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Edited Transcript of CRY earnings conference call or presentation 1-Nov-18 12:30pm GMT

Q3 2018 CryoLife Inc Earnings Call

KENNESAW Nov 10, 2018 (Thomson StreetEvents) -- Edited Transcript of CryoLife Inc earnings conference call or presentation Thursday, November 1, 2018 at 12:30:00pm GMT

TEXT version of Transcript

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Corporate Participants

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* David Ashley Lee

CryoLife, Inc. - Executive VP, COO & CFO

* James Patrick MacKin

CryoLife, Inc. - Chairman, President & CEO

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Conference Call Participants

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* Frank James Takkinen

Lake Street Capital Markets, LLC, Research Division - Analyst

* Jason Richard Mills

Canaccord Genuity Limited, Research Division - MD of Research & Analyst

* Jeffrey Scott Cohen

Ladenburg Thalmann & Co. Inc., Research Division - MD of Equity Research

* Joseph P. Munda

First Analysis Corporation - Analyst

* Suraj Kalia

Northland Capital Markets, Research Division - MD & Senior Research Analyst

* Lynn Lewis

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Presentation

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Operator [1]

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Greetings, and welcome to the CryoLife Third Quarter 2018 Financial Conference Call. (Operator Instructions) As a reminder, this conference is being recorded. It is now my pleasure to introduce Ms. Lynn Lewis, Investor Relations. Please go ahead, madam.

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Lynn Lewis, [2]

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Thank you. Good morning. This is Lynn Lewis from the Gilmartin Group. Thank you for joining the call today. Joining me from CryoLife management team are Pat MacKin, CEO; and Ashley Lee, CFO.

Before we begin, I'd like to make the following statements to comply with the safe harbor requirements of the Private Securities Litigation Reform Act of 1995. Comments made on this call that look forward in time involve risks 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 those forward-looking statements. Additional information concerning certain risks 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.

With that, I'll now turn the call over to CryoLife CEO, Pat MacKin.

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James Patrick MacKin, CryoLife, Inc. - Chairman, President & CEO [3]

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Thanks, Lynn, and good morning, everyone, and thanks for joining the call.

As you all know by now, CryoLife had a very strong third quarter, led by record revenue performance from our JOTEC and On-X product lines. Overall strength can be attributed to our technologically-advanced and differentiated product portfolio and the positive impact from the global realignment of our direct sales force. Later in the call, I will discuss the drivers behind our market share gains and update you on our exciting clinical and R&D programs.

Before we jump into the results of the third quarter, I wanted to share with you my thoughts on where we think -- where things currently stand and how I envision the future. I believe we are in very good position to drive continued solid performance for the foreseeable future. My belief is based on the fact that the 2 significant acquisitions we've made in the past 2 years, On-X and JOTEC, are performing as well or better than we anticipated at the time we acquired them, due largely to the efforts of our leadership team to quickly and smoothly integrate both companies, which has allowed us to capitalize quickly on both product lines' growth potential. With the integrations largely behind us, it is now all about our ability to execute on the significant growth opportunities presented by our existing product portfolio as well as in our R&D pipeline. We will capitalize on these opportunities by rolling out a steady stream of next-generation products and entering large new markets with existing products. These additions to our already strong product portfolio will enhance our growth potential and increase our current addressable market of $2 billion by about $1 billion.

We offer investors a company that is well positioned in executing on its key initiatives, has a clear path to continued growth given our differentiated products, strong sales and marketing organization and experienced management team as well as the clinical trials and anticipated new product introductions.

So with that, let's go over some of the highlights of our quarter. Our third quarter top line performance was strong across all of our major product lines. Revenue was $64.6 million, up 17% on a non-GAAP constant currency basis. Our On-X and JOTEC product lines again produced strong organic revenue growth, up 36% and 32%, respectively, on a non-GAAP basis. Even considering the impact of the prior year's hurricanes and revenue impact from inventory buybacks from distributors, our revenue still increased 13%. Given our performance to date this year and our expectations of a solid fourth quarter, we are raising our revenue expectations for 2018 from a previous range of $256 million to $260 million to a range of $261.5 million to $262.5 million.

As you have heard me say, our strategy has been to transform CryoLife into a company focused on treating aortic disease. We understood that to do so, we needed to have an end-to-end portfolio of technologically-advanced and differentiated products backed by compelling clinical data and supported by an experienced and well-trained team of direct sales professionals. We believe that if we could build and deliver on that strategy, it would deliver revenue growth, and it has. Our solid results continue to confirm the validity of our strategy.

One of our goals is to gain market share in a relatively short period of time. Based on the results from On-X and JOTEC for the first 9 months of this year, I believe we are delivering on that goal as we are already outpacing the growth of the market. We are accelerating growth due to not only our migration to a direct sales approach in key markets but also to our sales teams' ability to quickly integrate new products into our portfolio of offerings.

Just after we completed the acquisition of On-X in January of 2016, On-X sales growth was in the mid- to high single digits. Over the past few quarters, that growth has exceeded 20% over the corresponding periods in the prior year. Notably, our U.S. On-X market share, which has increased approximately 10% in the last 3 years since we acquired On-X, is still only 30%, providing us with ample opportunity for future growth in the U.S. On-X product line. We believe that the abilities of our experienced and well-trained team of direct sales professionals and the strong clinical data from the PROACT trial will continue to drive increased sales and market share.

Turning to our quarterly progress update for the 5 core initiatives we set for 2018. The first of our 5 initiatives for 2018 is to achieve our full year 2018 financial guidance. And as I already explained, we are updating that guidance, given our strong business momentum year-to-date.

