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Vascular Solutions Inc. (NASDAQ:VASC)

Q2 2008 Earnings Call

July 23, 2008 4:30 pm ET

Executives

Howard Root - CEO

James Hennen - VP of Finance, CFO and Corporate Secretary

Analysts

Chris Cooley - FTN Midwest Securities

Phil Nalbone - RBC Capital Markets

Matthew Scalo - Canaccord Adams

Ernest Andberg - Feltl & company

Operator

Welcome to Vascular Solutions second quarter conference call. At this time all participants are on a listen only mode, later we will conduct a question and answer session and instructions will be given at that time. (Operator Instructions). As a reminder, ladies and gentlemen, this conference is being recorded today Wednesday July 23rd, 2008.

I would now like to turn the conference call over to Mr. Howard Root, CEO of Vascular Solutions. Mr. Root, you may begin.

Howard Root

Thank you. Good afternoon, everyone, and welcome to Vascular Solutions' second quarter conference call. Joining me today is James Hennen, our Chief Financial Officer.

This conference call is being webcast to the public and is completely open to members of the media, Vascular Solutions' shareholders, and other interested parties. After our remarks, we will open up the call to questions.

First, the necessary preamble. Today's conference call is a proprietary Vascular Solutions presentation and is being recorded by Vascular Solutions. No other recording, reproduction, transmission, or distribution of today's call is permitted without Vascular Solutions' consent.

This call is being audio simulcast on the Internet via our webcast company website at vascularsolutions.com. A replay of the conference call will be available on the Internet shortly after this call is concluded through Wednesday, July 30th. To listen to the replay, visit the investor relations portion of our website.

Forward-looking statements made in the course of this conference call and webcast are made pursuant to the Safe Harbor provisions of the Private Securities Litigation Reform Act of 1995. These statements can be identified by words used such as may, will, expect, continue or other similar expressions.

There are certain important factors that could cause the company's actual results to differ materially from those anticipated by the forward-looking statements, as described in our annual report on Form 10-K and other recent filings with the Securities and Exchange Commission. Forward-looking statements are made based on our analysis as of today's date, and we undertake no duty to update the information provided on this call.

Today, we issued our press release with the results for the second quarter ended June 30. As I wrote in our 2007 annual report, Vascular Solutions' most important objective for the first half of this year has been to reach a resolution of the three pieces of litigation that have negatively affected us for the past several years. At the end of the second quarter we have successfully completed that objective.

The removal of the high legal expenses and uncertainties that are inherent at any litigation will transform our business allowing us to focus entirely on sales growth of our existing products and development of new products, and will allow us to demonstrate the soundness of our business in bottom-line results and consistent profitability, starting in the third quarter.

In this call, I will first provide an update on the components of our second-quarter net revenue by product category and our new product development projects within each of these product categories.

As a reminder, we group our products into five categories -- Hemostat products, that include our D-Stat Dry and D-Stat Flowable products all of which utilize thrombin to clot blood; extraction catheters, consisting of the Pronto V3 and other new aspiration catheters for the removal of intravascular blood clots; vein products, including our Vari-Lase laser console and procedure kits for the treatment of varicose veins. Specialty catheters, including our Langston, Twin-Pass and Gopher catheters for unique, clinical niches in catheterization procedures; and access products, including our micro-introducers and guidewires used in gaining percutaneous access to arteries and veins.

All of these products are sold by our direct US sales force and our international independent distributors to interventional cardiologists, interventional radiologists and other physicians performing percutaneous procedures.

After summarizing the results and developments in each of these categories, I will then provide guidance for net revenue for the third quarter of 2008 and for the remainder of the year. Finally, James will review the financial details of the second quarter and will comment further on our financial projections for the remainder of 2008.

In the second quarter of 2008, we increased our net revenue by 15% over the second quarter of 2007 to $15.2 million. Net revenue exceeded the top end of our guidance by over $200,000, primarily resulting from outstanding sales growth in our access products category.

US net revenue increased by 16% compared to the second quarter of 2007, while international sales increased by 12% over the prior year's second quarter.

At the beginning of the second quarter we transitioned our German direct sales operation to a distributor base system in order to lower our expenses and achieve better geographic coverage. This transition in Germany has progressed as planned in the second quarter with an excellent distributor performance, but as expected has resulted in lower percentage sales growth in international markets, as a result of the transition from hospital pricing to distributor pricing in Germany in the second quarter.

Our highest sales product category in the second quarter was our Hemostat products, with $6 million in net revenue in the second quarter, a decrease of 11% from the second quarter of 2007, but an increase of 2% over the first quarter of 2008.

