Vascular Solutions' (VASC) CEO Howard Root on Q2 2016 Results - Earnings Call Transcript

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Vascular Solutions, Inc. (NASDAQ:VASC) Q2 2016 Earnings Conference Call July 25, 2016 4:30 PM ET

Executives

Phil Nalbone - Vice President, Corporate Development

Howard Root - Chief Executive Officer

James Hennen - Chief Financial Officer

Analysts

Brooks West - Piper Jaffray

Jason Mills - Canaccord Genuity

Ben Haynor - Feltl and Company

Jim Sidoti - Sidoti & Company

Larry Haimovitch - HMTC

Operator

Ladies and gentlemen, thank you for standing by. Good afternoon and welcome to Vascular Solutions’ Second Quarter Conference Call. At this time all participants are in a listen-only mode. Later we will conduct a question and answer session. Instructions will be given at that time. [Operator Instructions] As a reminder, ladies and gentlemen, this conference is being recorded today, Monday, July 25, 2016.

I would now like to turn the conference call over to Phil Nalbone, Vice President of Corporate Development at Vascular Solutions. Mr. Nalbone, you may begin.

Phil Nalbone

Thank you, Vicky. Good afternoon, everyone. Thank you for joining us for Vascular Solutions’ second quarter 2016 conference call. You will be hearing presentations today from our Chief Executive Officer, Howard Root and our Chief Financial Officer, James Hennen, and all three of us will be available later during the Q&A portion of this call.

But first, the necessary preamble. This conference call is being webcast to the public and is completely open to members of the media, Vascular Solutions’ shareholders and other interested parties. Today’s conference call is a proprietary Vascular Solutions presentation and is being recorded by Vascular Solutions. No other recording, reproduction, transmission or distribution of today’s call is permitted without Vascular Solutions’ consent. This call is being audio simulcast on the Internet via our company website at www.vasc.com. A replay of the conference call will be available on the Internet shortly after this call is concluded through Monday, August 1. To listen to the replay, visit the Investor Relations section of our website.

Forward-looking statements made in the course of this conference call and webcast are made pursuant to the Safe Harbor provisions of the Private Securities Litigation Reform Act of 1995. These statements can be identified by words used such as may, will, expect, continue or other similar expressions. There are certain important factors that could cause the company’s actual results to differ materially from those anticipated by the forward-looking statements as described in our Annual Report on Form 10-K and other recent filings with the Securities and Exchange Commission. Forward-looking statements are made based on our analysis as of today’s date and we undertake no duty to update the information provided on this call.

I will now turn the call over to Howard Root.

Howard Root

Thank you, Phil and good afternoon everyone. It was another excellent quarter with solid execution by Vascular Solutions as we continued our long-term track record of strong revenue and earnings growth while also continuing to make progress with our long-term pipeline.

In the second quarter we achieved revenue growth despite the difficult comparisons for our number one selling product, the GuideLiner catheter. As we discussed in detail on last quarter’s conference call, our Japanese distributor Japan Lifeline purchased $3 million of GuideLiner catheter than the year ago second quarter to fill their extensive distribution network for the launch of the V3 version.

On an apples-to-apples comparison excluding these Japanese sales, our revenues grew 18% during the second quarter. I’ll go through these numbers in a moment, but the key message of the quarter is that we are well on our way to delivering our 13th consecutive year of double-digit product revenue growth and all of the underlying trends in our business remain solidly intact.

And with the Short Kit litigation now completely behind us, we have resumed generating the sort of operating leverage that you expect from our business model. Among our longer-term development projects, the RePlas freeze-dried plasma development program in collaboration with the United States Army remains our number one priority.

The development of the freeze-dried plasma to treat battlefield hemorrhage and save the lives of wounded soldiers has long been a top priority of the US Army’s Combat Casualty Care Research Program and I am pleased to say that Vascular Solutions continues to make progress toward helping the army achieve this goal.

The army’s target date for submission of the IND application to the FDA is the week of August 25. We continue to expect clinical studies to begin in the November timeframe. Based on the army’s current plan, we continue to target US launch of RePlas around 2019 or 2020, but that timeline could be accelerated depending on FDA responses and US Army initiatives.

As a reminder, the US Army is sponsoring and paying for all the expenses of the clinical study and the FDA submission. Vascular Solutions’ part in this process is the manufacturing of RePlas and we made a lot of progress in that area during the second quarter.

We completed the qualification of all the equipment necessary for clinical scale manufacturing and testing, we completed construction of our dedicated commercial scale production facility across the street from our headquarters and we continue to expect the production equipment installation to be done by early September.

Over the past couple of months, we have received several unsolicited expressions of interest in purchasing RePlas from government agencies, international military operations and private sector first responder organizations. As recognition has grown within government and civilian emergency treatment arena that Vascular Solutions is progressing in its development efforts for freeze-dried plasma, we have seen a great deal of evidence that this product will have broad applications beyond use by our initial customer which is the US Army.

Needless to say, we are very excited about the clinical and commercial outlook for RePlas freeze-dried plasma.

Turning to our financial results for the second quarter, we grew our revenue by 10% to a record quarterly level of $41.2 million. Our revenues were in the top half of our guidance, which was a range of $40.5 million to $41.5 million. On an adjusted basis, our second quarter EPS was $0.33 compared to $0.29 in the year earlier quarter.

