Pat Mackin - Chairman, President and Chief Executive Officer Ashley Lee - Chief Financial Officer.

Jason Mills - Canaccord Genuity Jeffrey Cohen - Ladenburg Thalmann Suraj Kalia - Northland Securities Brooks O'Neil - Lake Street Capital Markets Joe Munda - First Analysis.

Greetings and welcome to the CryoLife Second Quarter 2017 Financial Results Conference Call. At this time, all participants are in a listen-only mode. A question-and-answer session will follow the formal presentation. [Operator Instructions] It is now my pleasure to introduce your host, Pat Mackin, Chairman, President and CEO for CryoLife. Thank you. Mr.

Mackin, you may begin..

Good morning and thanks for joining the call everyone. I am Ashley Lee, the CFO of CryoLife. Before we begin, I would like to make the following statements to comply with the Safe Harbor requirements of the Private Securities Litigation Reform Act of 1995.

Comments made in this call that look forward in time involve risk and uncertainties and are forward-looking statements within the meaning of the Private Securities Litigation Reform Act of 1995.

The forward-looking statements include statements made as to the company’s or management’s intentions, hopes, beliefs, expectations or predictions of the future. These forward-looking statements are subject to a number of risks, uncertainties, estimates and assumptions that may cause actual results to differ materially from current expectations.

Additional information concerning risk and uncertainties that may impact these forward-looking statements is contained from time-to-time in the company’s SEC filings and in the press release that was issued last night. Now I will turn it over to our CEO, Pat Mackin..

Thanks, Ashley and good morning everyone. I am pleased to be here to report we had a solid quarter despite facing certain headwinds. In fact, the quarter might have been even better had we not taken steps to move to direct business in Canada and Benelux.

It was important to take these measures and endure the short-term impact to drive more robust growth and profitability in the years to come.

As we said in the past, if we can execute our objectives of establishing an experienced direct global sales force, marketing a highly select and high quality product portfolio, we will be well-positioned to maximize our growth potential. I am pleased to report we made excellent progress towards our goal. Our business momentum is strong.

Despite headwinds in our Asia On-X and U.S. BioGlue businesses and our transition to direct in four new geographies, we still met our financial expectations. On-X, BioGlue and tissue processing overall all grew in Q2 demonstrating the effectiveness of our product and sales strategy.

We expect the final decision over the coming weeks as to whether the CE Mark for our On-X AAP device will be reinstated. We are hopeful this issue will soon be behind us, which provide resolution for the last remaining issue that affected our revenue in the fourth quarter of 2016.

Gross margin was in line with expectations and we continue to see further upside potential from improved business mix and operational efficiencies.

I will now provide my quarterly review of our 2017 key initiatives, followed by Ashley, who will provide the detailed review of our second quarter financial results and then we will open the line to questions. Our first key initiative in 2017 is achieving our full year 2017 financial guidance.

In the second quarter of 2017, we delivered revenue of $47.8 million representing a 2% growth on a GAAP basis and a 4% growth on a non-GAAP basis. As a reminder, non-GAAP revenues exclude the divested HeRO Graft and ProCol product lines for 2016.

As I mentioned, we delivered revenue growth in all parts of our core business, reflecting solid demand for our products in the market. Tissue processing revenue grew 4% in the quarter, including our second consecutive quarter of double-digit growth in cardiac tissue.

Vascular tissue was down 3% in the quarter, following 6% growth in Q1 reflecting the quarter-to-quarter variability that can impact our tissue processing business. As we stated in the past taking a longer view of this business is more reflective of its performance. And through the first half of the year, tissue processing revenue was up 7%.

This is in line with our guidance of mid single-digit growth in tissue processing business for 2017, which we are maintaining at this time.

BioGlue revenue grew 3% in the quarter, primarily resulting from 59% growth in Asia-Pacific and Latin America driven by the timing of distributor orders and solid underlying demand partially offset by softness in North America and Europe driven by year-over-year decreases resulting from our strategy to go direct in Canada and Benelux as well as some competitive activities.

Importantly, revenue from our Japanese distributor remains on track with their plan to grow their business in 2017 by 20% over 2016. As anticipated, second quarter revenue was impacted by the suspension of the CE Mark for the On-X AAP product and softness in the OEM On-X business.

As I stated earlier, we expect the final decision over the coming weeks as to whether CE Mark for the On-X AAP will be reinstated. As for the non-strategic OEM business, we continue to factor this headwind into our 2017 guidance.

Regarding our second quarter earnings, we delivered non-GAAP earnings per share of $0.12 which puts us on track to meet our full year guidance. Our second key initiative for 2017 is to expand the On-X business and deliver low double-digit non-GAAP revenue growth for the On-X portfolio excluding the OEM business.

On-X strong performance in key geographies was somewhat overshadowed this quarter due to the negative impact of the AAP, OEM and performance of On-X in Asia. In the second quarter, total On-X revenues were $9.9 million and the core On-X business grew 5% on a non-GAAP basis excluding the OEM business.

In North America, On-X revenues grew 15% compared to the prior year. And when you exclude OEM, the core On-X business in North America grew 19%, up from 12% growth in Q1. Our U.S. sales force continues to open new On-X accounts with around 150 new accounts added since the acquisition.

