Executives
Scott Drake - President and Chief Executive Officer
Guy Childs - Chief Financial Officer
Analysts
James Francescone - Morgan Stanley
The Spectranetics Corporation (SPNC) Morgan Stanley Healthcare Conference Call September 11, 2013 11:45 AM ET
James Francescone - Morgan Stanley
Good afternoon everyone. For those of you that don’t know me, I am James Francescone. I work on the Medical Device team here at Morgan Stanley. It’s my pleasure to have with me the team from the Spectranetics, Scott Drake, President and Chief Executive Officer and Guy Childs, Chief Financial Officer. Scott, why don’t you just for those of us that are less familiar with story to oriented that, so why don’t just take us through three to five minutes Spectranetics, what the story is, what the key milestones for you have been over the past year and what the path is going forward?
Scott Drake - President and Chief Executive Officer
Yes, happy to, and thanks for having us James. So again from a broad context perspective, we are in two distinct businesses, vascular intervention and the lead management spaces. Two scaled sales organizations were present in about 40 countries worldwide, 45 maybe. We are very much in accelerating growth story. Our performance over the past couple of years has been very positive. We have grown double-digits on a constant currency basis for the last seven quarters and you see our growth rate accelerating and very nice balance between each of those two businesses and our U.S. and international business as well.
And we more recently to your point in the last three quarters we have grown 13%. And we said at the beginning of this calendar year we laid out for investors the goals of the company separate from our guidance. And we said in the short-term, I think in terms of the next 12 to 18 months, we would be able to get beyond that 10% growth to something like 12% growth in the mid-term. We would get 12% to 15% in the long-term, 15% to 20% growth. We are a little ahead of schedule on that given the performance over the last three quarters and we are in the midst right now of leaning into four really exciting incremental growth drivers for the company. They include in-stent restenosis opportunity. We should probably spend a little bit of time talking about that. It is a huge opportunity for the company and our two primary competitors are contraindicated in the space.
Second, the launch of mechanical tools on the lead management side of the business, very important milestone for us. That also will happen in the 2014 timeframe market development on the lead management and vascular side, but to give you a little snippet there, less than a third of infected leads are extracted a 100% should be. And then finally, commercial expansion, and this is something that we are talking about more aggressively now. This is true globally, but specifically within the United States we are going to significantly increase the size of our footprint with those new products, with market development with the indication coming online to really capitalize on those drivers. So we see our top line growth accelerating. We have had very good performance on the gross margin side of our business that will continue as we go forward and these things all lead to very nice leverage in our business over time.
James Francescone - Morgan Stanley
Perfect. I mean, so let’s start with something that as you mentioned has been top of mind for lot of investors the opportunity for you in in-stent restenosis, but I do want to get to your clinical program, but just as a prep if you could frame for us how you think about the commercial opportunity there? How many procedures are being done there today? What Spectranetics particularly in that segment? And how should investors think about the incremental revenue opportunity?
Scott Drake - President and Chief Executive Officer
Yes, great. So ISR big picture $750 million opportunity, about 250,000 procedures are done worldwide today. Standard-of-care is balloon angioplasty and outcomes from that are very poor. And that’s been well documented. So we are in the midst of proving the value of our laser atherectomy products to debulk that lesion to lead to a more durable clinical solution long-term. And we are doing that work today to get the indication in the mid ‘14 timeframe and then we are doing a clinical study called PHOTOPAC, which is designed to show the difference between laser atherectomy followed by drug coated balloon compared to drug coated balloon alone, very important study of ours. So the big picture that we see here is this. We will achieve the indication in the 2014 timeframe.
And to answer your question, the percent of the time that we are used today is very infrequent. There is not a lot of off-label use here. So achieve the indication, have compelling clinical data in the form of both EXCITE and PHOTOPAC are two primary competitors are contraindicated and when drug-coated balloons hit the U.S. market, we have three very large companies spending hundreds of millions of dollars developing the drug-coated balloon market and we are proving the complementary nature between our technology and drug-coated balloons and we believe we will draft on the wheel of those large companies in a very successful way.