On a GAAP basis, our earnings came in at $0.31 per share at the top end of our guidance range and compares with GAAP EPS in the year ago second quarter of $0.21. The adjustment in the second quarter was $500,000 in residual legal expenses that our outside law firms were slow in processing in connection with our Short Kit litigation that was concluded in February.

These were the final expenses and as a result starting in the third quarter, we’ll be reporting only GAAP EPS numbers. Our geographic mix of product sales was 81% US and 19% international. Our US sales increased 16% to $33.3 million, while international sales were down 11% to $7.9 million due solely to the Japanese effect I previously mentioned.

Excluding the Japanese orders for GuideLiner in last year’s second quarter, our international sales grew by a very strong 29%. So as I mentioned earlier, the underlying trends in all of our markets remain very healthy.

In today’s press release, we provided details on the sales performance of our top eight products. These eight products combined represented 79% of our total worldwide revenue and grew by 12% on a year-over-year basis during the second quarter whereby 23% when adjusted for the impact of GuideLiner in Japan.

As is obvious from the wide disparity in sales growth rates among these products, there is substantial variation in where our top selling products are in their life cycle. That is exactly what we expect to see at all times as our clinical niche strategy. We focus our sales and marketing efforts on actively promoting the products that are in the growth phase, while continuing to harvest without substantial additional promotion, our products that are in the mature phase.

Our top selling product during the second quarter once again was our GuideLiner catheter, which had worldwide sales of $12.1 million representing a decrease of 1% from the second quarter of 2015.

In the US GuideLiner now in its seventh year on the market grew by 25% excluding Japan, second quarter sales of GuideLiner in international markets grew by an impressive 31% consistent with the strong underlying trends in our GuideLiner business that we have been demonstrating for sometime.

GuideLiner sales growth continues to be driven by increasing utilization rates as more and more physicians rely on the device to perform challenging cases and as an increasing number of interventional physicians elect to take on more complex interventions.

Our second biggest source of revenue during the second quarter was micro-introducer kits with sales of $3.7 million representing growth of 24%. micro-introducer kits are one of the most widely used devices in the interventional suites and during the past couple of years, we have focused on transitioning to internal manufacturing, cost reductions and product line expansion.

Our strategy has worked very well resulting in the combination of lower prices for our customers and increased market share at higher gross margins for Vascular Solutions. Our third largest product during the most recent second quarter was our Turnpike catheter line, which moved up from the number six position in the first quarter.

Second quarter sales of Turnpike were nearly $3.4 million, a 419% increase from the year ago second quarter and a big jump sequentially from $2.3 million in the first quarter of this year. We launched our first configuration of Turnpike in the first quarter of 2015 and have launched three additional configurations since then.

Already Turnpike is our most successful internally developed new product launch since we introduced GuideLiner in late 2009 and like GuideLiner, Turnpike fits into the growing segment for complex coronary intervention now at a runrate of around $14 million annually, we believe Turnpike can become at least a $30 million product for us and we continue to expect Turnpike to be one of our major growth drivers over the next several years.

The number four product during our second quarter was our Pronto Extraction Catheter, which had sales of $3.3 million representing a decline of 11% on a year-over-year basis, but relatively flat sequentially which was consistent with our expectations given markets and clinical practice trends. We launched Pronto back in 2003 and the market for extraction catheters has been mature for a few years.

Our number five revenue source was our reprocessing service for the ClosureFast radio frequency varicose vein ablation catheter with revenue of $3 million representing a decrease of 2% on a year-over-year basis and flat performance sequentially. We view our ClosureFast reprocessing service as potentially a $20 million annual revenue opportunity and now in our fifth year on the market we are moving gradually towards those levels.

Our sixth largest product line was our Hemostatic patches with second quarter sales of $2.9 million representing a decrease of 2% year-over-year and stable performance sequentially. We launched our D-Stat Dry Hemostatic patches in 2003 and the market for femoral artery hemostatic patches has been mature for sometime now.

These competitive and pricing pressures are compounded by the rapid shift from femoral access to radial access for performing catheterization procedures in the US. Therefore, we are focusing our growth efforts on our newer products that address the rapidly growing radial artery access market in the US.

Our collection of radial artery products represented our seventh largest sales category during the second quarter with revenues growing 21% to $2.3 million. Vascular Solutions was early to identify the trend in the US toward radial artery access and our strategy of developing and assembling a variety of products to serve this market has paid off very well.

We expect this product line to be a significant source of growth during the next several years. The Langston dual lumen catheter was our eighth largest selling product during the second quarter with revenues of approximately $2 million, representing growth of 16%. We expect sales of Langston to continue to grow as it is an increasingly important tool to measure aortic stenosis in percutaneous aortic valve replacement, or TAVR procedures, in cath lab procedures that is growing substantially worldwide.

Overall, our clinically based focus on niche devices has clearly been paying off, especially in the area of complex interventions. Interventional physicians are spending more time to treat more patients effectively with minimally-invasive catheter-based procedures in order to prevent those patients from having to undergo open heart bypass surgery.