In Europe, the On-X business was up 9% despite the headwind from the On-X AAP CE Mark suspension. We think the U.S. is demonstrative of the potential of the On-X portfolio when sold directly by an experienced sales team. We are pleased with the positive momentum which we expect to continue as our sales force opens new accounts, particularly in the U.S.

Our team is leveraging our reduced INR indication of 1.5 to 2.0 and the clinical advantages of the On-X aortic valve from the PROACT trial to attract new physicians.

Accordingly, it’s important that these results from the pivotal study were presented for the first time in a major medical meeting in May at the Annual Meeting for the American Association for Thoracic Surgeons.

This presentation is already generating further interest in the On-X platform from physicians and we anticipate this interest to continue building with the publication of these results in a major peer-reviewed journal sometime later this year. Overall, we are very pleased with the progress of our On-X business in Q2.

Our third key initiative for 2017 is to transition our sales channels in Canada, Belgium, Netherlands and Luxembourg from a distributor to a direct model. We commenced direct sales in Benelux in June and Canada as of July 1. These transitions impacted our revenue in the first half of 2017.

We expect to begin to benefit from the direct sales of CryoLife products to end market pricing and margins during the second half of 2017. Ashley will have more comments on the impact from these transitions on the second quarter later in the call.

Our fourth key initiative for 2017 is to continue to pursue future growth drivers for the company through our clinical programs for PerClot in the U.S. and BioGlue in China. In the PerClot study, we are starting to enroll at a faster pace each month.

Since restarting the PerClot study under revised protocol, we now have IRB approval at 16 sites, including full site activation at 9 centers, where we are currently enrolling in the trial. We have enrolled greater than 45 patients in this study to-date and expect 6 to 7 additional sites to be activated in July and August.

We remain on track with our enrollment rate to support a potential FDA approval in 2019. For BioGlue China, we believe we have enrolled the first patient within the next month and remain on track for approval sometime in the second half of 2019. The study will be conducted at 7 sites in major cities in China.

Our fifth key initiative for 2017 is to continue to evaluate potential business development opportunities to enhance our focus on critical mass in cardiac and vascular surgery. We see business development as an essential component of our overall growth strategy.

We have and will continue to devote both time and financial resources to discover and acquire attractive assets. The current environment offers a company of our size numerous possibilities to review. We do not have any update on this front today.

Additionally, we continue to work to secure a commercialization partner for NeoPatch and hope to have news on this by the end of the year. I will now turn the call over to Ashley for his financial review..

Thanks, Pat. I will now review our results for the second quarter. Compared to the second quarter of the prior year, total company revenues increased 2% to $47.8 million. This was primarily driven by revenue increases in On-X, BioGlue and tissue processing. On a non-GAAP basis, revenues increased 4% compared to the second quarter of last year.

The non-GAAP revenue increase was primarily driven by the same factors. Please refer to our press release for additional information about our non-GAAP results, including a reconciliation of these results to our GAAP results. On a geographic basis Q2 North American revenues, which includes the U.S.

and Canada were $35.4 million, up 1% year-over-year driven largely by increases in On-X and tissue processing revenues partially offset by the absence of HeRO revenues and by a decrease in BioGlue revenues. Revenues for this region were also negatively affected on a year-over-year basis about our decision to go direct in Canada.

On a non-GAAP basis, North American revenues increased 4% for Q2 compared to the prior year driven primarily by increases in On-X and tissue processing revenues. Revenues from our European region were $8 million, down 1% compared to the prior year.

Revenues in this region were negatively affected by the unavailability of the On-X AAP and our decision to go direct in Benelux. Revenues from Asia-Pacific and Latin America were $4.4 million for Q2, up 12% year-over-year primarily as a result of an increase in BioGlue revenues partially offset by a decrease in On-X revenues.

I’d like to spend some more time focusing on individual product lines and specifically on tissue processing, BioGlue and On-X which combined account for about 90% of our total revenues. As Pat mentioned earlier, we continue to drive improvement in our tissue processing business.

In total, tissue processing revenues increased 4% for the quarter compared to the second quarter of 2016. During the second quarter, cardiac tissue processing revenues increased 12% year-over-year on an 11% increase in unit shipments.

Vascular revenues decreased 3% year-over-year on a 2% decrease in unit shipments, reflecting the historical variability we have seen in the business. As Pat mentioned overall, tissue processing revenues were up 7% for the first half of the year, which is consistent with our guidance.

We remain confident about the overall prospects for the tissue processing business. BioGlue revenues in the second quarter increased 3% year-over-year to $16.6 million. North American BioGlue revenues were $9 million in Q2, which was a decrease of 5% year-over-year.

The primary driver of the decrease was due to our decision to go direct in Canada, which was responsible for about half of the year-over-year decrease, with the remaining due to some trialing of the competitive products which we have previously spoken about.

I would point out we have successfully competed against this product in Europe, where we are the number one market player. O-U.S. BioGlue revenues increased 15% year-over-year to $7.6 million.

The increase primarily results from orders from our Japanese distributor in an improvement in our business in Brazil partially offset in Europe by our Benelux direct strategy. We continue to expect upside in BioGlue from our expanded indication in Japan, our ongoing strategy to go direct in select O-U.S.

markets and our anticipated regulatory approval in China in 2019. On-X revenues for the second quarter were $9.9 million, a 3% increase compared to Q2 of last year. Excluding OEM, On-X revenues increased 5% compared to the second quarter of 2016.

