LeMaitre Vascular Inc (LMAT) 2014 Q1 法說會逐字稿

Welcome to the LeMaitre Vascular first-quarter 2014 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. J.J. Pellegrino, Chief Financial Officer of LeMaitre Vascular. Please go ahead, sir.

Thank you Britney. Good afternoon and thank you for joining us on our Q1 2014 conference call. Joining me on today's call is our Chairman and CEO, George LeMaitre, and our President, Dave Roberts.

Before we begin, I'll read our Safe Harbor statement. Today we will make some forward-looking statements, the accuracy of which is subject to risks and uncertainties. Wherever possible, we will try to identify those forward-looking statements by using words such as believe, expect, anticipate, forecast and similar expressions. Our forward-looking statements are based on our estimates and assumptions as of today, April 29, 2014, and should not be relied upon as representing our estimates or views on any subsequent date. Please refer to the cautionary statement regarding forward-looking information and the risk factors in our most recent 10-K and subsequent SEC filings, including disclosure of the factors that could cause results to differ materially from those expressed or implied.

During this call, we will discuss non-GAAP financial measures, which include organic sales and growth numbers as well as operating income, excluding special charges. A reconciliation of GAAP to non-GAAP measures is contained in our press release announcing the quarter's results and is available in the Investor Relations section of our website on www.LeMaitre.com.

I will now turn the call over to George LeMaitre.

Thanks J.J. Q1 2014 was a productive quarter. I'd like to focus my remarks on four headlines. Number one, Q1 sales grew 9% to $16.8 million; international growth remained robust at 19%. Number two, Q1 XenoSure sales group 41% to a record $2.3 million. Number three, in Q1, we received market clearance for the new Hydro LeMaitre valvulotome. And finally, number four, in Q1, we signed a $7.8 million five-year TRIVEX Chinese distribution deal. We plan to open a Beijing office in H2 2014.

As to our first headline, we posted our second best quarter ever at $16.8 million in sales, a 9% improvement over Q1 2013. Four devices provided our Q1 growth -- XenoSure, TRIVEX, valvulotomes and catheters.

Geographically, our international operations led the way in Q1 with 19% growth. Sales growth in Australia and Norway was 92% and 235% respectively in our first-quarter selling direct. We now sell direct to hospital in 19 of the 25 highest GDP per capita countries. Our sales guidance projects 10% growth in Q2 and 9% growth in 2014.

As for our second headline, XenoSure posted 41% growth in Q1 and record sales of $2.3 million. We estimate the worldwide patch market to be $35 million and XenoSure has a 25% share. We project XenoSure sales will grow 33% to $10.3 million in 2014, becoming our third largest product. XenoSure is approved in the US, Canada, and Europe and we plan to file 2014 regulatory submissions in China, Australia, New Zealand, Brazil, and Korea.

On the manufacturing front, the transition from Vancouver XenoSure to Burlington XenoSure is on schedule. In Q4 2013, we produced and implanted our first Burlington XenoSure unit. Year-to-date, we have manufactured 12,000 Burlington XenoSure units and issued what we expect will be our final Vancouver XenoSure purchase order.

As to our third headline, our newest flagship device, the Hydro LeMaitre valvulotome, has now received US, European, and Canadian approvals. This next-generation valvulotome features water activated hydrophilic coating on a 1.5 millimeter shaft for easier insertion into smaller veins and smoother, less traumatic passage. The Hydro LeMaitre valvulotome is our most ambitious valvulotome redesign in 12 years. Our valvulotome unit share is approximately 50% and this category accounted for 24% of our Q1 2014 sales. We believe success with the Hydro is likely to move the needle.

At a minimum, we expect a $50 to $100 per unit price hike versus our current valvulotome. But we think this is more than just a price hike. The smaller size and slippery coating of the 1.5 millimeter Hydro should take share from our main American competitor. Already we are seeing excitement in our sales channel as our 80-plus reps are nine cases into the beta trial which started mid April. If all goes according to plan, the launch will take place in H2 2014.

