ev3 Inc. Q2 2008 Earnings Call Transcript

| About: ev3, Inc. (EVVV)

ev3 Inc. (EVVV) Q2 2008 Earnings Call July 29, 2008 8:30 AM ET

Executives

Julie Tracy - Senior Vice President and Chief Communications Officer

Bob Palmisano - President and Chief Executive Officer

Pat Spangler - Chief Financial Officer

Analysts

Ryan Chu - Morgan Stanley

Joshua Zable - Natixis

Chris Pasquale - Analyst

Jason Mills - Canaccord Adams

Tom Gunderson - Piper Jaffray

Charles Chon - Goldman Sachs

Peter Bye - Jefferies & Company

David DeGiralamo - Pacific Growth Equities

Charlie Jones - Barrington Research

Operator

Good day ladies and gentlemen. Welcome to the Second Quarter ev3 Inc. Earnings Conference Call. My name is Lacey and I will be your coordinator for today. At this time all participants are in a listen-only mode. We will be facilitating a question-and-answer session towards the end of this conference. (Operator Instructions). As a reminder this conference is being recorded for replay purposes.

I would now like to turn the presentation over to your host for today’s call Ms. Julie Tracy. Please proceed.

Julie Tracy - Senior Vice President and Chief Communications Officer

Thank you and good morning everyone. Welcome to ev3 second quarter 2008 conference call. We appreciate you joining us. I’m Julie Tracy, ev3’s Chief Communications Officer. With me on the call today are Bob Palmisano, ev3’s President and Chief Executive Officer and Pat Spangler, ev3’s Chief Financial Officer.

We issued a press release yesterday late afternoon regarding our second quarter 2008 results and updated 2008 guidance. A copy of that press release is available on our website at www.ev3.net along with an investor presentation summarizing our second quarter results.

The agenda for this call will include a business update from Bob, a review of our second quarter financial results from Pat, and closing comments from Bob, followed by a question-and-answer session.

Before we begin, I’d like to remind you that during the course of this conference call, we will make forward-looking statements that involve risks and uncertainties relating to future financial and business performance.

The forward-looking statements we will make on this call are covered under the Safe Harbor Provisions of the Private Securities Litigation Reform Act of 1995 and ev3 desires to avail itself for the protections of the Safe Harbor for these forward-looking statements.

Forward-looking statements that will be made on this call include statements regarding ev3’s future financial and operating results, new product benefits and market acceptance, future potential market sizes and annual growth, ev3’s plans, objectives, expectations and intentions with respect to future operations, products and services and other statements that are not historical facts.

Please be advised that actual results could differ materially from those stated or implied by our forward-looking statements due to certain risks and uncertainties, including those described in our annual report on Form 10-K for the year ended December 31, 2007 and in our quarterly report on Form 10-Q for the quarter ended March 30, 2008.

We suggest that you read these reports and other future filings that we may make with the Securities and Exchange Commission. ev3 disclaims any duty to update or revise our forward-looking statements as a result of new information, future events or developments or otherwise.

And, with that, I will now turn the call over to Bob for business update. Bob?

Bob Palmisano - President and Chief Executive Officer

Thanks, Julie and welcome to everyone that has joined our call today. Yesterday we reported net sales for the second quarter of $107.7 million. I’m pleased that all important financial metrics are on a strong positive trend. Total net sales increased 6% from the first quarter of 2008, adjusted net loss per share excluding Merck asset impairment charge was $0.05 per share which $0.01 to $0.04 better than the high end of our guidance. In addition we made good progress on the balance sheet with day sales outstanding decreasing by eight days and inventory days on hand decreasing 8% versus Q1 ‘08.

Our legacy ev3 peripheral vascular and neurovascular product revenue, which excludes Atherectomy and research collaboration, increased 6% to $76.6 million in the second quarter versus the first quarter 2008. Total peripheral vascular revenue was up 10% in Q2 ‘08 versus Q1 ‘08. Total neurovascular revenue of $30.7 million in the second quarter was basically flat versus Q1 ‘08. However, Embolic product sales recorded another robust increase of 36% versus the prior year quarter.

US sales increased 8% to $71.9 million in Q2 ‘08 versus $66.5 million in Q1 ‘08 and international sales of $35.8 million were up 3% from $34.8 million in Q1 of ‘08. I’m pleased to say that this performance exceeded the high end of our expectations as outlined in our last earnings call and reflects the increased productivity we are seeing from a US peripheral vascular sales organization and continued expansion in our neurovascular and international businesses. We were also encouraged to see a double-digit sequential quarter increase in our Atherectomy business and believe that our ongoing efforts to generate awareness in the referring physician community of the clinical benefits of our Atherectomy products will be an important factor in expanding the role of those products in the treatment of peripheral artery disease in the US.

We are particularly pleased by the growing interest in Atherectomy shown by endovascular specialist outside the US providing us another avenue for growth. We reported a net loss for the quarter of $27.4 million or $0.26 per share compared to a $11.9 million or $0.20 per share for Q2 ‘07, reflecting the impact of the consolidation of our Redwood City manufacturing operations into our Irvine and Plymouth facilities, our recent CEO transition, and an asset impairment charge of $10.5 million as a result of the termination of our collaboration and license agreement with Merck. ev3’s earnings before, interest, taxes, depreciation, amortization, or EBITDA, excluding charges for non-cash, stock-based compensation, and Merck research collaboration asset impairment was negative $1.6 million in the second quarter of 2008, compared to negative $3.5 million in the second quarter of 2007.

As I stated in our last call achieving sustained profitability remains a top priority for our company. We see substantial leverage potential in our business and continued to expect to see increasing benefits in the quarters ahead. We’re targeting positive EBITDA excluding charges for non-cash, stock-based compensation, and Merck research collaboration asset impairment for the year and GAAP profitability in the fourth quarter of this year.

Before I turn to our neurovascular, peripheral vascular business updates, I want to provide some comments regarding the termination of our collaboration and licensing agreement with Merck that we reported yesterday that we previously disclosed in February, the resignation of Dr. John Simpson from the ev3 Board triggered the right of Merck to terminate or modify the agreement at anytime within the next months.

