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

Jason Mills – Canaccord Genuity Jeffrey Cohen – Ladenburg Thalmann Suraj Kalia – Northland Securities Brooks O’Neil – Lake Street Capital Markets Jo Munda – First Analysis.

Greetings and welcome to the CryoLife Q3 2017 Financial 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] As a reminder, this conference is being recorded.

It is now my pleasure to introduce your host, Pat Mackin, Chairman, President and CEO; and Ashley Lee, CFO for CryoLife. Thank you. You may begin..

Good morning and thanks for joining the call. 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 these forward-looking statements.

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 we issued last night. Now I will turn it over to our CEO, Pat Mackin..

Thanks, Ashley, and good morning everyone. Before we dive into the results for the quarter, I wanted to share with you my thoughts where I think we are as a company from a strategic standpoint.

It’s important to understand the rationale behind our strategy and why we believe that we are already capitalizing on the significant potential before CryoLife. I’ve talked many times about my goals and objectives when I first joined the company.

I’m pleased to say in a relatively short period of time we’ve made considerable progress towards accomplishing what we set out to do. As a result, we become a far more profitable company when ability to address significantly larger opportunities and compete with anyone in our markets.

That transformation has been no small fee, but when JOTEC closed is, we will be there and will be – and we’ll come down to the next phase of our strategy, which is executing in the marketplace.

That starts with strong leadership and if you’ve been following, as you’ve seen that we put people in place that have considerable experience in running large organizations. Moreover during the past three years, we made meaningful changes to the product portfolio through acquisition and divestiture.

Upon the acquisition of JOTEC and implementation of our post acquisition product strategy, we will operate a highly competitive product portfolio with significant opportunities for growth. The legacy CryoLife products that we kept are all well entrenched in highly regarded by our customers.

As we continue to perform well in growth especially as our larger sales forces market and introduce them to new accounts. Furthermore, if our clinical initiatives are successful, our products will compete in larger new markets. Moving onto our acquired and soon to be acquired products, On-X and JOTEC.

We believe they are truly standouts in their categories. Under our M&A strategy, we seek our products that this as competitive advantages over the products of competition. And On-X and JOTEC easily meet that standard.

As you’ll hear today when all the noises removed from the quarterly numbers, On-X has been a strong performer taking share from key competitors. The On-X business grew double-digits in our direct markets. We had a first full quarter of direct sales in Benelux and Canada.

But even highly differentiated technologically advanced products are not enough to carry today. It’s essential to have these products detailed by a powerful direct sales organization.

Upon the completion of the JOTEC acquisition, we will have over 125 reps around the world educating physicians and hospitals on the advantages of our products many for the first time. We will be equipped to offer even more solutions to our customers than ever before.

The bottom line is that the pieces will soon be in place to maximize the value of this portfolio. We believe our investments in the business on the management level, in the sales channel and with the products will make CryoLife the go-to solution in the markets we serve.

The company is not only in an excellent position to drive its growth in the coming years in this dynamic portfolio, but also from our many new products in development including PerClot and BioGlue China clinical programs.

Our new product introductions and clinical trial work have the potential to dramatically increase our revenue potential in the coming years. Despite the quarterly impact of the recent hurricanes, the delay in getting AAP back on the market in Europe, and the top line effect of reversal from distributor terminations.

CryoLife is performing quite well and I’m very optimistic that we’re just getting started. Without question, our strategy is taking hold and will be topped off by the pending acquisition of JOTEC. They are an exceptional company in so many ways, which I will explain shortly.

If you didn’t get a chance to listen to our call last month discussing the acquisition, I urge you to call up the webcast replay to better understand why are we so delighted with the JOTEC -- that JOTEC will be soon be on board.

Following this transaction we will be a key provider of products and solutions, focus on treating aortic disease from the aortic root to the iliac arteries. And the recent acquisition put us in a stronger position to cross sell our other products. The task ahead is to execute.

I will now provide my quarterly review of our 2017 key objectives followed by Ashley who provide a detailed review of our third quarter financial results and then we’ll open up to your questions. Our first key initiative in 2017 is achieving our full year 2017 financial guidance.

In the third quarter of 2017, we delivered $44 million in revenues representing a decrease of 3%. Unfortunately the positive performance in our business was over shattered by three headwinds that I just discussed. That said I want to emphasize that the fundamentals of our business remain strong and so does the demand for our products.

And the long-term growth potential of the company will substantially increase upon the closing of the pending acquisition of JOTEC. Regarding our third quarter 2017 earnings, we delivered non-GAAP EPS of $0.08 per share, which puts us on track to meet our full year guidance.

Our second key objective for 2017 is to expand the On-X business and deliver low-double digit non-GAAP revenue growth on the On-X portfolio in our direct markets, which excludes OEM in the effects of distributor terminations and anticipation of our pending acquisition of JOTEC.

On that basis I am pleased to report that we continue to post double-digit growth for the On-X portfolio in our direct markets. We were up 11% in those markets including 28% growth in our European direct markets, despite the fact that we did not have AAP available to us.

In North America On-X revenues for the third quarter increased 9% compared to the third quarter of 2016. Our U.S. salesforce continues to open new On-X accounts with around 28 new accounts added during the third quarter.

In total On-X revenues excluding the OEM business were $8 million, but excluding the effects of the distributor terminations On-X revenues were $9 million, which is a 6% increase on a non-GAAP basis excluding OEM.

We’re going to continue double-digit growth of the On-X products in our direct markets is indicative of the growth potential of the On-X portfolio when sold directly by an experienced sales team. Our third key initiative for 2017 is to transition our sales channels in Canada and Benelux from distributors to direct model.

We commenced direct sales in Benelux in June and in Canada in July. These transitions impacted our revenue in the first half of 2017. We’re now beginning to benefit from direct sales of CryoLife portfolio in those markets and achieving end user pricing and margins.