As to our fourth headline, we plan to hire a general manager and open an office in Beijing in H2 2014. Our Beijing office will support our two Chinese distributors of TRIVEX and AnastoClip. We also anticipate receiving five more Chinese approvals by 2016.

In March of 2014, we signed a five-year $7.8 million exclusive TRIVEX distribution deal with our current distributor. While our Chinese sales carry lower gross margins, China is the third or fourth largest medical device market in the world.

I would now like to hand the call over to our CFO, J.J. Pellegrino.

Thanks George. I would now like to say a few words about operating expenses, gross margin, and guidance. Following a strong 2013 and as we moved into 2014, it became clear that we had over-hired in many areas, the factory integrations were underway, operating expenses were high, and our gross margin was under pressure. As a result, we implemented a reduction in force of 33 persons in February and another seven in April. The combined layoffs included employees from all areas of the Company. And we incurred $400,000 of one-time severance charges associated with these terminations in Q1, and expect to incur another $150,000 in Q2. Combined with other cost cutting measures, we have now reduced annual operating expenses by approximately $5 million. Although this was a difficult process, we felt the need to react quickly to our bottom-line issues and believe that these efforts will return us to profitability in Q2.

As you may recall from our February 25 conference call, in recent quarters, our gross margin has moved below its historic 70% plus range. There are several reasons for this, including mix, manufacturing transitions and factory closures. However, we believe that our gross margin may improve going forward. Indeed we increased our gross margin sequentially from 66.7% in Q4 2013 to 67% in Q1 2014. I believe that we are on track to record a 70% gross margin in Q4 2014. The XenoSure manufacturing ramp, the Southbridge closure, and cost reduction measures should drive this improvement.

Turning to top and bottom line guidance, we are expecting Q2 2014 sales of $17.6 million, up 10% versus Q2 2013, and operating income of $1 million. We are also guiding full-year 2014 sales of $70 million, up 9% versus 2013, and reiterating full-year operating income of $5.5 million, up 22% versus 2013.

Separately, we will be presenting at several upcoming investor conferences -- The Benchmark Company One-on-One Conference in May in Milwaukee, the Wells Fargo Healthcare Conference in June in Boston, and the Canaccord Genuity Annual Growth Conference in August in Boston.

With that, I will turn it back over to Britney for Q&A.

(Operator Instructions). Jason Mills, Canaccord.

Hi George. Hi J.J. So, George, on my recent visit, what most struck me or impressed me was the XenoSure manufacturing which you talked about, and then the breadth of the manufacturing, the expansion into concurrent buildings there in Burlington. So what J.J. and you talked about with respect to the gross margin line seems like you have what you need now in place to drive that. The valvulotome we all know is a very, very high margin product, and so Hydro in the second half of the year looks like it's tracking with XenoSure, continue to do well. So what I am wondering is just I guess boils down to two words, really, inflection point. Based on the operating income in the first quarter, the guidance in the second quarter, it implies that the second half of the year will need to be at some point north of 10% operating margins just from a quarterly standpoint. So, talk to us about all of the confluence of factors that are going on now. I didn't even mention the RIF -- the I guess RIF-2 the you just talked about also conspiring. But talk about the confluence of factors and whether or not -- and when we may see an inflection point in the business and walk into one of these earnings calls perhaps and see sort of blowout of the water or sort of great operating income numbers just based on everything that's going on. I guess what's the risk that that doesn't happen on the other hand?

So, that's a lot of stuff there, Jason. I'm going to try to answer a couple, then you just remind me what I missed in your question. I think your questioning up and come out in Q4 and up margin out in Q4, and where I would go in all that is we just implemented a very serious -- it was painful around here but we just implemented a very serious cost cutting set of measures which included the risks you're talking about, including closing the Southbridge factory. We think all of that all brought together is about a $5 million a year expense cut in the operating expenses, and that's not including what happened in the cost of goods sold types expenses. And if you assume those are installed officially May 1, and you get two-thirds of that, that's an awful lot of expense cuts that you will have. We feel pretty comfortable coming out again with the guidance which we are reaffirming of $5.5 million in op income for the year based on the size of that cut.

