All improvement: Cardiovascular Systems' CEO Discusses F2Q2014 (Qtr End 12/31/13) Results

Executives

Dave Martin - President & CEO

Larry Betterley - CFO

Analysts

Brooks O'Neil - Dougherty & Company

Ben Andrew - William Blair

Danielle Antalffy - Leerink Partners

Jose Haresco - JMP Securities

Jan Wald - Benchmark Company

James Terwilliger - Wunderlich Securities

Edward White - Laidlaw & Company

Cardiovascular Systems, Inc. (CSII) F2Q2014 Earnings Call January 29, 2014 4:45 PM ET

Operator

Good day, ladies and gentlemen, and welcome to the Second Quarter Cardiovascular Systems Earnings Conference Call. My name is Britney and I'll be the operator for today. At this time, all participants are in a listen-only mode. Later, we will conduct a question-and-answer session. (Operator Instructions). This conference is being recorded for replay purposes.

I would now like to turn the conference over to your host for today, Chief Financial Officer, Mr. Larry Betterley. Please proceed, sir.

Larry Betterley

Thank you, Britney. Good afternoon and welcome to our fiscal 2014 second quarter conference call. During the course of this call we'll make forward-looking statements. These forward-looking statements are covered under the Safe Harbor provisions of the Private Securities Litigation Reform Act of 1995 and include statements regarding CSI's future financial and operating results or other statements that are not historical facts.

Actual results could differ materially from those stated or implied by our forward-looking statements due to certain risks and uncertainties, including those described in our most recent Form 10-K and subsequent quarterly reports on Form 10-Q. CSI disclaims any duty to update or revise our forward-looking statements as a result of new information, future events, developments or otherwise.

We'll also refer to non-GAAP measures because we believe they provide useful information for our investors. Today's news release contains a reconciliation table to GAAP results.

I'll now turn the call over to Dave Martin, CSI's President and CEO, for overview comments. Dave?

Dave Martin

Thanks, Larry, and hello everyone. Let me start with a overview of our fiscal second quarter. We're pleased to report another strong quarter. Our performance in the expanding $2 billion PAD market and the launch of our recently approved coronary product led second quarter revenues to record levels. Revenues rose 28% year-over-year and 9% sequentially over the first quarter of this fiscal year.

We continue to drive success in the PAD market with our easy to use technology. We provide a compelling solution for treating arterial calcium. Calcium is present in approximately 65% of all PAD arteries treated and in nearly 80% of the small arteries treated below the knee. Expanding physician usage of our Stealth 360 PAD system was a key factor in revenue growth for the quarter.

Talking about the coronary, on the coronary side of the business our October 22 FDA approval of our technology to treat severely calcified artery was a watershed event for the company. Our unique technology is the first and the only device specifically approved to treat this complex disease state.

Since the approval, we began a controlled commercial launch of our Diamondback 360 Coronary Orbital Atherectomy System or OAS. With a dedicated team that will grow to about 20 coronary sales professionals this quarter, we are initially focused on a select number of top medical institutions in the United States. We'll continue the strategy for several quarters.

More than 50 prominent physicians at 17 sites in the United States have treated over 200 patients to-date with our new system. We expect to see the list of hospitals and noted physicians continue to grow as we penetrate this undeserved market, a market with a potential estimate to be $1.5 billion in the United States alone.

As we look to the second half of the year, our goals are consistent. We'd like to expand the use of our orbital atherectomy system as the primary therapy for treating calcified coronary arteries in the PAD market.

We are on a great path with our coronary franchise and we will continue a successful and targeted coronary launch. We're building our base of scientific data and continue to support the state the effectiveness and economic benefit of our products. And finally, investment in science, research development will continue to enhance and expand our product offering.

Now Larry is going to provide more details on our financial results and I'll come back to recap additional clinical and research activity before we take your questions.

Larry Betterley

Thank you, Dave. CSI performed well in the second quarter. Compared to a year ago, total revenues grew 28% to $32.3 million, which was above our guidance of $30 million to $31 million. Device revenues were 88% of the total.

We sold nearly 9400 devices bringing the life to-date total sold to more than 135,000. Devices sold included more than 100 coronary units. Coronary device revenue is in line with our expectations totaling $388,000. Our controlled launch of this dataset began in late October.

