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Executives

Scott Murcray – Corporate Controller & Chief Accounting Officer

Brian Farley – President and CEO

Peter Osborne – CFO and VP of Finance and Administration

Analysts

 

Tom Gunderson – Piper Jaffray

Ben Andrew – William Blair & Co.

David DeGiralamo – Pacific Growth Equities

Matt Dolan – Roth Capital Partners

Tom Zeifang – Lucrum Capital

VNUS Medical Technologies, Inc. (VNUS) Q2 2008 Earnings Call Transcript July 29, 2008 5:00 PM ET

 

Operator

 

Ladies and gentlemen, thank you for standing by and welcome to the VNUS Medical Technologies second quarter 2008 teleconference. During today's presentation all parties will be in a listen-only mode. Following the presentation the conference will be opened for questions. (Operator instructions) This conference is being recorded today, July 29, 2008. I would now like to turn the conference over to Mr. Scott Murcray, Corporate Controller and Chief Accounting Officer. Please go ahead.

Scott Murcray

Thank you. Welcome to VNUS Medical Technologies regular teleconference on quarterly financial results. Joining me today is Brian Farley, President and Chief Executive Officer; and Peter Osborne, Vice President, Finance and Administration and Chief Financial Officer.

Approximately one hour ago, we released our financial results for the second quarter ended June 30, 2008. In today's call, we will discuss our business and financial highlights for the second quarter of 2008. We will also provide our business outlook for the third quarter and full year 2008. After our prepared remarks we will open the call for questions.

The statements that will be made today on this call may contain certain forward-looking statements that involve a number of risks and uncertainties. Words such as expects, believes, intends, plans, estimates or variations of such words and similar expressions are intended to identify such forward-looking statements and such statements in this conference call will include statements regarding the outlook for VNUS's revenue and earnings, gross margins, commercial success of VNUS's licenses, operating expenses, new product development and pending patent litigation.

Investors are cautioned that actual events or results may differ materially from VNUS's expectations based on various risks and uncertainties. Information concerning risk factors that may affect VNUS's forward-looking statements can be found in the press releases issued by VNUS and VNUS's filings with the Securities and Exchange Commission including its annual report on Form 10-K filed with the SEC on March 14, 2008 and its quarterly report on Form 10-Q filed with the SEC on May 1, 2008. Copies of VNUS's press releases and additional information about VNUS are available on our corporate Web site at www.VNUS.com.

Investors are cautioned not to rely on forward-looking statements. VNUS is providing this information as of the date of this conference call and expressly disclaims any intent or obligation to update these forward-looking statements except as required by law.

Now I would like to turn the call over to Brian for a summary of our second quarter and more recent business highlights. Brian?

Brian Farley

Thanks, Scott. And thanks to everyone for joining us today on the call. I'm pleased to be reporting VNUS's financial and business results for the first quarter 2008. Second quarter revenues came in at $31.9 million with $20.5 million of product revenues and 10.4 million from royalty revenues. This was above our revised Q2 guidance which was for product revenues of $19.8 million to $20.8 million, and royalty revenues of $10.2 to $10.3 million. Organic revenues growth that we compute by excluding royalty revenues and by adjusting for past deferred revenue in Q2 of 2007 was 29% in the second quarter of 2008. Our net income in the quarter is $0.56 per share, was above our royalty revised guidance of $0.50 to $0.54 per share primarily due to higher product revenues.

Peter Osborne will provide further detail on our financials after I finish the business update for you.

Our ClosureFAST catheter represented 96% of our total catheter unit sales in the second quarter, up from 94% in the first quarter. With the gross margin in the second quarter of 76.9% represents the strong revenue and margin contributions from royalties receive from a settlement and license of our patents on minimally invasive treatment of Venus reflux disease.

Gross margins from product sales were 65.7% which was within our guidance range. We continue to see manufacturing cost reductions for our ClosureFAST catheter in the second quarter and these were led by reduction in material costs and by manufacturing the product at record breaking production yields of over 97%. We expect to see a continuation of catheter manufacturing cost reductions in the coming quarters as we increase production volumes in anticipation of continued strong international growth and to prepare for a seasonally strong fourth quarter.

We are also happy to report that unit sales continue to grow at a strong rate. Disposable catheter and device units grew 38% in the second quarter compared to Q2 of 2007. This annual growth in proprietary disposable products is especially noteworthy because of the comparison is to a quarter of 2007 which we had already launched because of FAST catheter.