Our fourth key initiative in 2017 is to continue to pursue further growth drivers for the company to 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 in 19 sites, including full site activation in 13 sites, where patients are currently being enrolled in the trial. We have now enrolled over 80 patients into this study and expect to add six to seven additional sites to be activated by the end of the year.

We remain on track with our enrollment rate for the FDA approval in 2019. For BioGlue in China, we experienced a delay and getting product for the trial to customs. That issue has now been resolved and we believe we will enroll the first patient any day now with the study eventually being conducted in seven sites in major cities in China.

Overall, we remain on track for approval of BioGlue in China sometime in the second half of 2019. Our fifth key initiative for 2017 is to evaluate potential business development opportunities to enhance our focus in critical mass in cardiac and vascular surgery.

Clearly, we made significant progress on this front with the pending acquisition of JOTEC, which we still expect to close this year. We intent to integrate the JOTEC business and similar to On-X, realize the synergy potential and delever before we shift our focus to new opportunities.

Let me briefly recap the highlights of the transaction, how we believe this acquisition will transform our business. First, JOTEC gives us access to the $2 billion plus stent graft market. Although, fairly small JOTEC is successfully compete against large competitors due to their innovative technology of their products.

They’ve also been effective in using the more differentiated branch products to pull through their less differentiated ones in the portfolio Second, JOTEC has an impressive R&D pipeline with multiple new products in development, including next generation products for almost its entire portfolio.

This provides us with robust cadence of plan new product introductions that will support ongoing growth, which believe we’ll ask for the next decade. Third, JOTEC’s existing commercial infrastructure accelerates our direct sales strategy in Europe. After integrating our teams, we will expect to have a 70 plus person sales team in Europe.

This expanded team will also have significant cross selling opportunities across the CryoLife in JOTEC product portfolios. When you bring it altogether, the addition of JOTEC to the CryoLife family will significantly change the financial profile of the company over time. JOTEC is profitable, cash flow positive, and has a diversified revenue stream.

We anticipate that over the next five years, the acquisition will be accretive to our revenue growth, gross margin, operating margin, non-GAAP earnings and cash flow generation. With potential future growth catalyst after this period, we expect to be able to sell JOTEC’s most differentiated products in the U.S. market.

Since announcing the transaction, we’ve had the opportunity beyond the ground in Germany and interact with the JOTEC team. We’ve been encouraged by their excitement around the deal. I will now turn the call over to Ashley for his financial review..

Thanks, Pat. I will now review our results for the third quarter. Compared to the third quarter of the prior year, total company revenues decreased 3% to $44 million. Third quarter revenues were adversely affected by the three factors that Pat mentioned earlier. On a geographical basis, Q3 North American revenues, which includes the U.S.

and Canada were $33.3 million, flat on a percentage basis year-over-year. Revenues for this region were negatively affected on a year-over-year basis by approximately $1 million as a result of the recent hurricanes. Revenues from our European region were $6.2 million, down 14% compared to the prior year.

Revenues in this region were negatively affected by $1.1 million reversal of previously recorded revenues associated with distributor terminations and the unavailability of the On-X AAP. Revenues from Asia-Pacific and Latin America were $4.6 million for Q3, down 7% year-over-year, primarily as a result of distributor ordering patterns.

I’d like to spend some more time focusing on individual product lines and specifically on On-X, tissue processing and BioGlue.

Despite decreasing on an overall basis for the quarter, On-X revenues in our direct markets excluding OEM were up 11% year-over-year for the quarter, including 28% in our European direct markets even without the AAP and up 9% in North America.

On-X revenues increased 10% in Asia Pacific and Latin America, where we are seeing signs of recovery in Brazil. On-X revenues decreased 51% in Europe, due to $1 million in distributor buybacks. Overall, On-X revenues for the third quarter were $8.3 million.

Total tissue processing revenues for the third quarter were $17 million, a decrease of 2% from $17.2 million for the third quarter of 2016. We estimate that tissue processing revenues in the third quarter were negatively affected by $1 million during the third quarter, due to the impact of the hurricanes in Florida and Texas.

During the third quarter vascular revenues increased 1% year-over-year on a 4% increase in unit shipments. Cardiac tissue processing revenues decreased 4% year-over-year on a 4% decrease in unit shipments. We remain confident about the overall prospects for the tissue processing business.

BioGlue revenues in the third quarter decreased 1% year-over-year to $15.7 million. North American BioGlue revenues were $8.5 million in Q3, which was an increase of 1% year-over-year, even in the phase of some trialing of the competitive product which we have previously spoken about. O-U.S.

BioGlue revenues decreased 4% year-over-year to $7.2 million, following a year-over-year increase of 15% in the second quarter of 2017.

The decreased results from distributor ordering patterns, we want to point out that BioGlue orders from our Japanese distributor, which is our largest, vary from quarter-to-quarter and year-to-date orders from our Japanese distributor are up 17%.

This is inline with our full year expectations for growth in that market and is consistent with what we have been indicating as the underlying procedural growth following our expanded indication in late 2015. We continue to expect upside in BioGlue from an improving outlook in Brazil, our ongoing strategy to go direct in select O-U.S.

markets and our anticipated regulatory approval in China in 2019. Our overall gross margin for the third quarter was 68% compared to 66% in the third quarter of 2016. Tissue processing gross margins were 53% for the quarter and product gross margin was 77%.

As we move forward and continue to execute on our growth and efficiency initiatives, we expect that gross margin will further improve over the coming years.

SG&A expenses during the quarter were $24.8 million, excluding $3 million in business development related expenses, SG&A expenses were $21.8 million, compared to $20.6 million in the third quarter of 2016. We recorded a very large tax benefit in the third quarter related to vesting of stock awards and the exercise of non-qualified stock options.

We discuss this situation in our previous conference call. Going forward, our tax rate for the fourth quarter and full year may vary significantly compared to our guidance due to the non-deductibility of certain transaction expenses related to the JOTEC acquisition once the transaction closes.

