LeMaitre Vascular Inc (LMAT) 2017 Q2 法說會逐字稿

Welcome to the LeMaitre Vascular Q2 2017 Financial Results Conference Call. As a reminder, today's call is being recorded. At this time, I would like to turn the call over to Mr. JJ Pellegrino, Chief Financial Officer of LeMaitre Vascular. Please go ahead, sir.

Thank you, Heather. Good afternoon, and thank you for joining us on our Q2 2017 Conference Call. With 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 be looking at 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, pursue, forecast and similar expressions. Our forward-looking statements are based on our estimates and assumptions as of today, July 27, 2017, 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 EBITDA. A reconciliation of GAAP to non-GAAP measures discussed in this call is contained in the associated press release and is available in the Investor Relations section of our website, www.lemaitre.com. I'll now turn the call over to George LeMaitre.

Thanks, JJ. I'll focus on 3 headlines: first, top to bottom Q2 is a record quarter; second, XenoSure continues to drive growth and was up 30% organically in Q2; and third, all 3 of our biologic products set records in the quarter.

As to our first headline, we've posted several financial records in Q2. Record sales of $25.8 million, up 15% versus Q2 2016; record op income of $5.5 million, up 46%; record net income of $4.6 million, up 78%; record EPS of $0.23, up 69%; and record EBITDA of $6.4 million, up 35%.

As to our second headline, XenoSure continues to drive growth and was up 30% organically in Q2 to $5.5 million. This is just $20,000 shy of XenoSure's reported Q3 2016 record when it benefited from a competitor's backorder. And we continue to invest in XenoSure. On June 29, we applied for regulatory approval in Australia. On July 13, the first 2 implants in our Chinese clinical trial took place. And in Q2, we broke ground on a dedicated biologic clean room in Burlington.

As to our third headline, our 3 biologic grafts had record quarters in Q2. Omniflow II and ProCol each grew 19% and Q2 results for RestoreFlow were 64% above its pre-acquisition revenues. On May 18, we obtained RestoreFlow approval from Health Canada. Biologics accounted for 34% of our sales in Q2, a high water mark.

I'll now turn the call over to JJ.

Thanks, George. Q2 2017, operating income was $5.5 million, an increase of 46% versus Q2 2016. The increase was driven by a 15% improvement in sales, as well as tight expense control. Cost containment efforts initiated a number of months ago are now bearing fruit. And operating expenses in Q2 2017 were up only 3% versus Q2 of 2016. On a sequential basis, expenses declined $1.2 million from Q1 to Q2.

As reflected in our guidance, we expect an operating margin of 21% for the full year 2017, up from 18% in 2016.

Our effective tax rate in Q2 2017 was 15%, with the lower rate driven largely by increased employee stock option exercises. Combined with the 46% increase in operating income, reduced tax rate resulted in net income of $4.6 million, a 78% year-over-year increase.

Earnings per share in the period were $0.23, a 69% increase. We finished Q2 2017 with $30.1 million in cash, an increase of $4.3 million from Q1 2017. Cash increases in the quarter were driven by cash from operations of $5.4 million, as well as receipts from stock option exercises of $1.5 million.

Turning to guidance. We expect Q3 2017 sales of $25.4 million, a reported increase of 10% and 3% organically. We also expect a gross margin of 70% in the quarter, operating income of $5.1 million and earnings per share of $0.20. As you may recall, in Q3 2016, we benefited from a significant competitor back order. For the full year 2017, we have increased our sales guidance to $101.9 million, a reported increase of 14% and 8% organically. We now expect full year gross margin of 70% and have increased our operating income guidance to $21.1 million, an increase of 29% and earnings per share to $0.79, an increase of 44%.

In closing, I would like to thank Charles Haff of the firm, Craig-Hallum, for recently initiating coverage on LaMaitre. We look forward to working with Charles in the coming quarters. Separately, we are pleased to note that in May, we were added to S&P 600 small cap index. With that, I'll turn the call back over to Heather for questions.

