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LeMaitre Vascular, Inc. (NASDAQ:LMAT)

Q3 2012 Earnings Conference Call

October 30, 2012 5:00 pm ET

Executives

George W. LeMaitre – Chairman & CEO

Joseph P. Pellegrino, Jr. – CFO

David B. Roberts – President

Analysts

Jason Mills – Canaccord Genuity

Larry Haimovitch – Haimovitch Medical Technology Consultants

Operator

Welcome to the LeMaitre Vascular Q3 2012 Financial Results Conference Call. As a reminder, today’s call is being recorded. At this time, I would like to turn the call over to Mr. JJ Pellegrino, Chief Financial Officer of LeMaitre Vascular. Please go ahead sir.

Joseph Pellegrino, Jr.

Thank you, Jeff. Good afternoon and thank you for joining us for our Q3, 2012 conference call. Joining me on today’s call is our Chairman and CEO, George LeMaitre and our President, Dave Roberts.

Before we begin, I would like to read our Safe Harbor statement. Today, we will discuss some forward-looking statements, the accuracy of which subject to risks and uncertainties. Wherever possible, we will try to identify those forward-looking statements by using words such as belief, expect, anticipate, forecast and similar expressions. Please note these words are not the exclusive means for identifying such statements.

Please refer to the cautionary statement regarding forward-looking information and the information under the caption Risk Factors in our 2011 10-K and subsequent SEC filings including disclosure of factors that could cause actual results to differ materially from those expressed or implied.

During this call, we may discuss non-GAAP financial measures. Please refer to our earnings release in our website www.lemaitre.com for a discussion and reconciliation of non-GAAP financial measures.

I’ll now turn the call over to George LeMaitre.

George LeMaitre

Thanks, JJ. Before we get started I’d like to pass along me and my team’s thoughts and well wishes to anyone who many have been affected by Hurricane Sandy. Of course the stock market was closed today and we do understand that many of our east coast investors and analysts may have more pressing and personal matters to attend to.

Turning to today’s call, I’d like to comment on our Q3 2012 results and then discuss a few exciting 2013 growth and profit initiatives.

In 2011, we clarified our European sales bag by exiting stent grafts. In 2012 we increased our international sales force by more than a third. These two moves played out as expected, powering Q3 2012 European Organic Sales Growth to 12%. Sales also grew smartly in Japan in Q3 coming in at 16% organically. Japan is in an enormous market of a 128 million people with more than 5,000 hospitals, by penetrating this market takes time and it takes sales reps.

We added our seventh Japanese sales rep in September and then our eight in October. I’m very pleased without continued momentum in Japan. Sales in the America has grown just 1% in Q3 2012, lack of US rep headcount growth maybe partly to blame but we also just had a disappointing summer quarter. Some good news to share, we are guiding 9% organic worldwide sales growth in Q4 implying a bounce in US sales. The strong October start in the US supports this guidance.

Also notable in Q3 2012 was a 350 basis point gross margin improvement to 73.4%, JJ will address this in detail but it’s nice to have the two 2011 factory closures behind us. So well 5% organic sales growth was below where we have wanted it to be, a nicely improved gross margin helped us post the $1 million in Q3 Op profits which we have projected.

Now I’d like to describe the three 2013 initiatives. We began to globalize our sales force in 1998 by buying out of German distributor. Since then we’ve added direct operations in one or two countries a year. We like the customer contact which the direct rep model provides as well as the more attractive gross margins. As we head into 2013, we’d be setting up a direct presence in Canada and Switzerland. These two countries rank number 10 and number 4 in terms of GDP per capita, above even our three largest markets the US, Germany and Japan.

Canada will likely be LeMaitre Vascular’s fifth largest market in 2012 with about $1.5 million of sales. We’ve hired a Canadian general manager and will begin shipping devices to Canadian hospitals from our new Toronto office in January 2013. We also plan to increase our Canadian sales force from two reps currently to five in 2013.