On the bottom line, we reported GAAP net income of $1.3 million or $0.04 per fully diluted share in the third quarter of 2017 and non-GAAP net income of $2.6 million or $0.08 per share. Please refer to our press release for additional information about our non-GAAP results including a reconciliation of these results to our GAAP results.

As of October 27, 2017, we had approximately $55 million in cash, cash equivalents and restricted securities. Following the anticipated closing of the JOTEC transaction, we estimate that we will have an excess of $20 million in cash on hand and in under arm $30 million revolving credit facility.

In regards to our upcoming financing, we recently met with the ratings agencies in New York and have begun efforts to complete the loan syndication process. We currently estimate that we will be closing the JOTEC transaction later this quarter. We are adjusting our 2017 financial guidance as detailed in the press release that we issued last night.

We believe full year 2017 revenues excluding any contribution from JOTEC will be in the range of between $184 million and $185 million, which puts fourth quarter total revenues in an expected range of between $47 million to $48 million.

Our revenue guidance provides up to $1.5 million in orders that we no longer expect to receive in the fourth quarter from terminated distributors and up to after $500,000 in lost AAP orders during the fourth quarter.

Additionally, the updated revenue guidance reflects a temporary disruption in the European sales channel during the fourth quarter due to the commencements of salesforce integration in territory realignment and reduced selling days by the combined salesforce resulting from offsite training.

These factors will undoubtedly weigh on the fourth quarter revenue performance, but once the integration and training are complete, we will be extremely well positioned for success as we head into 2018. On the bottom line, we are reiterating our full year guidance of non-GAAP income per share of $0.40 to $0.43.

We anticipate issuing our initial 2018 financial guidance in early March 2018 during our year-end financial conference call. That concludes my comments, and I’ll turn it over to Pat..

Thanks, Ashley. So, as you’ve heard this morning, we still need to work through a few issues with the good news we expect them to be behind us and fairly short order and that sets us up for a strong 2018.

The point I like you to take away from the call is that we’re very confident that our growth strategy is on track and already yielding the type results we had expected. On-X continues to grow at double-digits where we’re direct, BioGlue is performing well in the U.S.

despite competition, our business in Japan is tracking to plan year-to-date, tissue processing is overall performing in line even considering the effects of the hurricane. Our transition to a direct team in Canada and Benelux is complete and the pending acquisition of JOTEC will fulfill our acquisition objectives.

We will soon operate a sizable and experienced global sales team that will be able to champion our advanced high margin products and take this company to the next level. On top of that, our R&D capabilities will be significantly stronger with JOTEC on board. Our new product pipeline has never been this exciting or full.

We also have ongoing clinical trials that have the potential to open up new large markets and expand existing markets for us. As a result of all these factors, we are now in an excellent position to deliver our key goal of high single-digit growth starting in 2018.

Finally, I’d like to sincerely thank our employees and all of the JOTEC employees for their contributions this quarter that allowed us to reach this moment. These are exciting times at CryoLife and I truly believe we are poised for great success. With that, we will now open the lines for questions.

Operator, can you please open the lines?.

Thank you. At this time, we will be conducting a question-and-answer session. [Operator Instructions] Our first question today comes from Jason Mills of Canaccord Genuity. Please go ahead..

Thanks, Pat and Ashley.

Can you hear me okay?.

Yes. Good morning, Jason..

Yes..

Good morning. Sorry [indiscernible] travelling. So Pat, congratulations again on the JOTEC deal and look forward to seeing how that integration goes.

And I understand you’re going to give it a little time before giving official guidance for next year, but I would like your initial thoughts on, I know you said you expect the deal to augment topline growth, gross margins, operating margins, et cetera, so you’re looking for big things from the deal, will those things start to show up in 2018 you think? Could you give us a qualitative picture of growth and sort of qualitatively how you think directionally the business will react to the JOTEC deal early days in 2018? And then from an organic standpoint, doing those – a lot of moving parts with the AAP and distributor buybacks and things going on around the world with the core business, sort of what you think organically the business can generate next year in terms of growth? And I appreciate you are not ready to give future guidance, but maybe you can give some qualitative comments..

Yes, maybe I’ll start with the CryoLife’s kind of organic portfolio as you described it.

As we traveled around, Ashley and I, spoke obviously at many of the conferences and met with lots of our investors and that we felt pretty confident that CryoLife’s organic products were kind of mid-single digit growth and that’s kind of where we felt the portfolio was and one of the reasons we’ve been out looking for acquisitions is that we felt like our channels were under-utilized and we also were not at scale, which is where the JOTEC piece comes in.

And when you add in the JOTEC products and channel, that’s where we feel like we can get into the high-single digits, and I can kind of describe for you with that backdrop, the distributor, one of the messages here is that we did have to reverse some revenues in Q3 and we’re not going to get revenues in Q4 from distributors we terminated.

We never contemplated terminating those distributors under the CryoLife plan for 2017. But we thought it was really a great strategic opportunity for the company to accelerate our go direct strategy much faster than we normally would have.

And you’ve been a part of our story for the last couple of years where you’ve seen us go direct in France and we went direct in Canada and Benelux, and it’s always a challenge because you have to notify the distributor, you have to reverse some revenue because if you sold them anything that year and then you don’t get any sales while they burnout their inventory.

So that’s going to happen in Q4. We talked about that. There will be a little bit in Q1 of 2018, but I think the good news about this transaction is, we feel like both the distributor burndowns the AAP, that will all be kind of behind us going into Q2 of 2018.

And I think we’ll start to see many of these benefits starting in Q1, but really taking hold in Q2 of 2018. So, a little more color around the combination of JOTEC with CryoLife, we see significant advantages in Europe.

So, starting in Q2, we will have – we will be CryoLife will then be direct in Spain, Italy and Poland; three markets that probably would have taken us several years to get to that point, that we’re going to do in the next 90 days to 120 days.