Let me go a little bit deeper here, because I think it’s very relevant the way the PHOTOPAC study came about was very natural and very organic. There were two physicians in Europe one in Switzerland, one in Italy. They had no communication with the company, they had no communication with one another and they both recognized that patients ISR patients in-stent restenosis patients that were being treated with drug-coated balloons were continuing to come back for re-treatment in their lab. And they hypothesized that maybe debulking first would be beneficial to drug deployment. And they further thought about the morphology of the lesions that are inside of the stent and they contemplated what technology is going to work best when you have a watery lesion one that’s rubbery thrombotic what technology is going to work best and they both they came again independently to the conclusion that laser atherectomy would be superior, so they have done this. And they noticed that those patients were no longer coming back and this data in the case of Switzerland has been published, in the case of Italy is eminently going to be published. So we’ve proven in those centers that this works as a result of that we increased the size of the PHOTOPAC study and this is an enormous opportunity for us as we move forward.
James Francescone - Morgan Stanley
Okay and just sticking with PHOTOPAC for a minute as you said you increased that study to around 150 patients from 50 previously, what is the timeline of how that trial develops going forward?
Scott Drake - President and Chief Executive Officer
Yeah, the – so this decision was made relatively recently in the April-May timeframe of this year to really expand the size of the study both the number of sites and the number of patients. So, the vast majority of our work right now was getting new sites up and running. We haven’t talked publicly about when we think we’ll be able to fully enroll. It’s hard for us to predict that because we don’t have those incremental sites up and running, so for us to give false precision on that I think would be inappropriate. Certainly that will come after we get the indication via the EXCITE study and we think this has build really nicely over time.
James Francescone - Morgan Stanley
Okay, one the EXCITE study that is the structure of that trial is a little bit unusual, can you talk about how you have been able to leverage the prior work that you have done in the PATENT study to use that work in the EXCITE study?
Scott Drake - President and Chief Executive Officer
Yeah, happy too, so the EXCITE study for those of you that aren’t aware, it’s laser atherectomy followed by balloon compared to balloon angioplasty alone and the delta that we achieved and demonstrated in the PATENT study is very much what we anticipate seeing in the EXCITE study that’s why we are so confident that we’ll be able to achieve the indication. So, fundamentally that’s the construct of the study. And statistically the more similar the outcomes are between PATENT and EXCITE, the more that we’ll be able to borrow the PATENT data as we work to achieve the indication as quickly as possible. And again for those of you that are a little less familiar we reached an agreement in the May timeframe with the FDA on EXCITE that we would have multiple looks at the data, very important to maximize the speed with which we can get the indication. And number two not have to wait for six months follow-up for all of the patients, so we would be able to once we achieve the statistical end point be able to file the 510(k) essentially, immediately and gain approval and get the indication.
And as we’ve been saying now for over a year we expect the timing of that to be able to market on label mid ’14. And so as we’ve discussed so far the data sets that have been shown publicly have been very supportive of this therapy. That said, enrollments in EXCITE has a times not quite gone as fast as the (indiscernible) expected it to go. Where are we in enrollment in that trial right now, what have been the obstacles or headwinds to getting faster enrollment and are we starting to see an acceleration in the trial enrollment? Yeah, I think the punch line here is yes. First of all, we should acknowledge that it’s been slower than we would like it to be and slower than we predicted at the outset, but you saw last quarter when we announced our earnings that our enrollment rate had increased by about 50%. And this is primarily due to two things.
One, we have gotten smarter about how to manage the physicians that are in the study and what we recognized in conversations with them is that they see very clearly what happens with balloon angioplasty alone and the results are very poor. And when the patient would ask them about being a part of this trial, what happens to me doctor if I get randomized into the control arm, they would get weak need with their response there and that dramatically slowed down our enrollment rate or was an inhibitor to it. And we actually called them into my house. And we had a meeting in my basement in Colorado and we said hey, look you guys number one thing you guys want is randomized controlled data. You can’t get weak need here. We have to prove this even though you have a very clear hypothesis we have to prove it. And we are spending $9 million to prove it. And since that time, you see an increase in the enrollment rate and the other thing that’s driven it is we have some new sites that have become active. I’d highlight one not too far from here, Yale where Dr. Carlos Mena is. And we have had some very prolific sites come online here lately. So those are the two things that have driven it and the enrollment rate is pretty consistent now over the past several months.