This phenomenon is also giving a nice boost to several other products in our catalogue, products that in the past, we haven’t talked a lot about, but have taken on renewed clinical relevance as physicians attempt more and more complex cases.

For example, our sales of twin pass catheters grew by 67% our collection of the specialty guide wires grew by 49%, our line of interventional smears grew 38%, our SuperCross Microcatheters grew 36% and our Guardian hemostasis valve grew 21% in the second quarter. It continues to be an exciting time for Vascular Solutions. We have a full pipeline of internally developed products and a very strong balance sheet to support our efforts to bring in growth enhancing products from the outside in the form of distribution agreements and tuck-in acquisitions.

We believe our business model will allow us to continue to deliver superior financial performance for the foreseeable future, while maintaining our number one focus on the clinical side of our business which is delivering useful medical devices for doctors to improve the lives of their patients with vascular disease.

With that, I’ll turn the call over to James for the financial analysis.

James Hennen

Thank you, Howard. Our gross margin in the second quarter was 65.3%, compared to 66.3% in the year ago quarter. Our gross margin is subject to variability from quarter-to-quarter, based on the mix of products sold and the mix between U.S. sales through our direct sales force and international sales to our independent distributors at lower transfer prices. The decrease in gross margin was primarily due to the write-off of $413,000 of raw material as a result of discontinuation of our thrombin-based products in Europe due to the substantial regulatory requirements for continued commercialization.

For the full year 2016, given the expected product and geographic mix of sales and improved manufacturing efficiencies for our new products, we expect our gross margin to return to that 65.5% to 66.5% range consistent with our gross margin levels during the past four years.

Our operating earnings on a GAAP basis in the second quarter were $6.9 million, representing an operating margin of 17% compared to GAAP operating earnings in the year ago second quarter of $5.6 million or 15%. The big jump in operating earnings primarily reflects the wind down of legal expenses associated with the Short Kit litigation, which concluded in February.

During the second quarter, we incurred approximately $500,000 in residual legal fees reflecting delayed billing through outside law firms of litigation support expense. Without those legal expenses, our operating margins would have been 18%. In the year ago second quarter our Short Kit litigation expenses were $2.3 million.

General and administrative expenses in the second quarter were $2.8 million or 7% of revenue compared to $4.1 million or 11% of revenue in the second quarter of 2016. We expect to return to normal levels of G&A spending during the remaining two quarters of this year between 5.5% to 6.5% of revenue.

Sales and marketing expenses were $9.6 million or 23% of revenue compared to $8.5 million or 23% of revenue in the year ago second quarter. For the full year, we continue to expect our sales and marketing expense to be in the range of 22% to 23% of revenues. We continue to expect sales and marketing to be the primary leverage point for our improving our operating margin on an annual basis going forward as more products are added each year to relatively fixed cost structure of our US direct sales force and international distributor network.

Research and development expenses were $5 million or 12% of revenue, compared to $4.2 million or 11% in the year ago second quarter. The increase in R&D spending in the second quarter reflects headcount additions to support our pipeline initiatives as well as additional product testing required to meet increasingly regulatory requirements for new products.

For the full year, we expect R&D expense to be between 11.5% and 12.5% of revenue. Clinical and regulatory expenses were just under $2.2 million or 5% of revenue during the second quarter compared to $1.6 million, 4% than the year ago quarter. The increase on a percentage basis reflects additional headcount added to ensure compliance with the increase in the stringent quality and regulatory requirements of manufacturing medical devices.

For the full year of 2016, we continue to expect our clinical and regulatory expenses to be approximately 5% of revenues. Amortization expense for the second quarter was $404,000 flat on a year-to-year basis. We expect our amortization expense to be approximately $400,000 in the two remaining quarters of 2016.

During the second quarter, our income tax was $1.5 million and pre-tax earnings of $6.9 million resulting in an effective tax rate of 22%. In the year ago second quarter, our income tax expense was $1.9 million and pretax income of $5.7 million representing an effective tax rate than more normal 34%. The low tax rate during the most recent second quarter reflected the adoptions earlier this year with new accounting pronouncement that requires excess tax benefits from restricted share vesting and stock option exercise deduction to be recognized in earnings.

That excess tax benefit was $801,000 during the second quarter. We are modeling an effective tax rate of approximately 34% in the third and fourth quarters of 2016 subject to variations than the result of tax benefits recognized related to equity compensation.

Our second quarter net income on a GAAP basis was $5.4 million and earnings per share was $0.31 which came in at the top end of our guidance range. This compares to GAAP net income of $3.7 million and earnings per share of $0.21 in the second quarter of last year. On an adjusted basis, moving the Short Kit legal expenses, our earnings per share was $0.33 in the second quarter compared to $0.29 in the year ago second quarter.

The total number of shares used and calculating fully diluted earnings per share was $17.7 million in the second quarter of 2016, compared to just under $18 million in the second quarter of 2015. The reduction caused by share repurchases under our stock repurchase plan.

Turning to the balance sheet and cash flow. We ended the second quarter with $35 million in cash and cash equivalents, compared to $31 million at the end of the March quarter. We continue to have no long-term debt.