We also feel pretty good about sales. I think you'll notice that our sales guidance is shaved just a tad from $70.2 million down to $70.0 million, so we still feel pretty good about sales. Admittedly, we've had a tough couple quarters in the gross margin category, but we feel like we are bottoming here on gross margin, and things could get better as all these cuts get installed. So, we feel pretty good about it. We thought long and hard about this guidance. As you know, we usually do that, so that I think that answers a lot of your questions. If not, maybe you can jump in and ask another one or two of them.

Sure. That's helpful. Let's just follow up. So, if we are at a $40.5 million OpEx run rate in 2013, you're guiding to 9% growth. So I'm assuming that you've got, I'm just thinking about this a different way. So I am assuming you've got to grow your OpEx generally, maybe this isn't the case for you but generally at the same level as sales. Let's just start there. So that would take you up to sort of $44 million. At that rate, are you saying that the RIF-2 and RIF-2 should, on a run rate once you get through it, which say that happens later the second half of this year, puts you on a $39.5 million, sort of $39 million OpEx run rate?

Not quite, but pretty close. So that $44 million number you mentioned sounds real high, and $39 million seems a little bit low, although we can talk about it a lot but it does feel like we are going to have some sort of leverage. The numbers indicating some leverage in the back of the year versus the sales growth.

Okay.

This is J.J. Let me just follow up. So, if you think about it quarterly, you just had basically an $11 million OpEx quarter.

Yes.

And if you take out the severance piece, and so if you say that you cut $5 million and it sort of started a bit of the way through the year, April-May timeframe, you get some percentage of that $5 million, you get down to the low $10s million sort of quarterly in terms of OpEx.

By the third quarter, J.J.? Or should that happen soon?

Maybe you can -- you can think about it sort of phasing in over time over the coming quarters.

You won't get them all in April but you'll get them in May and June.

Yes.

(multiple speakers) you'd be heading by the map.

And just a housekeeping item. $5.5 million, you reiterated that. It's nice to see. Does that include the $400,000 Q1 severance and the $150,000 Q2?

It does.

Okay. So you're expecting if we back those out actually pro forma OpEx income to be north of $6 million?

Yes.

Almost exactly $6 million.

That's right.

Okay, all right. That's great. And then just lastly, you sort of, George, touched on my question with respect to XenoSure but I wanted to dig into it just a little bit more. XenoSure has been such a fantastic growth driver. So you characterize it relative to your share. I'm wondering if you could talk about, based on what you are hearing in the channel over the next call it 24 months a realistic share grab could be for you, but at the same time, what sort of market growth are you seeing for the XenoSure product I guess juxtaposed to the fact that you are seeing a movement towards the biological products, which behooves you. So, I guess it's -- I just wanted to get a sense for overall market growth, but within that segment that you're participating in that's actually taking share as a segment, and then from your standpoint what you see as a realistic share grab relative to your competition. So sort of a three-part question, and I'll let other people ask now.

Okay, so those are complex questions. Maybe I can answer it a slightly different way and I'll try to edge my way to answer your exact questions. So, the growth rates at this company for this product were 66% in 2012, 51% in 2013, and I think we are guiding for 31% -- 33% growth rate in 2014. I don't want to guide beyond that, but maybe that's a slope that we can agree is sort of fair. It's not going to go up from 33% after that I don't think. So, we keep thinking this thing is going to keep growing.

One tidbit we didn't put in the report was that 79% growth for Q1 OUS for this product line, and we still haven't gotten approvals in all of those Pac Rim countries that we talked about plus Brazil. So in a high-level answer this horse keeps running, and we are real excited about what it's doing.

