Artivion, Inc. (AORT) Earnings Call Transcript & Summary

Thank you, everyone, for joining us for this session. I'm Seth Damergy, I'm a Managing Director in the banking group. And I'm pleased to introduce our next team here. So with us today, we have Artivion. It's a NASDAQ-listed medical device company that's undergone a significant transformation over the past 5 years. And I'm pleased to host this event with Pat Mackin, CEO; and Ashley Lee, CFO of the company, whom I've known for quite some time. So I'm going to lead in with questions. I think you all know how to ask questions through the device -- the QR code -- and just feel free to send any across.

But I'll start off, Pat and Ashley, with just macro questions to kind of set the stage. I mean, I think we're all hearing about inflation in the news every day. So I thought, at least let's start off with your business. And how do you guys see just inflation in general impacting your business, whether it's through supply chain or whatnot?

Yes. So I think it's -- the headlines you read in the newspapers translate kind of one-to-one to what we see, right? So you're seeing labor rates going up to remain competitive. You're seeing supply chain costs, suppliers raising prices. And the net of that is obviously, costs are going up from us on product. So we've -- we're not passing it all on to the end-user hospitals, but we are definitely passing on price increases as we speak. I don't know if you want to add anything to that?

No, no. I think that you pretty much hit it.

So with the pass along, I mean, maybe help me understand it. So you have GPO contracts, you have...

We don't do a lot of GPO contracts. We have actually very few things on GPO contracts.

So direct sale to the hospitals are easier to pass it along.

Yes. I mean I would say the difference is that we -- depending on where you are in the world, if you have tenders in Europe that are 3 years long, you're kind of stuck. In the U.S., we have like rolling like 1-year contracts. So you have to wait until they roll through. But as they come through, we're definitely updating them. But we don't have very many GPO contracts at all.

And then you mentioned labor, too. Obviously, your procedures or a lot of these endovascular procedures, they're all critical care, cardiac procedures. Are these labor shortages as you see it, are they impacting volumes here in the U.S., in Europe? I mean, have you seen any kind of...

Yes. So it depends on where you are in the world. The one thing that I think has helped us throughout the pandemic and I think even today is the reimbursement on the procedures that we're in are extremely high. So if you talk to hospital administrators, they really kind of do what they can to make sure that -- and they're also kind of a life saving, life threatening type procedure, right? If you don't get it done, you have a problem. So, one, is there's a critical need from like a life saving standpoint, from a patient, but two, they also tend to be the highest reimbursed procedure. So if you're an administrator, you want to make sure those get taken care of. So they'll actually move people around to try to take -- now it doesn't always work when COVID, the January, February, Omicron breakout was really more of a staffing issue than a ICUs being filled with COVID patients, right? We definitely felt that and we talked about it on the Q1 call.

That's fair. I mean, and I think it's consistent with what we've heard, hospitals wanting to make sure that they preserve the most profitable procedures, because I mean, there obviously are a lot that they're taking in on the chin. You talked about -- well, you talked about supply chain. Any stockout issues or anything in the supply chain that you think...

No. I mean we tend to -- as part of our strategy, it uses some of our cash and ties it up on the balance sheet. But because the majority of our products are PMAs, forget about the whole supply chain issue, if you have any problems on the supply chain side, it takes time to test a new supplier, to get it approved, you have to go through the FDA. So we tend to actually hold quite a bit of inventory of raw materials. We always -- I mean, there's a lot of noise in the system. We have not really been hit on anything. I mean kind of under the radar, there's always kind of stuff going on, but we're able to manage it because we manage kind of our raw materials pretty closely.

Okay. Well, and you mentioned PMA. So this is opportunistic, right, a banker gets to actually play research analyst. So you've had a number of M&A processes where, I guess, you've added inorganically through M&A. It seems to have treated you well. You've got a full robust portfolio of products. And how do you think about M&A in the future? How do you think about where things stand as far as the portfolio composition is concerned and use of capital?