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

So I wanted to start with phenomenal profitability. You preannounced the top line, and I'm sorry, I bounced between a couple of calls, so you've probably gone over this. But maybe it's so good, perhaps worth going over a little bit more. What is driving, in terms of operating margin, really, the efficiencies you're showing in your business? I'd love for you to go over it a little bit more and what that portends going forward. Your guidance for the year, obviously, a little over $100 million in revenue and, obviously, where you are now with your op income guidance, we're sitting right there at 20% operating margins. Your gross margins, while a little weak are still 70%, much better than medtech averages. Maybe you could comment on, as you look forward with your 10% and 20% objectives, where we start to see maybe a little bit of law of larger numbers becoming -- making it harder to grow operating margins. Because you're sort of implying, next year, we're going to be into the low to mid-20s operating margins, which is obviously not something many medtech companies achieve?

Okay. So Jason, first of all, thanks for the question. There are a lot of questions resident in there, and I'm grappling with where to start. Maybe I'd start at the end and then, maybe you guide me through which other questions you want. You're talking about operating margins, and I would guess, yes, we're feeling really excited about our op margins. We went from 15% in 2015 to 18% in 2016, and now we're guiding at 21% for 2017. So, of course, we're thrilled. We never thought we'd get to these levels way back when and so, we're excited about what's happening. As far as the 10%, 20% goes and as it relates to op margin next year and the year after, you know we've been pretty hesitant to put numbers around op margin but, of course, anyone on the call can do the math, which is 10% and 20% indicates operating leverage continues. And I think you got 3 guys here, me, JJ and Dave, who would not open our mouth about 10%, 20% unless we believed in it. And you've heard 10%, 20%, we were looking back, I think the 10%, 20% got started in our press releases about 2 and 3 quarters years ago. So we're still on that, we still feel really good about it and for the foreseeable future. That's who we think we are. That all being said, of course, the law of larger numbers that you're talking about, we laugh around here that 10%, 20% is a cruel taskmaster. It makes you push hard and you can see that in the cost-cutting that you hear about. Even though things are going great guns here, we're still out there working cost cuts and things like that. We're conscious that we're on the hook for 10%, 20%, but we feel very comfortable about being on the hook for 10%, 20%.

Got it. And so I guess as a segue, sorry for the multiple-part question there. But maybe talk about the gross margin contribution. As we think about everything flowing through to the bottom line, gross margins are solid. They did come down a little bit. Where do they go over the next couple of years, given the mix in your business? And I guess, more specifically, you've talked about the new clean room for biologics. I wonder if there's a margin impact in the near term from that initiative that ultimately drives better gross margins over the longer term. Perhaps talk about that, as a specific within the broader conversation of gross margins, going forward?

All right. So Jason, I'm going to talk high level a bit about your question, and then I'm going to pass it over to JJ, who has a better handle on some of the tighter details of this. But I will say, yes, Q2 wasn't our finest hour, gross margin-wise. I look at that as an opportunity as the year goes on and as next year goes on because we did all of this -- this amazing quarter with a 68% gross margin. And I think everyone on the call knows that we're capable of doing better. In fact, to go back a couple of years, I think in 2014, we had a 68% gross margin and it's come up to 70% over those 3 years despite a highly dilutive acquisition called RestoreFlow and another diluted acquisition called ProCol. Both those happened in 2016. So what LeMaitre's sad or serious story is, is that we keep building the gross margin and then, it keeps getting beat up by the things that we buy, and then we go back and we repair them. But that trip from 2014, where we had a 68% gross margin to 2017 where we're guiding to 70% gross margin, that's 300 basis points. And then we lost another 200 basis points to FX over that time. So the company, despite those negatively accretive dilutive acquisitions in terms of gross margin, has been able to pick up 500 basis points. We're going and we're working on it. But unfortunately, as we keep buying things, we're never really going to be promising you guys something way beyond 70% because we keep buying in things. It's really hard to find companies of the size we're buying that are more than 40%, 30%, 50% gross margin. We need to fix them and it takes time. So that's the high-level look at it. And maybe JJ can -- if I missed any details there?