We have actively engaged with Merck for the past several months and had fully expected to renegotiate the terms of the agreement. Although Merck’s decision to terminate was unexpected, our research collaboration then was not a vital strategic program for the company. It is also important to note that the profit that we expected to realize for the Merck for the remainder of 2008 and 2009 was roughly $1 million per quarter, a $0.01 per share, taking into account the expenses and amortization cost associated with this research collaboration. Despite the termination of the Merck agreement, we are maintaining our full year 2008 guidance both revenue and EPS based on the very strong performance of our business, and our expectations for the remainder of the year.

Turning now to our global neurovascular performance, we have continued to advance our global launch activities for Axium coil. In the second quarter of ‘08, we saw an approximate 54% increase in the number of use accounts ordering Axium coils as compared to first quarter of ‘08, and an 85% increase in the number US accounts reordering Axium coils as compared to the fourth quarter of ‘07. We have also continued to see positive momentum and strong market acceptance in our international Axium launch, particularly in Korea, Australia and throughout Europe.

Given this encouraging progress, we expect the Axium coil to be the primary growth agent for our neurovascular business segment in 2008. At the recent link course in Paris, which is one of the largest interventional neuro courses, we had the opportunity to feature our new solitaire stent platform for aneurism bridging in a live-case demonstration. This case demonstrated the solitaire’s ability to navigate a complex lesion and facilitate secure coil placement, as well as its unique ability to fully be retrieved. We will be also investigating the use of solitaire stent platform to immediately restore flow and assist the removal clot burden in ischemic stroke patients and plan a US IDE study to investigate this application in the future.

And finally, as you saw in our press release, I am delighted to announce that Pascal Girin has been promoted to the new position Executive Vice President and President of our Worldwide Neurovascular and International. Pascal’s contributions as our President of International have been exceptional and his assumption of this role is a natural consequence of the outstanding operational leadership that he has provided since joining ev3. During his tenure our international business expanded to over 60 countries through a direct sales organization and distribution network, and international sales increased from $30 million in 2003 to $107 million in 2007. Under Pascal’s capable leadership, we will continue to focus on expanding our number 2 overall revenue position, in neurovascular and I look forward to Pascal’s continued future contributions in his new role.

Now, I’d like to provide additional detail on our peripheral vascular business. We believe that our focus on improving productivity of our US sales peripheral neurovascular sales force, through more effective cross selling and market development program, is having a positive effect on our business performance. This view is supported by the recent sales productivity data showing that our average daily US sales in the second quarter were up sequentially versus first quarter, and annualized US sales peripheral net sales per territory increased to approximately $1.5 million per territory in Q2 ‘08 compared to $1.4 million in Q1 ‘08 and $1.3 million in Q4 ‘07. In addition, we have continued to see gains from our Novation agreement. With sales of US peripheral products in Novation accounts outpacing sales and non-Novation accounts by 50% during the second quarter of ‘08.

During the second quarter we attended the Euro PCR meeting in Barcelona and the Society for Vascular Surgery meeting in San Diego. These two premiere meetings provided us an opportunity to showcase the breadth of our peripheral vascular portfolio and to educate endovascular specialists through live case demonstration. At the Euro PCR meeting, ev3 organized a critical limb ischemia symposium that was attended by approximately 300 physicians. This symposium featured a live SilverHawk case and the treatment of long, superficial femoral artery using 200mm EverFlex stent. Positive clinic data for our SilverHawk plaque system continues to develop and was also highlighted at the Euro PCR meeting as Dr. Jim McKinsey from New York Presbyterian Hospital presented favorable results of his SilverHawk Atherectomy case series which now includes 579 consecutive lesions treated from March 2004 to October 2007. He concluded that percutaneous excisional Atherectomy is associated with a low periprocedural complication rate, an 18 month secondary patency of nearly 80% claudicants and critical limb ischemia patients and long-term limb salvage of greater than 80% in limb threatened patients.

The launch of our SilverHawk plaque excision system with MEC TEC, micro efficient compression technology, has proven to be a valuable product enhancement for our SilverHawk product family and has been very well received by our customers particularly with regard to procedural time savings.

Based on our recent observational data collected from US physicians, we are using our SilverHawk MEC TEC devices, many report that number of insertion procedures have been down as much as 50% SilverHawk MEC TEC device.

Moving on to our product development clinical programs, we’re pleased to report that in the second quarter we received FDA approval for our ID application to study the RockHawk plaque excision system in combination with the spider FX embolic protection device. Results from this study, which we expect to initiate later this year will be used to support an FDA submission to gain approval for the RockHawk and spider FX device in endovascular use. We believe that the RockHawk system, which is currently cleared for surgical use in the US, provides a new option to treat complex calcified lesions in the peripheral vascular system.

We implanted the first EverFlex 200mm stent as part of our US durability to ID study, representing the first time a stent over 150mm has been implanted clinically in the US. I am also pleased to report that we received approval to market our EverFlex self-expanding stent system in China. Our customers continue to value the configuration of fatigue resistance of the EverFlex stent, which is specifically designed for the unique anatomical needs of the superficial femoral artery, and to reduce the need to place multiple stents in long lesions. As we previously reported our distribution agreement with our current balloon supplier, Invatec, expires at the end of December. We have been working hard at our own balloon development program and believe that we will be able to provide enhanced product solution with better margins to our current Invatec product.

During the second quarter we initiated a physician preference test for our EverCross peripheral angioplasty balloons at several European centers. The EverCross is ev3’s first internally developed and manufactured line of 035 balloons designed for use in peripheral angioplasty procedures. Initial European physician response to the EverCross has been very favorable, with several physicians commenting on its smooth deployment, track and ability to cross tight lesions. We expect to launch both EverCross and NanoCross, our 014 PTA balloons, globally in the first quarter of 2009.

With that business update I would like now to turn the call over to Pat Spangler for discussion of our second quarter financial guidance and results. Pat?