So we've got a very full portfolio. We can basically treat patients from the aortic valve all the way down to the iliac artery. We have 6 PMAs in the works as we speak, either 2 under review at the FDA, 2 in clinical trial, and 1 about to start and then 1 going to start next year. So really kind of an ongoing kind of layering of PMAs over time. And then we have more behind it from all the acquisitions we've done. So we really don't need to acquire anything. We're always looking at kind of ancillary technologies that might make a procedure faster, easier, safer. But as far as the platform, buying a company, right now, we've got basically all we need and to provide double-digit growth for kind of years to come.

On that point, that makes sense, too. And frankly, I don't know any company your size with that many PMAs. So it's remarkable. I was going to say on the growth point, you mentioned on your first quarter call for BioGlue that with MDR, MDD, the re-registration hadn't necessarily played out yet. That it potentially could have an impact in Q2. Is this impact something you think is going to persist throughout the rest of the year? Like how are you managing the...

Yes. This has really been -- I mean, for those who haven't been paying attention to the kind of MDD transition, medical device directive, transitioning to medical device regulation. Unfortunately, one of our notified bodies basically decided to kind of get out of the business at the end of -- when MDR came out. So we had -- they kind of dropped us along with a bunch of other people. So we had to go find a new notified body, which we did. And then with COVID going on, your notified -- new notified body has to come inspect your facility, which for BioGlue happens to be in Atlanta. So they were supposed to come inspect last fall. They didn't because of COVID, they kicked it to June. So obviously, next month. And so now we're in this kind of like CE Mark expired at the end of December. We've had inventory in the market to cover us, but we're kind of running out of time. So there's this unique process called derogations, where you can actually go country by country where they'll give you a short-term kind of approval to sell the product while you're waiting for your CE Mark. It's really administrative, frankly, there's no issue. I mean, what's ironic about this is BioGlue has been commercially available for 20 years. It's sold in the U.S., Japan, 100 countries around the world. We have no product problems. It's literally a paperwork issue. On the earnings call at the beginning of May, we basically signaled to people that we've been going through this derogation one-off country by country to try to get a kind of a bridge to the CE Mark, which we think will come in the third quarter. And we hadn't gotten a lot of feedback from a lot of the country. So we -- I mean no one's ever done it before. The good news is we've actually had some very positive news since our earnings call. We've heard good -- I'm not going to get into country specific detail, but we've had a number of positive responses from big countries in Europe that's going to lessen kind of the impact of what this could do to Q2 and Q3, but this is still going to play out for some of the other countries we're still going after. So it's still going to have an impact. But it's nowhere near what we thought it was going to be.

I mean, that's great. So actually, that's -- so lessening impact and potentially something that, knock on wood, could be entirely behind you as you work through all of the...

We think that they come inspect in June, summer holidays in Europe. I'm not going to be aggressive on how long it's going to take them to write up the reports. But I think the third quarter is probably realistic. So that to me, when that happens, then all this other stuff just goes away. So we think sometime in the third quarter, whether it's early or late in the third quarter, trying to predict what regulators do is a tricky business.

So -- okay. And I mean -- I mean, is -- maybe I'm off. But would you factor in potentially a tailwind then as this starts to come off? Obviously, right now, nothing's like baked in, but...

Yes, it could be. I mean, I think once -- and we have supply, I mean, this is not a supply problem. We have ample supply. And the fact that we got several big countries is going to help a lot. But we're kind of ready to go as soon as that CE Mark comes back online.

Okay. Maybe if we talk -- if we continue with Europe. So Europe is obviously a market where you've got a huge sales force. You've got the -- not the entire portfolio, but a large part of the portfolio in the market. It's kind of, I think, as an investor, it's kind of steep preview of what to come in the U.S., albeit at a -- maybe in a better market financially. So how do you feel about this portfolio that you've constructed? Are there gaps? Are you seeing a lot of synergy across the portfolio? Have you got a lot of unique products in there as well? How has it come together? And how well are your reps equipped to fight for share in the market?