Yes, Jason, if you've seen that slide on our corporate presentation, with the 10-year look back on the gross margins, I think we made it 5 or 6 years more recently. But sort of flipping in and around that 70% range, and when we do an integration, we bring an acquisition from wherever it is into our facility and we usually take a hit; or when we do an acquisition, it generally has a lower gross margin than ours, and then we repair it pretty quickly as we get those things centralized, and you see the recovery. But if you squint over the course of 10 years, you're sort of at that 70% range. So I would say, more specifically related to the first 2 quarters, Q1 was a little bit of an anomaly at about 72% for gross margin, sort of surrounded by a 69.5% and now a 68%. And then Q1, we had some efficiencies from prior periods coming onto the P&L from the balance sheet, and they all sort of conspire at the same time to come on and do nice things in Q1, and that helped out a lot. And so the comparison to Q2 and the result of Q2 wasn't as impressive, if you will, versus Q1. We also had some HYDRO rework items that we took care of in Q2. And then the mix from RestoreFlow and ProCol. As those guys grow, they're certainly going to be a drag on our gross margin, and we'll fix those margins over time. But since they're relatively new acquisitions, those margins, typically, have lower margins than our corporate average, if you will. So that's all sort of what conspired in Q2 to bring us down to 68%. But we're thinking, in the next quarter, maybe a rebound to 70% as some of those manufacturing inefficiencies, if you will, to Q2 level out. And maybe the FX piece actually helps us going forward. I think we're at 1.16 or 1.165 for the euro/dollar right now, so that's going to help the margin a little bit. And we've got a few little price increases coming through, as well, in Q3 and Q4 that'll help also. So I think a little rebound here to the norm of 70% is sort of what we're looking at for Q3 and the back half of the year.

That's helpful. And that was great color because you gave us sort of -- you reminded me of the 10-year look back. And on a go forward basis, George, you've talked about M&A is going to be -- continue be a part of your strategy. You're also going to continue to fix things and improve margins. So obviously, you're not giving us next year's guidance, let alone 10 years from now. But squinting forward a few years, it sounds like what you're telling me is you're going to continue to drive the operating margin, but as you acquire things that are maybe a bit dilutive in the near term, while you're fixing things and driving the organic business to higher margins, that we should be sort of comfortable here in, or in and around the 70% level, maybe a little bit of accretion to that but not much, and then really leveraging it to the operating margin line. Is it a fair way to think about more of the medium term, next 2, 3 years?

It is, Jason. And I would just say -- you say we're not guiding, but we are. We're saying 10%, 20% and you have the 3 of us on the call, saying 10%, 20%.

I would say, Jason -- I would just give a little more color. Because we're geographically diversified and because we do a lot of acquisitions, mix affects the gross margin and, obviously, acquisitions do as well quarter-to-quarter. So we have maybe a little more volatility in our gross margin line quarter-to-quarter. But over the years, and I think that the answer is pretty constant.

(Operator Instructions) Our next question comes from Chris Lewis with Roth Capital Partners.

George, it seems like this question gets asked almost every quarter, but I'm going to ask it again. So just on the XenoSure, another really strong quarter. Maybe you can just update us on what continues to drive the growth in that product. How -- are you seeing the growth rates differ between North America and internationally and potentially, the growth prospects reach of those markets going forward? And just any additional color you can provide around XenoSure would be helpful.

Sure. Okay. And so, I notably remember, back in February, we were talking about the Rubik's cube of what's this thing going to grow this year. And so maybe what -- we [have] and I think we have more clarity on now, and at a very high level, we can say it feels like on a reported basis, it's going to be about 25% number this year, but on an organic basis, it's going to be about 30% this year. That 30%, which you saw in Q2 and we think it's going to happen -- sorry, 25% reported in the year. Those numbers are roughly split 3/4 units and 1/4 quarter price. And if you're looking for the split, international versus domestic, it feels more domestic because we've discovered pricing power domestically but we haven't discovered pricing power OUS.

Okay, that's helpful. And then, just in terms of RestoreFlow, can you quantify what the contribution was for sales in the quarter? And just more broadly, just how that product is tracking at this point in the year relative to your original expectations?