Our second key initiative is to complete the integration of JOTEC and deliver double-digit non-GAAP revenue growth in the JOTEC product line for 2018. We estimate that the international market in which JOTEC -- in which our JOTEC portfolio competes is growing in the low single digits. In the third quarter of 2018, the JOTEC portfolio recorded non-GAAP revenue growth of 32%, implying meaningful share gain. We believe this is driven by the combined effect of our experienced direct sales team selling the best and broadest portfolio of branched stent grafts on the market. We expect the sales momentum in our JOTEC portfolio to continue as our sales team in countries that we recently converted to a direct sales model gain knowledge and experience selling the portfolio. As we mentioned during last quarter's earnings call, we are on plan to launch these 3 -- to launch 3 next-generation JOTEC products in the European regions in 2019.

Our third key initiative is to continue our momentum in our On-X business and to deliver double-digit revenue growth for 2018. In the third quarter of 2018, in 9 months ending September 30, 2018, On-X posted revenue growth of 36% and 23% year-over-year, respectively. Taking into consideration the prior year's distributor's buybacks, revenue still increased 20% in the third quarter compared to the prior year. In the third quarter, North American On-X revenue grew 25% year-over-year while Europe, Middle East, Africa On-X revenue similarly grew 29% after taking into account the prior year's distributor buybacks. We expect On-X revenues will remain solid as our sales force continues to educate surgeons and health care providers on the strong clinical results from the PROACT clinical trial. On-X is the only mechanical valve in the world that carries an FDA label that allows patients to be managed starting 3 months after their surgery at an INR level of 1.5 to 2.0, and this indication gives us tremendous competitive advantage.

Our fourth key initiative in 2018 is to expand our current total addressable market through investment in our R&D pipeline.

Regarding our pipeline. We've completed enrollment in our clinical trial for BioGlue in China, and we remain on track for a regulatory submission in the first quarter next year. Enrollment in our PerClot study in the U.S. continues. Based on the current status, we expect to complete enrollment in this study by the end of 2018, setting us up for a potential PMA submission to the FDA in Q2 of 2019.

Regarding the PROACT 10A trial. We have been in discussions with the FDA and are in the process of submitting our IDE to begin that trial. If all goes well, we could be enrolling patients in that study in the first half of next year. We will provide more details as they become available. And as previously mentioned, we remain on track to launch 3 next-generation JOTEC products into Europe, Middle East and Africa in 2019.

Finally, our fifth key initiative for 2018, which we have already accomplished, was to complete the transition to direct sales channels from our legacy CryoLife channels in Spain, Italy and Poland.

Before turning the call over to Ashley, I would like to announce that we have recently hired 2 new sales leaders, one for Latin America and one for Asia Pacific. Given their significant experience in those markets, we are very excited to have these employees on our team. We expect to see improved contributions from both regions as a result of their new leadership.

And with that, I will now turn the call over to Ashley.

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David Ashley Lee, CryoLife, Inc. - Executive VP, COO & CFO [4]

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Thanks, Pat. I'll now review our results for the third quarter as well as our financial outlook.

Total company revenues increased 46% to $64.6 million when compared to the third quarter of the prior year. On a non-GAAP basis, total revenues increased 17% and also 17% on a constant currency basis. Recall that Q3 2017 was negatively affected by $937,000 due to the impacts of hurricanes and approximately $1.1 million due to revenue reversals related to distributor terminations. After excluding the impact of these factors, third quarter 2018 revenues still increased 13% compared to the third quarter of 2017.

On a geographical basis, Q3 North American revenues were $37.7 million, an increase of 13% year-over-year. The increase was driven by a 25% increase in On-X revenues, a 15% increase in tissue processing revenues and a 3% increase in BioGlue revenues. Revenues from our European, Middle East and Africa region were $21.1 million, an increase of 250% and an increase of 31% on a non-GAAP basis compared to the prior year. Revenues from Asia Pacific and Latin America were $5.8 million for the third quarter, an increase of 24% and a decrease of 2% on a non-GAAP basis compared to the prior year. Revenues in this region would have increased year-over-year for the third quarter, but they were adversely affected by our decision to go direct with our legacy CryoLife products, On-X and BioGlue in Brazil, which is our largest market in Latin America, resulting in reduced orders from that distributor.

Looking at our individual product lines. On-X revenues for the third quarter were $11.3 million, an increase of 36% over the third quarter of 2017. Taking into account the distributor buybacks and hurricane effects in Q3 '17 that we've previously discussed, On-X revenues in the third quarter of 2018 increased 20% compared to the third quarter of 2017. On-X revenues in our North American direct markets were up 25% over the third quarter of 2017. Europe, Middle East and Africa On-X sales increased 167% overall year-over-year for the third quarter and 29% excluding the distributor buybacks. On-X direct sales in Europe, Middle East and Africa grew 11%. On-X revenues decreased 3% in Asia Pacific and Latin America, primarily due to distributor ordering patterns.

JOTEC revenues for the third quarter were $15 million. Non-GAAP JOTEC revenues increased 32% compared to the third quarter of 2017. On a constant currency basis, non-GAAP JOTEC revenues were up 33% from the third quarter.

BioGlue revenues in the third quarter decreased less than 1% year-over-year to $15.6 million. Despite an increase in competitive activities, North American BioGlue revenues were $8.7 million in Q3, an increase of 3% year-over-year. OUS BioGlue revenues decreased 5% year-over-year to $6.9 million. BioGlue revenues were up 5% in Europe, Middle East and Africa and decreased 17% year-over-year in Asia Pacific and Latin America, resulting from distributor ordering patterns and distributor destocking in Brazil, where we have elected to go direct with our legacy CryoLife products. We remain positive on the prospects for BioGlue based on our ongoing strategy to go direct in select OUS markets, the cross-selling opportunity with 45 JOTEC sales reps who [call on] vascular surgeons and the potential regulatory approval of BioGlue in China.

Total tissue processing revenues for the third quarter were $19.5 million, an increase of 15% compared to the third quarter of 2017, and grew 9% year-over-year after taking into account the impact of hurricanes from 2017. During the third quarter, vascular revenues and cardiac tissue processing revenues increased 10% and 20% year-over-year, respectively, and 5% and 14%, respectively, after taking into account the impact from hurricanes in 2017.