Yes. So I think in speaking, I'll let our customers, whether it's a cardiac or a vascular surgeon, be the judge. I mean we've launched a number of innovative new technologies, many of which nobody else has. Our AMDS for acute type A dissection, which you actually know well, there's no other product like it in the market. We just launched last year a off-the-shelf 4 branch thoracoabdominal stent graft system, which nobody else has got. Both are doing extremely well. We've got a brand-new frozen elephant trunk, second generation product that's doing extremely well. So we're getting really good traction on these platforms. We had 34% growth in our stent graft franchise last quarter. We had 30-plus percent growth the quarter before that. So -- and we're also starting to see expansion internationally. We just got our AAA product approved in Australia. We're getting approvals as -- part of our strategy is expansion in Asia and Latin America, with just new product approvals and then putting feet on the street to support that. So we're going to see nice growth. We've projected over the next few years, mid-teens to 20% growth on that franchise kind of on a consistent basis.

And your -- I mean, I know the TAM has grown substantially over your kind of 7-year tenure. I know you did a nice job of laying that out in the Analyst Day. But the market's not growing 30%. So you put together a management team in place -- how are you outgrowing the likes of, I don't know, Medtronic, Gore, the big guys?

Yes. So I mean we have a different portfolio, right? I mean if you think about where we -- it's kind of an asymmetric portfolio, right? We -- Medtronic -- and I ran that business 20 years ago, it was AAA and thoracic. They really didn't have anything else. We have those devices, but where our growth is coming from is in between the branch thoracoabdominal, the iliac, the arch. We saw the arch as kind of the final frontier of stent grafting, which is the ability to treat with a catheter or a hybrid surgical operation, treating that arch is something that really nobody has done. And it's kind of a wide open field and we're the leader in the space now.

No, I mean it's -- like you said, I think it's just a different way to think about it. And maybe just help me understand why with this type of TAM, with this type of innovation in that market why aren't these bigger companies focused there? I mean, how can you outflank them?

Yes. I mean, I guess part of it is a little bit of a challenge, because 2 of the bigger players in that segment, Cook and Gore, are private, so you don't really get a lot of information out of them. And we know what they do in the marketplace. Some of the other companies, they're so big -- a $500 million TAM on the AMDS devices at 90% gross margin is a big deal for us. It's a rounding error for some of these other companies, right? So I mean, for us, we can put together a company that can grow for a decade in some, call it, in '25 when these 3 next PMAs come forward, rapidly accelerate our growth, because we'll be $400 million at the time, right? So the ability for us to grow very rapidly off of our base compared to what these other companies do, it's very different for us.

That's fair. Well, Ashley, we've got to get you into the game here, because I got to ask you at least a financial question or five. I mean, at the Analyst Day, right, you talked about -- well, maybe before we get to the Analyst Day. So we talked about the portfolio, you've constructed it, it's come at a cost, right? So there's a lot of investors that look at leverage and kind of say, okay, well, you're at this higher point of leverage. Can you talk us through how does the company delever over the next couple of years? And I know you referenced $75 million to $80 million of EBITDA by 2024 at the Analyst Day. Take us through the levers. Is it cash flow? Is it margin expansion? How do we get from A to B?

Yes. So first of all, with -- we expect revenues to grow 10% over the next 3 years, which puts us at about $400 million of revenue. We also expect margins to expand about 200 basis points from about 66% to 68% by that time frame as well. We -- over that time frame, our investment in Asia Pacific and Latin America should play out in late '23, early '24. The investment in our pipeline is probably going to be somewhere in the $40 million, $45 million range. We expect it to be anywhere between 13% down to 11% of revenues over that time frame. And because of that, we expect both cash flow generation to increase significantly and leverage to go down over that period.

In that getting to the $400 million mark -- I mean, I've heard you guys say a number of times, the high number of 90% or high-margin products that you have, is it safe to say that, that mix is coming -- is the mix shift coming from those high-growth products or the high-margin products, generating a lot of...

Well, I think one of the things -- and Ashley kind of laid the P&L out for you. What's unique about this business, which I don't think a lot of people -- a lot of -- I've run a lot of bigger businesses that you have to scale your sales force with your revenue, right? You just have to keep having feet on the street. Interventional cardiology sales force in the U.S., you need like 200 or 300 reps, right? So we can launch the 3 PMAs that are in the pipeline -- 2 of them don't need any new reps. It's $1 billion worth of 90% gross margin revenue with no new reps. And there's no competition for either product. So it's not like I'm going to be the fifth player into an $800 million market and have to fight for share. It's like we'll be the only ones with a PMA with a 90% gross margin and I don't have to add reps. So the drop-through from the top to the bottom is like a one-to-one. So I think that's what's interesting that I don't think most people appreciate about this business is, that we've been building the infrastructure of the business to when we get to $400 million, we're kind of at scale and we don't need to add any more reps. So all that incremental pipeline revenue, that's all 90% gross margin. Really, there's no -- there's a fixed cost on your income statement. R&D goes down, gross margin goes up, revenue goes up and your sales force is fixed. So I mean, the profitability will accelerate rapidly.