During the second quarter, we used $4.1 million for capital expenditures relating mostly to billing improvements and the purchase of manufacturing equipment. We also made a payment of $500,000 of acquisition and licensing rates to a potential future product. We did not purchased any shares during the second quarter under our existing share repurchase program.

We currently have $17.4 million remaining under that $20 million authorization, which expires September 30, 2016. To-date, we have used $2.6 million to repurchase 97,600 shares at an average price of $27 per share under our repurchase program. Our inventory in hand at June 30 was 154, compared to 152 at the end of March.

We expect our days inventory in hand to be in the range of 150 to 160 days as we maintain high levels of finished goods inventory through the completion of our facility renovation. These renovations are expected to be completed by the end of 2016. Receivable days sales outstanding were 48 days at June 30 compared to 50 days at the end of the March quarter. We expect our days sales outstanding to remain at around 45 to 50 days.

Finally, I’ll turn to our financial guidance. For the full year 2016, we are raising our revenue guidance to a range of $164 million to $166 million, which represents growth of 12% to midpoint compared to 2015 revenue of $147.2 million. Our previous guidance calls for 2016 revenue in the range of $163 million to $166 million. We are also raising our adjusted earnings guidance for 2016 to a range of $1.22 to $1.26 representing 12% growth at the midpoint.

Our previous 2016 adjusted earnings guidance was $1.19 to $1.23 per share. The adjusted earnings per share figures for 2016 excludes the $7.5 million of expenses incurred during the first half of the year with the Short Kit litigation. Included in the 2016 earnings guidance for the year are $4.5 million of non-cash stock-based compensation, $1.6 million in amortization of intangibles and an assumed tax rate of approximately 30% reflecting the benefit of the new tax accounting pronouncement that I discussed earlier.

For the third quarter of 2016, we are providing revenue guidance of between $41 million and $42 million. The midpoint of this range represents growth of 12% in the $37 million in the third quarter of 2016. Our EPS guidance in the third quarter of 2016 is between $0.29 and $0.31 on a GAAP basis.

Our EPS outlook for the third quarter of 2016 includes $900,000 of non-cash stock-based compensation, $400,000 in amortization of intangibles and an assumed effective income tax rate of approximately 34%. In the year ago third quarter GAAP earnings per share totaled $0.16.

With that, I’ll turn the call back to the operator for the question and answer portion of our call.

Question-and-Answer Session

Operator

[Operator Instructions] We will go to Brooks West with Piper Jaffray.

Brooks West

Hi, thanks. Can you hear me?

Howard Root

Hi, Brooks. Yes, we can hear you fine.

Brooks West

Great, thanks, Howard. Please let me start, I’ve got a couple questions. Just starting with GuideLiner, which is just a heck of a product for you guys. Howard, I am just wondering the runway that’s left on that product, I mean, could this be, is this a $50 million product, is this a $100 million product? How much farther is that have to go?

Howard Root

Yes, we continue to kind of be impressed with it, obviously, I’ve raised my market assessment probably annually for the last five years and we took another look at it again as we are getting ready for this call to where we are and where we are going. And then we are growing in the seventh year by 25% and 26%, that’s a different kind of product, that’s a superstar product. Last time I think we said it was around $70 million, $75 million market, now when we look at it, we think this could be used in 10% to 15% of the interventional procedures. Japan, as you know, does a lot more intervention – challenging interventions. I think that might be a 15% number, US, more like 10% and the Europe in the 10% range too. If we do that and look at where interventions are right now, we think it has the potential to be in the $90 million product for us from $70 million we thought last. So we are closing in on that that $50 million level. I think Japan kicks back in, in the fourth quarter just the mechanics of the Japanese market which you’ve covered it for a number of years, they buy a lot of inventory upfront. They get distributors and sub-distributors and then consignment inventory to the hospitals that will stock. Then they wait to get that burned off, but the second quarter was the highest quarter of usage of Guide Liner in Japan. So we are encouraged by the pullthrough and that kicks back in, in the fourth quarter pretty substantially for us maybe 2017. So, we think we will see 2017 be another substantial double-digit year of growth and I don’t think that the end of it is kind of the way we look at it. We are also expanding a little bit into new markets. We’ve gotten into a lot of markets, probably about 50 markets so far, but even smaller markets like the Baltic States and Egypt adding those markets in, Russia coming in, in the third quarter, that could be a nice boost for us well. We don’t have another Japan up our sleeves, but I think we’ve got a number of smaller countries that could continue that revenue growth for at least a couple more years here.

Brooks West

Okay, that’s really helpful. And then, a couple of questions on the major pipeline of products if I could. Thanks for the detail on the RePlas, that’s where I wanted to go first. So, assuming the 2019, 2020 timeline holds, I am trying to think about, you described as this will be the $100 million opportunity I think when we chatted a few months ago, maybe half that was military, half was commercial. But it sounds like you had some encouraging conversations, maybe on both sides since then. So I am wondering if that dollar amount is still kind of the same and then, we are starting to get more questions, I mean, how do we think about the ramp of that product? Do you have capacity to go right to $50 million if you get that kind of demand from the military? And then, this looks like a product that maybe comes in at a little bit lower gross margins and corporate average, but it should have almost no kind of associated operating expense and maybe drops at a phenomenal operating contribution. Can you just give us - there are six questions, but all kind of around the same thing, just some modeling help with kind of how to think about the ramp of that product and also the contribution?