In Europe, we bought our long time Swiss distributor in October. 2011 sales to this distributor worth $300,000, so Swiss one should be a $500,000 a year business at the hospital level. We just hired our first Swiss sales rep and in December our Frankfort office will begin shipping products directly to Swiss hospitals. Including Canada and Switzerland we are now selling directly to hospitals in 15 countries. We should finish 2012 with approximately 85 worldwide sales reps.

In this growing international sales force, acts like a new product catch basin. The larger becomes, the more product development opportunities it attracts. R&D grew 29% in Q3 and much of this increase was spent staffing up to 14 product engineers. These folks speed to market new platforms, next generation devices and product fixes. The UnBalloon and the Over-the-Wire LeMaitre Valvulotome were launched in Q4, 2011 and sold at an annualized rate of $600,000 through the first nine months of 2012. On the drawing board for Q4 and Q1 launches are several UnBalloon modifications, a new smaller 1.5 millimeter expandable LeMaitre Valvulotome and the second generation MultiTASC plaque debulker.

This increased pace of development will help us expand our presence in niches like Valvulotome and Carotid shunting, while accessing new spaces like stent graft modeling. With respect to the XenoSure acquisition, the power of matching our wide vascular sales channel to a new vascular product was obvious as we increased XenoSure Biological patch sales from $600,000 to $4.5 million in just three and a half years.

With that, I’ll turn the call over Dave Roberts so we can hear more about the XenoSure acquisition.

David Roberts

Thanks, George. Yesterday we closed the XenoSure acquisition, now I’d like to give you refresher on the product provide you with deal terms and then discuss why this transaction was compelling.

The 2009 XenoSure transaction had two parts, a distribution agreement through January 2016 and a January 2014 acquisition option. Over the last three and a half years this product line is grown from roughly $600,000 of hospital sales to $4.5 million in the 12 months ended September 30th. Of course, as XenoSure sales grew so did the importance of this product line, so this summer we approach Neovasc in a bit to bring the acquisition forward and they agreed.

We are pleased we’ve acquired this high growth product line for one time sales or $4.6 million in cash. We were at $4.3 million of the purchase price to Neovasc yesterday and $350,000 as doing one year. As a part of the transaction we also signed our 40 month back up supply agreement in the event that the manufacturing transition is delayed.

Exercising the purchase option 14 months ahead of schedule was important to us for three reasons, first that secured permanent rights to this high growth product, second, we will now be able to capture manufacturing profits which should eventually drives XenoSure’s gross margin from approximately 50% to 65%. And third, we can now use the XenoSure platform to innovate new vascular products. More generally, this transaction brings LeMaitre Vascular into the biological space where we’ve seen growing vascular surgeon interests in recent years.

Since October 1st, LeMaitre personnel have been inside Neovasc spends cover facility to begin the manufacturing transfer. We expect startup and training activities to generate incremental of expenses of about $400,000 in Q4 2012 and $1 million next year. These figures are now incorporated into our Q4 financial guidance that JJ will discuss shortly.

In 2014, manufacturing XenoSure in our Burlington facility should be accretive to operating income by about a $1 million. We expect this amount will grow as XenoSure sales grow in the out years.

And with that, I’ll turn it over to JJ.

Joseph Pellegrino, Jr.

Thanks, Dave. From both of business and financial perspective we find ourselves in an interesting time. We just completed the five projects of 2011 and now we are announcing three new ones XenoSure, Canada, Switzerland. To our eyes, the 2013 initiatives are considerably less operationally challenging than the 2011 projects. They should also have much less of an impact on the P&L.

With this in mind, I’d like to say a few words about our gross margin, operating expenses, operating income, cash, dividends and guidance. Gross margin in Q3, 2012 was 73.4% versus 69.9% in the prior-year quarter, a 350 basis point increase. Improvement was due to our exit from stent grafts, higher average selling prices and improved manufacturing efficiencies. Including a reduction in training and start up cost associated with our 2011 factory transfers.

