covidien. I mean, do you think that changes the competitive dynamic with regards to how you compete with Permacol. It seems like it would definitely increase the number of people selling the product, obviously the product data, and clinical result aren’t going to change, but --?

Paul Thomas

Well, I think the acquisition of TSL by Covidien is a reflection of a lot of folks looking at the biologic arena as an attractive space and we have obviously pioneered that space and have a leadership position. I think that Covidien will certainly bring more marketing muscle to the sale of Permacol. Nonetheless, we think we are best-in-class with AlloDerm and Strattice, and we think we match up well against Covidien, as well as Bard and Ethicon and others who are in this space, but there will be more competitive activity and we will continue to do our best to build on our leadership position, and we feel we have the best-in-class products to facilitate that.

Michael Matson - Wachovia Capital Markets, LLC

You are due to be joining KCI; is your intention to really stay there for the long-term or is that going to be sort of initial transition period of a year or so and then you would maybe move on to something else?

Paul Thomas

I would prefer not to comment on my personal plans. Certainly, with the leadership team at KCI, we are working very aggressively to get the proper integration plan put together and there are talented people in both organizations, and we’ll integrate these businesses in a way that we can achieve our shared vision for what we may accomplish for patients with both our reconstructive tissue matrices, as well as the vac products, and we will make sure that we have the right folks in place to do that, Mike.

Michael Matson - Wachovia Capital Markets, LLC

With regards to Strattice and the $1.1 million in sales you had in the quarter, if I was going to try to get sort of a quarterly run rate, obviously, it wasn’t really out there for the full quarter. Can you tell me how many weeks you had your full marketing push behind that product in the quarter?

Paul Thomas

Sure. I’ll tell you it was five weeks, but the caveat is I am not sure that you could sort of analyze quarter even on the basis of five weeks.

Michael Matson - Wachovia Capital Markets, LLC

Okay.

Paul Thomas

I mean you can go ahead and do so Mike. What we hope is we actually have an accelerating trend over time.

Michael Matson - Wachovia Capital Markets, LLC

Yeah. Okay.

Paul Thomas

It’s one of the reasons why I mentioned in response to an earlier question that one of the important metrics for us is how many new accounts we are able to open. We think that’s sort of going to be a good barometer of what future demand may look like.

Michael Matson - Wachovia Capital Markets, LLC

My final question would be on the urological gynecological area. Can you talk about what this competitive activity that you referred to is?

Paul Thomas

Yeah, and maybe Steve wants to comment as well. We are having some conversations with the folks at Boston Scientific. My understanding is that most of the pressure is in the sling business and I think we’ve talked in the past about a lot of the sling procedures now going to these tension-free, these TBT-type procedures. My sense is that that’s where the competitive pressure is coming from primarily.

What I think we are going to try to do is look at, you know, are there opportunities for us to accelerate the growth in the pelvic floor to offset that sort of natural decline we are seeing in the sling procedure.

Beyond that, I don’t have a lot of first hand visibility but we do have some folks who are working with the folks at Boston to see what we can do.

Operator

We’ll go next to Caroline Corner with Pacific Growth Equities.

Caroline Corner - Pacific Growth Equities

Congratulations on the merger.

Paul Thomas

Thank you.

Caroline Corner - Pacific Growth Equities

So Strattice, the $1.1 million, you had a good showing there. You just said it was about five weeks accelerating trend there. Can you talk a little bit about how the scale up of your manufacturing is going and are you expecting at some point to become supply constraint before you move from pilot to full scale given your current acceleration?

Paul Thomas

No I don’t anticipate being supply constrained, and if we were that would be the extremely high-class problem given the capacity that we anticipate even in the pilot facility. But we are up and operating in the pilot facility; about mid year, we’ll actually have an opportunity to bump even the pilot capacity up a notch and then we believe we are on track for getting the commercial facility operational by the end of the year, and when that’s operational, quite frankly, we don’t see any issues with supplying as much product as we need on a global basis.

So I think we are actually in a pretty good shape. That’s not something that keeps me awake at night, Caroline.

Caroline Corner - Pacific Growth Equities

Right and then Bard reported yesterday, they missed on hernia, a lot of it seems to be falling on the CollaMend product, and they said in that commentary that they are designing their new version of CollaMend that we already knew about. Have your sales reps heard anything out there about expectations around this product? What really do you think they can do with CollaMend to make it that much better to make it compete with Strattice? Are you worried about a new version of CollaMend at all?

Paul Thomas

Well, I think we are always concerned about potential competition and Bard is a very capable company as is Ethicon and Covidien and I am sure they’ll continue to look for opportunities to improve their current products or develop new products. Our game plan is to try to stay ahead of that curve. We think we have some unique competencies in terms for our understanding of the biologic arena. We think that AlloDerm is best-in-class and we think that Strattice may very well prove to be a big leap beyond AlloDerm, and on a research and development basis, we continue to look for opportunities to move even beyond Strattice.

So there’s going to be a lot of competition there. I don’t know any of the specifics in terms of what Bard is attempting to do with CollaMend, but it doesn’t surprise me in the least that they will continue to try to improve their product lines.

Caroline Corner - Pacific Growth Equities

Okay, and then with regard to the supply out there, I’ve heard that possibly LifeCell is not using necessarily all of the supply that it’s been using previously and may be has turned off some of the flow; is that the case or you guys still possibly processing as much tissue as ever and still using as many channels as you have been previously?

Paul Thomas

Are you referring to human tissues side of that?

Caroline Corner - Pacific Growth Equities

Yeah, human tissue, sorry.

Paul Thomas

Yeah, so to answer your second question first; yes, we are continuing to process as much human issue as we have in the past. One of the things we have been able to do over the last number of quarters is we have been actually able to recover more tissue per donor by working with our tissue procurement partners.

So in that sense we have had less need for the number of donors that we have had in the past because we are getting more tissue per donor and that may be a little bit of what you are hearing in the marketplace, but we continue to process about the same amount of human tissue in our facility and we’re just able to do it in a more efficient manner now with greater recovery per donor that our tissue procurement partners haven’t been able to realize.

Operator

And ladies and gentlemen, we have time for one final question. We will go next to Christopher Warren with Friedman, Billings, Ramsey & Co.

Christopher Warren - Friedman, Billings, Ramsey & Co.

Just a question on pricing, anything changing in the way that the pricing trends are and could you just remind us what those are for the biologic tissue?

Paul Thomas

Yeah, there is no change in pricing or pricing trends, Chris. The Strattice product is priced at about 15% discount to AlloDerm, many of the other xenograft products are priced well below that. So if you look at the SIS product from Cook, Permacol, or CollaMend or others, they are priced well, well, below that. The other human tissue products priced at about parity with AlloDerm, and in some cases just a bit north of AlloDerm and of course as we’ve talked about the synthetics are well, well below any of the biologics out there. So, really no discernable change in the pricing dynamics.

Christopher Warren - Friedman, Billings, Ramsey & Co.

And just year-on-year there hasn’t been any pressure there through the years on AlloDerm either. Has there?

Paul Thomas

Our pricing trend on AlloDerm has been very stable. We’ve increased prices about at CPI and so no, we haven’t had pricing pressure.

Operator

And that will conclude our question-and-answer session. Now I will turn the conference back over for any additional or closing remarks.

Paul Thomas

That will do it Stacey and the next time we report, it will be most likely as part of KCI, so we look forward to talking to everyone then. Thank you!

Operator:

Thank you, and ladies and gentlemen that will conclude today’s conference. We do thank you for your participation, and you may disconnect at this time.

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Source: Lifecell Corporation Q1 2008 Earnings Call Transcript
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