Companywide year-over-year comps were affected by the lack of the AAP in Europe in our most difficult prior year quarterly revenue comp. But as you will see the business was very strong in our core business in North America and Europe. North American On-X revenues were $6.1 million for Q2, which represented a 15% year-over-year increase.

Excluding the OEM business, the North American On-X business was very strong posting an increase of 19%, up from 12% in the first quarter of this year. We believe this is a better indicator of the strength of the North American On-X business. We saw mixed results for O-U.S. On-X revenues, which were $3.8 million for Q2, an 11% year-over-year decrease.

Our Q2 On-X business in Europe increased 9% year-over-year despite the fact that the On-X AAP was not available for sale. Our Q2 On-X business in Asia-Pacific and Latin America decreased 36% year-over-year, which primarily results from our most difficult prior year comp and issues with the major Asian distributor.

Moving on, tissue processing revenues improved to 55% for the quarter, up from 47% in the second quarter of 2016. Product gross margins were 77% for the second quarter of 2017 compared to 70.4% in the prior year. Our overall gross margins for the second quarter were 69% compared to 64% in the second quarter of 2016.

As we move forward and continue to execute on our growth and efficiency initiatives, we expect that gross margins will further improve over the coming years. Our effective tax rate for the second quarter was 24% and was 8% year-to-date.

This rate reflects the change in accounting we discussed last quarter relating to the tax treatment of the difference between book expense and deductible expense relating to the vesting of stock awards and exercise of nonqualified stock options.

On the bottom line, we reported GAAP net income of $3.2 million or $0.09 per fully diluted share in the second quarter of 2017 compared to net income of $2.3 million or $0.07 per share in the second quarter of 2016.

Non-GAAP net income was $4 million or $0.12 per share for the second quarter of 2017 compared to non-GAAP net income of $4.3 million or $0.13 per share in the second quarter of 2016. A complete reconciliation of GAAP to non-GAAP net income and earnings per share is included in the press release that we issued last night.

As of July 17, 2017, we had approximately $55 million in cash, cash equivalents and restricted securities. We had approximately $71 million outstanding on our senior credit facility and had our full $20 million revolving credit facility available to us. The interest rate on our credit facility is approximately 4%.

With the exception of our income tax rate, we are reiterating our 2017 financial guidance as detailed in the press release that we issued last night. We believe third quarter total revenues will be in the range of $46.5 million to $47.5 million. Our revenue guidance does not include any contribution from potential acquisitions.

We have reiterated our full year guidance revenue guidance based on our expectation for a stronger second half than the first half. To put a finer point on it, Q4 will be stronger than Q3 for several reasons.

We expect to earn a full quarter contribution from On-X AAP in Europe, plus benefit more as momentum builds from going direct in Canada and Benelux. We also factored the impact of the European holiday season into the third quarter. We expect a full year effective tax rate in the mid-teen percent range. That concludes my comments.

And I will turn it back over to Pat..

Thanks, Ashley. So in summary, we had a very successful second quarter that demonstrates we are on the right track for taking CryoLife to the next level. On-X, BioGlue and tissue processing overall all performed in line with expectations and continue to have positive momentum in the market.

Our sales force is now well-versed with our product portfolio, which is leading to increase productivity in growth. The core On-X business is performing well, particularly in the U.S. and we still have significant opportunity to introduce the On-X valves and clinical data to a large number of cardiac surgeons.

Outside the U.S., we enhanced our sales organization by transitioning to a direct team in Canada and Benelux. Overall, sales will benefit from the continued strengthening of our global sales channels, which further enhance our ability to drive organic growth, launch our pipeline products and accelerate the growth of acquired products and businesses.

As a result, we believe we will achieve our 2017 financial guidance. When I joined CryoLife almost 3 years ago, my goal was to increase the growth and expand our profitability by establishing a leadership position in specific areas of cardiac and vascular surgery and we have been able to do just that.

Importantly, we are still in the early days of unlocking the full potential of our products and sales platform. Our sales team is now better acquainted with products, people and institutions they support. We will continue to look for ways to leverage our direct sales force through our business development efforts.

Looking further out, our clinical pipeline is progressing on track and has a potential to be a significant revenue contributor. So, as you have heard today, there are good reasons for us to be excited about the future of CryoLife. Finally, I’d like to sincerely thank our employees for their contributions in making this a successful quarter.

With that, we will now open the lines for questions.

Operator, will you please open the lines?.

Yes. [Operator Instructions] Our first question is from Jason Mills from Canaccord Genuity. Please state your question..

Thank you very much. Good morning, Pat and Ashley.

Can you hear me okay?.

Yes, good morning. We hear you just fine..

Good morning, Jason..

Great. Congratulations on the solid quarter guys. Pat, I wanted to start at a very high level, what we have seen in the med tech sphere and you have been at big co, you have been at small co throughout your career. So you have unique perspective and I wanted to get it from you.

What we have seen in the med tech sphere is a heightened activity on the M&A front. It’s quite obvious what’s going on both big co buying big co and big co buying small co and then several private companies going as well.

I am just curious as it relates to CryoLife what that environment does to either help or hinder your go-forward strategy and what you are trying to do with CryoLife ever since it helps? But I just like your perspective on the environment in the medical device sphere, what you would expect to see over the next 3 or 4 years and how that positively or negatively impacts CryoLife’s ability to execute upon the strategy you have had since you started?.