Our overall gross margin for the third quarter was 66%. Gross margins in the third quarter included a charge of around $60,000 related to a step-up in basis for acquired JOTEC and other distributor inventory.

SG&A expenses during the third quarter were $32.9 million, which includes $1.9 million in integration and business development-related expenses. Those charges include severance cost related to the JOTEC acquisition; ongoing expenses related to the JOTEC integration, which primarily relates to stocks implementation; and amounts for buyouts of distributor tenders related to our go-direct strategy in key European markets.

Our tax rate for the third quarter of 2018 was 26%, close to our estimated statutory tax rate.

Other income of $1.5 million includes a gain of approximately $2.7 million related to the settlement of a dispute with the former shareholders of On-X, partially offset by noncash charges related to unrealized losses on foreign currency and the write-off of certain fixed assets.

On the bottom line, we reported GAAP net income of $1.6 million or $0.04 per fully diluted share in the third quarter of 2018 and non-GAAP net income of $3.1 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 28, 2018, we had approximately $40 million in cash, cash equivalents and restricted securities. We had approximately $223 million outstanding under our term loan B. And based on our credit documents, our current gross leverage stood at over 4x, and our net leverage was just under 4x.

On October 15, we announced that we had launched a repricing of our senior secured credit facility. I'm pleased to report that we just completed that process, and we were successful in lowering our interest on the loan from LIBOR plus 400 basis points to LIBOR plus 325, which will effectively save us approximately $1.7 million annually and $10 million over the next 6 years.

As Pat said earlier, as a result of the performance year-to-date and our growing confidence in our business model, we are increasing our 2018 full year revenue guidance to a range of $261.5 million to $262.5 million from our previous range of $256 million to $260 million. This implies that we anticipate revenues for the fourth quarter of 2018 to be between $66.5 million and $67.5 million. Other changes to our guidance are summarized in the press release that we issued last night.

That concludes my comments. I'll now turn it back over to Pat.

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James Patrick MacKin, CryoLife, Inc. - Chairman, President & CEO [5]

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Thanks, Ashley.

So as you've heard this morning, our results for the third quarter reflect our strategy is on target and working. Throughout this year, we've had great momentum as our On-X and JOTEC product lines have had exceptional sales results and legacy CryoLife products and sales in tissue processing were also strong. We expect our sales momentum to continue, and we expect our pipeline to play an important role in our growth over the next 5 years.

In 2019, we'll be launching in our Europe, Middle East, Africa region our next-generation thoracic stent graft called E-nya, our next-generation and the first ever off-the-shelf branch thoracoabdominal device called E-nside and our next-generation Frozen Elephant product called E-vita Open Neo. Without going into detail, we believe these products are going to be standout performers given the clinical advantage they offer surgeons and their patients. The JOTEC engineers have done an outstanding job designing these products, and I commend them on their work.

We will also be submitting for regulatory approval for BioGlue in China in the first quarter 2019, followed by the submission for FDA approval for PerClot in Q2 of '19. We also hope to begin enrolling PROACT 10A in the first half of 2019. We believe that if the PROACT 10A trial were to hit its endpoints, this would be a game-changer for CryoLife.

So in closing, with both On-X and JOTEC now integrated, we are focusing our attention on further market execution. The results are already apparent. Our sales force is now well acquainted with selling these products and anticipate taking additional market share as we move forward. If we are able to execute on our plan for additional product launches of BioGlue in China, PerClot in the U.S, PROACT 10A, the European launches, these products will significantly enhance our growth profile and make us significantly a larger company. Without ever making an additional acquisition, we will still be able to increase our adjustable market by $1 billion from our current pipeline alone.

Our highly experienced leadership team, many of whom have worked in much larger organizations, will significantly enhance our ability to execute on the exciting growth opportunities in our future. Given what I've detailed for you today, we are optimistic that our best days are ahead.

And with that, let's move to take your calls. Operator, please open the line for calls.

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Questions and Answers

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Operator [1]

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(Operator Instructions) The first question is from Jason Mills, Canaccord Genuity.

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Jason Richard Mills, Canaccord Genuity Limited, Research Division - MD of Research & Analyst [2]

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Can you hear me okay?

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James Patrick MacKin, CryoLife, Inc. - Chairman, President & CEO [3]

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Jason, you're fine.

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Jason Richard Mills, Canaccord Genuity Limited, Research Division - MD of Research & Analyst [4]

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So Pat, I wanted to ask a couple of product and market-related questions. And then second part of my Q&A, I wanted to ask kind of a 20,000-foot question for -- from you. First, on the product-related side, a couple of things. JOTEC has outperformed pretty much all expectations so far. Could you give us a bit more granular sense as to why? You mentioned products. You mentioned management and additions to the direct markets that you've accumulated around the world. I'm wondering if there's anything else that's driving JOTEC and what sort of visibility you have into those kinds of growth rates going forward. And then on PerClot, it's a product that, I think, folks are familiar with because we've talked about it for a couple of years. But now that we're getting closer to perhaps seeing that launched into the United States market, maybe give us a sense for the competitive landscape there, the market opportunity that exists for PerClot and the different characteristics you believe PerClot possesses relative to the competition. And then I'll come back and ask my 20,000-foot question.