So then post $400 million, it's safe to -- I mean the leverage it starts -- that's a huge inflection...

Disappears.

Yes. I mean we expect it to drop from about 5.9x exiting '21 down to less than 3 as we get into '24. And then as Pat said, once you get AMDS approved in the U.S. as well as PROACT Xa, we think that we'll just be in great shape at that point.

So maybe take us through from a, I don't know, we'll say, competitive dynamic, but the beauty of PMAs and IDEs is there's visibility into what your competitors are doing. Do you see any one else or anything else on the horizon that's really going after aortic dissections or these FET procedures? Is the -- are there any of the other big guys really you're doing it? Because like you said, they're private, but they have to file their...

Yes. So if you look at the portfolio, AMDS, acute Type A dissection, that clinical trial is about to start kind of any day now. We're waiting for final approval. We've got a super strong patent portfolio. There's nobody else in the field. So the other thing from a clinical risk, which you talked about is the U.S. trial is 100 patients. This is a very -- as you know, a very extreme disease state. Half the people are dead in 2 days. We think this has a life-saving impact on patients. The European data was 50 patients. The U.S. trial is 100. We've done 100 patients in one center in Berlin. We know what the device is going to do. So I think that the -- we got to do the trial, and there's always risk when you do trials. But I mean I think the trial's heavily derisked. It's a little bit the same for the NEXUS device. There was a 30-patient trial in Europe done for the first in man to get the European approval. The U.S. trial for chronic dissection is at 60. So these aren't like -- I worked in biotech, it's not like your Phase I, II, III. We've actually seen how these devices perform. So I think the risk in the pipeline is not that high.

Yes, I think -- I mean what I didn't appreciate and I've heard you and I think others say, especially on AMDS is because patients that have these dissections can die so quickly, you have to have them on hand in the hospital. And hospitals are willing to stock them. I mean it's like a life-saving therapy, which is kind of a new -- it's a bit of an anomaly for a med tech product where there's usually an abundance of competition. So I think at least for me, maybe that was lost in the past, how unique your portfolio really was.

Right, if you look in some of the -- let's say, let's pick the 3 PMAs, actually 4 of the PMAs, one, the PROACT Mitral, the ability to lower the INR for a mitral valve. There's nobody else is doing it. We're going to get PMA -- again, we're working through it. We should get PMA approval in the second half of this year. No competition on low INR mitral. Next device will come AMDS, no competition. Next device is PROACT Xa, no competition. We've enrolled over 700 patients in that trial. No one's even started anything. They're years behind us. The game will be over. The NEXUS single branch device in the arch, 1 competitor, Gore, has done a trial with a single branch in the arch. So -- and in fact, I mean, having 1 other player in this space isn't necessarily a bad thing as you build the market. So as a smaller company, we do not, from a strategy standpoint, like going up head-to-head against a big player with a me-too. And if you look at -- frankly, if you look at what we've done with the On-X aortic valve, I mean we've taken 30 points of market share from Medtronic and Abbott over the last 5 years.

Yes. I was going to say, I mean, I think On-X is an interesting example, because like you said, I think when you acquired the business, maybe there was some question around that end market, and you've continued to outgrow the market and take share. So I think that's -- it's just interesting to see how -- when you're focused, you can actually do that. That's fantastic. Maybe if we kind of think about the here and now, you said from an M&A perspective, you tuck-in assets where you maybe see them fit. Do you really -- I mean, but are there really any needs right now? It seems like your best capital is deployed towards R&D and...