Yes, obviously there has been a lot of activity and I think it is all good news for CryoLife. As we mentioned in the transcript, we have been heavily focused on customer audience which is cardiac and vascular surgeons.

Our goal since I got here was to obviously get the core BioGlue and tissue processing businesses stable in growing, which they are obviously with the acquisition of On-X.

It showed another nice quarter where we have a direct sales force in developed markets where we are growing that business double-digits as we promised, but I think it’s allowed us to really focus on the next kind of acquisition that will provide, I think, significant growth opportunity for the company.

And we have spent a lot of time focusing on that as a team and we think we have got some very interesting opportunities for us.

And I think what big companies are going to be looking for is growth and in specific areas where a company can be even a smaller company like a CryoLife can be the best in the world at a certain segment of the market and that’s frankly what we are going to do.

We are going to create one of the world’s best companies and I am not going to kind of get too much deeper into the strategy, because it will kind of give too much direction as to where we are going.

But I think that in a broad brush, we are looking to take our current platforms add some significant technologies to focus on the same customer base, which I have saying since I got here and to drive significant growth for the company and create a company that’s very uniquely differentiated in terms of innovation and where we focused.

And ultimately I think what that will do is drive significant revenue growth and margin expansion and at some point I’m sure we will get noticed by lots of people and we will see what happens from there. But I think it’s all great news for us..

So it sounds like you – given what’s going on in the med tech environment right now that the work you are doing in evaluating potential M&A from your perspective, what the other companies have been focused on sort of different from what you have been focused on, is that allowed you more bandwidth and perhaps a better environment for you to execute your own M&A? And on that same topic, what you are doing globally and going direct should that give us a clue that you are looking at M&A that not only impacts your U.S.

business and leverages your U.S. sales force, but also are you looking at things that can also leverage your increasingly direct strategy outside the U.S.? I had couple of other follow-ups..

Yes. I think one of the unique things of our company, right, is when you know, I mean I have been in the cardiac and vascular device world for 25 years. So, it was an advantage coming in that I knew lots of the players, I knew the customers, I knew the new technology. So, we have had a really tight focus on what we are looking for.

And so I think when you have that focus and you know what you are looking for and you just kind of keep looking at opportunities you eventually kind of find the diamonds in the rough and they are definitely out there. The going direct has been a stated strategy from the beginning.

I mean, there is the obvious elimination of the middleman, so you get end user revenue, end user margins like we just did this quarter in Canada and Benelux.

So, you take a quarter worth of pain as you heard in both my comments and Ashley’s comments, you don’t sell any BioGlue, you don’t sell any On-X in those markets for a quarter, but now going into the back half, we have got full end user pricing, full end user margins. So, it will help our margin, it will help our growth rate.

And you got 5 new reps selling our products and we always see a boost in revenue after we do that. So, clearly that going direct has been in developed markets – has been a stated strategy from when I got here. And to the extent that an acquisition can accelerate that, I think it’s a huge kind of a 2-for-1 if you will.

You acquired a company, you get great products, great markets, but then you can leverage their channels we can leverage our channels just like we have kind of showed with the On-X transaction. So, that’s always – that’s kind of a stated strategy that if we can accelerate or boost through acquisition we will clearly do that and do it quickly..

That’s helpful. Just quickly and I’ll get back in queue. With respect to the guidance and you mentioned that the second half looking like it should be stronger than the first half. If we take sort of the midpoint of your third quarter guidance understanding that people go long vacation in Europe and that’s a big part of the guidance for Q3.

It implies Q4 is now like your biggest quarter of the year, but on a year-over-year growth perspective against not the easiest of comp, although the fourth quarter was not the strongest for you last year, double-digit growth.

And that’s not what we are modeling in 2018 and perhaps it’s not what you have us modeled for 2018, but is the fourth quarter a better reflection of how you see this business or the growth profile of this business sort of more generally speaking going forward?.

Yes. I think it’s always tricky when you have the kind of quarter-to-quarter kind of variability. So there is two things – actually, I’d say two things in Q3 that are real and that we wanted to be transparent about. Number one is just the cyclical nature of Europe in the summer.

I mean, I think I lived over there and worked over there for a number of years. I mean when I showed up in the first day of August, there was nobody there. They take off like the time to take the month August off. So, you clearly took a lot of holidays in the summertime.

The second thing is AAP is that we have lost a $1 million, Jason in AAP in the first 6 months of the year. That has been a significant kind of issue we have been dealing with. And it’s been a tricky situation to try to predict when this thing is going to get released.

I have said that early on that I can’t really predict what regulatory bodies are going to do. We are hopeful that we will get a resolution here in the next couple of weeks, but we have been saying that for a while. So, again I can’t really tell you with certainty, because I don’t control the outcome.

We have certainly been working very hard on it, but that to me, we have already missed another month of AAP in Q3. Back, I think we are at the upper end of the guidance that we just gave for Q3. So that to me is the big pivot point on Q3. Q4, we expect more momentum with On-X. We expect the Canadian Benelux to get traction.

We have got a product launch coming up. We have got a number of things that are kind of accelerating into the fourth quarter. Our tissue procurement has been strong. So, again I think that AAP in Q3 is a big swing depending on where we are going to be in that range. And then we do expect to have a good Q4..

That’s helpful. Lastly for me and I’ll get back in queue. Your PROACT results while we have known about them and you have known about them for a couple of years now, you know about them when you bought the business 1.5 years or so ago, they were just presented at a major medical meeting for the first time.