Sure. If -- we sold one -- tissue preservation services is what you're supposed to call it, was $1.5 million in Q2. So you can annualize that sort of towards the $6 million number. We bought a $3.7 million LTM business in November of '16. So I think you can start saying, gosh, that feels pretty good. Editorially, the sales reps are very excited about this device. They're not always right, but on this one, they voted pretty quickly. They're very excited about the device. We feel great about it, sales-wise. I think from contribution perspective, it's really not contributing much. I would say, you can think breakeven. You can think a margin and then, we're spending some stuff out there on admin and things like that. So it's not something that's helping us profit-wise, but it is something that's helping us, sales-wise.

Okay, great. And then just finally, in terms of sales management, you've had some turnover recently in the North America and in Europe. I think it'd be helpful for investors, this is a question I'm sure a lot of the analysts are getting, but just what your expectations are given that sales leadership transition period, and how the search is progressing to find new people to take over?

Okay. Yes, definitely. And I'd tell you, this will be a tale of 2 continents here. One is in Europe, where you have a guy for 20 years who's just retiring. He's 63 or 64 and he's retiring. He's fairly well telegraphed to the Board and me, over the years. He's still in his seat until September 30. We've launched a search to replace him, and I'm -- I'll be in Frankfurt all next week, interviewing candidates for that job. Who knows when that'll fill, we'll fill it when we find the right candidate. That one's a much more orderly transition, in that it wasn't forced on us quickly. We have 7 regional managers over there who've been with us for, pick a number, 5 or 8 years and I have very close contact with them. So in the interim, I'll play VP of sales over in Europe, but we expect to fill the job at some point. In the U.S., -- and so that's going normal on the transitions, well-telegraphed, everyone knows what's going on over there. In the U.S., you had a fellow who worked here for 22 months and then quit abruptly with a 5-day notice. So it's a little bit less well telegraphed to me. I'm lucky, in that, amazingly, for the first 6 months, and you mentioned turnover, the only turnover in the entire worldwide sales force, the only voluntarily turnover was actually Mike Wijas, the VP of sales. So we didn't lose one rep. We didn't lose RSM and that goes globally. But if you want to look into the U.S. portfolio of reps and managers, you'll remember that between the time I terminated the previous VP of Sales and Mike, the fellow who just left, there was a 5-month period when I was VP of Sales. So I expect that we'll reprise this role, and all the managers are the same except for one guy who Mike hired. 1 of the 7 is a new manager who's been there 2 years now, and the rest them -- or 1.5 years, and rest of them have been there for 5 and 12 years, and I've been their manager intermittently over the years. So in the U.S., it's much easier for me. It's a much more homogenous system. I feel very comfortable in the role as VP of Sales. In Europe, it is a little more complex, it's a little less homogenous. But I think the process in filling it, and Peter being there through September 30, make that a little bit less nerve-racking. And then in the end, Chris, I would just say, it's all baked in the guidance so you can hear, we've now had a month or so to think about what does Mike and Peter's departure mean to us? And I think, if anything, we've largely kept guidance the same, with a change for FX and a change for the beat. So it's not changed our view of this year. And on the bottom line, I think the show continues and I think our cost cutting has been a little bit more effective than we had thought it would be this quickly. So we were able to share some of those earnings with the guidance change on that topic.

And your next question comes from Joe Munda of First Analysis.

So first question, in regards to the clean room, can you give us a timeline as well as expected costs surrounding that, as far as when we can expect construction to be completed and total cost involved?

Yes, so Joe, there's 2 clean rooms, actually, that have been in process. One is an expansion of our existing main clean room, where the majority of our products are manufactured. And that was probably a $1 million to $1.5 million endeavor and that's turned on already over the last few weeks or so. And then we are working, as you know, on a biologic clean room, and that'll probably be a $2 million to $2.5 million project. And I'm going to guess that turns on sometime in Q4. And that time, it could shift forward a little bit, maybe, but I'm going to guess it's in that time frame. And the 2 of them combined are probably initially, maybe, are going to have an impact to the gross margin of around 0.5%. And Joe, that's obviously baked into guidance.