When we look further into where the quarterly unit growth is coming from, we see that in the U.S., 30% of the growth is from increases in the utilization rates in our existing customer base and 70% of the growth is from customers who did not order from us a year ago in Q2 of 2007.

Our unit sales in RF generators were also very solid with 120 RF generators sold in the second quarter compared to 95 in the first quarter of 2008. This growth in second quarter RF generator sales compared to the first quarter came from our U.S. sales team. These increases in RF generators unit sales do not include upgrades from our older mild generators nor do they include our generators that are placed with customers in exchange for disposables contract or SWAP related console. Clearly, together, we are seeing healthy growth in new customers both in the U.S. and overseas which suggests good future catheter growth from this nicely expanding base of customers. These numbers underscore not only a demand for our product but the overall health at the endovenous vein ablation market.

International product sales continue to be a driver in our business. In the second quarter, international revenues were13% of product sales and grew 113% from the second quarter of 2007 driven by excellent growth in countries where we have either a direct sales team or in distributor countries where the procedure is reimbursed to be a public health insurance.

Right now, we estimate that it will be approximately 700,000 severance pain procedures performed annually in Europe, approximately 100,000 are in countries in which public health insurance reimbursement is available for our endovenous vein ablation procedure. Clearly, we have a lot of work to do and opportunity to see as we strive to obtain public reimbursement in additional European countries.

This is a clinical and a doctor-driven process is difficult to place a timeline on to. Fortunately, for us, the public health officials in international countries can see how our clinical data is very strong, now with five completed randomized trials all showing that RF pain ablation is better for patients than either vein stripping or endovenous laser ablation. In addition, we have now completed one-year follow-up in 292 of the 295 patients treated in our ClosureFAST European clinical trial. And also obtained results on over 100 limbs now at two-year follow-up. The vein occlusion rate at one-year in this trial is 97% with nearly perfect follow-up compliance of 99%. And to-date the two-year follow-up in over 100 limbs with the ClosureFAST catheter show that of the veins occluded at one year, only one vein or 1% did not remain closed at two years.

U.S. reimbursement being as closer procedure remain solid with the passage of recent legislation that maintain the current Medicare fee schedule for physicians unchanged in the second half of 2008. In addition, we see no issues with a preliminary 2009 Medicare reimbursement for our RF vein ablation for either the hospital facility or M.D. office setting again in 2009.

On the competitive front, our marketplace has changed dramatically since our last earnings call. Diomed is no longer a competitor and selected assets of Diomed have been purchased by AngioDynamics. In addition, we successfully settle patent litigation with AngioDynamics and Vascular Solutions resulting in those two companies paying VNUS an upfront royalty amount of $9.9 million for path sales and a future royalty for endovenous laser ablation product shipped in the United States through September 11, 2017, the expiration date of our patterns.

We acquired Diomed business, is also subject to royalties to be paid to us. We have also pursued patent litigation with four other groups, including CoolTouch, Dornier Med Systems, Biolitec, and the owners of total weighing systems.

In parallel with this new patent litigation, (inaudible) discussions are underway. However, because of ongoing negotiations we won't be providing commentary on the status of negotiations with any of the parties.

I would like to wrap with the couple comments on our business versus that of the economy. We continue to grow well and have no indication that the weaker U.S. economy is impacting our business. Perhaps this is because our product performance and clustered demand is strong, or perhaps it is because varicose pain patients who receive endovenous ablation of their of their saphenous reflux are truly dealing with significant symptoms such as leg pain and fatigue, limb swelling or venous ulcers and need to seek medical care irrespective of the economy. Either way, we don't see any effect of the economy on our business. We continue to believe that we are taking market share and estimate that we have grown to now have approximately a 59% market share of revenues in the U.S. endovenous ablation market.

Now, turn the call over to Peter for his review of our financial results from the second quarter and our business outlook for the third quarter and full year 2008. Peter?

Peter Osborne

Thanks, Brian. For the first quarter, net revenues were $31.9 million, including 21.5 million of net product revenues and 10.4 million of royalty revenues. Net products revenues are derived from the sale of disposable endovenous capital and devices, RF generators and accessory products. Royalty revenues are derived from the licensing of certain pain patents previously subject to an infringement lawsuit. Total net revenues increased 86% from the prior year, an increase 69% sequentially. For the second quarter net product revenues were 21.5 million, an increase of 25% from prior year and 14% sequentially. As Brian mentioned earlier, after adjusting to the net recognition of $0.5 million of RF generator revenue deferred in 2006 and subsequently recognized in the second quarter of 2007, net revenues in the second quarter of 2008 grew 29% compared to the second quarter of 2007.