In terms of the market, the $35 million market we're quoting, I don't think we think patches is growing anything enormous. Maybe we can call it a 5% growth market, maybe 10%. But as you're pointing out, biologics are chewing up a bigger and bigger part of that market. So maybe proportionately if biologics are -- pick a number right now, they are probably about 50% of that market. They're really growing fast to be sort of 60s%, 70s%, and 80s% in a couple of years. So we think the trend of the market is our friend and that it is growing. And we also think the share of biologics in that market is growing very rapidly. The reason it's growing so rapidly is that surgeons perceive this product to have less infection and also it handles better than that inert substances like PTFE and Dacron.

Got it. Thanks George. Thank you.

(Operator Instructions). Chris Lewis, ROTH Capital Partners.

Hey guys. Good afternoon. First, I guess I just wanted to touch on, first, the first quarter. Revenues I think came in a bit light of where you were guiding. International is strong, so it looks like the majority of maybe that shortfall is related to some softness in North America you saw through the quarter. So maybe just walk us through what you experienced out there in North America during the quarter.

Sure. And Chris, so I'm going to steal a little bit of this from a couple analyst reports I wrote although I'm not saying this is the whole thing. So, clearly, Q1 was a light quarter for us in the Americas; there's no question about that. I think it was 19% international and 4% Americas was the growth rate.

One thing we did see, and you remember the guidance in -- I'm going to go back to Q4 for a second here, but we guided 16.5% in Q4 midway through, and then we came in with this crazy number of 17.9% I believe. So we were 1.4% ahead of our guidance in Q4. It feels to me, in retrospect, now having had a chance to watch these two quarters next to each other, that we got a lot of sales, and this holds true for the Americas as well as outside of the US, but I think the function was stronger in the Americas. We got a lot of sales that we didn't expect in Q4, again 1.4% beyond our guidance. And we missed our guidance by $300,000 in Q1. Feels to me like a lot of the sales were stolen from Q1 into Q4. We didn't know this at the time. There were a couple of contests running inside our company, but actually I think at a higher level, and we've seen this in a couple of analyst reports, people believe that because Obama care was really (technical difficulty) in January of 2014 that a lot of folks out there, a lot of patients out there drove their procedures to happen in November and December so they didn't have to worry about what would happen in the new world of Obamacare. There potentially they wouldn't be able to visit their own doctors or their own hospitals. So we think we saw some of that, although I hate to throw everything at external forces, and clearly there's some issues at our company we need to work a lot harder in the Americas. I am excited to see going forward a lot more training. We haven't and grown our sales force in the US for a while so we need to get back on the horse on that. But I think those two things as well as the GPO that we just signed with Premier, which started April 1, should encourage a little bit more American growth. So again, a couple things. I feel like the Obamacare thing did actually do something good for us in Q4 and maybe that took it out of Q1, and then secondarily there are some things we need to work on.

Great. And I think you mentioned in the previous questions that you still feel good overall I guess for the year on the revenue side. You didn't take guidance down as much as maybe you missed in the quarter, so kind of implies an improved outlook going forward. So are there any other factors besides the ones that you just talked about that kind of layer into that growth outlook for the year?

No. I mean you basically upped guidance by $100,000 for the entire year. It's not a big giant thing for us. So no, I'm not particularly more optimistic. I think Q1 was a miss and we are over it now. We took that out of guidance and then we are at where we were at before.

$70 million is a 9% reported growth, and if you extract from the 2013 numbers the capital equipment of TRIVEX in China, which is now not available in China because we've all talked about this, but the regulatory approvals lapsed in January, it's also a 9% organic growth rate in 2014. So, again, 9% reported and nominally it's 5% organic, but if you strip out TRIVEX China capital equipment, which you may not sell in 2014 from the equation, you get a 9% organic number. Last year I think we can all remember it was an 11% organic number. So our view of the sales power or growth of this company hasn't changed a lot from the 2013 that you saw to the 2014 that we are in the middle of.

Okay, great. Thanks for the color there. And then on the M&A side of things, maybe talk about the pipeline that you are seeing now where it stands today, and how close you are to maybe pulling the trigger on some of these deals.