James Francescone - Morgan Stanley
And then as you finish that on ISR, two questions on commercialization, how have you thought about from a qualitative or quantitative perspective, the investment required to support that launch in addition to sales and marketing? And two is there an opportunity for incremental reimbursements, if you get that indication on the label
Scott Drake - President and Chief Executive Officer
Yes. First, regarding the commercial opportunity there, I will give you kind of big picture and then I will maybe give you a way to think about it. So again 250,000 procedures worldwide and only considering the laser catheters here, no other pull through from a device standpoint. If you take that 250,000 times a $3,000 catheter, you are looking at three quarters of a billion dollar opportunity. And I don’t think that’s overstated. You could discount that a bit for where our installed base is although I do believe this will drive the installation of lasers across the world. So you are looking at something less than $750 million if you put that lens on it, but you know a very reasonable way, I think rationale way to contemplate what this means to us. We have got about 20% share currently in the atherectomy market. So, if you just take 20% of that $750 million market opportunity over the two, three-year horizon, I think that’s a very reasonable way to contemplate what this means to us commercially. So it is an extraordinary growth driver for the company. You might want to calculate in there that the two competitors that we face most notably Covedian and CSI are contraindicated. So we have the label. We have contraindication by our two primary competitors. We have a compelling value of clinical evidence and we should be running downhill on the opportunity. And because of that we see adding to the sales force both in the U.S. and globally incredible opportunity there.
As it relates to an increase in reimbursement, it is very reasonable given the durability that we have seen in Switzerland and in Italy that there is a shot at doing that. We can treat patients better, let me put the endovascular market into context and this opportunity into context. Today, taking the U.S. market alone, there are about 150,000, 160,000 amputations per year. Between 60% and 70% of those amputations according to the Sage Group are not proceeded by very simple diagnostic work that would tell us that the patient could be treated better with an endovascular procedure and preserve bypass and amputation later if necessary and we would save the tax payer huge dollars by treating patients better in this way because amputation is more expensive than endovascular procedures and the follow-on care is very expensive post-amputation mortality and morbidity are (indiscernible) as well. So, we believe that there is a great healthcare economic story that goes along with this improved clinical story, but it’s early to project that we’d be success getting increased reimbursement, but it is clear that we can treat patients better and save tax payer money throughout the world by doing more endovascular procedures.
James Francescone - Morgan Stanley
I think that was about half way through, any question from the audience?
Question-and-Answer Session
Unidentified Analyst
Is there any – with some product programs now companies are bringing CMS in earlier to the process, the FDA is that something you’re looking to do just make sure you get reimbursement more easily and a lot of these patients will be (indiscernible)?
Scott Drake
Yeah. So from an FDA perspective we’ve been partnering with the FDA very, very closely which was necessary to be successful with the adjunct analysis that I mentioned and we were successful with that announced in May timeframe. So we have been working very closely with them on that front and I think the collaboration has been effective. As it relates to reimbursement, it’s really important to point out here that reimbursement on both sides of the business, but on the vascular side specifically I think to your question is very favorable to physicians. It’s a compelling part of the story here.
Unidentified Analyst
And to that point on reimbursement?
Scott Drake
Yeah
Unidentified Analyst
CMS recently announced a proposed rule that would make the reimbursement in the physician office environment a little bit less favorable?
Scott Drake
Yeah.
Unidentified Analyst
And that I believe that there has been certainly a mix shift in that business for you towards the office environment probably partially as a result of the existing favorable reimbursement, is that with the understanding that it’s difficult to predict what the final rule will be just from the proposed rule, what would the impact be on your business where about proposed rule to be finalized?