We always -- I mean, because we're in the market, I mean, one of -- a big component of our strategy is just the surgeon engagement on what do they need to treat their patients better to get better outcomes. So we're with them all the time. And stuff will come up. And as I mentioned earlier, AMDS or the frozen elephant trunk, Neo or NEXUS, these are platforms. These are entire companies that you can build on a platform. I think what's interesting is there's some ancillary things around those devices that will make it easier to put them in, make the procedure faster, because one of the things that is interesting about -- look, so the frozen elephant trunk, they literally replace your aortic arch, right, from above your aortic valve to below your subclavian. They take your entire aortic arch out and put in a replacement, a stent graft with a surgical graft. The time on the pump is outcomes. The longer you're on, the worst the morbidity. So if you can make it faster, make it easier, right, you actually improve your outcomes. So I think that's where we're around the efficiency of the operation, not because we got Deming here doing time and motion studies. But literally, if you can save 20 minutes of a pump run, less strokes, less bleeding, less everything, right? So I think that's where we're at. We're at here to make the procedure better and the outcomes better. Part of it is that device. And the next step is the ease of use and the speed at which the surgeon can put it in. So I think that's where we focus on ancillary technologies. They're not companies. They're things that augment the procedure.

Understood. Yes. So I mean when we -- because I think that's one of the things that there's a lot of that like these are novel technologies, and they haven't been introduced in the U.S. And you referenced all these cases in Europe. So I mean that gives you a lot more comfort on being able to deliver NEXUS, AMDS and all these different products.

For sure. I mean, again, we're doing it every day. We -- the U.S. clinical trial for AMDS is 100 patients. We've done 100 patients in one center in Berlin.

That's fair. I mean, so again, I sit here and your EV is, I guess, about $1 billion. Like everyone, you've sold off at the market. I mean what do you think is maybe not that well understood with the market, if any, by the market of Artivion, if anything?

Yes. So I think there's a handful of things, right? I mean one, the pandemic didn't help anybody. And we're not making excuses. We grew every quarter in the pandemic except for Q2 of 2020. So we actually grew during the pandemic. I think it shows what I was saying earlier about, these are life-saving, life-threatening diseases people have that need to be treated. Two, they're very profitable for the hospital. So they're going to try to get resources when resources are constrained. So COVID did not help. Number two, we're kind of in a transformation, right? We're transforming from a low single-digit grower with BioGlue and tissue valves to a double-digit kind of aortic device company. And you got us kind of in the -- we're in the middle of that transformation. We posted 13% growth in Q4, 11% growth in Q1 -- even with the COVID outbreaks in the U.S., we actually had a phenomenal quarter, except the U.S. was down. So I think part of that is the transforming from what we were to what we're going to become. And you know better than I do, investors don't give you a lot of credit for stuff that's a year away, let alone 2 to 3 years away. And so we think we can grow double digits in the next 2.5 years, before the big pipeline hits. And if you look at the valuation today, I mean, it's a pretty good deal just for here and now for the next 2.5 years, before the $1.3 billion of 90% gross margin hits. So I think that's been one of the things, people -- everybody gets the pipeline. I think people are kind of like, well, are you guys going to able to grow double digits in that time frame. And then the leverage we already talked about, right? Some people don't like the higher leverage. And the fact of the matter is, and you know this as well, there are very few small cap med device companies that are profitable, right? We actually were able to fund and use a capital structure of debt, instead of equity, so we didn't dilute our shareholders. We don't need to raise any more money. We're not planning on buying anything. We just execute. We don't need cash. We can fund all of our R&D, all of our expansions in Asia Pacific and Latin America with our ongoing cash flow and service our debt. And so I mean, to me, it's -- I understand some people have screens and those kind of things. And we're going to delever rapidly over the next few years. So this is going to be an interesting -- over the next 2 years, if we're posting double-digit growth, expanding margin, expanding our EBITDA, growing our EBITDA and delevering, with the pipeline getting a quarter closer every day, at some point, something is going to happen here.

That's fair. And I mean, look, so all that changed, I mean, Ashley, we're fortunate enough to have someone who's actually lived through all of it, right? So from what the company was to what the company is today. I mean from a CFO's standpoint, the predictability of the business model and delivering quarters and these optics into '24, I mean how predictable is your business? And how confident do you guys feel about your ability to continue to take share and grow the business double digits?