Reorder revenues remain high at 96% of total revenue consistent with last year. We added 59 in PAD accounts and 11 coronary accounts, 10 of which were also PAD customers, compared to 48 PAD accounts in the year ago period.

Other product revenues rose 27% from prior year to $3.9 million which was a similar rate as overall revenue growth.

Gross profit margin increased slightly from 76% last year. The gain was driven by cost reductions from product cost improvements and higher production volumes. These were partially offset by a decline in average ASP. The declines stem from higher office space lab sales which tend to have lower ASPs.

We expect engineering enhancements to Stealth and increase in production volumes to continue to reduce unit costs in the future.

Operating expenses rose 33% over last year primarily from planned investments including approximately $7.5 million related to coronary approval, market preparation and commercial launch. We also made investments in sales and marketing, expanded clinical and product development initiatives and medical education programs to drive PAD adoption. All of these investments are geared towards generating higher future revenues.

SG&A also includes $558,000 of expense for the medical device tax which became effective on January 1, 2013.

Net other expense totaled $1.2 million versus $645,000 in the prior year. The increase was mainly due to debt conversions as all of our convertible debt was converted during the quarter.

We also incurred charges for transferring the remaining balance of our term loan to our working capital line of credit which has a lower interest rate. The result in that loss of $8.7 million was $0.32 per share was smaller than our guidance and compares to a loss of $5.8 million or $0.28 per share last year. The number of weighted average shares outstanding rose to 27.2 million from 20.7 million last year. This is due to the issuance of 3 million shares in our recent equity offering and 2.3 million shares in our March, 2013 offering as well as the issuance of stock from debt conversions, employee stock plans and warrant exercises.

Adjusted EBITDA was loss of $4.6 million compared to $3.2 million last year. The increase was from a larger operating loss partially offset by higher stock compensation expense. Excluding the $7.5 million of coronary investments, adjusted EBITDA was positive for the quarter.

We finished the quarter $146.7 million of cash. We raised approximately $84.4 million of net proceeds in our November, 2013 offering and the proceeds will be used primarily to fund growth investments including coronary launch initiatives, clinical studies, product portfolio expansion, education programs and international expansion.

The press release also contains our six-month performance date; I won't cover that in our prepared remarks but I'd be happy to answer questions during Q&A.

In concluding, I'd like to point out that as of January 2, CSI was accepted on to the NASDAQ Global Select Market. This market has the highest initial listing standards and we're pleased to be included in the select group of companies.

I'll turn it now back over to Dave for further commentary.

Dave Martin

Thanks, Larry. As you look at the coronary market, its estimated that significant arterial calcium is present in nearly 40% f patients undergoing coronary intervention. Calcium contributes to higher treatment costs and poorer outcomes when traditional therapies are used. These include a significantly higher occurrence of death and major adverse cardiac events. And fact remains that calcium is a vastly underestimated problem previously with limited options for treatment.

We're excited about the FDA's approval of our coronary technology. The impact will be enormous for our patients, our physician users, the payers, and for the company. Our 30-day ORBIT II trial showed CSI's Diamondback technology is safe and effective in treating a widespread and complex disease state.

One example is Dr. Sharma, Director of Clinical Interventional Cardiology at Mount Sinai Hospital in New York. You might remember that Dr. Sharma was the first physician in the United States to commercially use the Diamondback 360 coronary system. To-date, he and his colleagues have successfully treated more than 50 patients using the device. Seven different operators aside from Dr. Sharma have used the device.

Within the medical community, Dr. Sharma is a world-renowned interventional cardiologist. Mount Sinai, New York, is one of the most prestigious coronary institutions in the world adjudged by volume and clinical contribution. We're leveraging their experience and expertise and have made Mount Sinai our first national training center of excellence for the Diamondback 360 Coronary OAS system.

When asked about the device Dr. Sharma was quoted as saying, "The Diamondback is a real advancement in interventional cardiology. It's a device which is very safe and effective and easy to use. Our initial 50 cases treated at Mount Sinai have resulted in excellent patient outcomes demonstrating the true value of this advanced technology."

Our next milestone will be announcing ORBIT II one-year data which may occur at ACC in March. We'll find out this Friday about acceptance for our March presentation at the ACC. This data will be critical to highlighting the longer term efficacy of our technology.