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James Patrick MacKin, CryoLife, Inc. - Chairman, President & CEO [5]

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Yes. No, sounds good. So I think, I mean, like many of these things, the JOTEC performance, I agree, has been better than we expected. I mean, I think it's -- there are multiple factors that are at play there. Number one, the prior CEO of JOTEC became our Head of Europe, Middle East and Africa. And that was a significant upgrade from a talent in that region. So I think just, number one, we've got excellent leadership over Europe, which -- in the region where we have most of the JOTEC sales. Number two, as we talked about multiple times about cross-selling, JOTEC was primarily a vascular surgery-focused company, and CryoLife is primarily a cardiac surgery-focused company. So we now have 2 channels in Europe. Obviously, JOTEC was very strong on the vascular side. CryoLife is very strong on the cardiac side. So one thing we're seeing is a significant increase in growth in our Frozen Elephant Trunk device, which is a cardiac surgery-focused device because we now have 30 feet on the street, where previously JOTEC only had a handful. I think the second piece is our innovation. Our technology is superior to the competition, particularly in the branch segment. So our branch thoracoabdominal segment, our iliac branch segment are all growing in the high 20s or over -- or significantly over that. So one of the things I told people when we acquired this company, and you'll recall, that when we announced the acquisition and people -- their initial response was, "Oh, you're buying a AAA company. Oh goodness, it's a AAA company." And in fact, this is way more than a AAA company. And in fact, our most cutting-edge and differentiated technology is in segments where we're either 1 or 2 in the space, branched thoracoabdominal abdominal, branched iliac. And we're doubling down because we've got an even stronger portfolio coming right behind it. So we're already seeing 20%, 30%, 40% growth rates in these proprietary products, and we're about to launch next-generation products, and we're going to continue to accelerate that growth. So it's multi-factorial. Its leadership. It's cross-selling. And it's the current products. And we're going to back it up with the pipeline. So we think JOTEC is going to be a star performer going forward as it has been to date. As far as PerClot, I think I've been pretty transparent with the investor community that this is a legacy technology that was kind of here before I got here. It's not kind of perfectly in the crosshairs of our aortic strategy. That being said, it's a very important asset to the company. As I mentioned in my comments, the trial will finish enrollment at the end of this year for the next couple of months. We'll package up the data, and we're going to submit to FDA in Q2. That's a -- as best we can tell, that's an over $100 million market that we can go into immediately. The clinical trial -- this is a refresher. There are 3 primary arms in the trial: cardiac surgery; liver surgery, which is mostly general surgeons; and then urology surgery, mostly nephrectomies. Clearly, CryoLife is very strong on the cardiac and vascular side, so we're going to be exploring what our options are once we get that approval and leading up to the approval of how we're going to best accelerate revenue once that product becomes available. We're currently in the process of conducting some market research on those 3 segments, and we will probably update investors as we see that opportunity unfolding going into next year.

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Jason Richard Mills, Canaccord Genuity Limited, Research Division - MD of Research & Analyst [6]

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Okay. That's helpful. We'll look forward to asking you more about that as we get closer. The 20,000-foot question. I get more and more questions about CryoLife. Obviously, the stock has done fairly well over the last year or 2 as you've executed, and folks are paying attention. But it seems to me that generally speaking, there are still a lot of investors that really have not paid enough attention to CryoLife and really are not completely clued in to what you're doing and where you think you're going. So one of the things that I do -- what gets their attention is obviously companies that have done well and executed in the medical product space, companies that have used acquisitions and internal development to not only drive revenue growth but to see operating margins, which is something that I know you care about, ramp from single-digit range to the mid-20s, even as high as, 25%, 30%, has generated a significant shareholder value, the likes of Vascular Solutions. I know you're familiar with having competed with them a little bit at Medtronic and then [LeMaitre] Vascular, which you're competing with now, and it's gone [down] in the last 4, 5 years. Could you talk about the operating margin expansion story at CryoLife and just that sort of -- your sort of game plan and how that might fit into a story that -- but also in spite of itself, improving execution, not only on the top line, but you're seeing some early leverage on the operating margin side. But I know that having talked to you over and over again for the past several years that you see this business being a much more profitable business in the future. So it seems like maybe a similar playbook here to me where you could see operating margins double or triple over the next several years. I just wanted to get your commentary about that.

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James Patrick MacKin, CryoLife, Inc. - Chairman, President & CEO [7]

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Yes. So I think on the big picture, Jason, so we just -- if I look at a 5-year view of the company, the acquisitions -- I start with the acquisitions of On-X and JOTEC, CryoLife had great, great products in glue and tissue, but they've been out for a long time, and we're growing kind of in the mid-single digits. And you -- as you heard in the quarter, those products are performing well, and we have nice plans going forward. But what's accelerated, really doubled our growth rate, is the addition of On-X and JOTEC. I mean, On-X year-to-date is growing 20%, and JOTEC year-to-date is growing 32%. And that has taken our growth rate from the CryoLife of old, of 3% to 4%, and we're now growing 11% year-to-date. So we're double digit growing. Now that those acquisitions have been integrated and that risk is clearly behind us at this point, we have a phenomenal pipeline. And we -- you go through phases as you run a company. And I -- to your point, I don't think that the pipeline of CryoLife is well understood. We have an amazing pipeline. It's very powerful, and it's not that risky because a lot of the products are approved in markets already. It's really just the expansion of those going global. So I think really the start of this is if I work through the P&L, to your question, we think we can be, as we've communicated, a high single-digit grower with our current portfolio. As we execute that pipeline over the next 5 years, we think that'll push us up into the double-digit range. Simultaneously with that, we're looking to get 500 basis points of gross margin improvement over the, call it, 1 point a year. And then we're looking to leverage the middle of the income statement with our -- as we bring on new products in our channels, we don't really need to add more reps. So if you leverage the middle part of that income statement, we think we can take our operating margins up over 20%. So those are your 3 metrics. I mean as the pipeline comes to fruition trying to get to double-digit growth, getting our gross margins up from kind of non-GAAP, if you take it from our current gross margins, are probably -- you're going to finish the year at 67%, 68%. And adding a point per year gets you into the kind of mid-70s. And then work the leverage in the middle of the income statement, that gets you to an above 20% operating margin.

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Operator [8]

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The next question is from Brooks O'Neil, Lake Street Capital.