Pat Spangler - Chief Financial Officer

Thanks Bob and good morning everyone. I would like to begin by covering consolidated second quarter net sales results. Consolidated sales increased 65% to $107.7 million in the second quarter of 2008 compared to $65.4 million for the second quarter of 2007. second quarter sales included $24.9 million of Atherectomy product sales and $6.2 million of research collaboration revenue. This net sales growth was driven by consistent growth across several major product groups, including the pre-FoxHollow acquisition, peripheral vascular business segment and neurovascular business segment.

On a geographic basis, US and international second quarter 2008 net sales increased 82% and 39% respectively over the second quarter of 2007. In US our sales increased to $71.8 million in Q2 of ‘08 compared with $39.6 million in Q2 of ‘07 and this sales growth was driven mainly by our acquisition of FoxHollow.

Our international sales grew to $35.9 in Q2 of ‘08 up from $25.8 million in Q2 of ‘07 and this growth is primarily due to our Q4 ‘07 launch of our Axium coil and the continued market penetration of the EverFlex family of stents. Changes in foreign currency exchange rates had a positive impact of approximately $3.4 million on second quarter 2008 net sales compared to Q2 of ‘07.

On a business segment basis net sales of peripheral vascular products increased 74% to $70.8 million for Q2 of ‘08 compared with $40.6 million in Q2 of ‘07. Second quarter net sales includes $24.9 million of FoxHollow products. Stent sales increased 22% to $27.1 million in Q2 of ‘08 compared to $22.2 million in Q2 of ‘07, primarily due to the increased market penetration of EverFlex family of stents.

Atherectomy and embolic protection sales declined in Q2 of ‘08 to $7.1 million compared to $8.4 million in Q2 of ‘07. Q2 of ‘07 included a $1.6 million stocking order of our Spider Embolic protection device to Volcano. Procedural support in other net sales increased to $11.7 million up 16% from Q2 of ‘07. In the neurovascular business segment net sales of neurovascular products increased 24% to $30.7 million for Q2 of ‘08 up from $24.8 million in Q2 of ‘07. Within the neurovascular segment embolic product sales increased 36% to $17.4 million compared to $12.8 million in Q2 of ‘07 driven by the Q4 of ‘07 launch of Axium coil in the continued market penetration of the Onyx liquid embolic for the treatment of arterial venous formations of the brain, or AVM.

Sales of neuro access and delivery products increased to 11% to $13.3 million in Q2 of ‘08 compared to a $11.9 million in Q2 of ‘07 and strong sales of catheters and neuroballoons. Research and collaboration revenue resulting from our former agreement with Merck and Company was $6.2 million for the second quarter of 2008.

In Q2 of ‘08 we achieved an overall consolidated gross margin of 66.4% excluding research collaboration of product gross margin with 66.2% when comparing Q2 of ‘08 to Q2 of ‘07 product gross margin increased by a fourth-tenth of a percentage point. This slight increase in product gross margin was primarily due to manufacturing efficiencies and increased volume offset by additional access and obsolete inventory reserves related to our planned product transitions to next generation devices and cost associated with the consolidation of our Redwood City manufacturing operations into Irvine and Plymouth facility.

On a sequential quarter basis product gross margin decreased by two-tenth of a percentage point. Operating expenses in the second quarter of ‘08 increased in absolute dollars when compared to the second quarter of ‘07 primarily as a result of our acquisition of FoxHollow. However, SG&A expenses as a percentage of net sales declined by 2 percentage points to 61% of sales in Q2 of ‘08 as compared with 63% of sales in Q2 of ‘07 as a result of cost synergies implemented in Q4 of ‘07.

Amortization and intangibles increased approximately $4.1 million to 7% of net sales in Q2 of ‘08 compared of 6% of net sales in Q2 of ‘07 and is primarily due to the additional intangible assets reported as a result of our acquisition of FoxHollow. Our research and development expenses increased to Q2 of ‘08 in absolute dollar terms but as a percentage of net sales R&D expenses declined to 13% of sales in second quarter of ‘08 compared to 17% in the second quarter of ‘07.

ev3’s net loss for the second quarter of 2008 increased to $27.4 million or $0.26 per common share compared to a net loss of $11.9 million or $0.20 per common share for the second quarter of 2007. Our Q2 results were negatively impacted by the consolidation of our Redwood City manufacturing operations into our Irvine and Plymouth facilities, our recent CEO transition, and an impairment charge of $10.5 million related to the termination of our agreement with Merck.

Our second quarter 2008 EBITDA, excluding charges was up $3.9 million for non-cash stock-based compensation in the Merck research collaboration after the impairment charge of $10.5 million with a negative $1.6 million compared to a negative $3.5 million in Q2 of ‘07. Our reconciliation of EBITDA as adjusted, please see our press release issued yesterday. This reconciliation is also available on our website at www.ev3.net.

Moving now to the balance sheet, our cash balance at June 30, 2008 was $38.7 million. Our cash balance decreased during the second quarter of 2008, largely as a result of the payments related to the coil litigation settlements of approximately $15.1 million and the payment of approximately $7.5 million related to the Dendron earn out contingency. However, we saw increases in our cash balance as a result of improvements in working capital, through a reduction of both our days sales outstanding and our inventory days on hand. On June 24, 2008 we extended and modified our existing on-ground credit facility agreement with Silicon Valley Bank.

Under the amended facility, our revolving line of credit was increased from $30 million to $50 million, and the maturity date was extended until June 25, 2010. In addition, amounts outstanding under our equipment financing line, we refinanced and consolidated into a $10 million non-formula term loan with a maturity date of June 23, 2010. We believe that this credit facility, along with our existing cash and short term investment, will provide sufficient liquidity and financial flexibility to meet our anticipated operating and strategic needs for the foreseeable future. Let me now turn to the financial targets for the full year and third quarter.