And I am just curious what sort of impact you have seen in the business or what you might expect to see in the business from those results having been published or presented for the first time and what publication of those results might do to the psyche of surgeons seeing them for the first time? And then also you gave a little bit of an update on PROACT II, but I think we have one question that we get a lot is sort of how that trial is you are expecting to run it.

It’s a unique trial as far as I understand it. Maybe you could spend a minute to educate us again on the PROACT II trial design and framework and expediency that you might expect relative to enroll in a trial in a normal way. And this isn’t a normal trial as far as I understand it..

Yes. So, on the first question about the PROACT I, obviously the presentation at the late breaker at AATS was a big moment for the data. I think the more important – the two more important things are when we get that published and that’s being worked on right now.

We are hoping to get this into a major publication as I mentioned in my comments by the end of the year. That’s a big deal, because depending on what publication we are in, that will get a lot of attention. It allow us to market that again as another piece of information on the On-X platform.

I think the other big thing, which we haven’t talked about is, the guidelines were just updated in April and we now are On-X, the On-X valve is now in the – the American Heart ACC STS guidelines for a 1.5 to 2.0 INR mentioned by brand.

I had a number of heart surgeons, pull me aside at the AATS and said they have never seen that in their 20 years at heart surgeon, a brand specific product in the guideline. So I have been involved in a number of therapies like CRT and things like that, that took a number of years to get the indication expansion into the market as you are well aware.

So, these things take years to get the adoption, but it’s kind of not one thing, it’s everything, it’s a 60% channel in North America, it’s a 30% channel in Europe, constantly talking to their clinicians everyday about the data. It’s a late breaker at AATS. It’s the change in the guidelines. It’s the publication of the data.

And it’s that constant steady stream of information about the product that over time just we keep flipping accounts and we opened 30 new accounts this quarter. And I have said it before, look where we are direct, where we have the On-X product, we grew 19% on the top line in North America and we grew double-digits in Europe without the AAP.

If you put the AAP back into Europe, this business is growing 25% Jason in flat market. So, you tell me how On-X is going..

Yes, that’ helpful.

And then PROACT II?.

So, PROACT II, we are very excited about PROACT II. We have engaged – we are working with our investigators right now. The protocol is being drafted. It’s a very unique. And again, this may not be the final, because we have got – obviously we’ve got to go through FDA.

But rough numbers just again you can’t hold me to it, because I don’t have the FDA approval for it. We are talking about a 1,000 patient trial, where we will go – we will have the 1,000 patients that have the existing On-X valve.

So, these valves have already been implanted, which will be very insignificant from an enrollment standpoint, because you don’t have to have the index surgical procedure, right. So, these are existing On-X patients that are on warfarin or Coumadin today. Those 1,000 patients will be switched over to Eliquis and we will follow them for 2 years.

So, it’s really a drug trial. And we had already had discussions with the FDA about using the control arm of the PROACT I trial. So the Coumadin arm from the PROACT I trial has the control group.

So you asked about timing, we are hopeful to have the kind of protocol in front of the FDA and to get this thing approved by the end of the year so that we can start this trial off at the beginning of ‘18.

So by the time you get through the IRBs, get the centers up and running, all the things you need to do to get the trial going, we think it’s probably a year to enroll 2 years to follow and a year for approval, so probably a 4-year timeline. But I think again, it’s a very exciting trial. We have got a lot of interest from clinicians.

And if that trial was positive, I think it is an absolute game changer for aortic valve surgery..

Fantastic. Thanks, Pat..

Our next question is from Jeffrey Cohen from Ladenburg Thalmann. Please state your question..

Hi, good morning, Pat and Ashley.

Can you hear me, okay?.

Yes, we hear you fine Jeff..

Wonderful.

Can you talk more specifically about Luxembourg and Netherlands as far as timing, what amount of the inventory is out there and there should be transition during the third quarter or by the end of the year for both geographies?.

Yes. So, we basically let those distributors know we were going to be direct earlier in the year.

So, there was a – they probably got about three – all those geographies Belgium, Netherlands, Canada, Luxembourg all had roughly 3 months of inventory, which is why – as Ashley and I both said in our comments, Q2 revenues were somewhat muted because of those efforts. And those inventories have been burned down and we are now direct in those markets.

So we expect really the momentum to pickup from here, I don’t know Ashley if you have any other kind of comments from….

Yes. All of the inventory buybacks, revenue reversals and so forth have all kind of been plus through the first half of the year.

If you look at the four geographies combined, that’s Canada and the three countries in Benelux, we expect between $2 to $2.5 million maybe even more million upside in the first – in the second half compared to the first half..

Right. So, you had less revenue because of burning of inventory and then you get the end user revenue and pricing in the second half plus you have direct reps that are selling you products. I mean again, we think that will be one of the kind of differences in the second half versus the first half..

Yes.

And how many direct reps currently in the 4 countries?.

So, we have 3 reps in Canada. We have a Vancouver, a Toronto and a Montreal. We are in the process of working in – we will have the direct rep in Netherlands and a direct rep in Belgium, so 5 basically from what we were previously..

Okay, got it.

And could you talk a little bit about some of the other product lines on On-X and should we expect any line extensions or any new product introductions under On-X in the back half?.