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Frank James Takkinen, Lake Street Capital Markets, LLC, Research Division - Analyst [9]

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This is Frank Takkinen on for Brooks. So the first thing I'm looking to get a little more information about is your increasing the total addressable market. And looking at BioGlue China, PerClot U.S.A. and then your PROACT 10A, which one of those opportunities would you guys say you're most optimistic about going forward, let's say, over the next 2 to 3 years?

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James Patrick MacKin, CryoLife, Inc. - Chairman, President & CEO [10]

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So I mean I'm optimistic about all 3 of them. I think they're

(technical difficulty)

right, I mean. So PerClot in the U.S. is a pretty good-sized market. So that -- we believe that market is over $100 million and actually could be more because it's never been really pushed in into cardiac surgery area. There hasn't been much data in that space. So -- and that trial is about to finish enrollment, and we feel pretty confident about that. BioGlue China is a little bit less known because that market is -- there's not a lot of great data coming out of China. We don't know the numbers of procedures and -- like we do in a place like the U.S. or Europe. So we're really kind of having to guess. We've done some market research there, but it's significant. There are a huge number of procedures done. We just ran a very significant clinical trial, a randomized trial of 170-plus patients with the top aortic surgeon in China. Those results will be published and presented at a major Chinese society meeting. So I think that's going to change aortic dissections in China going forward. So very exciting. The challenge there is just the approval cycles in China take 1 to 2 years, and I don't have very great -- I'm not great at predicting how long it'll take to get something approved in China, and I've got a lot of experience there. And I think the other piece, the PROACT 10A is a massive opportunity for the company. I think it's an amazing -- it would be an amazing thing for patients if they could -- patients on a mechanical On-X valve no longer had to take Coumadin. They could take a -- one of the NOACs with none of the requirements to go. I mean it's almost like they're -- have a lifestyle of a diabetic. You have to check your -- get your fingers pricked every week and get your blood checked and go to the doctor's office. Those patients are really tethered to the cardiology's office. And with the PROACT 10A trial being positive, they could go in on NOAC and not have to do that anymore. So we think that's a significant opportunity. I mean that's further away because we have to conduct the trial and get the follow-up and prove that it does what we're setting out to prove and then get approved. So that one is probably the biggest opportunity. It's the furthest away of the 3 we just talked about. The one you didn't talk about was the 3 products we're launching in Europe next year. We have a next-generation Frozen Elephant Trunk, which is used in kind of the aortic arch. We pioneered that market. We fell a little bit behind with our -- from a technology standpoint. The next-generation product we have is going to be the market leader very quickly. We're launching the first ever off-the-shelf branched thoracoabdominal device. That will be an absolute game-changer in the market. And then we've got a next-generation thoracic stent graft, which is also used with those products. So -- and we have 6 products that are either getting approved next year, being submitted for their final regulatory approval or starting a big trial in the PROACT 10A. So our pipeline is starting to kind of sink in or kind of take hold here in 2019.

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Frank James Takkinen, Lake Street Capital Markets, LLC, Research Division - Analyst [11]

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Great. That's very helpful. I just have one more question on On-X and JOTEC. Could you give us a little bit of color around whether the growth is coming from an increase in average selling price or if it's a volume-based or possibly both?

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James Patrick MacKin, CryoLife, Inc. - Chairman, President & CEO [12]

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I mean our prices are fairly stable on both product lines. I mean this is a kind of a unit-driven increase. So it's -- I mean, price may fluctuate a point here or a point there. But it's -- we are not using price to take share, if that's the question. It's really been a unit take share and just people value our technology and are picking ours over somebody else's.

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Operator [13]

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The next question is from Jeffrey Cohen, Ladenburg Thalmann.

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Jeffrey Scott Cohen, Ladenburg Thalmann & Co. Inc., Research Division - MD of Equity Research [14]

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Can you hear me okay?

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James Patrick MacKin, CryoLife, Inc. - Chairman, President & CEO [15]

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Yes.

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Jeffrey Scott Cohen, Ladenburg Thalmann & Co. Inc., Research Division - MD of Equity Research [16]

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Nice readout for the quarter. Just a few questions to touch upon. Could you talk a little bit about the tissue business currently? It looks like it continues to remain very strong. And talk a little bit about margins, Q3 margins and how maybe we should think about margins more longer term as well.

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James Patrick MacKin, CryoLife, Inc. - Chairman, President & CEO [17]

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Yes. So I would say on tissue -- I mean tissue was a little bit -- and as both Ashley and I commented -- highlighted in our comments, tissue was a little bit -- the hurricane last year kind of had -- we had an easy comp, and we were trying to be very transparent about that. We said a year ago, we'd spent a lot of time -- remember these hurricanes hit Florida and Texas, which are major heart centers. And we figured that was about $1 million. So tissue in Q3, as reported, was -- grew 15%. But if you take the hurricanes out, it grew 9%. Year-to-date, we're growing 7%. So we're actually doing a little better in Q3 even when you take the hurricanes out than we have been for the year. It's interesting. Our vascular tissue business after you take the hurricanes out of Q3 grew 5% in the quarter, and we're 5% year-to-date. It's pretty much what we told people. We're going to grow mid-single digit on vascular tissue. Cardiac has been a performer. After you take out the hurricanes, we grew 14% on cardiac in the quarter, and we're growing double digit at 10% year-to-date. I'd say that's a combination of a couple of things. I'd say probably 3 things. One, our procurement, particularly of our proprietary pulmonary xenograft valve, which nobody else has got because we've got way better data than everybody else, there's a difference, a 20-point difference in reoperation rates in a decade for young kids when you use our valve versus somebody else's valve. The second thing is our sales force has been extremely effective in communicating that message. And last, our procurement group has done an excellent job of communicating that message to the procurement organizations, and they're disproportionately steering those tissues to us because of the difference in our technology. So we basically felt we could grow tissue mid-single digits. Year-to-date, it's grown 7%, 10% cardiac, 5% vascular. So we're very happy with those results. On the margin standpoint, maybe I'll have Ashley jump in and ask that -- answer that one.