Compared to a year ago, we experienced a 371% increase in catheter unit sales while compared to prior year, we saw a 12% decrease. When we include the RFS family of devices, which is primarily used to treat perforator vein reflex, the disposable catheter and device unit volume grew 38% year-over-year and increased 10% sequentially. The RFS family of devices represented approximately 10% of our disposable vein, catheter and device unit volume in the second quarter of 2008.

Sales of disposable catheters and devices accounted for approximately 76% of second quarter net product revenues. Sales of RF generators accounted for 10% with accessories and other revenues representing the remaining 14%.

In the second quarter of 2007, sales of disposable catheters and devices accounted for approximately 72% of net product revenues. Sales of RF generators accounted for 14% with accessories and other revenues representing the remaining 11%. In the first quarter of 2008 sales of disposable catheters and devices accounted for approximately 77% of net product revenues. RF generators accounted for 9% and accessories and other revenues the remaining 14%.

International sales more than doubled from a year ago and accounted for approximately 13% of second quarter net product revenues compared to 7% for the second quarter of 2007 and compared to 12% sequentially. In Q2 2008, we sold into 40 different countries versus the comparable period in 2007 of 24 countries. The increase in international sales was seen in RF generator sales and even more in a catheter unit sales.

As forecasted, our average U.S. catheter pricing and average U.S. RF generator selling price decreased approximately 1% sequentially. The outlook for U.S. catheter pricing could be favorably impacted in the future by the pressing strategies of EBO companies we have executed licensing agreements with VNUS. We expect it may take several more quarters before we are able to guide most specifically on U.S. selling price trends.

We continue to track the rate at which our customers perform the closure procedure in the office versus the hospital. 67% of new customers added in the second quarter in the U.S. are performing the closure procedure in the office compared to 57% of new customers added in the first quarter.

U.S. customers performing the closure procedure in the office represented approximately 67% of the unit volume of catheters for the second quarter compared to 65% in the prior quarter.

Excluding upgrades, laser stuffs and trade-ins, we sold 120 RF generators worldwide in the second quarter of 2008, compared to 96 in the second quarter of 2007 and 95 sequentially. The significant increase in the second quarter compared to the prior quarter was mainly driven by a seasonality of the business.

We had 1,319 U.S. customers ordering catheter in the first half of 2008 compared to 1,081 in the first half of 2007, representing an increase of 22%. The size of our U.S. sales organization remained relatively constant throughout the quarter with 61 persons. For 2008, we are generating plans to modestly expand this U.S. sales force and have already added salespersons to our European direct sales organization where the business has grown so quickly.

We're pleased with the current level of sales efficiency which has risen to $1.75 million in annual product revenues per year U.S. sales rep. This increase in annual product sales per rep provides us an opportunity to enhance top line growth by expanding the U.S. sales force and still generate an increasingly more profitable business.

Gross margins for the second quarter were 76.9%, an increase of 16.6 percentage points from 60.3% for the second quarter of 2007, primarily due to the recognition of 10.4 million of royalty revenues recognized in 2008 and manufacturing efficiencies achieved since the introduction of ClosureFAST in the first half of 2007. Gross margins also increased 10.8 percentage points from 66.1% for the prior quarter, primarily due to the recognition of 10.4 million of royalty revenues recognized in 2008.

Second quarter operating expenses were $15 million, or 47% of net revenues compared with $13.4 million or 78% of net revenues year-over-year and with $13.9 million or 74% of net revenues sequentially. Second quarter operating expenses include $1 million of non-cash stock-based compensation compared with $0.5 million year-over-year and $0.7 million sequentially.

Sales and marketing expenses were $7.2 million, up 11% from a year ago, primarily due to higher sales commission expenses and travel and flat sequentially. Research and development expenses were $2.5 million, flat from a year ago and sequentially.

General and administrative expenses were $5.3 million, up 19% from a year ago, primarily due to non-cash stock-based compensation and up 25% sequentially, primarily due to non-cash stock-based compensation and patent litigation legal costs. Patent litigation and related Diomed due diligence legal expenses included in the current quarter was $1 million.