Not in the back half on On-X. We have one – so, just quickly on On-X, we have a big line extension coming for our AAP product, which again is a little bit of a challenge given what’s going on in Europe, but we have a number of different – we got customer feedback that they want. The AAP obviously is aortic valve with a Dacron graft on it.

And we have had a number of customers that have asked for larger grafts to valve ratios and that product is that kind of line extension is being worked on. I think that’s going to be launched in early ‘18. The one product launch we will have that we are very excited about from our PhotoFix acquisition is the carotid patch.

We have got a 90% direct sales force in Europe and U.S. and we have got a fantastic carotid patch. So, that’s a good sized market and we are appointed on launch that in the fourth quarter. So, we also expect some upside from that..

Got it. Couple more if I may. I know I have asked before and it seems like you continue to break through the ceiling on our margins on the tissue side of the business.

Is it more out there to be achieved on the top line margins?.

Yes. I mean, we have commented on that. I mean, we were pretty happy with our 38 to 58, the 2,000 basis point improvement. I know you guys always want more, but I do think that the tissue margins have been fairly stable. I mean we are in the 55 range this quarter.

I have commented previously, I think the one thing that can change that, aside from just your typical kind of lean operations and things like that, which we’ll always continue to work on, is this NeoPatch deal, right, because if we sign the deal, we are hoping to sign with NeoPatch, the ability to leverage the infrastructure of the corporation on more units through the factory I think is significant.

And that could overall help us step our margins up, but I think we are pushing kind of the ceiling on the tissue margins. I think when you get kind of between the 55 and 60 I think that’s kind of best-in-class basically on what I have seen in other companies that are in this business. I think we are at the high end of that..

Yes, I concur. Okay. And then finally walk us through current sales force, U.S.

and domestically, you had mentioned 90 and how did those numbers look and how might they look between now and the end of the year and also have you seen turnover – do you expect turnover going forward?.

Yes. So we have got just to do the math for you. We will start in kind of North America. So, the U.S. we have got, I’d say when I talk about feet on the street, we have got 51 direct reps, 7 managers. We have got 58 kind of direct feet on the street in U.S. We have got 3 in Canada, so that gets you to your kind of 61.

And we have got about 30 in Europe, with the addition of the Belgium and Netherlands. So, that’s where I get to my 90. We expect that – that’s kind of the chassis from a U.S., Europe, Canada that we plan on kind of arriving for a period of time and we don’t see the need to add.

We will always be working with our sales leadership on making sure we have got the best team out there. I can tell you we have had some phenomenal performances from some of our reps. We are reps growing 60%, 50%, 40%, 30%. And like any sales reps we have got some reps that aren’t growing as fast.

And we will, as our sales manager works with those folks, we will work to obviously get them growing. And if we can’t them growing, we will work to find a better replacement for them. So, we have a great sales team and we will continue to work with our leadership to make sure we got the best team on the ground..

Perfect, okay. That does it from me. Thanks, guys. Nice quarter..

Our question is from Suraj Kalia from Northland Securities. Please state your question..

Good morning, Pat and Ash.

Can you hear me, okay?.

Hi, good morning, Suraj..

Pardon on the noise and congrats on the quarter. So I think a few things. First and foremost, I think just a bigger picture, when I look at Canada and Benelux few guys gave us the number of direct people there.

How do you think about challenging this whole endeavor could go direct? And the reason I ask as you go direct, obviously, you are going to have the markup on your products, but at the same time you have to put the feet at the drown and SG&A costs and so on and so forth.

So can you just understand how you look at a bigger picture whichever geography and balance of the activities of going direct?.

Yes, it’s actually a – it’s a great question. And in fact, I mean, there is markets where we haven’t gone direct, because exactly what you just described the math doesn’t work, where you go direct as you mentioned, you pickup the end user revenue, the end user pricing, but you have to add cost into your P&L and then what happens to the profitability.

To me, you have used Canada as kind of a proxy. We are doing – when it was just BioGlue and tissue, it really didn’t work. When you added On-X to the portfolio, the math starts to work. I will tell you the other thing is we have had significant – I think we have opened 4 new SynerGraft accounts where they are doing the Ross procedure.

We have run a couple of big training programs at the Montreal with one of their top surgeons there. And we have opened a bunch of new accounts. On-X is untapped in Canada and I think a lot of interest. We have got several investigators that are going to be in the PROACT II trial. They were also in PROACT I.

So, when we look at – I made this comment earlier, the On-X product is a very sophisticated product. SynerGraft is a very sophisticated valve. You need kind of direct rep attention on those products. So for Canada, we take a business roughly that’s $3 million and when you go direct, it comes 4.5.

And instead of growing single-digit through your distributors, it’s going to grow double-digit for the next 3 or 4 years, right. So, to me, it’s all about the growth, can you drive growth by going direct and leveraging your product portfolio and then what happens to your bottom line.

I mean, if you can breakeven on the bottom line year one and then get the growth and your profitability improves after that, it’s a great investment for the shareholders.

So we have been very pragmatic about it and we won’t go direct in a country unless the spreadsheet gives us a return on investment that’s consistent with any other thing we would invest in..

Fair enough. In fact on PROACT II and I apologize if this is an unfair question you gave us some hints on how the trial would look like. So, Pat, let’s say, forget all, Pat Mackin and Ashley Lee they both get an On-X level, right. Pat has been on the On-X aortic valve for, I don’t know, 9 months. Ashley has been on the 3 months and they have that INR.