Also, we are currently working on several post market studies to further build our body of clinical and economic outcomes evidence.

Let's turn to Peripheral. We continue to enroll Liberty 360. As a short recap here, this study evaluates the acute and long term clinical and economic outcomes of our OAS in treating PAD. It's the first study of its kind to compare orbital atherectomy to all other PAD interventional treatment options.

Practicing and academic physician communities are excited about the study and its opportunity to affect a change in the standard of care. Dr. Cezar Staniloae, New York Medical Center, is the study's principal investigator and he performed the fist procedure. Over 70 patients have been enrolled today and we expect the enrollment to accelerate as more sites complete their IRB process.

Now I'll detail our financial outlook for fiscal 2014 third quarter ending March 31, 2014. We anticipate revenue to be in the range of $33 million to $34.5 million. That represents year-over-year growth of 25% to 30%. This includes approximately $1 million to $1.5 million of revenue from our controlled coronary launch and PAD revenue growth of 21% to 25% over last year's third quarter.

CSI's gross profit as a percentage of revenues should be consistent with the second quarter of fiscal 2014. We anticipate operating expenses approximately 10% higher than the second quarter of fiscal 2014 primarily to support coronary investments and the launch of that franchise. Interest and other expense should be about $100,000.

The resulting net loss is expected to be in the range of $9.2 million to $10.1 million or loss per common share ranging from $0.31 to $0.33. This assumes 30.3 million average shares outstanding.

Our fiscal 2014 focus continues to be successfully launching our coronary system making growth investment as appropriate and driving further PAD adoption through clinical and educational initiatives, new products and product enhancements.

Now I'll turn the call back to the operator for questions.

Question-and-Answer Session

Operator

(Operator Instructions) And your first question comes from the line of Brooks O'Neil with Dougherty & Company. Please proceed.

Brooks O'Neil - Dougherty & Company

I have a couple of questions. First, I was just curious if there have been any surprises or things that you hadn't anticipated in the controlled coronary launch so far?

Dave Martin

Thanks for the question. It's behaving a lot like ORBIT I and ORBIT II with an easy to use device and phenomenal outcomes. It's been a real pleasure and surprise for those physicians who have used the device like Dr. Sharma at Mount Sinai, who wasn't involved in either of those studies. I think there may have a really risky patient and hair raising procedure can become routine with the technology and the optimal protocol.

So I think there is no surprises. We are excited about the potential. We like the advantage of the controlled launch, in fact, we had our first physician training in December. We, upon approval which was at the early part of the window and super thanks to team TSI, we really swarmed to a quality submission and if I think about over five, six years of work to get that data collected to queue it up for the FDA is really amazing and to get approved on the first stage of the window really speaks to the people in this building and the commitment to help patients especially in this expanse of calcified patients who had no other solutions previous to our device.

So the physician training in December, we'll continue that, put that into our already capable medical education hand. And then our first sales training, we're going to move to our sales force of up to 20 by quarter end and we had some trained professionals who had supported the trial ORBIT II and brought a successful result of that but we've been able to add to that since approval and we got a first few training classes in January.

Brooks O'Neil - Dougherty & Company

Great. Second question. I was just curious if our math is correct looks like you are getting a little bit of a premium price for the coronary device. Can you just talk a little bit about sort of your pricing strategy in particular relative to the paired device and what you are -- I mean I am assuming you're not seeing any push back at all on the marketplace, but I am just curious.

Dave Martin

Well, cost is always a concern but the value that we contribute, by eliminating complications we can also eliminate cost so that the value for the product and the proportion is really strong. We could save thousands of dollars upfront just that indicates we will track long term clinical and economic outcomes as well. In fact, our one-year data will show both clinical and economic outcomes. So the pricing is a little bit of a premium through the peripheral device and we'll watch that over time.

Brooks O'Neil - Dougherty & Company

Sure, and then just one last question, David. Obviously you said you would find out about whether your submission will be approved on Friday, but can you give us any feel for what the data shows in the study?

Dave Martin

Yeah, we can't at this time, but just in March we will be excited to put that out one year data both clinical outcomes and economic. We're relatively confident that the ACC would love to have us present there, but we'll get back data out one way or another and we will find out formally from the ACC on Friday.