It's Dave. Thanks for the question. So yes, the pipeline continues to be robust. I'd say it's as robust as it's been in the last many quarters. Obviously, I don't want to tip my hand with respect to anything that could be imminent, but it is full of a few deals of various sizes, one comparatively larger, one medium, one smaller at least. And these are the types of deals that are right up our alley, disposable implantable devices used by vascular surgeons, nichey markets, some procedural synergies.

So -- and then oftentimes, as you know, it comes down to valuation because we are a valuation sensitive company. And I can tell you that these opportunities in the pipeline are companies that we have been following for many years, and if we can line up the right price, then we will execute. And if we can't, we will be patient.

Okay, great. Thanks guys.

Joe Munda, Sidoti and Company.

Good afternoon guys. Thanks for taking the questions. George, a lot of my questions were answered, but I was curious. The inventory build on the balance sheet here, you're showing $14.2 million in inventory versus $13.3 million at the end of December. Can you give us some color as to what that build is, and where it's headed internationally, domestically? Any help would be great.

This is J.J. Thanks for the question. So yes, the inventory build was mainly in three areas -- TRIVEX, clips and XenoSure. And the XenoSure piece is about ramping up production, and so ramping up Burlington-made inventory. And so that piece probably continues for a little bit.

The clips piece of that increase is temporary. There's a larger order that we are building up inventory for, and that will be sold at some point fairly soon. And then we will see that clips inventory go back down.

And then the TRIVEX piece is about the relatively new acquisition. There's a disposable and a capital equipment piece to that. And as we add inventory, particularly with the capital equipment piece, it tends to be larger size dollars. So those three were really what was driving the $900,000 or so of increase in the quarter.

This isn't exactly a comment about the quarter, but in general, of course we realize inventory has been going up a little bit around here. One of the functions of trying to open up so many of these international subsidiaries that have warehouses is you have to fill a warehouse in Australia with products, you have to fill the warehouse in Toronto with products, so any shipping location or depot we set up has to be filled with products in order to keep the customers out of back order. So, that is some function of the build that you are seeing over the years.

Okay. Now, J.J., you mentioned capital equipment part. And I guess, in your prepared remarks, in 8-K, you talked about CapEx. Was there an increase in CapEx in the quarter? Can you give us (multiple speakers)

It was a little under $0.5 million I think, around there. It's sort of in line with I think what you have been seeing.

Okay. And then George, as far as the overall business is concerned, and you touched on a little bit of the expense reduction that you guys are going through, I'm just wondering. I'm guessing, based on the comments previously made by previous callers, I'm guessing it's going to be coming out of the G&A line because you're looking to open up all these offices internationally, and I can't imagine those cuts coming from the sales and marketing side. So, it's safe to assume that it's going to be coming from that general and administrative line item?

And you're talking about where those cuts -- where the RIF took place, which employees?

Yes.

Yes, you know, it was actually very broad-based, Joe. It came out of everywhere and some small part of it also came out of cost of goods sold-type expenses. The $5 million we are quoting you guys or talking about the annual cut is the OpEx portion, and that's out of all the different functions and line items on an income statement. And then of course there's some up in cost of goods sold. There's not quite as much but there's some also there.

Yes. But like somebody -- the caller previous mentioned that you are expecting some pretty significant leverage in the back half of the year based on what you just reported and what you're forecasting out for the second quarter. Correct? I mean --

That's correct.

Okay, I just wanted to double check that. As far as -- and then my last question, as far as China is concerned, expectations there and your thoughts on that market opening up for you beyond 2014.

Sure. So one thing about China that we have to keep remembering again, the approvals lapsed for that TRIVEX systems. So the sales are going to be lumpy and up-and-down over there given that we are working through distributors and we have had this lapse of approvals. But we do have a bunch of approvals that are in the queue right now and should come out by 2016, sort of one or two a year through 2016, a couple in 2014, a couple in 2015 a couple in 2016. We're going to look at it a little bit differently. It's such a big market that we are not going to try to go back to hospital. Our time and effort is going to be spent working with our distributors and working with the sub distributors that work for those distributors. And again just because it's such a big market, there's so many cities with more than 5 million inhabitants that we feel like we can't approach it with our own sales force this time. But we are excited.