And as you well know, that gets us end user revenue, end user margins and our pricing goes up between 30% and 70% in those markets when we cutout the middle man. We also will be adding some new people in those markets, but will be – the overall net cost would not be going up because we’re going to be repositioning folks.

So, on the SG&A line, we’re going to basically leverage the existing spend and just reposition folks. But to have a direct person in those markets, direct resources in those markets selling our CryoLife products is going to help drive that organic portfolio.

I think the other piece is the cross-selling, we are now going to have a 70 plus person channel in Europe starting on January 1. I’m going to a meeting next week, it’s going to be a kind of a sales integration kickoff meeting.

We will be training the JOTEC vascular surgery team on BioGlue and we’ll be training the CryoLife cardiac surgery team on the E-vita Open Plus, which is their frozen elephant trunk cardiac surgery hybrid system. So, that cross selling with that number of reps and being direct in that many countries is just a multiplying effect.

So, we expect the benefits of this transaction to start really frankly, in the fourth quarter as soon as we acquire them and to gain momentum through Q1 as we finish burning off some of that distributor inventory that’s going to hang around a little bit in Q1.

But we will be kind of gaining momentum through the first quarter and really hitting our full stride, I think, in the beginning of Q2. Hopefully, that answers your question, Jason..

Yes, that’s very helpful. Thanks, Pat. Just a few more follow-ups, I’ll get back in queue, and let others jump in.

Again, looking forward in the more near-term, the impact to gross margins on this deal and also as you get back to sort of normal course business with On-X around the world and AAP and BioGlue around the world and sort of get pass some of these disruption that you mentioned in your prepared remarks, how do you see gross margins trending in the early days of this transaction on a pro forma basis? And I guess secondly, just on your organic business, maybe you could talk specifically Pat, about On-X in the United States, it sounds like from a direct standpoint, North America, you had a pretty decent quarter, but recent developments, obviously with the presentation at the meeting earlier this year, and still a lot of surgeons coming to know On-X and the label and its differentiation for the first time, it seems, in our due diligence, what you expect from direct markets specifically North America for On-X over the next over couple of years? Whether we will see this kind of growth or is there potential for acceleration? And I’ll get back in queue, thanks..

So, I think on the gross margin, I mean, we’ve had some kind of choppy, frankly in Q3, we had some choppiness and I mean our margins were up, gross margin was up 3 points from 2.66 to 2.68 in the quarter year-over-year and we had some kind of some write-offs that unfortunately hit our third quarter.

I mean, our gross margins, when you eliminate some of the chop, we’re closer to 70% range. I think again, the product portfolio, our high margin items like Glue and On-X and even some of the JOTEC portfolio, we expect our gross margins, I think it should be stable in the kind of the 70% range and can actually accelerate over time.

I think the one piece is, obviously the inventory growths that we are going to have to do as part of the acquisition economics, and maybe Ashley, you can comment on, because that happened – everybody remembers with On-X, when you – as you guys know when purchase accounting, when you acquire your inventory, you’ve to kind of gross it up and then it has got to flow through your P&L.

I don’t know if we even know at this point what the timing of that’s going to be..

Yes, we’re still working with the consultants on the valuation and the purchase accounting and we’ll have more color on that soon, but it will certainly be a drag on near-term gross margins. But once we work through that fair value accounting write up as part of purchase accounting, that will be out of the way.

But as Pat mentioned earlier, coming out of the gates, we expect to be in the high 60s to 70s for the combined portfolio and I think over the next two to three to four years, our goal is to move those margins up into the low to mid 70% range through a combination of our direct strategies as well as cost down initiatives..

And then your second question was around On-X. And again, I think you know, as you know we’ve been covering all the different device companies that you follow. I mean, to move a clinical trial to get the word into the marketplace and to change practice takes a lot of time and a lot of work.

And I think there is a number of things that are going in our favor, I think as you know, the On-X guidelines were – On-X was put into the guidelines back in April. That’s a major shift. It typically takes guidelines like five years to get adopted and that’s partly through education and awareness.

I think the second piece is, we’re all still waiting for the publication of the major PROACT paper, which we think will be another near-term catalyst. I think third, our salesforce continues to get stronger every day. The more experience that they get with the product, I think the more powerful they become.

Fourth, we haven’t even talked about – really don’t talk about it much, but we’ve got an ongoing enrollment in the PROACT mitral trials.

So, this is kind of the brother product or sister product of the aortic PROACT which is we have a lower INR for the mitral valves, that trial is enrolling, we expect to see an approval I think in 2020, which we think can have dramatic impact on the mitral markets. So, this story just kind of keeps going.

You throw in there – they’re going direct in some of the developed markets in Europe and Spain, Italy, Poland, we just went direct in Canada, Belgium, Netherlands. So, from a margin, pricing, gross margin and then you’ve also got direct reps selling the product and where we do that we get double-digit growth.

So, we’re very bullish on the On-X portfolio and we think that it can deliver double-digit growth in developed markets for some time to come..

Okay. Thanks, gentlemen..

The next question is from Jeffrey Cohen of Ladenburg Thalmann. Please go ahead..

Hey, good morning. Can you hear me okay..

Yes. Good morning, Jeff..

Yes. Good morning, Jeff..

Hi, guys. Four focus, I just wanted to roughly – quickly.

So, you talked about the AAP taking hold in Q2, so another quarter or two quarters you believe that the situation will be more resolved as far some of the labels in some of the territories?.

Yes, and I think this has obviously been a disappointment for us and I think one of things that was a little bit out of the norm was that we had some challenges with this certification and while that was going on, we had a – we’ve got a change in kind of landscape in Europe.

I think many people know that if they haven’t heard it, it means they are going to hear about it more. The transfer from the Medical Device Regulation to the Medical Device Directive is a significant – around the Medical Device Directive going to the Medical Device Regulation is a significant change.