In the second quarter of 2007, our partner, King Pharmaceuticals placed a $725,000 stocking order for their initial launch of the ThrombiGel and ThombiPad products, which is the primary reason for the reduction in revenue year-over-year.

In the second quarter of 2008, King purchased $246,000 of ThrombiGel and ThombiPad, as they continue to ramp their sales into the surgical and trauma markets consistent with our long-term plans.

To assist in growing D-Stat Dry sales, in the second quarter we initiated new programs with our direct sales force to maintain our focus on the D-Stat Dry, and to expand into new accounts to address the competitive challenges, with good results to-date.

Our second highest sales product category was our extraction catheters, which are used to extract soft thrombus from within blood vessels. In the second quarter, we recorded net sales of $3.7 million, with the Pronto V3 and its derivatives, which was an increase of 40% from the second quarter 2007.

In the second quarter, the one-year follow up results of the TAPAS study on thrombus aspiration in SG-elevated MI cases was published in the medical journal, Lancet, and demonstrated a statistically significant reduction in cardiac deaths resulting from thrombus aspiration in all SG-elevated MI cases.

We are seeing accelerated growth in the aspirations capital market as a results of the TAPAS study and other clinical studies such as our own DEAR-MI study are driving sales growth in our Pronto sales in the second quarter. With our new Pronto low profile or LP catheter fully launched in the second quarter, we believe that our comprehensive product line of aspirations catheters will continue to deliver substantial sales growth through 2008 and in to 2009.

Our third highest sales product category was our Vein products principally the Vari-Lase products for the treatment lf varicose veins, which recorded $2.4 million in net sales. A 16% increase over the second quarter of 2007. With litigation with VNUS and Diomed now resolved, we have solidified our pricing and our product offerings within the endovenous laser market.

With the acquisition of Diomed's assets out of bankruptcy by AngioDynamics, vascular solutions is now the strong number two player in the lser market. And we expect our complete product portfolio combined with our excellent clinically-based nation wise sales force will results in continued growth, as our smaller competitors either leave the market or are forced to navigate in the patents litigation quagmire.

We also have continued involvement in our multicenter randomized 200 patient BRILLIANT clinical study that compares the clinical outcomes and the patient satisfaction of our Bright Tip fiber to a Bare Tip fiber, with an expected completion of enrollment September.

Sales of our access products were $1.4 million in the second quarter an increase of 146% over the second quarter 2007. In the second quarter we continue to increase our sales of Micro-introducers kits and we also benefited from the launch specialty guidewires called the access and the Jiffy wires with excellent clinical response.

In the second quarter we also signed a distribution agreement with Radius Medical Technologies, a small Boston-based medical device developer and launched their MICRO Elite 14000 Snare to cath labs in the US. Initial sales of the MICRO Elite Snare in the second quarter were outstanding and nearly matched our expectation for sales of this product for the entire year.

We have now added Radius's EXPRO Elite 35000 snare to our distribution agreement for the US and have launched the EXPRO Elite snare at our national sales meeting last week. The EXPRO Elite snare, addresses a market opportunity in access of $5 million annually and should further fuel our growth in access products starting in the third quarter.

Sales of our specialty catheters were $1.1 million in the second quarter, an increase of 31% from the second quarter of 2007. This product line consists of our Langston, Twin-Pass and Gopher catheters for specialty purposes in catheterization procedures.

In April, we launched the new Gandras catheter, which is principally used in uterine artery embolization procedures. In the early clinical uses the Gandras catheter demonstrated a excellent clinical result and good physician reception. Looking forward we have another specialty catheter that we expect to launch in the fourth quarter that has the potential to add $5 million or more in annualized sales to this category.

License and collaboration revenue was $367,000 in the second quarter. This line item includes the recognition of licensing revenue from King Pharmaceuticals, as well as payments from King for the preclinical and clinical work we are performing to obtain a surgical indication for the ThrombiGel and ThrombiPaste products.

Regarding the resolution of litigation, in April we won a $4.5 million jury verdict in our trial against Marine Polymers Technologies. Following the verdict the court has now dismissed all of Marine Polymers post trial objections and have entered judgment including interest at $5.1 million. The Court also issued a permanent injunction against Marine Polymer's representatives from making slanderous statements about our D-Stat Dry. While the judgment is subject to appeal, which will take about a year to be finally decided, the distraction and substantial legal expenses related to this litigation are essentially over.

Also in April, we settled with a bankruptcy estate of Diomed concerning the patent litigation regarding our Vari-Lase product line, resulting in a $1.659 million gain from the prior expense accrual.

And finally, in June we settled with VNUS medical technologies on a separate patent litigation concerning the Vari-Lase products, resulting in a $3.1 million payment for past sales and ongoing royalties to VNUS for future US sales of our Vari-Lase products, by eliminating the uncertainty and legal expenses of this litigation going forward.