Operating income for the second quarter was $9.6 million or 30% of net revenues compared with an operating loss of $3.1 million or 18% of net revenues for the second quarter a year ago and with an operating loss of $1.4 million or 7% of net revenue sequentially. Interest and other income net was $0.3 million compared with $0.7 million year-over-year and with $0.9 million sequentially. The decrease is primarily attributable to a foreign dominated cash equipment balance transfer to the U.S. and overall declining yield on cash and cash equivalent investments.

It is important to note that the second quarter 2008 organic revenue increase of 29% referred to earlier in my remarks was achieved on approximately a 13% increase in total operating expenditures after adjusting for patent litigation, and related Diomed due diligence legal expenses demonstrating the strong leverage of our business model.

Net profit for the second quarter was $9.3 million or 29% of net revenues compared with a net loss of $2.3 million or 13% of net revenues a year earlier and a net loss of $0.4 million or 2% of net revenues sequentially.

Second quarter net profit per share was $0.56, based on 6.6 million fully diluted weighted average shares outstanding. This compares with a loss per share of $0.13 [ph] in the second quarter a year ago, based on 15.3 million weighted average shares outstanding and first quarter 2008 net loss per share of $0.03, based on 15.7 million weighted average shares outstanding.

Adjusted EBITDA for the second quarter of 2008 was earnings of $11 million as compared to a loss of $2.2 million in the comparable quarter of 2007 and a loss of $0.4 million in the first quarter of 2008.

On the balance sheet at June 30th 2008 we had cash and cash equivalents and short-term investments totaling $74.7 million, an increase of approximately $10.3 million from a year ago, primarily due to royalty income and an increase of $12.3 million sequentially primarily due to royalty revenue collected of $9.9 million and cash generated from improved business operations of $2.4 million. Accounts receivable days sales outstanding at the end of June were 46 compared with 51 days year-over-year and 50 days sequentially. We expect days sales outstanding will remain between 46 and 48 days for the third quarter 2008.

Inventories increased $1.5 million from a year ago and were relatively unchanged sequentially. Our inventory levels at the end of June represented approximately seven annual turns, which compares to approximately seven annual turns year-over-year and five annual turns sequentially. We expect inventory to remain constant in the third quarter and annual inventory turns to range from four to five for the quarter.

Now, I will provide a third quarter and updated full year 2008 business outlook, which takes into account the risk factors regarding the forward-looking statements factored at the beginning of this call. We currently estimate that our seasonal third quarter 2008 net product revenues will range from approximately $20.6 million to $21.2 million, translating to an organic growth of 180% to 21%. Royalty revenues will range from $1.1 million to $1.3 million.

Gross margin is expected to range from 68% to 69% in the third quarter. Third quarter operating expenses are expected to decrease by approximately $0.9 million from the second quarter of 2008. Third quarter net income is estimated to range from approximately $1 million to $2 million, or earnings of $0.06 to $0.12 per share. The number of weighted average shares outstanding used to calculate estimated earnings per share for the third quarter is expected to range from approximately 16.7 million to 17 million. We expect adjusted EBITDA for the third quarter to range from $2 million to $3 million. We currently estimate the full year 2008 net product revenues will range from approximately $84.5 million to $86 million. Royalty revenues will range from $12.8 million to $13 million.

Gross margin is expected to range from 70.5% to 70.7% for the full year. Operating expenses are expected to range from $56.7 million to $57 million. Including patent litigation of expenses of $1.5 million to $1.8 million. Full year net income is estimated to range from approximately $11.5 million to $12.4 million or earnings of $0.68 to $0.74 per share. The number of weighted average shares outstanding used to calculate estimated earnings per share is expected to range from approximately 16.7 million to 17 million. We expect adjusted EBITDA for the full year to range from $17 million to $18.1 million.

Now we'll open the call for your questions. Operator?

Question-and-Answer Session

 

Operator

(Operator instructions) Our next question comes from the line of Tom Gunderson with Piper Jaffray. Please go ahead.

Tom Gunderson – Piper Jaffray

Hi, guys, it's actually Amy Sullivan in for Tom.

Brian Farley

 

Hello, Amy.

Tom Gunderson – Piper Jaffray

One more detail question here and then more of a broader market question. What is your base estimate the market share was for Vascular Solutions and AngioDynamics combined?