Although our agreement with Merck has been terminated, we continue to expect our full year 2008 net sales to be in the range of $425 million to $430 million, consisting of $408 million to $413 million of product sales and $16.5 million of research collaboration revenue. For the third quarter of 2008, we expect net sales to be in range of $104 million to $106 million consisting of $100 million to $202 million of product net sales and $4.1 million of research collaboration revenue. We continue to expect international sales to grow approximately 30% to at least $140 million in 2008 when compared to 2007. We continue to expect our full year 2008 adjusted earnings per share to be in the range of $0 to $0.05 per diluted share based on approximately $104 million shares outstanding. Adjusted EPS does not include pre-tax charges for amortization expense of approximately $30 million, non-cash stock based compensation of approximately $15.5 million and the $10.5 million work research collaboration asset impairment charge.

For Q3 of 2008 we expect adjusted net loss per share to be in the range of a negative $0.02 to positive $0.01 per diluted share based on approximately $104 million of outstanding shares. On a quarterly basis, adjusted net loss per share does not include pre-tax charges for amortization expense of approximately $7 million and non-cash stock based compensation of approximately $3.4 million.

With that, I would like to turn the call back over to Bob, for his closing comments.

Bob Palmisano - President and Chief Executive Officer

Thanks, Pat. For the second half of 2008 we are focused on continuing the financial progress made in Q2 and being a profitable company by the end of the year. Given the encouraging progress that we made in the second quarter, I remain confident on our ability to continue to improve our sales execution and operational efficiency to deliver outstanding products to our customers, capitalize on the market opportunities in front of us and to build a leading global and endovascular business.

Finally, I want to thank the entire ev3 worldwide team for their efforts for delivering a strong second quarter for the company. As we head into the second half of the year, we will continue to stay focused on building a great sustainable company that serves our customers and employees and for its values for our shareholders.

With that I would like to thank you for listening today and for your interest in ev3. I look forward to reporting on our progress throughout the year. Operator, I would now like to open up the lines for questions.

Question-and-Answer Session

Operator

(Operator Instructions). And our first question will come from the line of David Lewis with Morgan Stanley. Please proceed.

Ryan Chu

Good morning. It’s Ryan Chu in for David Lewis, thanks for taking my questions. My question is given the evidence of some revenue stabilization in the quarter, you believe you now have the appropriate operating structure in place and in addition to that does the loss of the Merck contract change your thinking on operating or R&D spending, given perhaps additional flexibility to revise some of the projects that you had originally postponed?

Bob Palmisano

Regarding the organization yeah, we just made a significant change in our neuro business that we announced last week, where we went through a worldwide business regarding the rest of the business, the peripheral vascular business, that is evolving project with in the ev3 there are it’s a I think that there is a room for to have some change of that as we go floor to better reflects the needs of the business but were still in the process of an execution mode rather than changing strategies there but stay tuned you may see some changes there in the future.

Ryan Chu

So you can’t really, sorry go ahead…

Bob Palmisano

Go ahead, Ryan.

Ryan Chu

Sure. Are there any metrics you can give us for how we should think of modeling that R&D reduction going forward or…?

Bob Palmisano

I think that we are maintaining about 30% of revenue rate on R&D, we have a lot -- one of the big needs that we have in the company one of our bundled few if you want to call it that way has to do a lot of gathering really good clinical data that is part of the R&D budget. And we have a lot of projects underway that way, we also have a lot of other projects in both the in both the neuro and peripheral vascular business. So, I would think that -- I would look for us to be maintaining about a 30% of revenue run rates in terms of R&D spending throughout the next couple of years.

Ryan Chu

Okay, that’s helpful. Second question as to but though US mix if we take FoxHollow sales or legacy FoxHollow sales away from sales in this quarter, it seems that US growth was just above flat and it seems like it was flat last quarter as well. It looks like the OUS growth continues to be pretty strong, how sustainable is that as most of the growth in the US from Axium launch and EverFlex, I think as Pat mentioned, and can the US return to growth in your mind?

Bob Palmisano

I think that the Atherectomy business grew about 10% in Q2 versus Q1 and that’s primarily US. So, I think that both markets are growing. I think that the US market is growing as Atherectomy procedures are increasing and the OUS business is also growing versus certainly ‘07, primarily due to the neuro business. But I also say is that the neuron business quarter Q2 to Q1 we said was flat, but it was still up significantly versus ‘07, I think about 35% or so, So I think that there is good growth potential in both market. The neuro business, if you look at how the sales flowed excuse me, is that there was some significant distributor sales at the end of Q1 that kind of in spite Q1 a little bit that didn’t repeat themselves in Q2, But that is just kind of the normal, that is adjusting to kind of a let the business slow kind of mentality rather then trying to squeeze things into quarters. So, I think both businesses are pretty strong.

Ryan Chu

Okay and do you have, maybe Pat has this the DSO from this quarter and last quarter as the change.

Pat Spangler

Yeah, DSOs from this quarter was 62 and from the prior quarter I believe there were 71.

Ryan Chu

Okay, alright. This is my last question on SilverHawk. Maybe you could give us an updates how many weeks of inventories in the channel and may be after this more experience you had with the competition in the market, how your perspectives on above the knee and below the knee competition are now and if would expect both the knee to get more competitive?

Bob Palmisano

Well, I think what we see we see the Silver Hawk inventory that we started the year with decreasing, and we still see some of it in the moderators smaller, smaller accounts most of these were through that issue and most of the larger accounts and as a result of that we’ve seen some nice growth in the SuperHawk business in Q2, what’s the second part of your question Ryan, I forgot.

Ryan Chu

Just with the kind of competition in the market below the knee I wonder if you see any more competition expecting on the horizon above the knee?

Bob Palmisano

Yes. Well, I think that we see where Pathway was recently cleared it may announce that there are in the process of building a sales organization, we see them in the markets certainly some times third, fourth quarter probably more like fourth quarter. That will have some effect on us as doctors always like to try new products, however we’ve already kind of the best job we could do in terms of factoring added to our guidance and have plans in effect that would hopefully grow our market share even in lieu of the additional competitors such as Pathway getting in the market.

Ryan Chu

Okay, great thanks for answering the questions.