Turning to future sales guidance, in the third quarter we expect continued growth tempered by the normal seasonal summer decline in varicose vein procedures and to a lesser extent, catherizations in general. As a result, we expect between $15.3 million and $15.6 million in net revenue in the third quarter.

For the entire year 2008, we continue to provide guidance of net revenue of between $60 million and $62 million. We believe that new product introductions in the access products and specialty catheters area should provide additional sales growth in the second half of the year; but at this time, we have not factored in substantial sales from new products into this estimate. As a result and similar to what occurred with the sales of the MICRO Elite Snare in the second quarter, introduction of these new products could result in revenue above our guidance during the last half of 2008.

We also continue to make excellent progress with our larger and more long-term medical device opportunities. In our second quarter we took the design of the Mechanical Duett into an animal procedure with good results.

During the remainder of 2008 we expect to complete the design for the initial version of the Mechanical Duett for use in the over $400 million annual world wide invasive sealing device market.

One important benefit of the conclusion of our litigation is that we can focus more of our attention on the progress with the Mechanical Duett project, as well as improvements in the Acolysis Therapeutic Ultrasound device to drive our growth after 2010.

In the interim. we believe that we have the devices either on the market or in development that will allow us to achieve a $100 million in annualized net revenue before the end of 2010.

James will now review the details of our second quarter financial results and the rest of our financial projections.

James Hennen

As Howard described net revenue for the second quarter was $15.2 million, an increase of 15% from net revenue of $13.2 million in the second quarter of 2007. US net revenue represented $13.4 million or 88% of second quarter revenue.

Our product gross margin for the second quarter was 64%, down 240 basis points from 66.4% in the year ago quarter, primarily the result of changes in our product selling mix and the on going royalty to VNUS on our US sales of Vari-Lase kits and consoles.

Looking forward we expect to increase our product gross margin to between 64% and 66% starting in the third quarter as a result of higher margins on our Vari-Lase products due to a price increase implemented in the second quarter, together with a more favorable selling mix of products.

Collaboration expenses related to our clinical work with King Pharmaceuticals were $187,000 in the second quarter. Looking forward, we are projecting margin of approximately 35% of license and collaboration revenue.

Sales and marketing expenses were $5.2 million in the second quarter, up 7% from the year-ago quarter. The primary reason for the increase was the increase in commissions paid to our direct sales force as a result of increased sales. At the end of the second quarter, we had a total of 82 field sales and sales management employees in the US. For the remainder of 2008, we expect to realize significant leverage in our sales expenses as we do not plan to materially increase the head count in our US sales force.

As a result, we estimate sales and marketing expenses would decline to 34% of revenue in the second quarter to approximately 31% of revenue by the end of 2008. Revenue generated per US field sales employee was $169,000 in the second quarter or $676,000 annualized. We continue to believe that we can grow this number to over $1 million per field employee by 2010, with our current and planned new products.

Research and development expenses for the second quarter were $1,553,000, up 15% from the year-ago quarter. The increase was the result of our continued emphasis on investment in new products, included an increase to 21 full time employees in research and development. We project R&D spending to be approximately 9% to 10% of revenue per quarter for the second half of 2008 as we continue to pursue additional new products and move our longer-term development projects forward.

General and administrative expenses were $1,192,000 in the second quarter, down 1% from the year-ago quarter. This decrease was primarily the result of lower legal expenses as substantially all litigation expenses were concluded in the second quarter following the settlements of Diomed and VNUS.

Concerning the litigation with Marine Polymer Technologies, the $4.5 million verdict has now been increased to $5.1 million including pre-judgment interest, but will not be recognized as a gain until the appellate process has been completed.

We do not accept to incur any further significant legal real expenses for the remainder of 2008 and as a result we project G&A expenses to be approximately 7% of revenue per quarter for the second half of 2008.

Clinical and regulatory expanses were $759,000 in the second quarter, an increase of 1% from the year ago period. The increase was result of timing of our clinical studies and regulatory submissions. We project clinical and regulatory expenses will be approximately 5% of revenue for the remainder of 2008.

In the second quarter we did not incur any additional thrombin qualification expenses and we do not expect to incur any thrombin qualification expenses going forward related to our Thrombin BSI project.

In February we receive CE mark of approval to commence using thrombin BSI and our hemostat product sold in European markets. In the second quarter we begin using thrombin BSI in the manufacture of our European market hemostat products.

We currently have remaining approximately $400,000 inventory of thrombin BSI vials and approximately 800,000 of bulk thrombin. We expect to consume this supply of thrombin BSI over the next several years and hemostat product sold in European markets.