And what we’re finding is, when we’re going back in for research, many of the notified bodies are already applying the more stringent requirements of the new Medical Device Regulation and that is really an upgrade from where your current technical file is.

So, again, without getting into too much of the detail, this has been a lot of work and in some cases, happened to go back and buy compatibility and things like that. So, there’s – the unfortunate thing is there’s nothing wrong with the product, the product is fantastic. It wasn’t driven by complaints or anything like that.

It’s just really a shift in the kind of the landscape in the European regulatory environment and this one product kind of caught really in the middle of that. So, this is taking us longer and we think that we should be back in kind of Q2, and we’re going to plan for that.

We’ve obviously talked about it in our numbers for Q4 and I said even in the last quarter’s call that if we don’t get AAP back, we’re going to do something with our guidance, because we’ve being keeping up, throughout the year we’d already lost $1 million and we still held our guidance.

But at this point it is going to be gone for Q4 and we’ll take that into account in Q1 when we put our numbers not in March..

Got it.

And on the On-X portfolio, is there some SKU expansions as far as sizing and other R&Ds and possible new product introductions that you could talk about, at this point?.

Yes, we do have 17 millimeter and it again depends on where you are in the world. We have a 17 millimeter which is used primarily in pediatrics and also has a potential in Japan just for the – given the size of the patients. We should get that into Europe first and then the U.S.

and then Japan and so I think, Europe were actually looking at 2018 and then I think U.S. is 2019 and Japan’s 2020 something like that. It’s not a huge – it’s not going to be a huge thing, it is a – I mean for us, it’s important because we do a lot of work with pediatrics and a lot of our pediatric heart surgeons have been asking for that.

I also mentioned the PROACT mitral, which is, it’s not a SKU extension as much as it is a – it’s an indication expansion for our lower INR, which we expect I think in the 2020 timeframe..

Yes, got it. And on the direct front, so now you’ve got Spain, Italy and Poland in the coming quarters so Canada, Belgium, Benelux is done.

Are there other territories available or other territories you are looking at? Could we expect some?.

Yes. So, when I first got here, I – just from my experience in obviously bigger organizations, I just found with a sophisticated product portfolio, high margin, high technology, high position touch, lots of clinical data, you just – you do a lot better with a direct organization and have to be supported by the pricing in the margin.

But my stated strategy was to be direct in all developed markets at some point in the future. And with the move we just made in Italy, Spain and Poland, we’re pretty much direct in Europe. And the only place we’re really not direct in Europe is in the Nordics and we’ll have to look at that. We don’t have any plans for that at this time.

That basically leads you to Australia and Japan and we don’t have plans at this point and we think there’s enough with what we’re doing, in what I described earlier when Jason’s question to drive the growth with all the things we’ve done in the countries you just mentioned.

And we’ll obviously look at those over time, but we’ve got great distributors in Japan, and Australia and at this point, we don’t have any plans, but those are kind of last two or three markets where we would even consider..

And Jeff, this is Ashley. The other thing about the – after the JOTEC combination closes, all of the markets that Pat mentioned that we’re going to be direct in, by and large the headcount that we’ll have there is going to be what we need. We may need to augment it slightly as we move forward.

But the headcount that we have is going to be what we need and it’s going to be a highly leverageable salesforce over the next few years and we expect to drive a lot of operating leverage off that..

Okay, got it, which leads me to my last questions as far as the JOTEC closing date. So, we previously estimated about a month of contribution in 2017. Does that timeline slip a little bit because your guidance discussion is talking about excluding contribution from JOTEC.

What do you expect the closing day, because I know we’ve got $4 million or so for the fourth quarter in 2017, how does that look as a change?.

Yes, so again, we feel things are on track, as Ashley commented, we’ve been in front of the rating agencies, we are going up this week to do the debt syndication. So, we expect to be able to close call it the – let’s say, the first week of December. So again, I don’t control all the pieces there, but I think that’s a pretty a reasonable day.

We did not include any numbers from JOTEC just because I can’t predict exactly the date it’s going to close.

I can control all the CryoLife pieces so we decided to give guidance on, consistent with what we’ve done all year on CryoLife and then whenever JOTEC closes, it closes and whatever revenues there is going to be there, but we’re not going to, at least from our guidance standpoint, we are not going to include anything even though, to your point, if it does close on December 1st, there’s probably some revenue in there..

Okay.

So the guidance, 184, 185 for the year includes zero from JOTEC for the closing and something closes from the first to the 31st December, so be it?.

That’s correct..

Okay. I got it.

Thanks for the clarification, I guess one last one if I may, any spillover from the storm effect into Q4 that you’ve seen at all?.

No, we don’t think so. I mean, we feel like it kind of worked its way through in the third quarter. We have, basically – when we ran the math, there was about two weeks now, could there have been some stuff on the front and back of that, but it was all contained in the third quarter. So, we don’t really see any spillover effect of that..

Perfect. Thanks, guys. I appreciate it..

Thanks, Jeff..

The next question is from Suraj Kalia of Northland Securities. Please go ahead..

Good morning, gentlemen.

Can you hear me?.

Good morning, Suraj..

Good morning, Suraj..

Just had couple of questions for you and one for Ashley.

Kind of your prepared remarks, you mentioned, or at least I heard that going direct yields your ASP increases of somewhere between 30% and 70%, obviously that range is dependent on the type of product, first, did I hear that correctly? And second Pat, these are ASP increases, can you help us to reconcile what you’ll see once you all go direct? What is the impact on units?.

Yes. So, it’s really two questions, right? So, I mean it’s really the way we look at this when we decide to go direct or not.

So, the first piece you asked about is – there is – it depends on the country, the products, the distributor, the agreement and there is a lot of variables that you have to consider but the pricing range pick up is somewhere between 30% and 70%. And that was the number you heard, that’s accurate. So that’s the first piece.