Operator

And your next question comes from the line of Ben Andrew with William Blair. Please proceed.

Ben Andrew - William Blair

Good afternoon guys, couple of questions for you. First, can you talk a little bit about what you are saying with an individual doctor that takes up the technology in terms of repeat use that they kind of do a case or two and then pause or are you seeing steady usage on those accounts?

Dave Martin

Yes, it's a great question. Thanks Ben. We are focused on the option, before the launch we wanted this very easy to use device should be used broadly for an under treatment population classified coronary arteries. And so far we have seen that. If you take just two to the accounts, one Mount Sinai and we had seven different users in that account. It's too early to maturely trend the frequency but right now we have got a lot of physicians with multiple uses, some we put on in those first two weeks others we put on just recently.

Another example is Chandler Hospital. In Chandler Hospital out in the Phoenix, Arizona, they've had 10 users in a very short period of time. So I think that the ease of the use is going to allow the physicians to routinely treat this disease that maybe previously that they are referred it to a specialist on who -- specialist in the practice who might have specialized the treating, the complicated cases that come with calcified artery. Now, every physician continues to treat those patients who need.

Ben Andrew - William Blair

And Dave, you talked about 20 reps at the end of this quarter. Can you give us a sense what that may look like at the end say June, and what timeframe you would roll that to the broader sales rep, and will you keep that separate coronary group within that or you fully integrate it at some point you are going forward?

Dave Martin

Yeah, we will keep it to 20 give or take for the time period, but obviously over time we'd like to grow that. We do -- amongst the 20 and we are not there yet, we do have a few people who carry both the peripheral and the coronary line and early indicators is that's great for the account. It allows us to deliver a lot of intense training and service and it's great for the business and that we just don't, in that case we don't have a travel territory and a face time of our customer in the time helping educate and treating patients is much more than if he had a larger territory. So that experiment is going very well. We look forward to modeling based on the results here in Phase I and II of the coronary launch.

Ben Andrew - William Blair

And then finally, you guidance seems to assume kind of study dynamics in the peripheral space. Any impact that you are building in or anticipate from potential changes or changes in the physician office lab reimbursement dynamics? Thanks.

Dave Martin

Thanks, Ben. Yes, reimbursement is a big issue for the physicians and we are really watching it. The reimbursement was raised a little bit in the hospital setting and lowered a little bit in the office space. But we like our physicians even under continued reimbursement pressure which we think is going to happen, because we could treat multiple lesions with one device. We are the safest way to treat and that's great for the office based lab.

And our growth is market expands, not only for us we are getting to patients who previously couldn't be treated routinely, but as market expands for those physicians who are looking to grow practice and better serve the patients. So we feel great about our potential to face reimbursement channels as coming forward. We think there will be continued pressure on reimbursement in the future.

Operator

And your next question comes from the line of Danielle Antalffy representing Leerink Partners.

Danielle Antalffy - Leerink Partners

Just wanted to ask whether you are seeing some sort of or any sort of I guess halo effect in your coronary and conversely peripheral accounts. I mean, I guess what I am asking is in the accounts in which you have penetrated the coronary have you seen an uptick at all in peripheral in those same accounts, and then conversely the one account that you added as a coronary account that's not a peripheral account do you expect to be able to drive peripheral sales into that account? How do we think about that going forward?

Dave Martin

Yeah, it's a great question, Danielle. Anecdotally we are and over time we will build a trend on that but right now we have got some really fun events for hospitals and physicians where we've had four peripheral cases and three coronary cases in the same account. And we have met with a lot of funfair, not only but our team but I think for physicians who had been on the sidelines waiting for more data, seeing the fact that we are safe and effective in calcification even in the coronary setting that I think it will have a halo effect on our peripheral business. Those physicians who said well, I'm not sure if I want to treat below the knee routinely, but now that have gone through the scientific and clinical rigor to get approved in the coronary and I've seen for myself how easy it is use, literally 60 seconds or sometimes or less of sanding in the coronary arteries can produce phenomenal results, they're taking that information and applying it to their peripheral practice. So anecdotally early on here in the first couple of months, yes, we've seen some halo effect and we'll work to continue that as we go forward.

Danielle Antalffy - Leerink Partners

And then I wanted to ask what your updated thoughts or views were on atherectomy plus drug-coated balloons, we obviously saw the VAD-II data from Bard at TCT. So just curious on what you think the opportunity is there as it seems to be a potentially exciting line?