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David Ashley Lee, CryoLife, Inc. - Executive VP, COO & CFO [18]

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Yes. Our gross margins in the tissue processing business were in the low 50% range during the third quarter. And based on all the information available to us, we think that, that level is sustainable going forward. They may fluctuate 100, 200 basis points here or there just depending on revenue mix and between cardiac and vascular. But by and large, we think that, that gross margins in the low 50% range are sustainable.

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James Patrick MacKin, CryoLife, Inc. - Chairman, President & CEO [19]

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And were you -- Jeff, did you also want gross margins overall or just tissue?

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Jeffrey Scott Cohen, Ladenburg Thalmann & Co. Inc., Research Division - MD of Equity Research [20]

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Yes. No, that's helpful on the tissue side. And maybe a little bit of commentary on gross margins overall, how you finish 2018 and how that might look forward.

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David Ashley Lee, CryoLife, Inc. - Executive VP, COO & CFO [21]

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Yes. I'll go back to some comments that we made in the previous conference call. Obviously, in the first half of this year, our reported gross margins were muted a little bit by the purchase accounting related to the JOTEC inventory. So if you look at our gross margins year-to-date, we're around 65.5% roughly, something like that. But going back to a comment that we made in our previous conference call, all of that purchase accounting has now run through. And we expected our gross margins in the second half of the year to be between 67% and 68%, and that's kind of what we're expecting for the fourth quarter.

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Jeffrey Scott Cohen, Ladenburg Thalmann & Co. Inc., Research Division - MD of Equity Research [22]

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Okay. And when would you expect that carries through into early '19?

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David Ashley Lee, CryoLife, Inc. - Executive VP, COO & CFO [23]

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Well, we haven't made any comment on 2019 at this point. We regularly or usually give out our guidance in our year-end conference call, and we're anticipating on doing that in February.

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Jeffrey Scott Cohen, Ladenburg Thalmann & Co. Inc., Research Division - MD of Equity Research [24]

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Okay, okay. Got it. And the European launches out of JOTEC for 2019, any indication on timing and how they look as far as cadence on that list of 3 products, early or later, they all get launched same time? Or is there more kind of a...

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James Patrick MacKin, CryoLife, Inc. - Chairman, President & CEO [25]

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There's a staggered -- there's a -- I'm not going to get specific because I don't really want to give competitors a road map, but I will tell you that there is -- we're expecting to launch 2 of the 3 in the first half and one of them kind of late in the year.

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Jeffrey Scott Cohen, Ladenburg Thalmann & Co. Inc., Research Division - MD of Equity Research [26]

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Okay. Perfect. That's helpful. One more. Ashley, could you comment a little bit about looking forward some of these -- well, 2 in particular. The business development integration expenses, has that concluded? And what kind of follow-on should we expect? And also the On-X settlement, is it settled so we should expect nothing further?

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David Ashley Lee, CryoLife, Inc. - Executive VP, COO & CFO [27]

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Yes. So in regards to the On-X settlement, it is settled, it is done, and we expect nothing else going forward from that. In regards to the business development and integration expenses, going back to the comments that I made in the prepared remarks, the primary thing that we're working on right now is just related to stocks implementation, and that has both a finance and an IT component to it. We have until the end of the year to get that completed. It's a big work stream, and the ongoing integration efforts are primarily or almost exclusively related to that, and we expect that to be completed in the fourth quarter of this year.

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James Patrick MacKin, CryoLife, Inc. - Chairman, President & CEO [28]

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Yes. We think going into '19 should be clean on kind of the integration side.

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Jeffrey Scott Cohen, Ladenburg Thalmann & Co. Inc., Research Division - MD of Equity Research [29]

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Okay. I got it. And then finally, I guess an M&A question on this front, Pat. So it seems like you're relatively stuffed up as far as projects and launches and trials and submittals. How, kind of, does that correlate to how you're thinking about M&A and products in the marketplace and other things nonorganically?

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James Patrick MacKin, CryoLife, Inc. - Chairman, President & CEO [30]

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Yes. So I think the great thing for investors is that with the acquisitions of On-X and JOTEC and the pipelines that came with that and some of the things CryoLife is already doing like PerClot and BioGlue China, as I mentioned, we have a very nice R&D pipeline. It's balanced. We have stuff that hits every year. We have short. We have middle. We have long. It's a phenomenal pipeline, and we don't need to do any deals. This is really an execution story, and I think we've shown that we can do that. That being said, we're going to be opportunistic. If we see something that fits our strategy, fits our growth profile, our margin profile, has competitive advantage, again, if it overall fits our strategy, we will execute against that. I think you're more likely to see a tuck-in from us if we're going to do anything. I don't think you're going to see a big On-X or a big JOTEC-type deal because we don't frankly need to do it. It would be more of a product that we would just tuck in under the current infrastructure. But again, I think the great thing for an investor is we're not -- we don't need to do it.

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Operator [31]

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Next question is from Kalia -- Suraj Kalia, Northland Securities.

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Suraj Kalia, Northland Capital Markets, Research Division - MD & Senior Research Analyst [32]

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Can you hear me all right?

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James Patrick MacKin, CryoLife, Inc. - Chairman, President & CEO [33]

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Yes.

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Suraj Kalia, Northland Capital Markets, Research Division - MD & Senior Research Analyst [34]

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A bunch of questions. So Pat, the first 2 -- let me see if I can intertwine them, and maybe you can give us some clarity. The number 30% has been brought up for On-X's share, specifically in the U.S. I believe it was last quarter also. Pat, help us understand, how do you determine the overall market? And partly, the reason I -- I'm trying to get a handle on the denominator per se. Are you looking at from a unit's perspective? Are you looking from a dollar's perspective? And how do you factor TAVR in some cases that have some indication creep also? And the second part of that question, Pat, is what are you seeing on the ground in terms of your centers as you guys enter the next year? We all know PARTNER III readout is going to be in March. So from a low-risk perspective, we don't know what the patient baseline characteristics, age and all that, are going to be. I'm curious, how do you see the hand-to-hand combat shaping up? What are the centers telling you on low risk?