We already interviewing candidates and we will be getting a lot closer in the next month or two. We are already starting to see real estate in Beijing, and I was over there I think in March to sign that deal that we talked about. We are really excited about that deal. It's a five-year deal. It's worth about $1.5 million a year in sales when it starts. It starts when we get those approvals back for TRIVEX which we are currently quoting for you guys as about mid-to-late 2015 we get those approvals back, and then that distribution starts up. And it's with the current dealer of TRIVEX, so they really do know what they are doing. It wasn't like we just signed a deal with someone we had just met. We know these guys well. They have been dealing TRIVEX for a good five or eight years with InaVein, the old owner of TRIVEX.

Thank you George. That was helpful.

Jan Wald, Benchmark and Company.

Good afternoon. Thanks for taking the call. I guess pretty much all my questions have been asked, especially the detailed launch. So let me ask more broadly. In terms of the markets, how do you see procedures? Are they growing? Are they declining? You made some assumptions on what your sales will be, but what do you think the markets are doing at this point and where you're interested?

So, again, I answer this question probably the same way a lot, which is I am only seeing what I am seeing, and last year was a great year. I feel this year, if you strip out this TRIVEX capital component, it's also a great year here. It's a 9% organic year. So, that's what I am seeing and those are the procedures I am seeing. We had 11% unit growth in Q1 if that helps at all with answering to the question.

It is getting more GPO-y, we see that. We are real excited about that Premier contract we just signed. We are now at 60% or 70% GPO in Germany, which is our second largest market in the world. So we are seeing more GPO's. We are seeing more evidence-based medicine. Our sales reps and our sales managers are spending a little bit more time in the executive suite in the hospitals rather than just at the OR manager's desk. That's changed a lot for us.

But procedures -- talking about what I said about Obamacare maybe pushing procedures into Q4 rather than Q1, I don't have further insight into the medical market besides the products that I am selling. I don't feel equipped to answer that.

Do you see the market moving more towards intravascular kinds of procedures or things like that that could affect your business down the road?

Oh, certainly. That's a trend we have been on and talking about for an awful long time. We feel as though those procedures grow 6%, 7%, 8%, 9%, 10% a year and we feel like our procedures generally I would say we are 85% open and 15% endo. We feel like our open vascular procedures are growing 1s% and 2s% and 3s%. We've been able to a certain extent avoid just dealing with the 1% and 2% growth markets by getting ourselves into places like Canada and Switzerland and Australia where we are brand-new to the market. So, even though the Australian market for bypasses for instance is only growing at 1% a year, LeMaitre has never been there. And so to us we are like a kid in a candy store down there. We have a 2% market share and we are going to grow that to -- normally our valvulotomes are 40% and 50% and 60% unit share in the bypass markets and a lot of these markets where we have been there for a long time. So places like Switzerland and Canada and Australia, we've been able to set up for ourselves a larger growing market even though, at the top end, the market is indeed 1s% and 2% growth.

And as teams move towards the endovascular, is it still the vascular surgeon that's doing the procedures, or are we seeing other kinds of physicians stepping in?

This is Dave Roberts. There's an interesting article in the Journal of Vascular Surgery addressing that exact question. I think it's from 2012 that shows, specifically with respect to peripheral interventions, the vascular surgeon is performing 60% to 65% of those, and the remaining portion is performed by the interventional cardiologist and interventional radiologist in the US. So the movement has been -- and the data is a little stale because it's from federal reimbursement databases, but the movement has been towards the vascular surgeon. They control the patient. The interventional radiologist doesn't. They can treat the patient either through an endovascular or an open vascular surgical approach.