Howard Root

Right I think, yes, the market, the ramp, the gross margin and I’ll add the timeline, just could you probably ask it on the follow-up. So I’ll get it all at once.

Brooks West

Sure.

Howard Root

Yes, as you could tell, we elevated the discussion here in the call, because I am very, very excited about it and we are making great progress toward it. The market starts with the army, because that’s where we signed the agreement, that’s obviously the highest priority to staff – or to supply our soldiers with a life saving product in the field and they are sponsoring the clinical study and paying for it as well. So we kind of scope that out and we know what the requirements are, the army just to give you a little bit of flavor, that’s more in the $10 million kind of potential market for us and that rotates every year, so maybe $10 million annualized for the army. And that’s something that they will start wanting to buy immediately. So, kind of rolling into that second part of ramp. If you look at someone like the military, they want to buy the entire troops right away, so we get approval, we need to be building up inventory with their capacity which I will talk about in a couple seconds. So I think we can meet that. Then the other part of the government market, we call it government civilian, government starts with the army, then there is the Navy, Air Force, Marine and Homeland Security and then the other one that we’ve kind of seen a little bit more, we’ve gotten enquiries from other agencies of the government. So, the State Department of Supply in embassies, foreign embassies obviously has a need for this. And then in the government side, there is an international government supply, the Israeli forces obviously has a huge need for freeze-dried plasma and as they see more combat, than probably any military organization in the world and there is other organizations that are reaching out to us to see about supplying. And now we haven’t fully addressed all the international regulatory requirements, but this is one where you can pretty easily imagine that you can work hand-in-hand with the government to get the product supplied once we confirm the efficacy of it and the safety through at least the first phase of our US clinical study. So that’s kind of the market looks like 50% to us is government and then 50% in the civilian. And as we’ve started digging into the civilian side, it could be substantially more than that. The rural hospitals obviously don’t want to stock frozen plasma. There is cost savings just by not having the waste associated with having to have already freezed or thawed supply of frozen thrombin to use for any trauma patients coming in. Also being able to deploy it into the first responder for us gives you a big advantage as well. So, we haven’t really identified that more than saying, it’s not $1 billion market and I am pretty comfortable saying, you total it altogether, this could be a $100 million product and I don’t want to say monopoly, but there is no other supplier in the US. So it gives us that position. In terms of the ramp, the army is that way. A lot of these other ones are as well. They want to buy it. Hopefully, they don’t have to use it. It will have at least a one year shelf life, maybe a two year shelf life, but we work with the army, the navy, air force to make sure that it’s not just a one and done and then two years later another one and done contract. We have to be able to stagger it manufacture this because the manufacturing process is about a week long process for one lot. So we will have to build up the inventory in anticipation of lots and then have it ready to go to be able to supply the requirement. On the gross margin side of things, as you kind of anticipate it, the gross margin will be below our average. We are in the 70%, 75% average for US products. But the operating margin will be above average, because we will not have a sales force for this, you can easily imagine getting above 25% operating margin on this type of product even if your gross margin is in that 55% to 60% range as opposed to the 70% that we have with our interventional device as well. We aren’t making this product for the financial return, but it will have a nice financial return once it’s on the market. And then the timeline, it’s the clinical study part that we need to get complete by up with the FDA. We had good interactive review of the IND on a pre-IND meeting and our communications, we actually then have to meet physically because they gave us the answer the questions. Now we’ve rolled that into our protocol and our assessment, filing at the week of August 26, 30 days for them to respond. Hopefully start seeing the clinical study in November. It’s a smaller clinical study paid for by the US Army. So it does not hit our financial statement. But it will take sometime to get the patients enrolled. Generally it’s a healthy volunteer study. So this is in waiting for trauma patients which we have to have healthy paid volunteers in order to do the study. And that puts us on track to that 2019, 2020 approval with the provision that it could be earlier than that ceratinly for some kind of use within the army because once you would demonstrate at least your first part of the clinical study that is successful, they are currently buying some freeze-dried plasma for foreign operations from France, from Germany and we can replace that with the just the way how it’s ordered even without FDA clearance. So there is an ability to start generating revenue before that full approval if that’s – if it plays out likely expected to. Second, if you kind of a flavor that’s about as far as we wanted to go on and I know it’s a hard thing to model because it’s a completely different product. It has a big upside for us. It’s an important product but it’s kind of hard to financially put a model around it with another product.

Brooks West

Very helpful color, Howard. Thank you so much.

Howard Root

Thanks, Brook.

Operator

We will go next to Jason Mills with Canaccord Genuity.

Jason Mills

Hi, thanks, Howard. Congrats on another solid print. Just following up on that last RePlas question and your commentary on that, when would be the first time you would know about the expedited indication or the potential for an expedited indication? Will that be sometime next year?