Operator

And our next question will come from the line of Joshua Zable with Natixis. Please proceed.

Joshua Zable

Hi, thanks very much for taking my questions and congrats on the great quarter here everyone.

Bob Palmisano

Thanks Joshua.

Joshua Zable

Just a couple of quick ones just relates to the Merck deal obviously went through, I noticed some language they were saying there is potential to renegotiate. Can you just give us just a little bit more color as far as what’s going on there exactly because I know you said you were surprised obviously that happened. Then there was language about renegotiating and then regardless of that, is there going to look to sort through this with other partners or kind of move on and deal with, with other things?

Bob Palmisano

I wouldn’t say I was surprised. What the way this played out it was unexpected. I do not see this being renegotiated, in any way shape or form with Merck I think this is something in our past and we should look it at that way. There is the potential to provided Merck doesn’t step back in and in any way shape of form to offer this kind of collaboration of the partners. I would also say, with everything on our play this is not strategic to us, and that it doesn’t produce a lot of income, as I said in the tax this is about a million dollars of quarter, when you net it down it’s a 50%, its about a $6.2 million of revenue about 50% margin, you throw in expenses of amortization you get down to about million a quarter or penny a share. Now that’s not insignificant that’s money and we would like to have it but on other hand is what effort that we have to put forth to maintain that or to grow that. So, we may throw out some fields to see if someone else would be interested in it but this will not be a full hard court press for us to revive this.

Joshua Zable

Great, that’s very clear. Thanks very much. And then just getting back to Atherectomy here. I know you’ve talked about through gathering data and I know you mentioned some pretty good data in your comments but you talked about potentially doing through the trial of, moreover formal trial here in the US that relates to SilverHawk. Is there any, can you give us any update, sir or any commentary on that?

Bob Palmisano

Well, yes. The company and the management team is identified clinical proof for Atherectomy is one of our absolutely key priorities. And we are in the process, trying to, working with outsiders as well as insiders, the smartest people in the world that we could find to help us devise and launch a definitive Atherectomy study. And we expect that work is progressing and we expect to have that study certainly underway sometime this year. And we will design that study in a way that we will hopefully be able to get data along the way. So, that we’ll be able to understand the positive affects or whatever the science leads us in terms of Atherectomy. And so, this is a casualty, key priority, it’s one of the things that we are going to be focused on and it’s well underway within the company.

Joshua Zable

Alright, great. Thank you very much, I will let some other people get some questions in thanks.

Operator

And our next question will come from the line of Mike Weinstein with JP Morgan. Please proceed.

Chris Pasquale

Good morning. This is Chris Pasquale here for Mike. Can you hear me, okay.

Bob Palmisano

Yes.

Chris Pasquale

Couple of questions. First, the SilverHawk, obviously making some progress on the sequentially basis again this quarter but still well below the historical run rate. Where do you think we are now in terms of the inventory rationalization process? And when should we expect to you normalized run rate? And what do you think that really is?

Bob Palmisano

I think we’re thinking about our progress. And then what we would think is that certainly by the end of the year we will be completely through that. And I think that is one of the key reasons that we’ve seen the progress in Atherectomy sales procedures. Procedures in certainly the larger accounts I have picked up. It is in the smaller more moderate sized accounts that we still see some inventory. And if we just look out for that versus the kind of case load that people are doing, we’re saying that by the end of this year, is that we should be completely through that.

Chris Pasquale

Okay. And then a couple for Pat. First, Q2 gross margin came in better than we were expecting. When we talked on the first quarter call you assumed $2 million to $3 million in costs associated with the consolidation of the Redwood facility. What did that impact in the beginning of the quarter and what if gross margin had been excluding those costs?

Pat Spangler

Yeah, the $2 million actually turned out to be a $1 million in margin and $1 in SG&A though that $1million would have benefited obviously the gross margin.

Chris Pasquale

Okay, and then one last one. If I look at your SG&A target for the year, it implies a lower level of spend in the back half both as a percentage and I think on an absolute level as well. Can you talk about what the major drivers of that leverage are going to be? Specially given the fact that they were right-sizing sales force which would have seemed to be some of the low hanging fruit, has largely been in place now for a couple of quarters?

Bob Palmisano

I’ll take that. We had started thinking in our last call was that we were looking to have a $4 to $6 million reduction in cost in the second part of the year. And we haven’t got into all of that yet but we are well on our way and we see ourselves attaining that across the board in many different areas to bring in that cost savings.

Chris Pasquale

Is there one or two areas in particular that is driving that?

Bob Palmisano

Pasquale, I think it is pretty much across the board. What we’ve done is kind of reprioritized our clinical program. We’re focused on a few projects, we have cut down a few projects that were part of the nice to have many as opposed to the vital few. And so that has been significant part of it.

Chris Pasquale

Okay, thanks guys.

Operator

And our next question will come from the line of Jason Mills with Canaccord Adams. Please proceed.

Jason Mills

Thanks guys. Good quarter. Hi, Bob, how are you?

Bob Palmisano

Good Jason. How are you?

Jason Mills

Good. Just I wanted to follow-up on the last question. Was it where, what’s going to start? But just to be clear, with respect to cost savings in the back half of the year, did you mention a number and I think I just missed it with respect to how much per quarter you would expect operating expenses to be reduced in the second half of the year. Could you just reiterate that?

Bob Palmisano

No, we didn’t Jason. But we said is that, we are going to target in buying that we need to hit in order to make our EPS targets and in being profitable up somewhere between $4 million and $6 million. And so, we started that project, we’ve identified, most of that, there is still some to define. But I feel confident that by the end of the year we will have that savings in the bank.

Jason Mills

Got it.

Bob Palmisano

And it really comes more from not cutting things out but reprioritization against what we considered the more important projects.

Jason Mills

Okay. So, this probably the question is also for Pat as well. But this will include a mix of perhaps increasing or in maintaining R&D expense percent of sales. Where in SG&A expense for all these percentages of sales and then time with what costs of consult is doing, you mentioned $1million in the quarter owing to the FoxHollow transition? Perhaps we could just move to gross margins for second, and you could perhaps help me out with what impact on gross margins probably losing the Merck revenue could have offset by excluding the transition cost what you could see in terms of positive gross margin impact going forward from the FoxHollow transition. Where we could see gross margins go broadly in the second half of the year?