Well, I mean I think that we kind of communicated that in our shareholder meeting on March 23. I think that the company is probably as well positioned as we've ever been, since I've been there, and I've been there an extremely long period of time. But we've got a great level of confidence. The portfolio is set. As Pat mentioned, we don't really need to add anything. I think all of our investments that we're making in international markets and channels is starting to pay off as evidence as what you saw in the first quarter of this year. Every quarter that goes by, we get closer to these new products getting approved here in the U.S. So I think that we're really well positioned to deliver double-digit growth. Now we -- this year, we guided 9% to 11%, 10% was the midpoint that we communicated in the Investor Day. Some quarters, we may be a little bit below that. Some quarters, we're going to be above that as we were in the past couple. But we feel very confident that we're going to be able to deliver double-digit growth over the next 3 years.

Look, I am amazed at what the company has become. And I think it's like you said, it's not just human capital and operational changes, portfolio changes, you've done a lot for a small business. It's quite material. And I mean that growth is hard to come by in medtech. So bravo. Maybe one last one. I don't know if there are any questions in the audience at all, but maybe just from our perspective, what's the biggest risk to all of this bullishness that we've kind of talked through here? What keeps you up at night? Like what do you -- is it clinical risk? Is it human capital? Is it inflation? What do you think about as far as this could derail us?

Well, all of it keeps me up, right? I mean yes, because I mean, to me, I mean there's a lot of encouraging things, right? We don't lose sales reps, right? So through the pandemic, we didn't lose any reps. We actually, correct me if I'm wrong, we had one in the U.S. leave because of the vaccine mandate, right? So -- but we don't -- we have a lot of loyalty. People believe in kind of what we're doing. Now I will say at the manufacturing line, when they can make $2 more an hour going to deliver for Amazon, that's where you're seeing it in the inflation and those kind of things. But I mean every day, we're -- there's supply chain stuff, there's inflation stuff. I mean -- so that's what we get paid for, right, is to manage that. I think the clinical risk in the pipeline, I already made comments about that, about AMDS and about NEXUS. PROACT Xa, we've enrolled over 700 patients of that 1,000 patient trial. It will enroll probably late this summer. Every quarter that goes by is -- probability goes up. That's a $600 million 90% gross margin revenue opportunity with no competition. So I think on balance, the other thing that's interesting about the company, which, again, you know -- very few companies of our size -- most companies have like 1 or 2 products in the U.S. We're very diversified. We're in 100 countries. We've got 100 reps in Europe. We've got 60 in the U.S., we've got 25 in Asia. We're very diversified geographically. We're very diversified for our product portfolio. So if you do have a hiccup somewhere, the risk is minimized to some degree. But I think back to your question, growing double digits is and executing a pipeline of 6 PMAs, that's a lot, right? I mean it's just a lot to keep on in this environment with COVID and staffing and inflation and all this kind of stuff. So I think it's execution. Really, this is just an execution story at this point.

But I have to imagine like executing those PMAs, given the lack of innovation in cardiac surgery or into vascular surgery, you're going to have all the KOLs flock to and want to be a part of these trials.

We've had tremendous, both on the vascular and cardiac side, tremendous feedback and support.

And then Ashley, too, financially, I mean, you're, I think, right, your debt stack is fixed. Your convert is kind of a fixed coupon. So I mean what about for you? What about on the financial side? What kind of keeps you up at night? Keeping Pat's spending in check or...

I mean, as Pat mentioned, like everything kind of keeps me up at night. I mean that's kind of what we get paid to do is kind of worry about and manage everything. But again, I think that we're just really well positioned right now. I think that we proved during a pandemic that we know how to run our business. And we talked about the debt and the leverage and so forth. But we can react very quickly. We know how to run the business. Now it's just a matter of execution.

All right, I don't know if there's any questions from the audience. But if not, I personally would like to thank you guys for making the trip up here. I know there is weather getting in. You made it no problem, so -- and then, look, I mean, it was a treat for me. I haven't done this in probably 13 years since I was on the sell side. So -- it's nice to actually be able to sit up and talk to...

Thanks for having us.

Thanks for that.

Thank you, everyone.