With our AlboGraft and LifeSpan factory transfer is complete we now turn our focus to integrating XenoSure manufacturing into our Burlington facility. It is also important to point out that other initiatives the portable – the another initiative the portable K-Rak will adversely impact our profit starting in January of 2013 by approximately $900,000 per year, this expense will be a reduction to our gross profit. As a reminder, all medical device companies will a 2.3% excise tax on US sales in 2013.

Moving down to P&L, total operating expenses in Q3 2012 were $9 million versus $8.2 million in the year earlier quarter. Adjusted Q3 2011 operating expenses were $8.5 million excluding a onetime $300,000 gain. Increases were driven largely by additional sales reps and product engineers increased direct marketing and product development expenses related to the UnBalloon, 1.5 millimeter expand Valvulotome and the MultiTASC.

Q3 2012 operating income was $1 million versus $2 million in Q3 2011. The decrease was driven by the loss of sales and gross profit from stent graft exit, higher operating expenses and the non-recurring gain of $340,000 in the year earlier quarter. Our operating margin in Q3 2012 was 7% and our EBITDA margin was 14%. Cash in marketable securities were $20.6 million at September 2011, an increase of $0.5 million during the quarter. Cash provided by operations was partially offset by share repurchases and dividends of $1.1 million, an increase inventories of $1.2 million.

Excluding these items, we generated over $2.5 million of cash in the quarter. During the quarter, our Board of Directors approved the payment of a quarterly cash dividend of $0.025 per share of common stock. The dividend will be paid on December 4, 2012 to shareholders of record on November 20, 2012. Future declarations of quarterly dividends and the establishment of future recurring payment dates are subject to the determination of the Board of Directors.

Turning to guidance, we expect Q4 2012 sales of $14.4 million, up 9% organically versus Q4 2011 and operating income of $900,000. We expect 2012 full-year sales of $56.4 million, up 8% organically versus 2011 and operating income of $4.2 million and 8% operating margin. Q4 and full-year 2012 guidance now include the effects of our three 2013 initiatives, XenoSure, Canada Switzerland.

With that, I’ll turn it back over to the operator for Q&A.

Question-and-Answer Session

Operator

Thank you. (Operator Instructions) Our first question comes from the line of Jason Mills with Canaccord. Please proceed.

Jason Mills – Canaccord Genuity

Hi guys, thanks for taking the question. Can you hear me okay?

George LeMaitre

Perfect, Jason.

Jason Mills – Canaccord Genuity

Thanks George. First a backward looking question and then a forward-looking one, in the quarter, could you give us the sense for on an as reported basis how you did from a divisional standpoint? You gave us the geographic breakdown but was curious how we did in vascular and general surgery etc.

George LeMaitre

Well that’s interesting Jason. I have to admit we stopped to a certain extent looking at the business in that way. I think about 85% of the revenues are now in open vascular and about 15% are in endovascular and other. And so I don’t think there was a material difference. We’ll look it up while the call is going on. How is that?

Jason Mills – Canaccord Genuity

Okay, fair enough. I know you changed that I just like to keep my model updated if I can on that front. I understand you haven’t given formal 2013 guidance; I’d like to the extent that you can walk down the P&L and give us some preliminary thoughts as to how you’re looking at revenue growth, gross profitability and operating margins next year.

Joseph Pellegrino, Jr.

Yeah thanks Jason this is J.J. So yeah we haven’t given guidance for next year yet. I would say at a very high level, if you look backwards we’ve basically been sort of 7% to 9% organic grower and that’s probably a benchmark that’s relevant looking forward and probably fairly consistent this year to next year. So I would say on the top line looking backwards is probably a good barometer.