Brian Farley

 

We don't have that information available. We really only computed our own – also subject to the settlement agreement are not liberty to discuss any specific numbers of the licensees so, I think that from the Vascular Solutions call, they articulate what their venous revenue volume was and there's probably some derivation that could be obtained from that, but we haven’t done that.

Tom Gunderson – Piper Jaffray

 

Okay. Then I guess just more from a market growth perspective, and I guess I'm thinking more from a strategic perspective, are you guys thinking at all how your approach, trying to get that, that market growth to increase, now that U.S. have kind of bit more from the broader..?

Brian Farley

It's something that regularly on our minds. We're – first of all, very pleased with the 38% growth in unit sales that we saw year-over-year because that is probably the best measure of overall number of procedures and patients getting treated since we're the market leader. We also have given instructions to our U.S. sales force that we want to make sure that they are including in their time management working with their – our installed base of customers, helping them, utilize the tools that have been created by our marketing organization, for helping to educate patients about the benefits of the procedure, helping to educate the referral position groups and we continue to broader things as well including very active PR campaign which this year has already yielded somewhere in the neighborhood of 40 new stories we run pilot television advertising in eight different cities in the U.S. this year, expanded Web site presence, we've added the recovery clinical trial that randomized trial that showed RF has sphered laser ablation into the communication process broadly through our Web site, but also in communications with customers and for them to also communicate to patients and to referral physician. So these are just some of the things, but this is very much in our mind to help keep the growth rate as healthy as it is now.

Tom Gunderson – Piper Jaffray

 

Okay. Thank you.

Brian Farley

Welcome.

Operator

Our next question comes from the line of Ben Andrew with William Blair & Co. Please go ahead.

Ben Andrew – William Blair & Co.

 

Good afternoon, guys.

Brian Farley

Hi, Ben.

Peter Osborne

Hi.

Ben Andrew – William Blair & Co.

 

Couple of quick questions. if you look at the – you talked about the unit placements only including the ones that you've sold, can you give us a sense of scale for how many have been placed on lease [ph] arrangements or other types of deal that don't show up in that number, just kind of leave this more towards the installed base?

Brian Farley

Yes, I will share with you. Just what we have done through the first half of this year which won't include what we did last year. We're not counting upgrades, because upgrades are really a replacement of one of our generator for another, we strictly look at the number of generators that we put out there under contracts of various kind we received laser console in exchange of the SWOP sometimes we get some funds with that as well. If you look at that you can add another 50 units this year in the United States, again the number is bigger than that cumulatively since we have been doing this starting about third quarter of last year. But it's a small number relative to the overall quantity of generators sold and I think assume that – and again, I don't know if this will continue in this round, but currently, somewhere in the neighborhood of about 80 to 85% of the generators that are placed out there are still sold in the traditional manner.

Ben Andrew – William Blair & Co.

 

Okay. And then I know the internationals been starting to ramp, can you give us a rough breakdown between the installed base as it mere the procedure numbers or is it meaningfully different than that?

Brian Farley

We actually run a different forecasting model that doesn't rely as extensively on the existing user-end installed base internationally. For the simple reasons that in the distributor markets which that 36 markets for us, we really don't have the objects on that quite as well as we'd like. Certainly, in the direct countries we have a better sensitive, but I can't unfortunately, Ben, quite take that for you, because we just haven't been tracking it in that kind of fashion like we do in the United States.

Ben Andrew – William Blair & Co.

 

Okay. And then you talked about increasing the size of the sales force, that's a new move I believe it's been some time since you've changed that. Can you give us a sense of the magnitude through the end of the year that you're targeting?

Brian Farley

We are still in the discussion phase amongst ourselves that how big of an increase it should be. It would be on the modest size and I'd rather not comment until we developed our own plan. But, let me explain a little bit of rationale and the timing on it. We continue to see the growth of the U.S. be good, we think we can help make it even better, given all the positive we have going forward with the clinical trial, the part performance and the reimbursement in 2009 being very solid. And so we want to – not that we have reached the level annual sales per rep that will sustain good profitability and even better profitability in the future, the time is now to add the staff in the U.S. sales team and that's why we're doing it now. As you can imagine when we quote 1.75 million in annual sales per revenue in the United States, just like with any situation that the average is going to be some territories that are substantially larger than that and that's a case, and of course, we look at opportunities to get more efficient and get the word out more thoroughly. Because anyway you cut it, we still see in any given territory likelihood that as good as our business is, there are more laser accounts in the given territory than they are RF accounts. So this is a tremendous opportunity for us when we can put more (inaudible) industry, recharge [ph] those accounts, as well as further make sure we are talking to the new entrance into the marketplace which we think we have been extraordinarily successful at winning those deals, but might enhance us even further if we can increase our bandwidth this way. But I'm sure we'll have more to say on the next earnings call about the actual size of planned increase in the U.S.