Scott Drake
Yeah, great, so to put it in the context for you here, about 8% of our total revenue is in the office-based arena that we’re talking about here. So I wanted to share with you the context of that if the proposed rules went into the effect and we do believe there is a credible chance to improve from what the recommendations were. I would characterize the reimbursement going from outstanding to very good give you some data. If atherectomy and balloon angioplasty are used, the physician with the propose reimbursement still makes using our products about $3,000 per procedure.
And these procedures are roughly 90 minutes long on average. So still making very good money in that arena if a stent is deployed and atherectomy and angioplasty are used, but you’re simply adding a stent and that takes on average between 5 minutes and 10 minutes to deploy a stent. The profit to the physician, not the total reimbursement, but the profit to the physician in the office based setting is about $7500. So it’s still very good reimbursement albeit less than it was previously. We have talked to dozens, dozens of our customers that are in the office based setting to a person they are looking at ways that they can accelerate the number of cases that they do to make up any gap if you will. And if you think about it that’s not very surprising because these are both physicians and capitalists that are doing this, right. They have put $1 million to $2 million on average of their own money at risk opening up these labs and it’s quite a natural reaction they would try to close that gap by doing more procedures of being more efficient in the lab. And that’s where the cost differential between us and the competition is very important. The cost of one of our catheters from an ASP perspective is in the $2200 to $2500 range and the competition is low $3000 to $3500. So we’d like that physician, so as pressure increases I think the difference between us and the competition is even more favorable. So we are not overly concerned. We think frankly the street hasn’t roughly wrong right now, but that line itself out over time. And the other thing I would point to here is the number of physicians that are opening labs, since they’ve known about the CMS proposal and there has been no shortage of them and we don’t see anybody slowing down on that front. So sorry for the long winded answer, but I think given the reaction it’s probably we are spending a little bit of time on.
Unidentified Analyst
How should we think about the sales force expansion and the impact on financials and if you can talk to a little bit about productivity of your current sales force and how long it takes to line up?
Scott Drake
Yeah, so productivity of the sales force over the past couple of years has increased very nicely and Guy you may want to chimed in on some of this. I would think of the sales force expansion first coming in very early of ‘14. Second really adding few to the growth drivers that I talked about earlier on overall little impact all of those. Third it will have the short-term affect I will think in terms of two or three quarters of SG&A maybe increasing as a percentage of revenue but after that SG&A decreasing as a percent of revenue leading to more meaningful leverage given acceleration and growth rate overtime.
Unidentified Analyst
Any comments.
Guy Childs
I would say is roughly six to nine months for sales professional that would be cover the cost and more like 12 months to 18 months for them to be nearly fully protective. So, we’ve done this before between ’04 and ’08 we tripled the size of the sales organization managed to be financially responsible at the same time and there is a pretty clear return for this investment. We manage the stay profitable in the mid to investing for growth in over the last several years, this year’s its R&D focus. And we think we have the R&D investment roughly righted 14% of revenue that’s help from 12 last year. The sales force expansion is the next investment and completion of that as well as getting a couple of quarters into the ISR launch. We think is a key catalyst to merging operating leverage in the business.
Unidentified Analyst
(Question Inaudible)
Scott Drake
We’ve not talked about the number of territories not interest sure that with our competitors, but it’s reasonably sizable and come guidance time will share with you what we think the specific impact of the – on the P&L. The one thing that we had that’s maybe heartening to you, we have emphasize that we are kind in the way of our growth given the relatively small footprint that we have commercially.
And we announced the test that hypothesis with the best company that I am aware of have been in sales force optimization they came in did very expensive work and really validated our thought that expanding the sales forces is major growth driver for us. So, we validated this externally were building the right messaging and market development work on both sides of the business making sure. We have the right management team to really benefit from and leverage the sales force expansion. So, this is been very thoughtfully done over very long period of time then we are really leaning into outcome beginning of the calendar year.
Now let’s switch gears just for a minute away from vascular and to the other half – roughly half year business, lead management. I think there has been perception here perhaps not entirely correct that the reason growth in that business has been associated with one highly publicize, highly visible quality situation in the CRMs space. I mean what extent is that correct have you seen of both of business the associate with that event. What are the opportunities for you to maybe leverage that situation into a broader awareness of the important for lead management.