On the gross margin line, I guess I would say that we are going to be working on the XenoSure integration as we discussed and that’s going to impact our gross margin negatively. When we talk about $1 million total P&L impact in the press release, so some significant portion of that’s going to be in cost of sales. And then additionally the Affordable Care Act is about 2.3% tax on our U.S. sales which is going to amount to about $900,000, $950,000 and you’re going to see that in the gross margin line as well.

Jason Mills – Canaccord Genuity

Okay. Excluding the Med-Tech tax, however, in assuming that you’re in the 72.5% range fourth quarter, you’ll end this year with around 72.5% gross margin. So should we expect somewhere between 50 and 100 basis point reported declining gross margins next year?

Joseph Pellegrino, Jr.

Yeah I don’t want you guide too specifically, Jason, but I would, and you sort of look backwards and forwards we’re sort of, we’ve come out of in the low 70s into the 73.5% range and there is a sort of little bit moment there in the gross margin line as we get better manufacturing AlboGraft after that transition and get more efficient at manufacturing LifeSpan after that transition. So maybe the underlying sort of gross margin number, it feels a little bit better going forward, but then it’s impacted negatively by those two big items which I quantified for you.

Jason Mills – Canaccord Genuity

Okay. Perfect, that’s helpful. That’s it from me. Thanks guys.

Operator

(Operator Instructions) Our next question comes from the line of Larry Haimovitch with HMTC. Please proceed.

Larry Haimovitch – Haimovitch Medical Technology Consultants

Good afternoon gentlemen.

David Roberts

Larry.

Larry Haimovitch – Haimovitch Medical Technology Consultants

Did you guys get smacked pretty hard with the storm?

David Roberts

I think we got away with it versus some of our other states on the east. I think it was a little bit easier on non-coastal Massachusetts.

Larry Haimovitch – Haimovitch Medical Technology Consultants

Good, good. Question number one, fourth quarter guidance is for higher sales growth than Q3. I’m assuming that’s mainly because of the XenoSure deal?

David Roberts

Well actually, Larry, the XenoSure deal on a revenue – reported revenue basis doesn’t really impact guidance in terms of sales whatsoever. We’ve already got that revenue inside the company and it’s ongoing.

Larry Haimovitch – Haimovitch Medical Technology Consultants

That’s right, of course, right. Okay. So that – did the effect of it that it has is now you get the manufacture chapters more in that gross margin if you will.

David Roberts

That’s right. And we feel like the transition is going to take approximately 14 months, 12 months, 16 months to put a number on it.

Larry Haimovitch – Haimovitch Medical Technology Consultants

So what accounts then, George, for the jump in Q4 versus Q3 organic?

George LeMaitre

It just we feel like we have a good quarter coming at us. We actually even have proof from October. We had an extraordinary October, so we feel good about the guidance. And honestly, when we look at our company right now, we do look it at as steady state, it’s an 8%, 9% growth company, so the 9% is nothing extraordinary for us. I feel like the summer quarter was a little weaker than we expected, but Q4 seems to be a rational guess here.

Larry Haimovitch – Haimovitch Medical Technology Consultants

Okay. My second question is, there is a content some on the press release of higher average selling price, did you have across the board price increase this quarter, George, or recently that is affecting either the sales line or the gross margin line?

George LeMaitre

Sure. So first of all, yes we had a price increase, but it did happen January 1 of 2012 and we also planned to have a price hike January 1 of 2013. We started having our price hikes on the beginning of the calendar year January 1, so that’s one answer to that, so you’ll see the prices helping through the year. Roughly speaking, the price cycle was about 5% this past year and roughly speaking it’ll be about 4% next year in our provisional pricing model.

Larry Haimovitch – Haimovitch Medical Technology Consultants

So the unit growth then is more like around five-ish if you look at – if you take back of the price increases.

Joseph Pellegrino, Jr.