Ben Andrew – William Blair & Co.

 

Okay. And then maybe a couple of questions for Peter. Can you be a little bit more exclusive about the interest income expectations in terms of what sort of rates you're getting and does your guidance including some tax because you paid some this quarter and if so at what rate is we haven't baked that under our model historically?

Peter Osborne

So, our sort of weighted average yield is about 2.3% for our cash and cash investments portfolio going forward.

Ben Andrew – William Blair & Co.

 

Okay.

Peter Osborne

And the tax rate that we're using for risk this year is 5.4%.

Ben Andrew – William Blair & Co.

 

Okay. And is there an expectation for next year in terms of what you'll actually report on the P&L?

Peter Osborne

Help me on the tax rate.

Brian Farley

On the tax rate or…

Ben Andrew – William Blair & Co.

 

As we used the tax effective number, but I'd like to kind of understand what is going to be in your GAAP numbers?

Peter Osborne

So next year in 2009, I think from what we currently understand of our expectations of company's performance and the position of our NOLs I think we would suggest that the investment community can't use 10% right now from next year.

Ben Andrew – William Blair & Co.

 

Okay. Great. That maybe causing some confusion relative to the EBITDA versus the GAAP numbers that it will had., so, thank you very much.

Peter Osborne

You're welcome.

Operator

Our next question comes from the line of David DeGiralamo with Pacific Growth Equities. Please go ahead.

David DeGiralamo – Pacific Growth Equities

 

Thank you. That was a tremendous job of pronouncing my name correctly, that's terrific. Just a few quick questions for you, guys. First of all, congratulations on yet another strong quarter. You mentioned, Brian, market share estimates –I think you said on a sale basis, you thought you're 59%, is that right?

Brian Farley

That's correct – in the U.S., yes.

David DeGiralamo – Pacific Growth Equities

How about on a procedural basis?

Brian Farley

That roughly translates into around 40% to 42% procedure market share.

David DeGiralamo – Pacific Growth Equities

Did you say 40% to 42%?

Brian Farley

 

Yes.

David DeGiralamo – Pacific Growth Equities

Okay. What was it first quarter?

Brian Farley

 

We actually don't have that information. The last time we had reasonably good information was Q3 of last year in which we had 56% – an estimate of 56% market share in dollars. With the subsequent non-reporting by Diomed due to their situation, and the fact that we don't have all the breakdowns by quarter basis, from the other parties either we really only once again this quarter we are able to gather up and updated they start reporting this with some reasonable accuracy that we thought comfortable with. So, sorry for the lack of that, but I would guess that it was a pretty linear increase from Q3 of last year to the 59% up from the 56% in dollars. In procedure share, you can pretty much do the (inaudible) on this for every one percentage point of procedure share that we gain in the neighborhood of about 1.5% just less than 1.5% of dollar market share because of pricing.

David DeGiralamo – Pacific Growth Equities

 

Okay. Now turning to the generators that you sold, you sold 120s it's impressive this quarter, and I think you said 95 in 1Q that's over 200 generators sold, can you give us a for who is buying them not names of course, but just the type of specialties and whether or not you're seeing any changes in the dynamics of your new customer base?

Brian Farley

 

Sure. I think there is some dynamics that have shifted. Mostly what we're seeing is that the vascular surgeon community has been reasonably well penetrated, so that when we sell a generator and if it's to a vascular surgeon it very well may be to somebody who is previously a laser user. But when we look at the specialties that are more newly sort of driving the sales, general surgeons are in there, interventionalists, like interventional cardiologists are growing as a specialty and I'm just actually looking at our data as we go forward. And we basically have a catch-all category of other which went from 8% to 10% four customer installed base from Q1 to Q2. So this is essentially an indication that vein ablation is moved – it's already been very multispecialty, but even moving maybe a little more broadly so into that direction.