Guy Childs
Yes, you bring up the great point and I think this market by enlarges pretty fundamentally not well understood and people hypothesized that in the 2007 timeframe when another CRM player had a quality issue with one of their leads that was the catalyst the business growth and here more recently another large CRM company has had a problem with one of their leads and if you look at the CAGR of our business over the past six years and is incorporates both of those quality issues. You don’t see a perceptible bump-up in our business in fact it’s a pretty steady CAGR over the past six years of 21% growth in the business. So, lumpy a little bit from quarter-to-quarter and as you would expect nothing other than Ponzi scheme go straight up so a little bit lumpy, but what’s really driving this business fundamentally and this will continue to be true for very long period of time. Younger patients were being implanted with devices and those patients are living longer and so the physician is being confronted more times in that individual patients life with the decision of what do I do with the hardware that’s left inside and we know for a fact that those physicians that exclusively cap leads and don’t either extract or refer appropriately for extraction. They are providing suboptimal patient care and in fact in the case of infective leads and less than a third of them are extracted that’s a legal condition for the patient.
So, those are the fundamental dynamics and as these patients are living longer infection rates are going up. So, that’s what’s been driving and that’s what we’ll continue to drive it out into the future and one thing that may be interesting to keep your eye on as CRM companies are launching more sophisticated MRI conditional devices. The focus has been on de novo implants and that focus will shift overtime to replace to the replacement market. That is about an order to magnitude growth driver of this business because in order for the patient to benefit from that MRI conditional device we have to take out all of the hardware so, very interesting catalyst two, three years down the road.
Unidentified Analyst
Today have you actually seen a lot of physicians that are willing to switch the patient who already – with the replacement device to an MR conditional device and undergo the additional risk of lead extraction.
Scott Drake
I would say the short answer is no. It’s a very small part of our story today, but we think given what the big CRM companies are doing that indeed will happen and I think what physicians are appreciating more is the relative risk of all of these different considerations that we are talking about. There is a risk to extraction, very small risk, but there is risk, mortality rates are about 0.3%, adverse event rates are about a 0.5% much lower than for example ablation procedures. There is now a very clear emerging view that there is risk to capping especially when you have multiple leads left inside. So, this is a fundamental dynamics of this business are changing and those are you that attend HRS if you saw this year, they had a full day lead management symposium and they required overflow rooms and if you went to HRS five years ago, anyone then talk about lead management there will be 10 guys in a room and it was either before after the show started and now with the central part of the calendar for HRS and it’s becoming a central issue from a clinical standpoint. So, we are benefiting from that and I believe the impact of that is going to be measured in quarters and years and decades not in days so, we love the position that we’re in here.
Unidentified Analyst
One last question, profitability and leverage, right now about breakeven may be a little better if that even get up to a mid-teens operating margins over the long-term certainly reasonable given you got 70% gross margins. How fast can you get there and what are the key variables either positive or negative that will make that shorter or longer.
Scott Drake
Yes, I think the – you are looking at exactly the right way, what we said at the beginning of the calendar year is that in the mid-term, we would see a emerging leverage and then in the long-term we would see meaningful leverage and I think the first stop is kind of the mid teens that the model actually sets up much better than that, but we want to say on the right side of what we are saying to investors. So, few things we are going to drive it, one accelerating top line growth, two, we believe in that long-term environment we can get to high 70s gross margin, and three as we put more products in the bag and have more indications that just represents the leverage to the business over time. So we are doing it organically, but we are also looking in a very disciplined way about M&A opportunities that fit right into the bag and the call point that we have today.
James Francescone - Morgan Stanley
Perfect. I think we will have to call it there, but Scott and Guy thanks very much for being with us.
Scott Drake - President and Chief Executive Officer
Thanks James.
Guy Childs - Chief Financial Officer
Thanks James.
James Francescone - Morgan Stanley
Thank you all.
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