So, by eliminating the distributor, depending on which product and which market and what the contract looks like, what the arrangement was, we obviously eliminate that middleman and we take end user revenue, end user margin, which is an immediate step up just for frankly – just keeping what you have.

The second step that you have to figure out is, when you put a direct rep in that area who is now selling the full CryoLife portfolio to your customers on a daily basis, you also tend to get unit pick up from doing that.

Because again, you have a dedicated person selling your products all the time versus a distributor who is carrying multiple products. That additional growth rate has varied depending on the markets, we’ve seen massive revenue growth in many of the markets when we’ve done that.

We’ve seen less strong revenue growth if we had a great distributor where we’d already penetrated quite heavily. So, we typically see nice growth after we put the direct reps and that’s on top of the revenue and pricing benefits – margin benefits that you get..

So, there is no – per se, there is no unit volume lost either due to the relationships or otherwise when you all go direct.

Is that a fair way to look at it?.

Well, again I think that’s a good point. I mean, you obviously don’t – you don’t want to eliminate the distributor then having units go down. We’ve been very successful in not have – in fact, we do work very closely with our distributors.

I mean, part of the reason that you see these – we have termination payments, we have revenue reversals, we have burndowns because we basically are, I think very pragmatic and I think very fair to our distributors, they’ve been good partners of ours. It’s not personal, it’s just business.

And we sit down with them and have a very orderly transition of the business, including customer list, pricing list, these kind of things. So, our primary objective when we do this is that, we don’t lose any revenue.

And I think to your point, we want to kind of put a box around what we have, keep that, get the end user revenue and pricing as part of the transition, put our own people and then grow that business..

Sorry, this is Ashley. A lot of it depends, to Pats point on what the particular market is, if we terminated a distributor and then our BioGlue distributor and it’s been in the market for a very long period of time, you’re going to see low unit growth just because the markets were mature, we typically haven’t seen unit loss.

But if you’re in a market that’s emerging like On-X, then you’ll see 28% growth that we saw in our direct markets in Europe. So, a lot of it depends on what the market is, what the product is, and what stage the maturity of the market..

I think the other thing that is very different about – I’ll give you a perfect example kind of a case study. CryoLife went direct in France a couple years ago.

We have the exact same type of dynamics, we had to reverse revenue, we had to burn inventory, we basically hired all of the distributor – our current distributors’ reps which to Ashley’s point, they’d already been selling the product in that market to those customers. We didn’t lose any business, we picked up end user revenue and end user pricing.

But that was a lot of work for us to go from zero to a direct team in France. The real benefit of – one of the real benefits of JOTEC is in Spain, they have a country leader in Spain.

They have a back office in Spain, they have direct reps in Spain, same in Italy, same in Poland with very experienced commercial leaders that are going to help us go direct and we are going to put people – feet on the ground.

So, the likelihood of having good outcomes is even higher because we’ve already got infrastructure in the countries because of the transaction..

Got it.

Pat, maybe I missed it, did you give an update on PROACT II status? I know in the last quarterly call and there were talks about 1,000 patients study, existing patients, any – did I – maybe I missed those comments?.

No. We didn’t put anything Suraj, is because obviously we had a lot to go over in the call and we wanted to make sure we left plenty of time for questions. We’ve done a lot of work on PROACT II.

In fact, we just had a big investigators’ call last week and we’re slowly but surely kind of – it’s a big complicated study and I think we’ve got a lot of the pieces in place.

Really the next step is to get in front of the FDA and we plan to do that probably in the first quarter and basically to show them we have a couple different options on the protocol.

And so, we will be having those meetings and I think at that time, based on what we hear back from FDA, it would be appropriate to give everyone update on where we are in PROACT II..

Fair enough. And finally, Ashley one for you and I will hop back in the queue, and forgive me if it sounds half baked, I am just trying to get my arms around this. So, Ashley in 2017, the euro was roughly up and I mean roughly up 10%, right, versus the dollar.

If you look at JOTEC, you all have given publicly what their numbers for – and I believe – if I remember correctly, 17% nominal growth year-over-year.

So, question number one is, what was JOTEC’s constant currency growth? And moving forward, how do you all expect either to hedge or – the European component is going to be a pretty significant portion, any color there would be great. Gentlemen, thank you for taking my questions..

Yes, so in regards to JOTEC, I can tell you what their nominal growth was as denominated in euro. I don’t have the growth in constant currency available at my hands right now, but if you look at JOTEC’s growth in their functional currency, which is euro over the last three years, it’s been about 25%.

So – and maybe this might be helpful for you guys going forward. So, if you look at JOTEC for the last four quarters ending June 30, their euro denominated revenue – I’ll just go and give that to you, for Q3 of 2016 it was €9.9 million; in Q4 of 2016, it was €10.3 million; in Q1 of 2017, it was €11.2 million; and in Q2 of 2017, it was €12 million.

So that hopefully will give you a little bit of perspective as to where they are. And again, in their functional currency, their growth has been about 25% over the last three years..

In regards to hedging, prior to the combination with JOTEC, we really didn’t do any hedging, we kind of had a natural hedge on the bottom line because we had an infrastructure based in just outside of London. So, from a net cash flow basis, we had a natural hedge and we didn’t really do any hedging.

If you look at the combined entity going forward, we are going to have a significant business in Europe, we’re going to have $80 million, $90 million business coming out of the gates, and it’s something that we need to focus on in regards to hedging. Now JOTEC does have over 300 employees.

So, we are going to have somewhat of a natural hedge there too and coming out of the gates, we don’t expect to have a significant amount of cash flow being generated right out of the gates.

But as we go out over the next three to five years, we expect that that business is going to grow significantly in hedging, it’s something that we’re going to have to pay more attention to, but we don’t have any firm plans at this point..

Thank you..

The next question is from Brooks O’Neil of Lake Street Capital Markets. Please go ahead..