Okay, that's helpful. Okay, you answered my question. George, in terms of XenoSure and the competitive landscape, yes, third quarter of last year, you did get a one-time sort of advantage because of a competitor. I mean, what are you seeing in the competitive landscape as far as that product's concerned? Is the competitor deemphasizing that product? Or can you explain, I guess, some of the dynamics you're seeing in the space?

Okay. So I think the competitor, which is Baxter, as we all know, has sort of been the same the whole time and I just continue to think that our call point is more valuable than theirs. We are the vascular surgeon company. These things get sold to vascular surgeons and so, we just keep going. We were trying to point out for everyone that in Q2, we almost got up to the Q3 high point, which is all of these free sales from Baxter in Q3 of last year. This Q2, coming around 3 quarters later, we've almost made it to that level. So yes, comp-wise, it's going to be a little difficult. But I mean, the package of LeMaitre and XenoSure keeps rolling on, it feels great right now. And I would say, we even have a place to go, I know I keep talking about this, these are long approvals. But Australia and China and Japan, Korea and Taiwan, these markets will come on at some point, and you sort of have 20% of the world to give there. And then even then, I feel like if it's a $75 million market, Dave knows these number better. What are we calling this market and what's it growing at?

$80 million market, growing, I'd say mid-single-digit driven by infection resistance.

And Joe, we had $18 million of that $80 million last year. And you can stick a 25% number on top of that $18 million, as we mentioned here in the call.

Yes, okay. Okay. So as far as Australia and China coming on, any idea, I mean, as far as what that could look like?

Yes, size-wise, I'll be less specific. I just know it'll wind up being our best product in all those markets when it gets online. It's certainly bigger than the Valvulotome. It's certainly bigger than what we have out there. Timing-wise, which may have been your question, Australia is the one with the most visibility. We've labored over that application so we're closer to understanding that. It's not a clinical trial. It's a plain old application and we feel like it's an 18-month, at the outside, approval. And I don't think there's that many hurdles. This thing should pass but we'll leave that up to the Australian regulators to decide. The Chinese one, as you've heard before, after many delays, we finally got our first couple of implants. We're going to see, over the next month or 3, how quickly this thing starts enrolling, given that we've now broken through every single one of those bureaucratic hurdles. But we're still saying something like 2021 approval. But honestly, there's a lot of back and forth between here and there. That's a long way away. I'd be surprised if all the shareholders on this call still own the stock in 4 years.

Okay. And then, I guess my final question will be on the rep count. Any significant change over Q1?

No. I think I mentioned before, we terminated 2 reps [inside this] so we're down from 95 to 93. And we have job requisitions out there for 3 more to hire. So we're not really trying to go down right now, we're just trying to get at the underperformers and sort of move forward.

(Operator Instructions) Our next question comes Drew Ranieri with Stifel.

This is Drew, on for Rick tonight. I just had a question on your thoughts for your portfolio. So you have 15 product lines right now, about a $900 million addressable market, with still a lot of runway in the products, and you're participating in the $5 billion in the peripheral vascular market. Just as you think about your internal development pipeline and acquisition strategy, do you need to get up to 20 or 25 products in the bag to continue your 10% top line growth over the next 3 to 5 years? And do you feel like a need now more than in the past to push more into endovascular versus open procedures?

Drew, it's Dave, that's a good question. I would say, a high level no. We don't feel like we need to get to 20 or 25 product lines. As you pointed out, our addressable market now is around $800 million or $900 million and, of course, we have about $100 million in sales. So what do we have, like 12% or 15% share of the addressable market. So certainly, with the existing portfolio, we could grow a lot. On that being said, there are a lot of interesting product opportunities that we don't currently offer in our bag. I'd say that center of the fairway for us, still, is open vascular. But we also like endovascular, for sure. It would leverage our call point very well. And then, we also look beyond arterial work into maybe venous or varicose vein or dialysis access. Those are, to mix metaphors, zip codes right next door. So I think there are a lot of opportunities for us in terms of products, but no, I don't feel like 20 or 25. I feel like at 15, we could maybe add a few or 5 more and have plenty of room to grow for years. At the end of the day, a typical sales rep has trouble focusing on more than 5 or maybe 7 products in the bag. So you just need to get really good suite of 5 or 7 core products, I would say.