So it's pretty obvious also when you go to the vascular congresses you can see the vascular surgeons, every vascular surgeon coming out of fellowship now can do an angioplasty, atherectomy, stenting. Why would they refer those procedures on to the radiologist any longer? So it is really the vascular surgeon who controls the endovascular procedures largely. I think it's been serendipitous; we've picked the right horse.

And so I guess, in terms of the M&A pipeline, should we expect to see you moving in that kind of direction, or at least looking in that direction, or not?

Sure, absolutely. Even though the bulk of the products of our 14 product lines are used more in open vascular procedures, at least one of the opportunities I described earlier is an endovascular or interventional type of device. We are sort of agnostic with respect to that. We have our criteria.

And I think the one pitfall we want to avoid is entering a very large market like we did years ago with stent grafts and facing too much rivalry. But the nichier endovascular space is something we absolutely would be interested in entering, and we are actively looking at opportunities in that space.

I also -- this is George. I want to take a slightly different cut at that answer, which is of course endo is great and everything. Just to reiterate here, part of our explicit business plan at LeMaitre is to try to zig when everyone else is zagging. We feel like there's a lot more open space when you do that.

And since everyone is running over to endovascular, we found a lot of companies are exiting open vascular. And we find, even though we are talking here about 1s% and 2s% and 3s%, that there's plenty of fun that remains in the open vascular market. I would just keep pointing people at this could be done really nicely. Look at our international numbers. The bulk of what you're seeing is our European number and I think -- let me read you the quarters. For the last five quarters here, these are reported growth rates. Europe hasn't really had that much new in terms of acquisitions from us. So, you can almost say these are organic numbers through the last five quarters -- 19%, 25%, 23%, 28%, and now the last quarter 21%. So while you are talking and thinking about endo markets, we do think there is still an awful lot of interesting activity remaining in the open markets where we play.

That's fair. Thanks a lot.

Larry Haimovitch.

Good afternoon gentlemen. There is something in the press release that confused me, the second paragraph. Unit sales of all products increased 11% and organic sales grew 4%. Could you help me understand that?

Sure. We always trip over this one, and it's driven by the fact that many of our product lines that are lower priced have huge unit increases, and many of our products that are higher-priced did not have huge unit increases. So to simplify this, if there's 4% organic growth, three-quarters of that or more specifically 70% came from price increases, and 25% came from unit growth. So even though it's 11% unit growth, it really doesn't add up to too, too much in this particular quarter. I think in previous quarters, for instance Q4, it was the opposite. We had 12% organic growth, of which 4% of that was price hike and 8% of that was unit growth. So you've really got look closely. You need to know all 15 product lines, which of them had unit growth, to be able to understand how that works. Those two numbers I assure you are true and they have been -- the tires have been kicked on them 100 times even though they look odd sitting next to each other. (multiple speakers)

Yes, to me they did. So the organic sales number is 4%. The reported sales number is 9%. Is the difference between 4% and 9% 5%, five percentage points of price increase, is that the way I should read that?

So 4% organic, another 4% or so from the recent acquisitions that have not been around for more than a year yet.

Yes, okay.

And then another 1% from FX if you want to cut it that way. And then George is saying of that 4% organic, not the 4% from biz-dev and not the 1% from FX, that was a 4% organic. That's the 70/30 split between pricing and units.

Okay. So when you look at the reductions you've had in your overhead and you've done two now, one was larger, one was smaller. How much of that was driven by your concern on the gross margin and your desire to stay profitable? I know George, you and I have talked about this. I think you feel it's quite important for a company to be in the black, be profitable. And so to what extent were the overhead cuts related to hey, we really want to be a profitable company, we see our gross margin coming in lower than we might like. Obviously, or clearly you've discussed it's going to be temporary, but nonetheless your gross margins are under a little bit of pressure here.