Good morning. So it seems to me that the market is a bit skeptical about your ability to compete in the stent graft market, Pat, against the big players. And I was hoping you would just comment about your thinking why you’re so confident you will be successful in the market..

Yes. So again, I have the advantage of having worked in that space, ran one of the big companies’ business in that space. So, I obviously know a lot about it and have been watching the business for a number of years. I think one of the misnomers – it’s just kind of human nature, when you say stent graft market, people immediately jump to AAA.

So abdominal aortic aneurysms, which is the biggest market and where the whole thing started. I think that’s probably the least – that was like the lowest part of our focus on this transaction, is the more commoditized, crowded AAA market.

What excited me about JOTEC was, one; their pipeline, they’ve created really an amazing pipeline over the last decade and if you kind of just go on the real state of aorta starting kind of up at the aortic valve, the first product is a, which is called a frozen elephant trunk product, which is a hybrid open surgical graft with a stent graft.

That is a product that’s implanted by cardiac surgeons. There is only one other player and it’s not the big player, it’s certain other company, but it’s not one of the big players. So, JOTEC is one of two players in that segment, which is very synergistic with our channel.

If you jump down to the thoracoabdominal region, JOTEC has been very successful with their customized branch technology and there’s only one other player in that segment. So, two of the big players in that space don’t even have the technology. So, when people say they don’t think you can compete with the big players, it’s like – that’s not our goal.

We think about this concept of asymmetry in competition where we’re going to compete, where we think we can win, and we think that JOTEC has got some very novel technology and with our focus on aortic disease and our size and scale, it puts us in a sweet spot to focus on really the fastest growing segments of the stent graft market, which is not where the big players have been focusing.

So again, I think we will prove it out in the market. I mean, also you can use JOTEC’s performance in Europe as a proxy. I mean JOTEC has been competing against all the big players for the last three years in a market that’s been growing 2% or 3%, they’ve been growing 25%. So, I wonder what’s happening there.

If I can’t compete with them, why is the JOTEC growing eight times as fast as the market?.

That’s very helpful and I agree with you a 1000%. So, as you probably will recall, I’m not an expert in the cardiac surgery market, but it’s my sense that historically you’ve talked a lot about the strategic focus of the company being around building a cardiac surgery focused business.

Clearly, you just alluded to some of the proximity of the new products that JOTEC, to your historic strategic focus areas.

But can you just elaborate a little bit more, perhaps for more generalist about the fit between the businesses you’re adding and the historic strategic focus you targeted?.

Yes. So, I think I will start with – CryoLife has been a company focused on cardiac and vascular surgery for quite some time between the saphenous vein and the tissue segment and BioGlue. So, CryoLife has always had a position in vascular surgery.

Several years ago – I guess a couple of years ago we divested the dialysis vascular portion, which is a very different market. So, after that divestiture, I mean, I would say CryoLife was more predominantly cardiac surgery, but still had probably 30%, 40% of the revenue in vascular surgery.

And I think what is very unique about this transaction is that as we looked at the different opportunities, the different companies that were out there, this company really fit quite well with us on the focus on cardiac and vascular surgeons, but we’re focused around the disease state, we’re focused around the aorta.

So, I think one of the things that I believe makes a company, a smaller company, successful is kind of a hyper focus. And again, we are of the size and scale, I mean, if you look at, we’re going to have over 1000 employees, we’re going be direct, we’re going to have a 75% direct sales force in Europe.

We’ve got probably, in North America, pushing a 60% direct sales force. So, we’ve got good channels, good products, a great R&D pipeline. And this idea, I mean, many of the customers we talked with, both on the cardiac and vascular surgery side, there’s a small segment focused on aorta and that’s where we’re focused.

And there’s tons of synergy between this. I mean there is vascular surgeons that do stent grafting, but they also do open surgical cases where they can use by BioGlue. There’s cardiac surgeons that do open surgical cases, but they also do stent grafting.

And we’re more focused on our strategies around aortic disease and we will work with the customers and a more narrow set of customers in the cardiac and vascular surgery segment that focus on the aorta. And I think it’s a space that we like, it’s growing and we think we can differentiate and win in this space..

That’s perfect.

Last thing, I know you have a ton on your plate, but I don’t think I heard you say anything about progress with the wound care product and I’m just curious if there has been any or that’s just something that got moved to the side with all of these other stuff going on?.

No, I think it’s a little bit like the question on PROACT II. I mean, obviously we could have had 45 minutes of prepared remarks and we decided to focus on the quarter and on the deal, which is – what our investors had asked for. The NeoPatch, which is our wound care product, our amniotic membrane, we’ve been actively trying to partner that product.

We’ve been in discussions with a couple of players and this typically take longer than you like. Obviously, we’ve been somewhat focused on other things at this time so, it hasn’t been on the front burner. But we’re still very excited about that and we are hoping to get something done by the end the year, that’s still one of our priorities.

Obviously with the JOTEC acquisition and the financing and closing and we haven’t really been spending as much time, but we are still hoping to get something done by the end of the year on that..

Perfect. Thank you very much and congratulations on all your prior works..

The next question is from Jo Munda of First Analysis. Please go ahead..

Good morning, Pat and Ash. Can you hear me? Okay..

Good morning, Joe..

Just couple of quick questions here. Ashley, real quick, I think we asked this on the last call, but interest rate on the debt, can you give us some baseline sort of proxy range we could use for modeling purposes? I think you had talked about LIBOR plus four in a quarter over 450.

Does that still hold true?.

Joe, that’s ultimately going to be determined by the syndication process and the demand. But if you look at comparable transactions, they’ve been pricing somewhere in that neighborhood. So, we think that that’s appropriate..

Yes, okay.

As far as – Pat and then switching over to On-X, you talked about 28 new accounts opened in the third quarter, can you give us a total account, I guess, number where you guys stand as of year-to-date or in total?.

Yes, we’re at about 600. We’ve been adding about 30 accounts a quarter since we acquired the company. So, we’re sitting around 600..