Pat Spangler

Jason, that’s got to be before that we would be roughly we are going to be at 67% for the year. I think what you will see is you will see a positive impact obviously from the change in the Merck agreement because the gross margin on that agreement was about 50%. However, we are still in the transition in terms of the start-up cost up through the shift to our Redwood City facility into Irvine and into Plymouth. So, we will have some charges in Q3 and Q4 related to that in the margin as well. And so, from an overall margin perspective we are still kind of guiding into that kind of, 6% to 7% range for the second half of the year.

Jason Mills

Okay. So, Pat, presumably some of these expenses you referred to associated with the transition will not recur in 2009. And I am even going to ask the question about guidance for 2009 because you are not going to give it to me. But surprised to say can I assume that gross margin improvement is on your radar screen for 2009?

Pat Spangler

Yeah, that’s a correct assumption.

Jason Mills

Okay.

Pat Spangler

We actually had disclosed previously that we thought that the annualized savings from the transition of the manufacturing operation would be in the range of $10 to $12 million for annualize basis.

Jason Mills

Okay that’s obviously most, if not all in COGS, okay. So, moving on to neurovascular that we haven’t talked about yet Bob, very strong quarter out of Axium. You, mentioned strong growth rates and new accounts, both in the US and OUS. I would be interested to know just because, perhaps I am just ignorant with respect to the number of accounts that there are available and the penetration you have achieved internationally, especially in this business, if you could help me, help educate me a bit in the opportunity that still exists for Axium and for the neurovascular embolic business at large internationally, and as well as what your strategy would be, Bob, from a regulatory standpoint, in the coil market in Japan?

Bob Palmisano

I don’t think we have broken that out as to the number of counts available. Particularly international, I think somewhere around 60% of our international revenues are coils and Onyx. It really is a strong area, and is poised for growth. We’re new into some of the larger countries including China with Axium.

So, I think there is a great opportunity there. And, we have a terrific organization, we’re direct in Europe and we have a distributor organization outside of Europe. And so I think that the neurovascular business with the products that we now have and the products that are under-development including the products with PGLA and nylon attached to them are really making significant inroads.

Regarding Japan, we’re planning to get a submission in as soon as possible. We have the data from the RACER trial, and that will be available and can be used in that submission in Japan. I just can’t give a timeframe on that because when you get to these regulatory bodies it is up in the air, but we have data, we plan submission. And Japan, is really a key market, and we’re going to do everything we can to maximize our opportunity there. I just can’t tell what you the time period is right now.

Jason Mills

Okay. Is it safe to say it is sometime in the near to medium term, the next 18 months probably or is it beyond that?

Bob Palmisano

I just don’t want to get pinned down on that. I would hope it would be in that. But I am not optimistic it could be in that time period.

Jason Mills

Okay. Last, question I will get back in queue with respect to the balloon line, should we expect you mentioned I think Bob you were going to launch your internally developed line in the first quarter, if I got that wrong correct me. And you still have inventory or will have inventory from Invatec through the first half of next year. I am just curious if you will have all of the sizes that you have in the Invatec line available for your customers without any disruption as you move through the transition in the first half of next year?

Bob Palmisano

No, we think that between our internally developed product and the time period we have, to sell out the inventory of Invatec which takes us through June of next year, is that there will be no disruption in providing those products. We also think that some of the innovations in our products will prove superior and also the fact that we can make them internally will have a nice effect on our gross margins.

Jason Mills

That’s helpful thanks guys.

Operator

And, our next question will come from the line Tom Gunderson with Piper Jaffray. Please proceed.

Tom Gunderson

Hi, good morning. Were there any SilverHawk sales overseas and, if so, could you put a number on that for us?

Bob Palmisano

Yes, Tom we launched SilverHawk in the first quarter with kind of minimal sales. I think we don’t break it out but what we see is a kind of a rapid adoption. I can tell you are that our sales in Q2 about doubled what they were in Q1. There weren’t a lot in Q1 but we do see progress being made there. And we do think in the future, particularly the way we’re designing our clinical work is that, and the reaction that we have gotten so far is that international sales, particularly in Europe, are going to be a strong growth area for us in Atherectomy.

Tom Gunderson

Is that mostly through your direct sales force?

Pat Spangler

Yes. And, I would also say if you want to pin it down is Germany seems to be the strongest country so far. In that with Atherectomy, where we have full reimbursement in place, the country that we don’t have reimbursement in is France, and we’re working on that but once we get that in place we think that France will also be a very strong country for us.

Tom Gunderson

Okay, thanks. And then, regarding the Merck deal, as far as you know, does Merck still own all their shares in ev3 and do those shares have any restrictions on them, any 144 or any other kind?

Pat Spangler

I believe they still have their shares and I don’t think there are any restrictions on them.

Tom Gunderson

Okay. And, then switching over to Axium in the US. You gave us some numbers, 54% increase in reorders in Q2 over Q1. But we don’t really have a denominator or based for that, are you comfortable that you’re gaining share? Or are you just switching your past users of coils to the new coil?

Bob Palmisano

Well, I think that we are gaining share. Thom, but I also think that there is a lot of work out this front us here. We, made a management change there recently, we’re looking for some increase in our ability to execute on the sale line. So, I think that what we’re looking for is really an acceleration of our share gain. Particularly as we introduce nylon and PGLA later this year.

Tom Gunderson

Okay. Then, last question. Is back to SilverHawk and FoxHollow and the US. A, previous questioner asked about a couple of actually, on the normalized inventory, etcetera, but also asked what you think the normalized demand for SilverHawk is. Could, you tell us once you get who the end of the year and the small and moderate guys have used up most of their inventory, is this in the $30 million to $35 million a quarter, more less? What is your feeling on right now?

