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Executives

Fern Lazar - Lazar Partners

Nachum Shamir - President and Chief Executive Officer

Yuval Yanai - Senior Vice President and Chief Financial Officer

Analysts

Jeremy Feffer - Cantor Fitzgerald

Bryan Brokmeier - Maxim Group

Steven Tepper - Harel Finance

Debbie Wang - Morningstar

Given Imaging Ltd. (GIVN) Q4 2012 Earnings Call February 13, 2013 9:00 AM ET

Operator

Good day, and welcome ladies and gentlemen to the Given Imaging fourth quarter and fiscal year 2012 financial results conference call. (Operator Instructions) At this time, I would like to turn the call over to. Fern Lazar of Lazar Partners.

Fern Lazar

Good morning and thank you for joining us. With us today from Given Imaging are Homi Shamir, President and CEO; and Yuval Yanai, Chief Financial Officer.

Before we begin, I'd like to read the following regarding forward-looking statements. During the course of this conference call the company may make projections or other forward-looking statements regarding future events or the financial performance of Given Imaging.

We wish to caution you that such statements reflect only the company's current expectations and that actual events or results may differ materially. You're kindly referred to the risk factors and cautionary language contained in the documents that the company files with the Securities and Exchange Commission, including the company's Annual Report on Form 20-F filed March 7, 2012. The company undertakes no obligations to update any projections or forward-looking statements in the future.

In today's call, the company will make reference to certain non-GAAP financial measures including adjusted net income, adjusted net income per share, adjusted EBITDA and adjusted operating expenses. The reconciliation of these non-GAAP measures to the most directly comparable GAAP measures can be found in the company's fourth quarter and fiscal yearend 2012 earnings release, which is posted on the Given Imaging site.

I'll now turn the call over to Homi Shamir, President and CEO of Given Imaging.

Nachum Shamir

Thanks, Fern, and thanks to all of you for joining us today. Overall fiscal year 2012 revenues were lower than anticipated due to revenue shortfall in the EMEA and APAC regions. The ongoing economy downturn in Europe weigh on revenue growth in the EMEA, while lower sales in China and changing our commercial strategy in Japan negatively impacted revenues in the APAC region.

Nevertheless, in fiscal 2012, we achieved record revenues as a result of 6% increase in revenue in the America region. In that market we delivered a 10% increase in sales of our functional GI diagnostic product for the year as we as 2% increase in PillCam sales.

I would also like to point out that PillCam sales in Q4 increased by a solid 7% compared to the same period in 2011. Sales in the America regions were negatively impacted by Hurricane Sandy, which hit the Northeast in October.

I am pleased to report that PillCam had big sales in Japan grew by 30% in 2012, the majority of which occurred in the second half of the year. This increase was due to the change we made in our commercial strategy, in which Given Imaging is taking a direct role in sales and marketing.

The implementation of PillCam SB reimbursement code that went into effect in July of last year also had a positive impact on sales. We are confident that now we have the right thing were in place in Japan, and expect the solid increase in sales to continue going forward.

I am pleased that we delivered on our goal of increasing profitability. GAAP and non-GAAP EPS achieved record level of $0.45 and $0.72 for the year. This is even more encouraging news, since the SmartPill acquisition has, as expected, a dilutive effect on EPS. Yuval will provide additional detail shortly.

We expect 2013 to be a pivotal year for the company. Our goal is to return to double-digit revenue growth as we expand the market for our comprehensive line of devices to visualize, detect, and monitor disorder in the digestive tract and introduce new innovative products.

First, we will continue working to expand the markets globally for the PillCam SB obscure GI bleeding indication. There is a significant market opportunity to grow this indication globally. While we already have strong penetration based on our position, as a gold-standard for detecting OGIB, our market therefore shows that there is still significant upside potential.

We also plan to expand the use of PillCam SB as a tool to detect and monitor Crohn's disease in the U.S. and Japan. Educating physician about this indication was a key focus of our U.S. sales for us last year and will continue to be in 2013 and beyond.

Third, we will continue growing our functional GI diagnostic business in the U.S. and abroad. In addition to our Bravo, Digitrapper and ManoScan product lines, we will be working in this field to expand the market for SmartPill in the U.S.

Given Imaging has a strong pipeline of new product and this year we are very excited about two significant product launches. First, we are introducing our next-generation small bowel capsule, PillCam SB3 in Europe this quarter, and we plan to launch in the USA later in 2013, pending FDA 510(k) clearance. PillCam SB is a game-changing product and we will provide more information about it when we launch it in the USA market.

Second, PillCam COLON is currently under regulatory review in the USA and Japan, and we anticipate decision by the fourth quarter of this year. We believe that this will be valuable diagnostic tool to visualize and diagnose disorder of the colon in two of the world's largest healthcare markets. We plan to disclose data on the USA PillCam COLON study at DDW in May.