And can you remind us, I mean, I forget what the total opportunity was as far as….

Yes. So there is – I mean, it’s a – having been in this field for a long time, there’s about 1000 heart hospitals. Some of the volume is skewed obviously in the bigger accounts. So, if you got the wrong 200, I mean, you could have the 200 smallest versus the 200 biggest, the unit volume will be a lot different.

So, I mean I think our goal is to really have On-X available in every place that does aortic valve surgery. And so, we obviously still have some room to grow there..

And then, you guys, in your prepared remarks you talk a little bit about the OEM business.

Can you remind us is that the coating business that you were talking about? And if it is, can you give us a little bit of color as to what’s going on there?.

Yes, so this was, Joe, if you remember a year ago, I guess it would have been the fourth quarter announcement, we have an OEM business that On-X has had for quite some time.

They basically use their coating technology one in the orthopedic space and in the cardiac space and we can’t get into who they are because we have confidentiality provisions for a good reason. But again, it’s non-strategic, it’s not – got anything to do with our end user products. It’s just something that we use the technology for other companies.

We were just notified by one of the companies that they weren’t going to be placing any orders because they are having some issues with – on their side. And that was – that happened kind of to us in like, about a year ago. So, the good news is that that supplier is kind of worked out of the system now as far as the revenue, it’s kind of gone.

Our remaining OEM suppliers still in good shape – and again, it’s not a strategic part of our business and it’s something that – now that it’s annualized on itself that it shouldn’t really be a headwind anymore..

Okay.

How big is that business? Can you give us ballpark?.

Yes, about a $1.5 million..

A year? Okay..

Yes..

And then I just got two more real quick ones here. As far as BioGlue, you guys are talking about competing products that are being trialled. I guess, it is a two-part question.

A; Are you losing any accounts to these – to the new product that you’re coming up against in these trials and B; Can you give us some sense of how big the BioGlue business is in Japan currently?.

Yes, on the first question, I mean I thought it was very positive. I mean any time you have a new competitor come in, and we run into that. I think the biggest issue for us has frankly been them offering free trials where we just – the customer uses the product and we don’t get any BioGlue sales.

We have not really seen any loss of our accounts there other than during the trialing period. So, I mean BioGlue was up last quarter, going up like a point, but it still was up in the face of a new competitor. I mean we’re pretty happy with that.

And I think there was a point where this is kind of just – they’ve been trying to get it in and they had and we saw the same thing in the UK where they try to come in and we kind of kept them out of our accounts. So, it’s more of a new sense anything else. We also have a dedicated focus team that calls on heart surgeons all the time.

So, I think we’ve got a good position on that. As far as the second one in Japan, the original indication that we’ve got, we went from like zero to $5 million fairly quickly.

We’ve got – then just got this – we expanded indication that got us and again I can’t get too technical because it’s probably not important at this point, but we then opened up kind of the remaining part of the BioGlue indication, and we think that’s another $5 million opportunity and we’re now sitting probably at about $6 million.

We are about 60% penetrated to the indication, that’s in Japan at this time..

And then my last question. Pat, you talked about – or Ashley you talked about some noise, some integration noise from the salesforce in the fourth quarter that obviously have a little bit of an impact on the business.

I guess when – as far as the timeline is concerned, when you figure the entire salesforce will be fully integrated and on a go-forward basis via cohesive unit and this issue should dissipate?.

So, I’ll take that. There is a number of things that are going to be happening. So, number one, we’ve got a European kickoff meeting kind of next week. So, both the CryoLife and the JOTEC’s sales teams they are going to be all the field for the better part – half a week or so. So that’s the first step in kind of the integration.

They are going to get cross-trained on – the JOTEC reps are going to get cross-trained on BioGlue, we are going to have 40 new reps on BioGlue to heart surgeons.

Our cardiac reps on the CryoLife are going to be trained on the frozen elephant trunk which will be selling to the cross-unit sell through, the heart – so that’s the cross-selling which you’re going to start to see.

The other thing is we – without getting into numbers, but we went through a very sophisticated sales alignment process which JOTEC had not done and frankly CryoLife had not done in Europe, we have done in the U.S. and this is something that I’ve got a lot of experience and you’ve probably got a dozen of these in my career.

Where you basically look at the products and the countries and the opportunity and you size and position your reps for full optimization, we went through a pretty significant consulting project this summer on the combination of the JOTEC-CryoLife salesforce.

And what we found was, we had some reps in the same cities which we’re going to eliminate but we also had probably half a dozen reps out of position that we’re going to eliminate those and re-hire them in different places. So that’s some of the choppiness you’re going to see in the fourth quarter.

But as we – as the transaction closes in early December, as we move into January, we’ve got a global sales meeting in mid-January, we’re going to hit the ground running with kind of a full feet on the street in January with a new team..

Okay, thanks for taking the question..

There are no further questions at this time. I’d like to turn the call back over to Pat Mackin for closing remarks..

Yes, thanks. I know we’re little bit over, I apologize for that. But I want to thank you all for joining this morning.

And as you could hear, we obviously have a lot going on, we had a little bit of choppiness in the third quarter, we try to give you clear guidance on the fourth quarter given the distributor reversals and AAP kind of lingering and some of the integration we’re doing on the salesforce side.

But at the end of the day, we are very excited about the transaction, we hope to close it in the first week of December.

We think the majority of the salesforce integration work, we’re going to be strong in the first quarter, we got some inventory burn down we’re going to be dealing with as we talked about, but we’re going to be gaining momentum and hitting our stride starting in the first quarter and really, I think hitting full stride going into Q2.

So, we’re very excited, we will be giving a full year updated guidance at our March call, and I think you’ll see the fruits of the labors we’re doing right now in that messaging. So, thanks again for calling in and have a good day..

This concludes today’s conference. You may now disconnect your lines. Thank you for your participation..