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James Patrick MacKin, CryoLife, Inc. - Chairman, President & CEO [35]

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Yes. So the first one is pretty easy. I mean the market share -- and this is third-party data that's collected by independent outside groups, and we just subscribe to the report. And we -- it's a unit-based market share, so they calculate the number of mechanical aortic valves that are put in, in the United States, and then they kind of report it. You buy the report, and it tells you kind of your share and everybody else's share. It's unit-based, so that is a discrete share of the mechanical valve market. And again, we report a -- we don't have a -- it's not quarter-to-quarter. I think we get it a couple of times a year, so it will be updated next time we get it. So clearly, we had 30% share kind of exiting 2017. As we get the next update with our growth rate in what we think is a flat market, we expect our share to increase even further. As far as the TAVR question -- I get this one a lot, and I've talked to you a lot about this. I mean what's -- to your -- in the clinical trials in the current market, what do you think the average age of a TAVR patient is today?

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Suraj Kalia, Northland Capital Markets, Research Division - MD & Senior Research Analyst [36]

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Probably 65, 68?

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James Patrick MacKin, CryoLife, Inc. - Chairman, President & CEO [37]

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No, it's more like 75, and the average age of a mechanical valve patient is 58. So these are 2 patient populations that don't even kind of touch each other. I don't know what PARTNER III is going to show. But what I do know is that the market research that we've done on the On-X valve with a lower INR, we reduced the major complication of a mechanical valve by 65%. So there are patients that are actually now opting for an On-X mechanical valve over a tissue valve. In fact, I've talked to a couple of patients who were actually friends of mine who had aortic aneurysms and needed a -- and had a bicuspid aortic valve, and they were struggling with the decision. And they opted for a one operation and a lifelong solution. So again, I can't predict what PARTNER III is going to say. All I can tell you is the average age of a aortic mechanical valve patient is below 60, and I think it's a long way away for TAVRs to be going in under 60 -year-olds. And I think if you follow that up with PROACT 10A, I think if PROACT 10A works, and that trial should start in the first half next year, if that trial works, I think we will be competing against TAVR for patients between 60 and 70. Because why wouldn't you just get one operation for the rest of your life instead of having to deal with multiple reoperations?

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Suraj Kalia, Northland Capital Markets, Research Division - MD & Senior Research Analyst [38]

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Got it. And no disagreement on the last part in terms of PROACT. I guess I was trying -- I was referring to age potentially to PARTNER III because you know Edwards lowered their age requirements. And specifically on PROACT 10A, again, you've highlighted the opportunity many times. We are at the cusp of starting this trial. My memory fails me. Remind me what are the secondary endpoints beside the potential for a reduction in thromboembolic events once you move to Eliquis after 3 months. I'm kind of drawing a blank what the secondary endpoints were.

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James Patrick MacKin, CryoLife, Inc. - Chairman, President & CEO [39]

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Yes. So the primary endpoint -- yes, we're still finalizing the protocol with the FDA. So I mean -- this isn't written in stone, but I think there's pretty good agreement that the primary endpoint is non-inferiority between Eliquis and Coumadin on thromboembolic events. That's the primary endpoint. Do we have the same amount of strokes or thromboembolic events as the standard of care? The secondary endpoint would -- obviously, bleeding would be a secondary endpoint. And we know from all the trials that have been done that Eliquis has got a much better bleeding profile than Coumadin. So those -- that's -- the primary would be the thromboembolic, and the secondary would be bleeding. And we may have some others in there, but those are the 2 big ones.

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Suraj Kalia, Northland Capital Markets, Research Division - MD & Senior Research Analyst [40]

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Got it. And finally, Ashley, remind me as well, and I know you are not giving guidance for FY '19. But just given the FX landscape, can you kind of at least on a slightly higher level walk us through what are the natural hedges in your P&L? And how do you see exposure in FY '19 vis-à-vis FY '18?

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David Ashley Lee, CryoLife, Inc. - Executive VP, COO & CFO [41]

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Yes. Once we completed the JOTEC acquisition, Suraj, we had a much larger base of European operations and much larger base of European expenses. So if you look at -- I mean, obviously, we have a much bigger book of business, but we've got a much larger expense base. So that's the first kind of natural hedge that we have in regards to exposure between primarily the euro and the USD. Going into 2019, we consult with banking advisers and read a lot of literature about the current landscape and so forth, and it's kind of like a lot of things. You can ask a handful of people and get a handful of different opinions as to where rates are going to go. I mean there are lots of variables that factor into this. You have the rate environment both in the U.S. and in Europe. You've got the ongoing headlines regarding tariffs and what's going to happen there. You've got Brexit and whether or not there's going to be something that ultimately happens there and how that may impact the landscape as well. So there are lots of moving parts. I can't tell you that we've got a consensus view internally here as to what -- how this is going to play out, but we remain in constant dialogue with our advisers to keep a handle on it and are always evaluating strategies to mitigate any risk associated with this going forward.

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Operator [42]

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(Operator Instructions) We have a question from Joe Munda, First Analysis.

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Joseph P. Munda, First Analysis Corporation - Analyst [43]

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Pat and Ashley, can you hear me okay?

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James Patrick MacKin, CryoLife, Inc. - Chairman, President & CEO [44]

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Yes.

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David Ashley Lee, CryoLife, Inc. - Executive VP, COO & CFO [45]

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Yes, Joe.