Litigation expenses of $1.457 million in the second quarter consist of a net between a gain of $1.659 million recognized upon the April 8 settlement agreement with Diomed and expense of $3.115 million recognize upon the June 4th settlement agreement with VNUS.

Interest income was $48,000 for the second quarter as we yielded a 2.3% return. We anticipate a similar rate of return for the remainder of 2008.

Interest expense was $18,000 for the second quarter relating to our equivalent line of credit. We paid the entire remaining balance on the equivalent line of credit on July 9 and now have no outstanding balance in our bank lines.

Income tax expense was $53,000 for the second quarter as a result of alternative minimum tax and higher state taxes where we do not have sufficient NOLs to offset our income. We estimate we incur an approximately $19,000 in additional tax expense for the remainder of 2008.

The resulting GAAP net loss for the second quarter was $468,000 or $0.03 per share compared to net income of $695,000 in the second quarter of 2007. Reflecting the adjustments described in our press release we achieved adjusted net income of $867,000 or $0.05 per fully diluted share in the second quarter, compared to adjusted net income of $691,000 in the year ago quarter, an increase of 25%.

We project our adjusted net income to be in the range of $0.06 to $0.08 per share in the third quarter of 2008. For 2008 as the whole we are reaffirming our guidance for adjusted net income to between $0.21 and $0.29 per fully diluted share.

Regarding the balance sheet, we ended the second quarter with $5.4 million in cash, a decrease of $5.4 million from December 31 balanced too, to the one-time payments totaling $6.7 million in the settlements with Diomed and VNUS. Adjusting for these one-time payments we achieve cash flow of $995,000 in the second quarter, making this our seventh consecutive quarter of positive cash flow operations.

With the settlement of the litigation, we expect to continue to improve our positive cash flow for the foreseeable future and end 2008 with approximately $8 million in cash. We expect our inventory levels to continue to increase slightly through the rest of the year and end 2008 at approximately $10 million.

During the second quarter we incurred $364,000 of capital expenditures, mainly consisting of manufacturing and R&D equipment. We still expect total capital expenditures to be approximately $1 million in 2008.

We continue to believe that our current working capital of $15.4 million is sufficient to fund all of our foreseeable operating requirements. We also have an additional working capital flexibility with our $10 million line of credit.

Our GAAP calculation of our weighted average fully diluted shares was $16 million in the second quarter. We expect this number to increase to $16.5 million by the end of the year due to the fully diluted calculations. We currently have 15.8 million shares outstanding with 17.3 million shares fully diluted on a share count basis.

Concerning Germany, in March we decided to transition from a direct sales operation in Germany to a distributor relationship. We transferred our existing business and entered into a five-year distribution agreement with our new distributor, Nikolai, in exchange for payments totaling Euros 500,000, which will result in recognizing $37,500 per quarter in licensing revenue over a five-year term starting in the second quarter.

We received the second payment of these four installments of Euros 125,000 in July, and we expect to receive the remaining two installments in successive quarters, with the final payment being received in the first quarter of 2009.

Finally, looking longer term, we are reaffirming our more general targets. We continue to believe that we can achieve $100 million in annualized net sales by the end of 2010. In this timeframe, we target our product gross margin to be approximately 64% to 66% on a blended rate across all of our products.

As a percentage of net revenue, we have targeted our 2010 research and development expenses to be 10%, clinical and regulatory expenses to be 5%, general and administrative expenses to be 7%, and sales and marketing expenses to be 25% with the resulting operating margin at approximately 20% of net revenue.

With that I will turn the conference call back to the operator for questions.

Question-and-Answer Session

Operator

Thank you ladies and gentlemen we will now begin the question and answer session (Operator Instructions). And first we will go to Chris Cooley with FTN Midwest Securities

Chris Cooley - FTN Midwest Securities

Thanks, congratulation on a nice quarter, Howard and James.

James Hennen

Thanks, Chris.

Chris Cooley - FTN Midwest Securities

Couple of questions if I may be get the bad one of the way at the offset,. If I just back out the King purchases on your hemostat line in '07 and '08 our core business level still looks like that product declined year-over-year kind of low-single digits even though we saw PCI volumes during the states come back up in kind of low single to kind of three or five range domestically. Can you just walk me through a little bit of what you are seeing there. Is that still aggressive sampling in you mind? Is it less utilization? Is it mixed shift internally, I just wanted to make sure I fully kind of understand what is going on there, than I would have a follow up. Thank you.

James Hennen

I will start and then I will turn it over to Howard. As we said we switched over to the distribution model in Germany and Germany we sold quite a bit of D-Stat Dry, so know that is roughly sold at 50% margin and they sell it to the end user customers. That is part of that decline in a quarter-over-quarter basis. Now I will let Howard comment on the general market.