David DeGiralamo – Pacific Growth Equities

 

That's great. And one more question then I will jump back in queue and give the operator a chance to pronounce it a second time. International, you said, 13% of overall revenues, came from the international side of the fence, what would it have been if you normalize the currency? And then kind of part (b) is what is the reasonable expectation, maybe not for 2009, but just going forward for international as a percentage of overall revenues?

Peter Osborne

Our revenues through the distribution generally is denominated in U.S. dollars, so those international revenues not – there is only a small proportion actually exposed to foreign currency translation gains and losses. So we have done this exercise and it's on a normalized basis. It's a percent or so. It's not meaningful at all.

David DeGiralamo – Pacific Growth Equities

 

Got it. And in terms of what a reasonable expectation is then going forward? It sounds like 13% as a pretty real number for where the things are right now. I think it was 11% in 1Q and it's gone up fairly steadily. What's the reasonable expectations over the long run?

Brian Farley

I think in 2009 if that's a long run, it could be 15% or maybe higher in 2009.

David DeGiralamo – Pacific Growth Equities

 

Got it. Okay, that’s great. Thanks guys.

Brian Farley

 

Thanks.

Operator

(Operator instructions) Our next question comes from the line of Matt Dolan with Roth Capital Partners. Please go ahead.

Matt Dolan – Roth Capital Partners

 

Hi, Brian, hi, Peter.

Brian Farley

 

Hi, Matt.

Peter Osborne

Hi.

Matt Dolan – Roth Capital Partners

 

Couple questions. first on the product revenue guidance for the rest of the year, if I look at – if I strip out deferred from last year in the comparable period it looks like you grew over 30% in the first half of the year, it looks like the guidance implies high teens growth rate in the second half of the year, can you walk us through some of the assumptions there that, that somewhat of a conservative number how should we look at that number relative to those growth rate?

Brian Farley

I think your algebra is correct. And the growth rate assumptions are smaller in the second half of the year on a year-over-year comparison, again, because the comps become more substantially challenging is – I'm sure you recall we had a terrific second half of 2007 and enormously successful Q4 of 2007, so, it's just half of a much more substantial basis success from last year that we are projecting this growth. Nevertheless, it's showing very good organic growth, unit growth and – yes, there's always some upside, but we're providing the guidance really in the same-store that we always have, I should say that we have certainly in the last year or so, in that we really fully expect that this is a good way to look at our business for the second half of the year and for the 2008 year in total, I don't want to characterize it as either overly conservative nor optimistic I think it's really right word should be.

Matt Dolan – Roth Capital Partners

 

Okay, great. And then on the royalty relative to AngioDynamics and now their bid on the Diomed assets, what are you assuming from that segment of the market in terms of their ability to repaying those accounts and their forepayer royalty on those laser customers?

Brian Farley

We have no detailed optics on their ability to retain those accounts. I think so much that depend on the level of attention they give to those accounts. Furthermore, by specific acts that we really won't know about for some time for example, if they raise price in conjunction with having to pay a royalty, if they make a very strong conservative effort to convert customers to their never touch, non-contact fiber, this is no way to know exactly how that might be received, so we just can't project how they're going to look. But, I don't see much downside for us. I think implies in your question was is there some downside if some of that business is lost to AngioDynamics, and my view of it is there is first of all not much downside I think AngioDynamics knows how to run their business. Secondly, any time a Diomed customer is putting to play we are one of those players that could step in as well. So, if there was some attrition on the Diomed customer base, the expectation was that we pick up some of that business and of course getting the product revenues and product margins from one laser customer that we pick up is worth – five to ten royalty paying customers. So it's an easy catch-up.

Matt Dolan – Roth Capital Partners

 

Okay. Great. And then finally, looking at to '09 I think at a recent investor conference you gave some kind of general ideas and the margins you might be targeting for the year, which came in, I think it about 14.5% on the net margin, is that still a decent number to go off here relative to Peter's comments around tax. And also, does that assume the sales force expansion that were basically hearing for the first time here today?