Let’s just say for argument sake, 1.56. Now, you enrolled them in PROACT II. I guess, what I am trying to understand is even if all the issues with Eliquis once or twice daily, the dose titration and all that are worked out.

How do you normalize the patient baseline? And the reason I ask is that acute defense post-surgery always, the Dacron graft is going to get utilized. And I am curious how you all factor it, would you only choose patients that have, let’s say 3 months post-surgery or is it all commerce? Very curious in that front..

No, it’s a great question, Suraj. I mean, there is a trial out there called RE-ALIGN that actually tribes us with [indiscernible]. And I believe we have done of – we have had a – probably half a dozen investigator meetings talking about anticoagulation and aortic valves.

And one of their, I think big mistakes was that they actually randomized to the drug right after surgery. And you already highlighted the kind of the issue with that when you put a heart valve in somebody, it takes 3 months to endothelialize those sewing cuffs and kind of these areas that need to be kind of covered, but with tissue.

And if you look at the PROACT I trial, all patients were on standard Coumadin for the first 90 days, right. We didn’t randomize to a lower INR until after the first 90 days. So, we will not enroll anybody in this who has had the valve for less than 90 days.

Again, we have to work all the stuff through the protocol with the FDA but that to me has got to be and that’s written into the protocol. Patients have to be out 90 days from initial implant before they can have their anticoagulation change..

Fair enough. And final question, Pat, thank you for answering my questions. Whatever strategic passage you will acquire, is the expectation still on track that one of the key gating criteria for this acquisition is to push it all to double-digit growth rate on a composite basis? Thank you for taking my questions..

Yes. I think it’s another good question. I mean, we have talked about this before. I mean, I think as I mentioned in some of my comments, I mean, CryoLife, I think we have got a nice kind of chassis for the company, right. We have got three big product groups highly differentiated, our tissue processing, our On-X valve and our BioGlue.

We have got a strong 90 person channel in U.S. and Europe. The fact of matter is those product lines are kind of mid single-digit growers which is consistent with what we have put out for guidance.

What we have been looking for on the M&A side is how can we leverage all of our infrastructure, our sales infrastructure, our clinical infrastructure, our regulatory infrastructure to tap into faster growing markets, bigger markets that will ultimately drive double-digit growth for the corporation.

And I think one of the things we found and we talked about this on our previous call is doing small deals actually doesn’t really help us anymore. We are pushing $200 million next year. Again, I am not giving guidance I am just doing some rough math.

If you do an acquisition that you have heard, that’s going to do $5 million in revenue, which doesn’t help the growth rate of the company.

So, we tend to – I think to look at bigger transactions and I think as I have said a number of times before, I think we are one transaction away from really kind of a game changer for the company and putting us in the double-digit growth category for years to come..

Our next question is from Brooks O'Neil with Lake Street Capital Markets. You may state your question..

Good morning. You have mentioned several times the strategic importance of getting that AAP back on the market in Europe. Could you just refresh my memory and our memory about what the issues the commission is considering? And it sounded like you feel quite confident and we will get back on the market.

Just help us to remember why you believe you will have smooth sailing through there?.

So I will assure we are going to have smooth sailing. I think let me take you back Brooks. So, I guess it was last November we got notified from our notified body on this product line, because we have a couple of different notified bodies. And this was the group that covered the On-X platform.

And basically – and this was, I mean, to be clear this was kind of our fault that we got into this situation. And it was probably one of the very few kind of issues we had with the On-X acquisition. So I think about a month or two after we acquired On-X, we had an onsite inspection by our notified body.

There was nothing anything crazy about the write-up, but they had a few items that we needed to follow-up on. We frankly dropped the ball of the process and there is some kind of mitigating circumstances where we had terminated a couple of quality employees out at On-X at the facility there, because they weren’t up to our standard.

In the process that all happening, it kind of fell through the cracks. And what was surprising to us – and again, our Head of Senior Vice President of our operations, quality and regulatory is a 35-year experienced executive and is very well-versed in this.

We have never seen a notified body pull a certification, because you are kind of laid on a follow-up. Again, it was our fault. I am not trying to shirk the responsibility there, but we have never seen it. And we have actually heard of a lot of other companies this is happening to.

So, there is kind of a ratcheting up of the notified bodies in Europe, which again, it was the first they kind of caught us by surprise. So, we have been going back and forth. So we have been out of the market. This certification is currently suspended.

We have been just for the AAP just in Europe which is roughly about $1 million business, but it was growing. We have gone back and forth of them. We have turned in all the paperwork. And we are kind of at the final stop on the kind of train if you will. We have to – they are supposed to meet and we are supposed to get back to the next couple of weeks.

So I am hoping it’s positive. But as I said on the call, I can’t predict what you guys are going to do. I don’t control the decision. We have done everything we can to get the product back on the market. And as soon as we know, we will let folks know that we are – what the outcome has been..

Great. It sounds like things are going well. Congratulations..

Thanks, Brooks..

Our next question is from Joe Munda with First Analysis. Please state your question..

Good morning, Pat and Ashley.

Can you hear me okay?.

Good morning, Joe..

Good morning, Joe..

Real quick. Couple of questions here. Pat, in your prepared remarks, I want to start with BioGlue, you talked about some of the issues. Last quarter you had mentioned Prevalite trialing competition. I want to try to understand I mean did that Prevalite trialing also play a role in second quarter results.

Any update there would be much appreciated?.