Bob Palmisano

Yeah. Even, I think that is probably a good numbers $30 million to $35 million. As we get more clinical data that could accelerate, but I think that if I were to peg it right now without that additional clinical data, I would say it is in that area of $30 million $35 million.

Tom Gunderson

Okay. That’s it thanks.

Bob Palmisano

You’re welcome.

Operator

And, our next question will come from the line of Charles Chon with Goldman Sachs. Please proceed.

Charles Chon

Yes, hello can you hear me.

Pat Spangler

Hi, Charles.

Charles Chon

Great. I just wanted to ask you, just a couple of house keeping items first. I saw some movement in interest expense and other expenses for the quarter. Pat, could you help us frame what those two line items could look like for the full year?

Pat Spangler

Well, obviously, with our cash position right now, we’re basically going to be kind of at a push between the interest expense that we pay on our equipment line, and our interest income that we’re going to get from that. The other income line this time actually included two different charges, one was a positive charge for the sale of our interest in Phenox, which was a company in Germany that we had a partial interest in, and another was a write-down of an investment that we had that was publicly traded and we had an interest to market, so.

Charles Chon

So, that will be all included in the other expense line item or the interest expense item?

Pat Spangler

No, that was strictly interest. The other line is what picks up the assets.

Charles Chon

Okay great thanks. And then second of all, I was really impressed by the performance of stents during the quarter. Was anything remarkable that happened there? Or have the incentives for the peripheral sales force changed in any way to maybe see stronger growth in that category.

Pat Spangler

Well, I -- yes I think that gets back to the whole issue of sales force productivity, and carrying the full bag of products. When we looked at it ev3, about 50% of our sales force are made up of former FoxHollow sales force. And they really grasped very well the ability to sell the full bag and so the productivity of the whole organization is up but particularly in that area. The only change in the incentive system is that they have what we believe to be attainable targets. That is really motivating for them. In the first quarter think had very, very lofty targets, didn’t make it. We redid the targets based upon the guidance we had given everybody. Now they have attainable targets and they are seeing something progress. So, I think that we’re in good shape there and we would see that continuing actually.

Charles Chon

Okay great. So, in terms of stents going forward here, we can continue to grow off of this new base level that that we saw during the quarter?

Bob Palmisano

I think that way, yes.

Charles Chon

Great. Fantastic. Another house-keeping item. You know several vascular companies have received subpoenas recently regarding a biliary stent marketing practices, wondering if ev3 has been caught up in that at all.

Bob Palmisano

No.

Charles Chon

And do you by chance have any understanding as to what those inquiries were regarding?

Bob Palmisano

Just what was public, Charlie. We really don’t have any insight at all on that.

Charles Chon

Okay. And the last question is just, you know, looking at revenue guidance for the second half of the year. You know, if my math is correct, I think we are banking on really big first quarter. Especially with the third quarter revenue guidance $104 million to $106 million. I am thinking my math tells me $110 million to $117 million for the fourth quarter pretty massive, sequential increase. Can you tell us what you see in the fourth quarter that gives you the confidence that you can get to that level in revenue?

Bob Palmisano

We don’t give out fourth quarter guidance already but if you just do the math what we give you in the first three quarters you get to a number probably somewhere around 112 to 115 for the fourth quarter. Now, it also says you have to factor into it that Q3 is lower than normal and there is seasonality in that particularly in Europe as doctors take a lot of time off there. So, we see as pretty much for normal trends in Q4 just, it is lower than, if you just straight lining this you would probably think you do more in Q3. We have the place that the factors they are which are some seasonality.

Charles Chon

Great. Thank you very much.

Operator

And our next question will come from the line of Peter Bye with Jefferies & Company. Please proceed.

Peter Bye

Hi thanks. Good morning Bob and everybody else. Just a quick follow ups with most things have been asked but just on the normalized FoxHollow 30 to 35, that’s a US only number?

Bob Palmisano

No. that’s worldwide number but the upside you would see from that would be that -- at more impressive margins international.

Peter Bye

You know, obviously reimbursement probably in France and as it rolls out through the Europe, I assume is the gating factor and when you start to be more aggressively on push there. Any visibility on reimbursement decisions?

Bob Palmisano

Peter, France is really the only larger country in Europe that we don’t have reimbursement and we’re working on that. You get as one of those things when you get to these regulatory bodies, you just don’t know. But we do have reimbursement in Germany which is going really well. We also have reimbursement in UK, Spain where else? Italy. Those other countries other than Germany are really just beginning. We launched fully in Germany very aggressively that we are going to try and repeat that through all the countries in the Europe that we do have reimbursement, and then go after reimbursement and as aggressively we can in France.

Peter Bye

And then just on the follow up on that from going out into Pan Asia and the like, how do you back that into your growth expectations for your gross margins as well vis a vis US/OUS, you’d mentioned that you expect competition, it is not a surprise that a new one is coming this quarter and the like. Can you quantify what your expectations are for them to do? I think CSI did $7 million to $8 million in Q1. They probably roughly did $9 million or $10 million by our estimate and $11 million in Q2, what is your expectations for competitive revenue numbers on that front, i.e., what is your expectations for overall market growth in Atherectomy?

Bob Palmisano

I have a hard enough time with my own expectations, you know?

Peter Bye

What’s the market growth number then, with your expectations?

Bob Palmisano

Yeah, I think one question about international and one question about international, let me get to the international question first. Regarding Asia, is that basically through Asia, we’re approved and we have a distribution network and there is reimbursement. We have not launched fully there yet, as this is just in the beginning stages. We expect the Atherectomy business internationally to be initially more focused in Europe where we have a direct organization. As we move into Asia where we have a distribution organization it will be a little slower and also the margins won’t be as great because obviously you’re dealing through distributors. Regarding your question on market growth. I think that certainly you can make a case once you are through the inventory issue, is that we should return to kind of double digit kind of growth rate. And I think that getting other competitors in the market actually will stimulate more interest in Atherectomy. And we think that doctors will try products when they come in but most doctors will revert back I think to our products particularly as we continue to make improvements in them. So I anticipate Atherectomy as really key growth driver on a quarter by quarter basis of ev3 both in the US and outside the US.