Howard Root

Yes, thanks, Jason. I think it would be late 2017 would be the first. We’d have to get the first phase of our clinical study done and there is not – it’s kind of the way we look at it, two phase and one part of this clinical study, there is no phase three, there is no massive randomized clinical study here. But if we get the first patients from Phase I A, I think at that point we’d be in a position to sit down with the FDA and to sit down with the Department of Defense and the US Army and see what we can do. We have to definitely establish that this is safe and effective. But I think we can do that with the first part of this clinical study at that point it be comfortable sitting down and then that would be more like 2018 if we were going to get very early 2018 to start supplying our troops for foreign operations. But, again, I am going beyond plan to getting a little into speculation here, but I think, just to give you a flavor for what we are thinking rather what we are projecting it could happen with for us.

Jason Mills

Sure, I understand, and so the next question is about operating leverage and maybe excluding RePlas from that conversation for a second, just given that’s a little further out and timing is uncertain. When you look at the base business, but including sort of the iterational products outside of RePlas that you have in your pipeline, maybe over the next 12 to 18 months, I am just wondering, how you are thinking about the potential for the business to generate more operating leverage than we've seen over the last year or so and part of that obviously is the incremental cost associated with the trial, et cetera. But backing those out and backing out the positive impact you have had this year from the med tech tax being gone, I presume that you would expect operating income or would want to your business generate operating income at a growth rate faster than what we have seen over the last couple of quarters. And just maybe just talk about what you see the potential operating leverage is in the business now that the trial is behind you and you can focus on it again?

James Hennen

I think I’ll take that one, Jason, it’s James. We achieved about 90% operating in Q2 just excluding the Short Kit legal fees in the $400,000 and the product discontinuation expenses, that $400,000 in thrombin. So since we were at 90% in Q2, we see it go into 19% and 20% in Q3 and then greater than 20% from Q4 just to round this year as an operating margin, but looking longer-term, 12 to 18 months, we’ve been telling investors somewhere in that 25% to 28% within at the $250 million in revenue within 12 to 18 months marching towards north of 200% in 2016 and then improving on that later 25% to 28% at the $250 million range.

Howard Root

Yes, getting bit of the Short Kit litigation expenses the comparables are going to look outstanding but at a incremental progress and pretty quick incremental progress for the next couple of months – next couple of quarters.

Jason Mills

That's very helpful and encouraging. In fact, James, going to come across the border into your gross margins seemed like that they hold steady in the range that you have shown over the last couple of years. So when we are looking at the four components of operating expenses, do you expect to see leverage across all four of those cost centers or more in any one than others, maybe you could shed some light on that?

James Hennen

Yes, sales and marketing has been the driving force of our operating leverage. So, our sales and marketing expenses, we are at about 106 reps currently in steadily the last four years sales rep has increased faster than our revenue growth. We’d expect that operating margin to continue and that’s really been the biggest driver of our sales marketing to operating leverage of our company.

Jason Mills

Got it, and Howard, said a little bit tongue-in-cheek, but the Turnpike growth decelerated quite markedly from 1400% to only 420%

Howard Root

Yes.

Jason Mills

Quarter-to-quarter.

Howard Root

Double-digits, that has stayed, yes.

Jason Mills

That’s just been quite an important product for you and obviously, quite a surprise to the Street. Help those of us here on this side of the business understand the potential for that product. I think you said in the past, very hard to generate products internally that reached the heights that GuideLiner has, not that this will, but it certainly seems to be on a trajectory that you like. Talk about the potential there both from an indication standpoint, market growth standpoint, just what you expect to see over the next couple of years?

Howard Root

Yes, I’d be real happy to. It’s a friendly question. This is a good one. So the Turnpike, it’s a tool, it’s a catheter, a small little low profile single lumen catheter, but it’s used in complex coronary interventions and peripheral intervention to help place wires where it’s difficult to get them and there is one competitive product out there from a Japanese company that’s very well engineered. We’ve been able to hit that and exceed it and add other options with chips on it that allows us to – I think, have the best portfolio of products where there used to be this one device now, we have four different versions that fits a little bit better in each one of the different pockets. So, a little bit of an improvement over what’s out there. The big advantage of the Turnpike is this is a growing market, it is the only growing area of coronary intervention, I mean, excluding percutaneous valves, which I don’t consider to be coronary intervention in that area the complex intervention, the CTO procedures, those are the areas that are growing and we have the products that is used most often in those procedures and also kind of hand and glove works with the GuideLiner, because the lot of the GuideLiner uses in those same procedure. So, when we look at the market, there was no market for this product four, five years ago. The Japanese product came on sort of establishing one, we brought our four versions on and the market started growing quickly around it. And now we look at it as being roughly a $60 million to $70 million potential market and that’s kind of what we expect at a penetration rate of 5% to 8% of the interventions maybe challenging interventions and us being out that with the Turnpike against one competitor. Right now, we are annualizing at around $13 million. We thought we would do, maybe around $10 million this year, that’s up from the $3 million last year and now we are looking at already doing maybe $13 million this year. So, kind of nicely going over our forecast in the first full year of all the versions being on the market. Next year, I mean, you could see this going up into the 20s and then from there the 30s, 40s. I think it will be a little bit smaller than the GuideLiner. We think the GuideLiner has a $90 million potential this will like $60 million. But clearly, in that same category, as opposed to the more common products you’ve seen from us that are $5 million to $10 million in sales.

Jason Mills

Got it. I'll get back in queue, Howard. Congrats on really a good quarter.

Howard Root

Thanks, Jason.