There is some weird math going on there, which we always try to explain to our self and I’ll try it once and I don’t expect to have follow this, but unit growth as you can see on our press release was 10% year-over-year in Q3 and actually it was roughly that number in Q2 in Q1 and what’s happening is, the unit growth of the XenoSure which is a lower price product and of the catheters and of VascuTape. The unit growth on those three products is extraordinary however, they’re lower price products. So if you want to look at it different way and I know you didn’t exactly ask this, but I’ll just go forward here. If we had a 5% organic growth in this quarter, roughly speaking, 40% of that is due to unit growth and 60% of that is due to pricing. And in Q2 and Q1 we were asked that same question and it was 50-50 in both Q1 and Q2.

Larry Haimovitch – Haimovitch Medical Technology Consultants

Okay, great. And then the impact of the excise tax for you guys is really considerable because it whacks out nearly $1 million of operating margin which is huge for you. I had referred from couple of places and I know Jason Mills is on the call and we both heard Vascular Solution CEO mentioned the fact that Regs for the excise tax have really not been put in place totally yet. And he was thinking it might even be postponed several months. I’m wondering if you have any intelligence on that George or the others.

Joseph Pellegrino, Jr.

Yeah Larry this is J.J. thanks. I would say there is some confusion in the application of the Regs and the clarification of the Regs. There is something called constructive pricing which helps you to figure out what’s the appropriate tax for you to pay and there is some clarity that needs to be provided I think for companies to properly and fully understand how to apply constructive pricing in some cases. So I would say, yes there is some clarity that we expect to get over the coming weeks, but I have not heard that it would be postponed because of that or some other reason.

Larry Haimovitch – Haimovitch Medical Technology Consultants

Okay. Yeah that was probably speculation on his part, although it sounded like pretty informed speculation.

George LeMaitre

Yeah we’re going to had assuming that it’s happening starting January 1 and we’ll be paying the tax every two weeks.

Larry Haimovitch – Haimovitch Medical Technology Consultants

And you were going to put in the, as you were saying in the call, through the gross margin lines through...

George LeMaitre

Yeah that’s where we’re feeling it belongs for now.

Larry Haimovitch – Haimovitch Medical Technology Consultants

Yeah it’s interesting some other companies are putting it through SG&A. Jason and I were on a call this morning with Spectranetics and they were talking about putting the SG&A line and other company I recently met talked about putting it in and at the invoice level, so if they’re shipping $100 of product to a company – to a hospital they would build them $102.30 that tacking on the $2.30 or 2.3% on to the invoice itself.

George LeMaitre

Yeah, that’s another interesting approach. One of the issues with that is it’s basically identifying the hot potato and then the buyers are going to say, that’s not my hot potato that’s yours and then you get to fight over that, so.

Larry Haimovitch – Haimovitch Medical Technology Consultants

Yeah, okay. Thanks guys.

George LeMaitre

Thanks Larry.

Joseph Pellegrino, Jr.

Thanks Larry.

Operator

And at this time there are no further questions in queue. And I would now like to turn the call over to Mr. George LeMaitre for closing remarks.

George LeMaitre

Thank you very much, Jeff. And first a quick follow-up Jason’s question. Jason, if you’re still on the line, unfortunately we just aren’t following it that way. I can’t tell you that endovascular of our other made up 17% of revenue in the most recent quarter. And I would tell you that I don’t feel they’re materially different. We can track that down for your model later on if and when we speak to you. So I wouldn’t have that number available right away for you.

So first I’d like to thank all the participants on this call. I’d also like to remind folks that we will be presenting it several upcoming investor conferences and I’ll go through this five conferences, Brean Murray on November 7 in New York City, Lazard on November 13 in New York City, Southwest Ideas on November 14 in Dallas, Lazard December 18 in Denver and Sidoti & Co. in New York City on January 7.

So with that, I’ll turn the call back over to Jeff and again thank you very much.

Operator

You’re welcome. And ladies and gentlemen that concludes today’s conference. I would like to thank you for your participation. You may now disconnect. Have a wonderful day.

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