Howard Root

Right.If you look kind of in the sequential basis we are up 2% hemostat products. In the second quarter we initiated a new program, in continuing education programs, get in their and beat back to competition.

As we said on the conference call, in the fourth quarter and the first quarter there was aggressive sampling by a couple of competitors. I think that they died down somewhat, although they are still lingering free product in the labs and when that happens, they tend to use the free stuff until they see that it doesn't work and then come back to something else.

So were still battling through that. I think our market data says that we are the clear number one patch in the US market, which is the vast majority of that market. So when you are number one, it is hard to grow more patches as a whole or kind of a more of a mature area of that. They are not growing in terms of utilization within the diagnostics or within interventional procedure. But our market share has remained steady to growing over the last couple of quarters here.

So, we are not looking, as we said last time, we are not looking at hemostat products to be the biggest growth driver for us. We want to maintain that business and have single digit increases sequentially. And I think we are in a position to do that. So I am happy with where we are right here at the start of the third quarter.

Chris Cooley - FTN Midwest Securities

Okay, that makes sense. And then if I could just follow-up maybe Howard, just from your perspective, I guess its not having to stay in a lot of Boston hotels going forward. How does your time management change and what do you think we can start to see in terms of execution going forward from a corporate level, now that and to your credit, all of these various legal overhangs have now been resolved?

Howard Root

Yeah, I think, from my standpoint, I was going to be in a California hotel for about three weeks in July and then try to do our sales meeting as well. Instead of that, I got three weeks to get ready for our sales meeting. And we just had it last week and really gave a lot of great content as well as launched new products to the sales force.

So going forward, my responsibilities first and foremost is as we say, feed the beast, keep products in the bag, look for new things, develop new things and the beautiful thing with our model is signing distribution agreements for new things like with Radius, which is a perfect organization to match up with us, and our sales force is perfect with their products, and continue that going forward.

That the majority of it along with the other part that I was not able to spend time on last couple years but I can is, really on this bigger, longer-term projects the Mechanical Duett and Acolysis and both of those we know an awful lot about. Mechanical Duett, we worked in an invasive sealing device for 11 years we got a great design, we just got to finish it up and get it out there and prove it in the animal model and move it into clinical studies and European commercialization and Acolysis, that's where we have been selling it for about five years.

We just need to make improvements on the design of the disposable to make it where it is a completely commercial device and then expand that, because there is really a big market for peripheral debulking and then this device does a really good job of that.

So that's the thing, making sure that we are on target for that $100 million in annualized sales by the end of 2010 and then we have got some big things that are coming through the system which we are now starting to talk about that are for the growth after that to go from $100 million up to hopefully a $500 million company in the, obviously in the next several years after 2010.

Chris Cooley - FTN Midwest Securities

If I could just maybe squeeze one more question in, and then I will get back in queue. Just on the vein products business, the [RELIEVE] trial; I believe you submitted that, it was like the second or third week of April, to the FDA. You were hoping for an approval there for use of that in treatment of perforated veins kind of here in the July timeframe. Is that still the case?

I know we are dealing with guessing about the FDA. And then also, could you just remind me again, on the royalty that was paid to VNUS in the quarter for sales up through the March quarter, can you remind me again when the clock started there on those sales? Thank you.

Howard Root

On the royalty, just to make sure on legal terms, it is when we started selling our products in the US, which I think was 2003. And then that went through, the amount that we paid, the lump sum $3.1 million, I think was up through the end of the first quarter and that is the litigation amount.

Then going forward, it is included in our cost of goods sold and that is why you saw the margins dip down, it is because of royalties there. But we do not disclose the amount of the royalty on per unit or per dollar or percentage basis.

Chris Cooley - FTN Midwest Securities

Understood.

Howard Root

What was the second part of that question?

Chris Cooley - FTN Midwest Securities

Just on the RELIEVE trial, I just was hoping to get some update there as to the indication.

Howard Root

Yes, the RELIEVE trial is to get a separate indication on the use of the Vari-Lase kits for treating perforated veins, which is a small but important segment of the growing market for varicose vein treatment. We have submitted that with the FDA. We have not gotten approval with that.

We are at the point where we should be getting that accomplished relatively soon, but we have not gotten it so far. And beyond that, since as you said, it is the FDA, we can only guess. But I do not know anything more definitive than that.

Chris Cooley - FTN Midwest Securities

Understood. Thank you so much.

Howard Root

Thanks, Chris.

Operator

And moving on, we will go to Phil Nalbone with RBC Capital Markets.