Brian Farley

It does. Yes. And so just to quip that out in a little more clarity, we are thinking that with the continuing growth of our business in conjunction with the U.S. sales force, expansion and continue good growth in international that we should be able to see with accounting royalties gross margins at approximate 70%, operating expenses of around 56% which produces an operating income of about 14% and net income of about 14.5% as you indicated. This is preliminary from the standpoint of – it's an operating model guidance that we discuss rather than raw numbers because we do feel it's important to get another quarter or two under our belt of the royalty experience and also frankly, the question I guess earlier about what's going to happen with the royalty paying companies and their customer base is something that won't be completely clear for also another quarter or two, because although there has been discussion in the marketplace, it's not clear how much discussion about price changes are really going to play out. And until that's known, there has been going to be some uncertainty in just how that impacts our business. Nevertheless, this is a good model to consider for what our business can grow to. And of course, the other way to think about is with the 2009 operating income level of 14% as per the full year internationally a stronger in the second half of the year and especially in the fourth quarter.

Matt Dolan – Roth Capital Partners

 

Great. Okay. I will let somebody else in. Thanks.

Operator

Our next question comes from the line of Tom Zeifang with Lucrum Capital. Please go ahead.

Tom Zeifang – Lucrum Capital

Hey, guys. I am little slow this afternoon. Can you reconcile net income and EBITDA for '08? I can't come up with a number for this.

Peter Osborne

It's Peter. So talk about operating income as opposed to net income and basically the operating income had back stock-based compensation non-cash stock-based compensation, and depreciation.

Tom Zeifang – Lucrum Capital

What's your ESO for '08? Employee Stock Option Expense.

Peter Osborne

 

If you look at the last page of our press release, it's $1 million.

Tom Zeifang – Lucrum Capital

 

For the full year of ’08?

Peter Osborne

 

That was for the three months and the full year…

Tom Zeifang – Lucrum Capital

 

What do we expect for the full year?

Brian Farley

We will see if we can pull that out in a moment here.

Tom Zeifang – Lucrum Capital

 

It seems to me like the delta between EBITDA and net income is materially larger than I would expect and even in back understanding interest rates have come down, it seems like I'm missing something. If I use 5% tax rate in the back half, and I think it's ESO that I have wrong.

Peter Osborne

Our expectation for stock-based compensation for the whole year is $3.6 million.

Tom Zeifang – Lucrum Capital

 

$3.6 million. Okay.

Peter Osborne

 

Welcome.

Brian Farley

Does that reconcile your number? Okay.

Operator

Thank you. (Operator instructions) Our next question is a follow-up question from the line of Matt Dolan with Roth Capital Partners. Please go ahead.

Matt Dolan – Roth Capital Partners

Hey, guys, just one more on the guidance, maybe Peter can you help, done this down a little bit the full year guidance we are juggling a couple of reports here, but relative to what you provided back in February, it looks like you're bumping up the low end of your product revenue guidance, looks like gross margin on a product basis continue to be healthy, but now that we have the payment you paid to evaluate the Diomed asset, the royalty settlement in those variables and there can you give us maybe just a general directional look at what you're doing with your operating leverage and the guidance around operating expenses specifically?

Peter Osborne

The level of efforts that we bring, discussions with some of the other parties that we're talking to about their interest in licensing our intellectual property is the wildcard here that we're trying to manage as effectively as possible. And as Brian outlined at the beginning of the call, we would be not fair or prudent for us put much specificity around that, but outside of that caveat, we continue to expect to see very nice leverage so from our operating expenses as our revenues growth. As you notice we had a 13% increase in our revenues, but in our operating expenses for the quarter that supported the 29% growth in revenue. So that's 4 to 5 to 1 sort of leverage there.

Matt Dolan – Roth Capital Partners

 

Okay, great. Thanks, guys.

Operator

Thank you. (Operator instructions) And there are no further questions. I would like to turn the call back over to Brian Farley for closing remarks.

Brian Farley

Thank you. In summary, we are very pleased with our second quarter results and our recent successes in defending our intellectual property, have been so successful. As we go forward, we now have one last competitor, we have a royalty stream, that helps our profitability and our operating model, we have solid U.S. reimbursement heading into 2009 and just the beginning of communication of our compelling clinical data and product performance from the recovery trial and we have strong adoption of our product internationally. These together make us more positive than ever about the near and long-term prospects for our business. This concludes VNUS's teleconference on second quarter 2008 results. We look forward to speaking with you again when we report our third quarter 2008 results. Thanks again for joining us today.

 

Operator

Ladies and gentlemen, that does conclude our VNUS Medical Technologies second quarter 2008 teleconference. Thank you for your participation and you may now disconnect your lines.

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