Operator

We’ll go next to Ben Haynor with Feltl and Company.

Ben Haynor

Good afternoon gentlemen. Thanks for taking the questions.

Howard Root

Hi, Ben.

Ben Haynor

First for me, on the Japanese GuideLiner orders, do you - just with the way that the Japanese market is structured, do you expect that it will be five or six quarters between reorders, typically or could that be every once a year?

Howard Root

No, I think the way that it’s – the way the Japanese market is structured, there is a lot of distribution stocking. So, the distributors shelf to sub-distributors shelf to hospital shelf and that’s what required roughly $5 million of GuideLiner purchases last year. $1 million in the first quarter, $3 million in the second, $1 million in the third, that was the inventory stocking. And then once they have that there they really overbuy and then they start using it down and then all of a sudden they start buying replacements and we are kind of in that area where it’s billed, working up that inventory of the initial stocking and buying some replacements of the sizes that they need to fill up the stock, but Q3 is the last quarter of these tough comparable, because we had $1 million in Q3 of 2015 that was the last for the stocking orders and then Q4 is the double-barrel effect is we are not looking at a comparable of the stocking quarter from a year ago, but also we are projecting that Q4 that will be kicking in for more substantial replacement orders. The usage of GuideLiner, we get good visibility all the way through it as a customer, they’ve stocked in a 1000 cath labs which is virtually every cath lab in Japan, they’ve trained the physicians, they are using it, they are getting more utilization per cath lab each quarter and the third quarter, the second quarter was the best quarter we’ve seen for them in terms of utilization. So with that kind of pull through that you want to see, now it’s going to result in order flow in the fourth quarter starting building. And then once that’s started, it will be the more normal procedure of every distributor where they are buying every quarter to re-supply their stock. They just buy a lot to get started with. They work it down and then they start buying normal reorder pattern than a more frequent basis. So we are encouraged about that for 2017 obviously as we get the full benefit of Japan.

Ben Haynor

Okay, great. That's helpful. And then, on RePlas, could you foresee a situation where you might be making sales to either foreign militaries or other foreign groups prior to making sales to the US Army and other groups within the US?

Howard Root

Well, my preference would be the US Army first and assuming the FDA and the White House are amenable to that where we could supply them for foreign combat, that would be my first priority. But in terms of the full scale government part, I could see us supplying to other international markets before we get the full US approval in order to supply to the US base forces and the Homeland Security and other areas. So, if you look at the government market, the first priority is US Army troops engaged in overseas combat they are currently buying German and French freeze-dried plasma which has limited scope and not clinically tested, not something that – it’s only done because they need to and we’d like to replace that with ours even before we get FDA clearance. That would require a special government approval for that, that’s what we are going to be working for in 2017. But after that, then we have to wait for FDA approval before FDA approval, we could have approval in some of the international markets to supply their troops and their international military operations.

Ben Haynor

Okay, great. And then, lastly for me, on the licensing rights you acquired for a future product. Can you provide any color there, or maybe expected market size? When it might be introduced? What area it might be in?

Howard Root

Yes, we are not going to get into that. We disclosed a $500,000 payment which require the rights to it. It’s not a commercial product right now and when it launches, that’s when we are going to start talking about it, but the problem is, if we start talking about our product development, its competitive development, competitive information, that we don’t want to get out there. But it is in our current target market, it’s a place that we already sell. So it’s not us going into a different area. It’s in our core competency with a similar type of product, but something that I don’t want to talk about what specific area it’s in and what it does.

Ben Haynor

Okay. Well, I had to try. Thanks guys.

Howard Root

No, I am trying Ben. Thanks.

Operator

[Operator Instructions] We will go next to Jim Sidoti with Sidoti & Company.

Jim Sidoti

Good afternoon. Can you hear me?

Howard Root

Hi, Jim. Yes, we can hear you fine.

Jim Sidoti

Great. Just a couple questions, one, CapEx ticked up a little bit in the quarter. Did you say what that was for?

James Hennen

Yes, most of that CapEx was for our building renovations of our manufacturing facility which we expect to complete in 2016. So that's what the tick-up was.

Jim Sidoti

Okay, and is that for specific product lines or is that just general space?

James Hennen

Yes, that’s the general space and that’s all of our manufacturing facility where pretty much renovating 100% of our clean room and our tech space. So that’s all been renovated and that’s the use of that cash.

Howard Root

And it is for the commercial RePlas facility for the freeze-dried plasma we built that out. So we purchased our manufacturing facility a couple of years ago and when we did that, we decided it – we’ve been using it for almost 15 years I think in 12 years and we decided to a complete renovation. That should be done here in 2016. So 2016 is a little bit high on the capital expense, quite a bit high.

James Hennen

Yes.

Howard Root

On capital expense because of that, but you won’t say repeat it, I said, do it right, do it once, and we’ll be using that facility for many, many years to build our catheters.

James Hennen

Jim, on a normal year, we are about $4 million to $5 million in CapEx, this year, we are double that. We expect about $11 million, $4 million to $5 million is for that improvements to the manufacturing side in for the RePlas manufacturing facility.

Howard Root

And that will be done in the third quarter that’s why maybe a little into the fourth quarter.