Phil Nalbone

Hi, thank you very much. Nice quarter, guys. Thank you. Howard, you talked a little bit about your guidance and not factoring in a bunch of products that could make things look even better. I am trying to get a sense for how cautious and conservative you have been for the second half of the year.

Can you give us some sense for what new products are likely between now and year-end that you have not factored into your guidance, and kind of the opportunities for those products?

Howard Root

Yes, I think there are two that we can talk about, because they are the near-term, and I have actually talked about them all already in the conference call. The first one is the EXPRO Elite snare. This is a 35,000 snare. The MICRO Elite is the one we launched in the second quarter, and did in the second quarter what we thought we could do for an entire year and that really caused our access products to jump.

The EXPRO Elite, when you get to a 35,000 snare, the market for that is probably somewhere between 5 and 10 times the size of the MICRO Elite snare. So this is more than a $5 million a year potential product for us. We have the product on the shelf. Its FDA approved. The beauty of this signed distribution agreement, it goes from nothing to launched, as soon as you sign that agreement. And we had our sales force completely trained on it last week at the sales meeting.

So we are out there selling it right now. And that is what could cause us to go above our estimates in the third quarter, because we have, in order to be conservative, we have not given any guidance on a single snare sale of the EXPRO Elite in the third quarter here.

And then in the fourth quarter -- what we would like to do is launch a new product every quarter. We have a support catheter; we are calling it the Mini. Beyond that, I am not going to go into a description of it, because we have not launched. But the Mini support catheter is a potential $5 million plus product for us. And we expect to have it approved sometime at the beginning of the fourth quarter. And that could be material in our sales above what we expect for the fourth quarter number.

Those are the two ones for the rest of this year. And then we have several that are on the boards for January or later in 2009.

Phil Nalbone - RBC Capital Markets

Okay, great. You know, I appreciate that you cannot talk about the details of your ongoing payments to VNUS. But I was wondering if you could talk a little bit more generally about what your pricing strategy currently is?

What you are trying to do to protect gross margins in the leg vein business? And companywide, it looks like certainly in the quarter, gross margins were below what we expected. Your guidance is below what we expected.

So perhaps, James, you can talk a little bit about what the company is doing to offset the gross margin pressure that seems to have crept into the equation here?

James Hennen

Yes. The price increase was not implemented until the very end of the quarter. So what are you seeing in the current margin percent in our Q2 is really a very small amount of price increase impact there.

So going forward, that price increase is obviously implemented for the third fourth quarters, so that is where we guided to increase margin on a going forward basis.

Howard Root

Just to add to that, the idea behind the price increase, obviously we could not do it until we settled. Once we settled, we took a look at where our prices were. Our margins on the Vari-Lase business had dripped down. It is a competitive business. Over the years, the selling price gets under some pressure as low-cost competitors come in.

When we looked at it, and saw what is going on in the patent side with both the Diomed patent, or formerly Diomed patent, and the VNUS patent, we saw the opportunity for us to improve our gross margin.

So the price increase really had two effects. One is to take account of the royalty. And the other one is to get our margins back where they should be. We target every product at least at a 50% gross margin. So that is where we go. But we have wide range, obviously, from the hemostat products down to our distributed products from the top to the bottom in the margin, but nothing should be below a 50% margin for us.

Phil Nalbone - RBC Capital Markets

Okay. Do you think that in the current environment, where there are fewer players now, and potentially fewer still, that you are going to have some increased pricing flexibility going forward?

Howard Root

It depends on what you want to do. If you want to try to gather the most volume you can, you can lower your price and go after it. That is not our strategy. We are a value-added player. We have a nationwide sales force that supports them, and we are playing off that value, so we are not going to chase it down the hill.

The other people who are down there are going to see the problems with that strategy when the patents are now coming at them. I think the market is going to come to us rather than us having to go to the market.

Phil Nalbone - RBC Capital Markets

Great. Thank you very much Howard.

Howard Root

Thanks Phil.

Operator

And moving on, our next question will come from Ernest Andberg with Feltl.

Ernest Andberg - Feltl

Hello, Howard.

Howard Root

Hey, Ernie.

Ernest Andberg - Feltl

On the new product front, you called it the MICRO Elite snare that is there, was the new version of that one of the products, of a couple products, you were expecting to get out in July?

Howard Root

Well, the MICRO Elite snare we did launch in July. When I say we expected it, we signed that agreement not shortly before that.

So I do not know if we have really talked about in the second quarter or the first quarter conference call or not, but that was one of the big drivers for us in sales above estimates in the second quarter.

Ernest Andberg - Feltl

Was there another product that you expected to get out here at this point in time?

Howard Root

Well, we have a couple of other ones. We have the Gandras catheter that we launched; that is a specialty catheter we launched.

Ernest Andberg - Feltl

That was in Q2, yes.