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Joseph P. Munda, First Analysis Corporation - Analyst [46]

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So really 2 quick questions here. First off, I wanted to touch on tissue preservation. That business, you gave us some comments, and I really appreciate it. I just wanted to drill down a little bit. In the past, you guys talked about possibly the market growing as well. I guess could you give us some sense of the dynamics? I know one of your competitors is -- on their earnings call was talking about some issues that they're experiencing on the market. So are you taking share from existing competition? Or are we seeing an expansion of the market and you're growing alongside the market?

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James Patrick MacKin, CryoLife, Inc. - Chairman, President & CEO [47]

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It's actually -- it's a good question, but it's actually hard to know the answer because unlike -- I just talked about the On-X mechanical valve. There's very strong -- there's good infrastructure from a market research standpoint. There is not good data on the tissue market, tissue share. I think it's spotty at best. So I mean I would say that given, I mean, just the overall procedure growth, you can kind of triangulate for -- I think we're clearly taking share on the cardiac side. On the vascular side, I think we're actually growing that business 5%. I think we're probably taking some share there, but we're the market leader. So again, it's hard to really kind of give you a definitive answer on that. I would say that, clearly, our business has been pretty robust, and we're just leveraging the strong clinical data that we've got. And our customers are buying more of our valves than other people's valves.

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Joseph P. Munda, First Analysis Corporation - Analyst [48]

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Okay. And then -- that's helpful. And then my second question relates to Latin America. A lot more commentary, I feel like, on this call than in past calls. You talked about going direct. You hired a new sales leader in that region. I guess the crux of my question here is, are we to expect some sort of direct initiative much like we saw in Europe that is going to occur in South America? I guess can you give us a little bit more color on what your thoughts are for the region and how it shapes up?

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James Patrick MacKin, CryoLife, Inc. - Chairman, President & CEO [49]

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Yes. So we clearly are now focusing on the 2 large regions that we had not really had a strong focus on previously, both Latin America and Asia Pacific. In Latin America, we -- somewhat, this was predicated on the issue where JOTEC was -- when we acquired JOTEC, JOTEC was direct in Brazil, which was a very nice thing for us. We had, had all distributor operations in Latin America. And the fact that JOTEC was direct, we already had the infrastructure. We had the leadership. We had people on the ground. So it made it extremely easy for us to go direct with the CryoLife product portfolio. So as you heard in Ashley's comments, we actually had negative BioGlue revenues in the third quarter. So even posting the numbers that we posted, we were actually burning down inventory from our distributor in Brazil in preparation for going direct in 2019. So that's just one step in Latin America. We brought in a very seasoned commercial leader that previously has worked with me, and he has really extensive distribution networks, experience, and he's in the process of putting together his plan. Now, I don't think you're going to see us going direct in every country in Latin America. That's really not the right model. But I think you will see us be opportunistic, and we have a seasoned professional down there that will basically put a plan together to optimize our product portfolio in the region. And we're going to be doing the exact same thing in Asia Pacific. So I think those are 2 areas that you're going to hear more from us about going forward.

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Joseph P. Munda, First Analysis Corporation - Analyst [50]

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And Pat, just to follow up on that, I mean, as far as far as direct reps, how many do you have down there if you have any either in Latin America or in Asia Pacific? And maybe to start off, once you start switching over the distribution to direct, like what does that look as far as initial rep count would you think?

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James Patrick MacKin, CryoLife, Inc. - Chairman, President & CEO [51]

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Yes. So the JOTEC team in Brazil is roughly 6 to 8 people, direct people, feet on the street. We'll probably add 2 or 3 in Brazil to cover the CryoLife products. So what's nice is once you have -- it's kind of like what we did last year in Italy, Spain and Poland. Once you have the back office, the leadership, the infrastructure, you can go direct, and you don't really have to add kind of the full complement of what you would typically have to add. You can -- because you can leverage what's already there. Beyond that, we're really kind of in the early stages, and we're not -- we haven't commented on what that might look like. And we'll give more color on that as we go into '19 and roll out those plans.

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Operator [52]

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There are no further questions at this time. I'd like to turn the floor back over to management for closing comments.

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James Patrick MacKin, CryoLife, Inc. - Chairman, President & CEO [53]

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Yes. I want to thank everybody for your time on the call this morning. Just maybe a couple of quick remarks.

We've had a great year thus far. I mean we're up 11% year-over-year. When you factor -- you take out the buybacks, take out the hurricanes, the real number after 3 quarters are up 11%.

The On-X portfolio has grown 19%. The JOTEC portfolio has grown 28%. Tissue has grown 7%, pretty much what we told you. BioGlue is a little bit flat, but mostly, that is destocking and distributor ordering patterns. So we've been very happy with the performance this year.

The integration, as you heard from Ashley, will be done at the end of this quarter, and that's mostly kind of finance and IT. It's not commercial. So we've integrated both On-X and JOTEC. All that integration risk is behind us. And really, it's about executing, and it's about our pipeline, I mentioned multiple times on the call.

Going into 2019, we've got 3 JOTEC products launching in 2019: our thoracic stent graft E-nya, our branched thoracoabdominal device E-nside and our next-generation Frozen Elephant Trunk E-vita Open Neo.

We're submitting for BioGlue China FDA -- CFDA approval in Q1. We're submitting for FDA approval for PerClot in Q2, and we should start the PROACT 10A trial in the first half.

So our pipeline is really starting to take hold, and we are going to, again, be very aggressive in execution of that pipeline and of our commercial strategy.

And then finally, we just got finished talking about Asia Pacific and Latin America. We've got 2 new leaders in those regions that are putting their plans together, and we expect those to start contributing to growth as we go forward in 2019 and beyond.

So again, I think we're very excited about what we have in front of us and look forward to updating you on our next call. Thank you.

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Operator [54]

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Ladies and gentlemen, this concludes today's teleconference. You may disconnect your lines at this time, and thank you for your participation. Have a good day.