Dave Martin

You bet it's a fantastic opportunity and I think more and more people both in industry and the scientific community are seeing the advantage of removing calcium but leaving a healthy native artery intact in advance of a fine matter of therapy. And that's the path to have predictable results and a better outcome. So we're excited about that. We'll be working diligently on that. We're investing, as you know, in research and science and development, drug therapies and producing a better outcome in combination of drug therapies is a big part of that. I think we announced publicly that Michael Yang came on board as our Vice President of Science, Research and Development, and we've already got a start on that.

Danielle Antalffy - Leerink Partners

And then last question, on Liberty 360 you mentioned you're still enrolling. When can we expect to see some early data out of that trial? And thank you so much.

Dave Martin

Yes, thanks, Danielle. And there's a lot of excitement about that from practicing physicians and academics we're -- its the first-off comers trials. It's the use of our device and any device that's currently being used in practice we'll be able to do a great comparison and study the clinical benefit of different modalities for patients and the economy impact as well.

The short answer to your question is 50 and 100 cases; we're at 70. We'll let those 50 age a little bit and collect up that data but I think you'll see some of our faculty members produce some publications and presentations based on that 50; we're at 70, and again at a 100. And there's really nothing from keeping us from continuing to mine that data for advances and information that would help physicians expand their practices with the use of the Diamondback for this patient population.

We think that in fact its been complications and lack of durability that's gated growth in the market and I think our 28% growth year-over-year is evidence that our technology really opens that broader treatment of patients needs. So I think Liberty 360 is an absolute key to understanding the clinical and economic impact but also to continued high growth in reaching patients in need in the peripheral market.

Operator

(Operator Instructions). And your next question comes from the line of Jose Haresco with JMP Securities. Please proceed.

Jose Haresco - JMP Securities

So just a couple of housekeeping items first. On the expenses for the next quarter you said 10% sequentially in terms of an increase?

Larry Betterley

Yes, 10% over our second quarter, Jose.

Jose Haresco - JMP Securities

Okay, and then we can assume that's almost all SG&A, right, not a --

Larry Betterley

Yes, a lot of it has to do with the new coronary reps that aren’t going to be on board for a full quarter. So I'd say 80 plus percent in SG&A and the balance in R&D.

Jose Haresco - JMP Securities

Dave, can you tell us about the coronary cases that have been done? Are they the worst of the worst, were they Rotoblader cases, were they CCOs or any -- can you just tell us about the patient population that some of the users that's seen in the early days?

Dave Martin

Yes, we've seen a range. Certainly we've seen some tough cases, we've seen a lot of cases that looked like our ORBIT II population which was severely calcified. And the device is very safe. So the overall experience has been great. Dr. Sharma is tough critic. He likes what he was using before, the Rotoblader and he's moved very quickly to our device, and more physicians in his institution has been able to use our device because we could take a complex case in a complex situation and turn it closer to routine. So we've -- what is calcium we eliminate it, and that is the biggest contributor to risk and a poor outcome; we can really do great work. So a lot of wow factor cases. People with maybe tepid expectations before they used the device but then after a few seconds of handling big smiles and some great feedback to our hardworking team.

Jose Haresco - JMP Securities

As we think about the next set of accounts who become part of the user base, should we assume that these are still KOLs that you're going after and the big research centers?

Dave Martin

Yes, we'll do a mix of KOLs and certainly there's still some of our study sites. 50 of them don't even have the device quite yet, and then large factor is physicians. In general, on the go forward for years to come we will start with at the top 75 volume institution of the United States. That's where a lot of the KOLs are parked. We've grown the coronary faculty very quickly and they put on a great training event in December. We're committed to medical education and that's part of a -- one of the driving forces to market expansion which we've experience fantastically in peripheral, we'll experience that in coronary as well.

Another driver too, Jose, is their field sales team. Their intellect and execution has been superior. They have prepared so hard in advance of handling a second franchise and its really showing up in the quality of outcomes and that patient outcomes but also the physician satisfaction with how we deliver that technology into an institution and get them to their first cases has been fantastic.

Operator

And your next question comes from Jan Wald with Benchmark Company. Please proceed.