James Hennen

Little into the fourth quarter, yes, correct.

Jim Sidoti

All right, and then, on sales and marketing expense, it's down pretty nicely from the first quarter. It's up a little bit year-over-year, why does that bounce around?

James Hennen

Some of that is depending on our trade shows, the marketing meetings that we go to. So that bounces around from quarter-to-quarter. We have a increase of about two to three reps on a quarter-to-quarter basis. So that went up a little bit there. But generally, it’s for marketing expenses from hiring additional product managers, for this medical meetings.

Jim Sidoti

All right. Thank you.

Howard Root

Thanks, Jim.

Operator

We will go next to Larry Haimovitch with HMTC.

Larry Haimovitch

Good afternoon.

Howard Root

Hi, Larry.

Larry Haimovitch

So, Howard, the FDA approval of Absorb, the new bioabsorbable stent from Abbott, couple of people have suggested that that may benefit both Turnpike and GuideLiner because of the complexity of that implant. Can you talk about that at all?

Howard Root

Yes, I think it will definitely benefit the GuideLiner and Turnpike. I don’t think it will benefit the Turnpike is more to get the wire through, but the GuideLiner often can be use to help in the delivery of the stent and the absorbed bioresorbable material vascular scaffold from Abbott is a relatively bulky stent as the need to be the bio bioresorbable material versus metal. So getting that into tight lesions or across tortuous anatomy is sometimes relatively difficult compared to the what we have probably the eighth generation coronary stent that we have on the market now which is a perfect. In a lot of ways the deliverability of these absorbed stent is going back to the first generation Palmaz-Schatz Stent from 15, 20 years ago now. And because of that, the use of the GuideLiner to get good guide position, get good apposition, the good alignment of the stent to the opening and then be able to deliver it. We’ve seen that in European markets where the absorbed stent has been out for quite a while. Now I think we will see that in the US and we’ll see, I think a good boost in Japan as well where I think Abbott is projecting even higher utilization of the absorbed stent in Japan because – again it’s essentially our practice of patterns. But in cases where they are delivering the absorbed stent in a challenging anatomy, the use of the GuideLiner in some case I would say would be required and we will see how quickly and how far Abbott pushes the absorbed stent beyond just simple type A lesions and into more complicated vessels that will determine how much of a beneficial effect we get with the GuideLiner in the absorbed stent.

Larry Haimovitch

Okay. I was smiling all along the call when you were giving projections for Turnpike, laughing, I couldn't help but laugh about that versus all of your wonderfully conservative projections for GuideLiner, Howard.

Howard Root

Yes, I am a horrible projector if the size of the market and fortunately I am historically, on the small size. So I’ll continue to take that abuse from you every quarter.

Larry Haimovitch

Well, don't become an analyst, then. Just keep doing what you do. And my other question is, many months ago you announced another initiative, another potential project in reprocessing, and that still has not come to fruition. Can you give us an update on that?

Howard Root

Yes, well, it’s – so we have a second product for the reprocessing initiatives. We are working with our partner at Northeast Scientific. They are the ones that handle the regulatory approval and we are the marketing commercialization sales arm of that. So it’s one thing that we are not pushing through. I will say this on reprocessing and regulatory clearances. Those are much more unpredictable, because they aren’t told that many of them and so therefore it’s you can imagine that it’s the regulatory hold up and the hang up in the FDA as to what’s keeping us from hitting what we want to do with that product. We have not put any revenue from that product under process and product in our models. So it’s pure upside. We will not give you an update on what the product is. What market it serves other than to say that it’s in our existing call point and say that it is a larger opportunity than our existing reprocessing for the closure path catheter. And it’s just you are going to have to wait and one day we will have the press release then you will say that’s what it was and then what added to the forecast going forward. But, honestly, there is no other way to it because that we gave any information, I would be giving competitive information publicly which we don’t want to do and as far as the timing, it’s just all in the partners’ hands, Northeast Scientific along with working with the FDA.

Larry Haimovitch

Is there an FDA problem there or is it just normal business?

Howard Root

Well, there is always FDA problems, right. If the FDA issue is what they need to prove and I’ll just talk in general terms, when you are reprocessing a medical device, you do not have access to the entire device history file. So you don’t know everything that they are testing, everything in how it’s manufactured. So you have to prove to the FDA that you know enough about a product that’s made by someone else that you are reprocessing doesn’t change the mechanics of action of that product. And so that’s where it becomes an issue of them being convinced of what you are doing and what data you need to show. How much testing, bench testing, animal testing, other testing that you would have to do and until you convince the FDA that you have this product knowledge that your reprocessing does not change the treatment parameters of the product with the diagnostic parameters of the product, they won’t give you the approval. So it’s a lot different than a standard 510 K product that we go through and get repeat approvals on it. It’s a much more complicated regulatory path here.

Larry Haimovitch

Thanks, that's interesting color. I appreciate that. Okay, Howard, thanks very much.

Howard Root

Thanks, Larry.

Operator

At this time, I am showing no further questions. Mr. Root, please continue with your closing remarks.

Howard Root

I want to thank everyone for participating today. It was a great quarter for Vascular Solutions and we look forward to continuing to report these quarters in the future. Thanks again.

Operator

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

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