I think that's just it, Larry. We think -- we generally try to sell this company to investors as we're going to try to grow sales 10% and we're going to try to grow op income 20%. And so when we came out with that 5.5% guidance for the op income line in February, that's something we take pretty seriously. I think the seeds of all this were happening in Q4. We just couldn't see it that well because we sold so much stuff. And we when you sell a lot of stuff, that it covers up a lot of sins, I guess. And so we do look at these cuts as they are largely op expense type cuts, but they are done in order to deal with the fact that the gross margin is a problem here. It's been a problem for two quarters. We feel as though op expense type cuts can go in quick and hard, and we do feel like gross margin is an item that takes a while to turn around. So while we are all going to patient here watching the gross margin, we felt like we needed to give you guys and ourselves op expense relief and that was where we came to that.

Okay. Jason earlier ask a question which I was going to ask and I'm going to ask it maybe a little bit differently. Clearly first quarter didn't meet your expectations, particularly on the profitability side and gross margins side. You haven't really reduced your op income expectations for the year very much, if at all, I believe. So that implies that towards -- let's say look at the fourth quarter of this year. It sounds to me like the gross margin issue should be behind you. You'll have a lower operating expense, as you talked about with Jason, maybe $10 million a little bit more than that. So it sounds like Q4 could be a very nice-looking quarter if this plays out as you kind of hope it will.

This is J.J. I think generally you're painting the picture that we are painting, which is gross margin improves sequentially over the quarters and you hopefully get into the 70% range into Q4, and while that is happening, your op expense is going down from $11 million a quarter to somewhere in the low $10s million or $10.3-ish million range. And so if those two dynamics are happening and you can model out some sales getting to $70 million throughout the year, then by definition you're going to have some decent op margin quarters in Q3 and Q4.

Has anything changed structurally within the Company such that, over time, with the things that you are doing, bringing XenoSure inside and closing factories, etc., is there anything to suggest that you can't get back to near or at your previous gross margin peaks, which is 73%, 74% I think? I can't remember exactly.

Obviously, we are not guiding on this topic beyond what I've said for this year. I would say structurally there is a change, which is your mix has shifted. And a few things are driving that. One is as the US growth slower than international, that's a drag on gross margin. The US has superior margins to international gross margins, generally speaking, and so that's a headwind. And to the extent that continues, it will continue to be a headwind.

And then XenoSure, as that take sort of a bigger slice of the portfolio going forward, with the 55% or 60% gross margin, that's going to have a negative impact as well. So, to the extent that mix stays in the equation, it's going to be a headwind, but we do have two sort of I'll call it transient items that are going to go away. One is the XenoSure piece as we ramp the production (technical difficulty) margins there -- can you hear me?

Yes, sorry, I got distracted. Go ahead.

And then the closure of the clinical instruments facility will also help the margin as we integrate that into our Burlington group and sort of strip costs out of those product lines. So, those two things are going to help and structurally have the mix piece going the other way.

Okay. Let me ask one more question and I'll jump back in queue. I know I've asked a lot of questions. You mentioned XenoSure at a 55% or 60% gross margin. But you are bringing it in-house. I would think the gross margin for a product growing that well with a competitive advantage could be a little bit better than that. Can you elaborate on that at all?

I think over time that's the right answer. Typically, with these integrations, you sort of get it up and running and it's fairly inefficient initially. And that sort of a year-long plus process of getting it up and running, and then you start to strip out costs. You start to learn how to be a little bit more lean in your manufacturing, and in this case, you also have great unit growth behind you as well. So, you can basically leverage your fixed costs over more and more units as time goes on.

There's an accounting piece behind the scenes too, which is we've built out the XenoSure clean room recently. We are depreciating it over the life of the lease that's going through 2017. So after a few more years you're sort of getting accelerated in a bad way, depreciation going on and that goes away at some point so then you'll get a nice bump from that on an annual basis. So I think the high level answer to your question is yes, I think we should be wringing out a lot of costs and costs per unit out of XenoSure over the coming years.

Great, okay. Thanks guys.

Ladies and gentlemen, that concludes the presentation for today's conference. You may now all disconnect and have a wonderful day.