Howard Root

Yes Q2, we have the Axis guidewire and the Jiffy guidewire. So we launched all four of those in the second quarter. Three of those are in Axis products, one of them is in the specialty catheters category and not surprisingly, those are two of the big growth drivers for us.

Ernest Andberg - Feltl

Just thinking about the seasonal pattern in your various businesses, Howard, you or James suggested that Vari-Lase could be down seasonally in Q3, or are likely to be down seasonally in Q3. But you have got a price increase that will be factored in there and your overall sales are up modestly, to up more than modestly your guidance.

Is that the price increase flowing through in the Vari-Lase products, or is there something else going on in your expectations there?

Howard Root

No, It is not really the price increase. It has continued growing sales and launching, continued benefit of the launch of the new products. As far as procedures go in the summer, no one wants to wear support stockings, least of all the guys, in the summer months. So the number of varicose veins treated in July and August goes down, and that is what we have seen historically. That is why we kind of forecast for the drop there. The price increase will come up, assuming we maintain all of our business. But we are not looking at a growth in Q3 over Q2, sequential growth for the Vari-Lase business.

Ernest Andberg - Feltl

That is what I was trying to figure out, what you were discussing.

Howard Root

Right, and then fourth quarter is always the biggest quarter for vein products. So it comes shooting back, because everyone wants to get it done before year-end, some co-pay and some things, and insurance reasons as well. But that is kind of the way that business works out. There is a slight drop in catheterizations in the summer months because of vacations and everything, not anywhere near what you see in the Vari-Lase market.

Ernest Andberg - Feltl

Okay, for James, you indicated in the press release that there were about a $176,000 in legal expenses in G&A in Q2. And I know, we can see where the absolute dollar was. But after Q1, you gave us an idea where you thought those legal expenses would be in the next three quarters, two, three and four.

Does all that go away, so that we can see lower absolute G&A expenses in Q3 and Q4, or is that being too aggressive?

James Hennen

No, that is a correct assumption. We gave guidance of $575,000 in Q2 of legal fees. Obviously, they came in at $176,000 because there was no VNUS trial. We gave guidance of $375,000 in Q3, and then I think down to like $50,000 in Q4. So now our guidance, we said in the press release that there will not be any material legal fees going forward. So that is a true assumption.

Ernest Andberg - Feltl

Okay, fair enough. Thank you very much.

Howard Root

Thanks Ernie.

Operator

And moving on next we will go to Matthew Scalo, with Canaccord Adams.

Matthew Scalo - Canaccord Adams

Hey guys, good quarter here.

Howard Root

Hey Matt, thanks.

Matthew Scalo - Canaccord Adams

I wanted to ask you about the Pronto side, 40% growth. I cannot recall a quarter when you had that level of growth. And I am wondering, the LP, what the contribution was maybe to growth in the quarter versus, say, the Lancet article and maybe the generation of demand on that side?

Howard Root

Yes, I think the big driver was, finally, the appreciation by physicians that you should remove thrombus before you inflate a balloon in an infarcted vessel. And so aspiration catheters in the second quarter really had a strong benefit, and the benefit of the TAPAS study was that it is not invisible thrombus, it is not just to use it when there is visible thrombus, but the principle is to use thrombus aspiration in every ST-elevated MI that comes into the cath lab.

And as people adopt that, the usage goes way up and then we combine that with our ability to have the LP and V3. So, large and small, we think best-in-class products there, that is good, but, the LP, there was a small impact on that, I would say maybe 25% of the benefit. 75% of it was on the clinical side with the improved clinical data coming out at PCR and TCT last year, and the Lancet article getting published.

Matthew Scalo - Canaccord Adams

Okay. And then from the impact of Germany there, is Germany a pretty big user of Pronto, or?

James Hennen

Yes, Germany, right behind D-Stat Dry, it was the number two product in Germany. D-Stat Dry was number one in Germany and Pronto number two. So yes, even with that factor going into the distributor model, we still grew 40%.

Matthew Scalo - Canaccord Adams

Yes, was that material impact, the German switch to go into distributor?

James Hennen

The point of the German switch is, if you are selling to hospitals, say you are selling at $100, you sell it to a distributor it will be a $50 deal; it cuts your sales in half as soon as you make that switch. That was kind of the headwind we had to recover, and we did that nicely, obviously, and still grew sales considerably in terms of having broader exposure.

With our direct operation, we only had two people covering, four at the most and two at the end. And with the distributor, now, I think they have seven or eight different sales reps covering the country. So we think we will get better volume for that.

Matthew Scalo - Canaccord Adams

So, going forward do we expect to see growth in this kind of range?

Howard Root

You mean in which, in the Pronto range in the 40%?