Peter Bye

Al right great, I know, you obviously not given ‘09 guidance on that sort of front but you know may be you talked about overtime, may be mid teens OP margins on that sort of front. Is there an inflection year where you see that or is it still really a quarter-to-quarter blocking and tackling on getting your expenses down on the SG&A line and modest improvements on a year-over-year basis on a gross margin front?

Bob Palmisano

Yes I think we are making progress ‘09 be better, 2010 will be I think when we really hit our stride of really pounding it so I think that the idea is to make progress every quarter. But if I look out, I am saying is that the back half of 2008 is getting better. 2009 will be better than that and 2010 I think will be even better than that. We’re just looking at it in that way.

Peter Bye

Just you know, there were some comments in the US business. Any commentary Novation and what that has done for you, what it means, what it could mean, how that is impacting your business and can impact your business in a go forward basis?

Bob Palmisano

It is being very positive, but growth in their Novation accounts far exceeds the growth in our other accounts. I think it is about 50% more Novation accounts in Q2 of into Novation accounts then in other accounts. So, this is working positively and if that continues, it’s going to be a terrific story.

Peter Bye

I mean, I guess its -- how quickly do you see the benefits of that broadly based. Is it in the early stages of the benefits to that, later stages, what do you think you are focusing--?

Bob Palmisano

Definitely, in the early stages.

Peter Bye

Alright, great. I’ll jump back. Thank you.

Operator

And our next question will come from the line of David DeGiralamo with Pacific Growth Equities. Please proceed.

David DeGiralamo

Good morning and great job on the quarter guys.

Bob Palmisano

Thanks, David.

David DeGiralamo

Can you hear me, okay?

Bob Palmisano

Yes.

David DeGiralamo

Great. So, most of my questions were asked in fact just by the last two callers in fact. But let dig just a little bit deeper on the stent question that Charlie asked. So, in his case it might be stent performance was quite strong related to our expectations. I know, you mentioned that internally things are starting to really click for you guys on that front. But can you provide us a little bit more insight as to whether or not this performance was due to market share gains or perhaps there is also at some shift at least a short term shift from Atherectomy usage to stent usage in your reaping the benefits of that transition?

Bob Palmisano

No, I think it is really an execution issue on our part. We have 145 sales force -- people in the sales force, the largest peripheral sales force out there. So, I think it is execution, more than anything. Having good alignment in the organization with incentives everything. You can also look at the Atherectomy business growth, very nicely also. So, I don’t think it was at the cost of Atherectomy. I just really think we executed well. And I haven’t seen the market numbers yet so I don’t know if we gained market share or not but we’d like to gain market share. We will have to wait and see on that.

David DeGiralamo

Got it. Just, one other shop-related question. In that neuroembolic division, you guys had a sequential decrease from Q1 to Q2 as you mentioned. But within that division, itself, did both Onyx and coils decrease sequentially or just one category, perhaps you can give us insight there?

Bob Palmisano

It was basically flat. It was close. As I indicated I think earlier that is at the end of Q1 we saw some large orders that went into some distributor markets that is not uncommon, but we certainly didn’t push that at the end of Q2, because we had no need to do that. So, I think that is part of the normal business flow. I think that the underlying business is still a growth business in terms of usage, Q2 over Q1.

David DeGiralamo

But just to be clear about the Q1 distributor issue was for both Onyx and the coils.

Bob Palmisano

Yes, yes. We put those together Rick.

David DeGiralamo

Got it. All right, thanks.

Bob Palmisano

You’re welcome.

Operator

And, our final question will come from the line of Charlie Jones with Barrington Research. Please proceed.

Charlie Jones

Good morning. Thank you for taking the questions. Just a couple quick ones. Did you have any change in the number of reps needed in the peripheral or neurovascular side and if so how many?

Pat Spangler

No, we were pretty constant. We average about 145 and, at times due to people leaving and for one reason or another, and gains, there might be less than that but that’s pretty much the number that we averaged in the quarter. That was the same number in Q1. That is in peripheral and in neuro again it was pretty constant.

Charlie Jones

Okay. And, do you expect to be able to continue to increase your sales productivity in each of the next couple quarters, or have we leveled off here 1.5 further loan?

Pat Spangler

Our goal is to get the 2 million. How long that it will take I can’t tell you but we were working on it, its one of our again talk about the vital few in the company and in terms of building shareholder value getting from 1.5 to 2.8 million is a key for us, so that’ so still we think we have opportunity in front of us.

Charlie Jones

And so, now that you have been there for a little low do you think that comes from just sales growth or do you think that you will be able to cut reps in our six months from now would be able to get that higher?

Bob Palmisano

No we think its going to cut from growth and we have the largest organization and there were seeing the benefits right now I just combine upon how our step business had increased and I think that a lot of that have to be is that were there in the doctors’ office or in the hospitals when these procedures are done more roughly, and hopefully we can gain share there.

Charlie Jones

Got a long shot here though, but just curious if you could tell us whether or not the neurovascular business is profitable on a GAAP basis if you separate out your G&A structure for the percentage of revenue it represents?

Bob Palmisano

We don’t break that out that way and so you took your shot and I just --

Charlie Jones

Yes, thanks I appreciate it. Last one. Were there RockHawk sales in the quarter? And if you add the RockHawk sales in the international increase, did that make up the majority of the sequential growth in SilverHawk? Thanks a lot.

Bob Palmisano

Oh, no, there were some RockHawk sales but the majority the growth was SilverHawk.

Charlie Jones

Right thanks again.

Bob Palmisano

You are welcome.

Operator

This concludes our question and answer session. I would now like to turn the conference back over to Bob Palmisano for closing remarks.

Bob Palmisano

Yeah, thank you, operator, and thank all of you for joining us today, and will look forward to keeping you updated as the year progresses. Have a good day. Bye.

Operator

Thank you for your participation in today’s conference. This concludes your presentation. You may now disconnect.

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