Okay, great? And just as a reminder, your sales force is incented, too, on the gross margin side not on revenue. Is that correct?

That's right. All 93 reps have gross profit plans, not sales plans.

Okay. And just lastly, could you just maybe update us on how you see growth in, maybe, in your total addressable market now?

Sure. So the total addressable market now, again, our bag is centered mostly on open vascular which we feel is converging as a total market; could be flat, could be growing a little bit. We've grown primarily from taking share. But as endovascular growth rates come back down to earth and now are turning towards the mid- and low-single digits, as we've seen some uplift in the open vascular surgery growth rate. So I think we're in a market that's growing, maybe low single digits, possibly more than that. But generally, in that range and we're taking share and we're growing units also by going into new geographies, getting approval and selling in places like China and other countries.

And our next question comes from Lucas Baranowski with Craig-Hallum Capital.

This is Lucas Baranowski, on for Charles Haff. And my question relates to Omniflow and ProCol. We have been thinking about those as more like mid-single digit growers. But from the comments in the prepared remarks, it sounds like they've accelerated a bit. So is there any color you can give us on what's happening in those markets?

Hi, Lucas, and a special welcome to Craig-Hallum to the team. We're really excited about you guys covering us, so thanks for the great question here. Yes, actually, Omniflow, I think we bought that in August of '14, and I think, initially, we sort of shared your baseline expectation for that product line. And it's gone swimmingly in Europe over the last -- it's only available in Europe effectively and Canada, and it's gone swimmingly. And again, that 19%, I think, we quoted on the call today, that's kind of a new normal number for that product line. And it is basically all Europe and Canada -- sorry, and Australia as well. So yes, we've had it for a couple of years. It's exceeded our expectations. I think we bought about a $2.5 million business back then and I think it's about a $5 million business right now. In Terms of ProCol, we have a lot less information on that. We've just lapped the one-year time after we acquired it. We happened to have a really nice Q2. It was sort of a standout Q2 so I wouldn't put all of my reputation on the line, saying, we know we've discovered a winner there. It had a nice quarter. It had a couple of medium quarters before that, so we'll see, we'll take a watchful eye on that. But Omniflow, we're starting to get really excited about around here. So we now have -- I would say, the excitement is centered around RestoreFlow in the U.S. and Omniflow in Canada and Europe.

Okay, that's very helpful. And then, when we look that gross margin being below 70% this quarter, I mean, is it safe to say that it was really the growth that you saw in these biologic grafts, the Omniflow, the ProCol and the RestoreFlow, that was the reason it wasn't at 70% this quarter? I mean, if those had grown more like they did last quarter, would it have been 70%?

Yes, thanks for the question. They definitely have an impact on the reported corporate number. It depends what time frames you're comparing. But year-over-year, certainly, the impact is significant, probably around 2% negative to the margin because of the introduction of those products. And then, as they grow sequentially, it'll be a drag as well until we start fixing that. So I would say, yes, a lot of work on fixing that gross margin like we typically do with our acquisitions and that will happen over time. But in the meantime, yes, those margins are definitely lower than corporate and they definitely have a drag on the answer.

And JJ, can I add in that maybe a little of that is driven by the purchase accounting from the inventory that we got at the acquisition. So when we bought RestoreFlow in November of last year, we got a year, maybe a little bit more, of inventory. When we bought ProCol in March of last year, we got 2 years worth of inventory. So, of course, Lucas, when you acquire inventory, the margin we get on that is probably in the 30% range. We have to sell all of that through before we start to get the full corporate gross margin on the products that we manufacture internally.

And I'm showing no further questions at this time. Ladies and gentlemen, that concludes the conference for today. I would like to thank you for your participation. You may now disconnect, and have a great day.