Matthew Scalo - Canaccord Adams

Well, maybe not exactly 40%, but the 30% to 40% range in the second half of '08?

Howard Root

You know, we have not broken out growth specifically by product category. Pronto should be above our growth as a company, and we're looking at, 20% growth year-over-year is what we were forecasting, and that's what we think we can do. I think Pronto will be above that. I think 40% would be high, but between 20% and 40%, that is a real ballpark.

Matthew Scalo - Canaccord Adams

Fair enough, Howard. Thanks. On the King Pharmaceutical contribution, did that kind of meet your expectations internally for the quarter, and how should we be looking at the hemostasis product sales from King going forward in the second half?

Howard Root

Right. Well, we had given guidance to $1 million in sales for the year, and I think we came in at $246,000 in the quarter, so we are annualizing at that rate in the middle of the year. That really is right where we thought that we would be at this point.

We are going to continue at that level until we get the surgical approval. And we are always waiting for the FDA to finally finalize the down classification, but, that is like watching paint dry. It kind of happens when it happens, and you can really predict it that well.

But for us, the clinical study is in the process. We want to get that done so we see this kind of incremental slow progress until the approved indications get done. When that happens, we will see an inflection point and jump it up. We think long-term, that should be a $10 million business for us selling to King, when we have the full surgical approval for it.

Matthew Scalo - Canaccord Adams

And just last question, as far as guidance, the $60 million to $62 million in sales, how much is going to come from new products introduced, let us just say, by January 1, 2008?

Howard Root

All right, so $60 million to $62 million for '08 sales, what percentage is the new products that we launched this year?

Matthew Scalo - Canaccord Adams

Yes, and ballpark?

Howard Root

It is not a huge. 10%, maybe?

Matthew Scalo - Canaccord Adams

Okay.

Howard Root

It depends on what you call a new product. Sometimes you change the color of a box, do you call it a new product? LP, I consider a new product, but a new version of the Gopher would not be considered a new product in my book.

If you look at purely new products, completely new, never been sold before that, I would say it would be around 10%. But 90% of our sales are products we have launched in the last five years.

Matthew Scalo - Canaccord Adams

Okay. And actually, just one follow-up. With the price increase on the Vari-Lase , is it structured in the sense of each account comes around once a year to update, kind of that pricing, or is it immediately, start from the end of second quarter, you will have an automatic bump-up?

Howard Root

When we do price increases, it is across the board at one point date for everyone, unless we have a contract, and that is a very small number of accounts where there is a contractual agreement.

Matthew Scalo - Canaccord Adams

Okay. Thanks, guys.

Howard Root

Thanks, Matt.

Operator

And we do have a follow up and that will come from Ernest Andberg with Feltl.

Howard Root

Ernie, are you there?

Ernest Andberg - Feltl

Yes I am.

Howard Root

Okay.

Ernest Andberg - Feltl

Just back on the question that you were just answering on King, you said you had expected $1 million for the year. You did $246,000 in the second quarter, and you thought you would run at that rate. Are you talking about roughly $250,000 a quarter going forward, or do you get to the $1 million for the year?

Howard Root

No, I am not trying to be that fine. $246,000 is annualizing at $1 million, I would say we are there; when I say at that rate, these are bigger orders that come in. So when they order, it is a big chunk. And when that falls, you do not know exactly, so there is a little variability. But, you know, it will not go over a $1 million.

Ernest Andberg - Feltl

Somewhere between the two?

Howard Root

Yes, somewhere between there, but it is not going to be $1 million in the third quarter I can tell you that.

Ernest Andberg - Feltl

No, I meant for the year.

Howard Root

Yes.

Ernest Andberg - Feltl

Okay.

Howard Root

So we are looking at $1 million for the year. That is kind of the ballpark guidance. Could it be $700,000; could it be $1.3 million, in that range? Yes, and at that point it should be considered rounding for us, on these types of deals.

Ernest Andberg - Feltl

I like that answer.

Howard Root

All right, thanks.

Ernest Andberg - Feltl

Bye.

Howard Root

Thanks, Ernie

Operator

(Operator Instructions) I am showing no further questions. Please continue with your closing remarks.

Howard Root

I think as everyone can tell, we are really excited about what we were able to accomplish in the second quarter. It really sets us up nicely to go forward with the new products and unfettered by the litigation that has been on our backs for the last couple of years.

So I look forward to the third quarter. And thanks, everyone, for participating on the call.

Operator

Ladies and gentlemen, that concludes our conference for today. Thank you for participating in Vascular Solutions' second-quarter conference call. You may now disconnect.

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Source: Vascular Solutions Inc. Q2 2008 Earnings Call Transcript
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