Yes, it’s hard to tell to be honest with you. We looked at – so, half of our kind of shortfall was as I mentioned in North America was Canada, right. So, we didn’t sell anybody in Canada last quarter, because we went direct and that’s very common. We notified the distributor.

They had 3 months inventory vessel their inventory into the market and we didn’t get any sales. So, I mean that’s fairly normal. The other half we had – we looked at our top 10 accounts where we had losses versus kind of this time last year. And there was really no competitive activity.

It was more in one case we had a surgeon broke his ankle and he couldn’t operate it. One of our biggest users was kind of on the bench. In another case, a big account we had surgeon switch hospitals. I mean, so there was really nothing kind of out of the ordinary. As I said in previous calls we have talked about we have seen some competitive trialing.

We really have not seen a lot of activity. And we mentioned it – Ashley mentioned in his comments, I mean, we have computed against these guys in Europe and we kind of ran them out of town. We got a 90% channel calling on heart surgeon everyday in the U.S. and Europe. This for them is kind of an afterthought.

So, again we take it seriously, but I am pretty pleased actually how we have kind of weathered the storm on that front. We have not seen a lot there..

Okay, that’s helpful. As far as the tissue business is concerned, you talked about last quarter about SynerGraft data, there is a couple of slides in the presentation, the results from the cardio, this is second quarter in a row here of double-digit growth. Just wondering how much of a factor was that the reach out to the docs, view this data.

Any correlation I am sure there was, but I would just like to get some commentary from you guys as far as the impact of the data that you are presenting to docs on the SynerGraft side?.

Yes. And I have mentioned before, we have kind of worked this from both ends. What I mean by that is from procurement as well as from the end user implanters.

So, we have had a number of examples where our sales team has gone in and convinced surgeons that the SynerGraft data is highly differentiated from non-SynerGraft and it’s showing 20, 30 point differences in explants and valve performance and these are mostly in little kids.

These are little kids are having aortic valve replacement and you are talking about a 20, 30 point difference at a decade. So, these surgeons are basically saying I want all my pulmonary valves to be CryoLife’s SynerGraft. So, we are clearly seeing the difference. I mean, that data, this market has not grown 12%.

I think we have made a significant impact on the end user as well as on the procurement side and two quarters of double-digit growth I think is basically the fruits of that..

Okay. And then on the vascular side, you talk about I think as we had said a 2% decline in unit shipments, is that competitive impact maybe from [indiscernible] entering the space or is it shortage of tissue.

Any color there would be great?.

Yes, it’s not a shortage of tissue. We have got a very good inventory position on our long happenstance. I think again, we looked at our top accounts and we have seen a little bit of [indiscernible] laid out there using price, but we have been able to in cases where they have gone and taken business, we have gone and taken it back.

We believe we have a much higher quality product than they do. We have a much tighter range of what we take versus what they say. So, I think again, I would put my sales force up against them all day long. And we just really didn’t see any kind of – it wasn’t really a competitive issue in the quarter.

I have mentioned before these, because our customers have freezers onsite, their buying patterns and this business can kind of go up and down quarter to quarter. And as I said through the first half of the year, we are growing 7%. We guided to mid-single-digits for tissue. Some quarters we see vascular tissue growing double-digits.

Some quarters we see vascular growing double-digits. They don’t ever seem both grow double-digits. But I say the fact that we are growing 7% halfway through the year is above what I thought we are going to be doing. I thought we are going to be 5% to 7% and we are on the upper end of the range..

Okay. Just two more here. On On-X, I think in your prepared remarks you said you added 150 accounts since acquisition. I am looking back on my notes from the last call and it was at you guys had about 150 accounts, you went from 450 to 600.

So, are you still at 600 you had – you guys are probably adding 30 a quarter, maybe it was a timing thing or yes?.

I have to look at the – so we are six quarters into this. Right, so I guess five full quarters in. So we have been adding about 30 accounts a quarter. There is your 150. I look back at it. So again I think as the timing whether you count which is the first quarter, but every quarter we have added about 30 accounts..

Okay. And then I guess my final question Pat, I guess many of us would agree, I mean, the stock is trading up here on the expectation that growth is going to accelerate through acquisitions and knowing you guys are being very diligent and knowing that you guys do a ton of market research. I mean, could we expect something by the end of this year.

We are sitting here in July.

Could we expect something on the M&A front this year?.

Yes, I mean, look I can’t – until the deal is signed I can’t commit to anything. I mean, we always look at stuff. We are very aggressive at it. And we are hopeful to get something done in the near future, but I can’t – I mean, again tell the things aside, it’s hard for me to kind of commit to it..

Okay, thank you..

Yes. Thanks, Joe..

Thank you. Ladies and gentlemen, we have reached the end of the question-and-answer session. I would like to turn the call back over to management for closing remarks..

Well, thanks everybody for joining. And again, we are happy with the quarter. We obviously got a lot – we’ve got a lot going on between going direct in the three new geographies we talked about. We have got trying to get our AAP back on the market, the M&A activity you talked about, partnering of NeoPatch, our clinical trials PerClot and BioGlue China.

So, we are pretty excited. And as I said, we are highly focused on the M&A front. And as we kind of have something to talk about, we will obviously let you know, but we are looking forward to good strong back half of 2017 and thank you all for joining this morning..

Thank you. This concludes today’s conference. You may disconnect your lines at this time and have a wonderful day..