We recently announced that we ended the strategic alternative review process. The executive committee enormously concluded that the continued execution of the company operating plan, supplemented by additional acquisition and alliances, provide the best opportunity this time to enhance value for all of the company shareholders.

In summary, we are optimistic about 2013 and we look forward to return to double-digit growth in our international market, and we believe that we will be able to accelerate growth in the America region in 2013. Given Imaging has a robust product offering of seven marketed product across 22 GI disease states, and we are dedicated to expanding our footprint globally, while we deepen our clinical presence within each market segment.

I will now turn the call over to Yuval Yanai, who will provide some more additional details on our fourth quarter results.

Yuval Yanai

Thank you, Homi. As mentioned before, we achieved revenues of $48.7 million in the fourth quarter of 2012, bringing total revenues for 2012 itself to $180.5 million. Revenues in the America region in the fourth quarter increased 1% to $31.3 million. The growth is attributable mainly to a 7% increase in PillCam sales.

This increase was offset by decrease in sales of functional diagnostic products. Sales of this product in the Americas region decreased 4% to $6.7 million from $6.9 million in the same period in 2011. This brings total revenues in the America region for fiscal year 2012 to just over $115 million, a 6% increase over 2011.

In the EMEA region, the 1% decrease in revenues to $11.3 million from $11.4 million in Q4 2011. Total 2012 revenues in EMEA were down 5%, from $45.1 million to $42.9 million in 2011. Revenues in the APAC region decreased by 2% in the fourth quarter of 2012 to $6.1 million from $6.3 million in same period in 2011. 2012 revenues in the region fell 7% from $25 million in 2011 to $22.5 million in 2012.

Total PillCam SB sales were 61,800 capsules in the fourth quarter of 2012, a 2% increase compared to the fourth quarter of 2011. In the Americas region, PillCam SB sale in the fourth quarter increased 7% to 40,300 capsules compared to 37,800 capsules in the same period last year.

Compared to the fourth quarter of 2011, PillCam SB sales in the EMEA region decreased 8% to 14,200 capsules, while PillCam SB sales in the APAC region increased by 2% to 7,300 capsules in 2012.

Worldwide sales of functional diagnostic products increased by 2% to $14.6 million in the fourth quarter of 2012 compared to $14.3 million in the same period of last year. In the America region functional diagnostic products revenue decreased 8% in the fourth quarter of 2012 to $11 million compared to $12 million in the same period last year.

Functional diagnostics revenue in the EMEA region was $2.9 million compared to $1.8 million in the same period last year. Revenues in the APAC region was $700,000 slightly over the $600,000 in the same period last year.

Gross margins on a GAAP and non-GAAP basis in the fourth quarter of 2012 were 74.6% and 76.1% compared to 77.4% and 77.9% in the fourth quarter of 2011 respectively. The decrease was due primarily to the acquisition of the assets of SmartPill Corporation in October 2012 and product mix. On an annual basis, we continue to generate solid non-GAAP gross margin of 77.2%, and we believe we can continue generating high gross margin in the foreseeable future.

During the fourth quarter, we completed the transfer of SmartPill production to Israel, and we are now manufacturing this product with there. During in 2013, we will be reducing the cost of manufacturing of this product, which should reduce the dilutive effect of this product on margins.

On a GAAP basis, operating profit was $3.6 million compared to $4.9 million in the fourth quarter of 2011. The decline in GAAP operating profit is attributable predominantly to the acquisition of SmartPill. Non-GAAP operating profit was $7 million compared to $7.1 million in the fourth quarter of 2011.

It is worth noting that cash generated from operating activities correlates nicely with our non-GAAP operating profit. This quarter, cash generated from operating activities totaled $11 million. In 2012, we generated almost $28 million from operating activities.

On a GAAP basis, net income for the fourth quarter of 2011 decreased 9% to $5.1 million or $0.16 per share compared to $5.6 million or $0.18 per share in the same quarter of last year. On a non-GAAP basis, net income for the fourth quarter of 2012 increased by 3% to $7.9 million or $0.25 per share on a fully diluted basis compared to $7.7 million or $0.25 per share on fully diluted basis in the fourth quarter of 2011.

On an annual basis, non-GAAP net income increased 12% to $22.6 million, while EPS increased 11%. The variance between gross of net income and gross of EPS is due to the increased number of shares on a fully diluted basis.

Tax expenses were lower in 2012, as a result of closing tax assessment in Israel and other tax adjustments. The reconciliation between GAAP and non-GAAP earning is available in our fourth quarter press release, which is posted on our website.

Turing now to 2013 guidance, as we mentioned in our press release, we expect 2013 revenue will be between $195 million and $205 million. We also expect the earnings per share will be between $0.55 and $0.63 on a GAAP basis and between $0.80 to $0.88 on a non-GAAP basis.

I would like to spend a few minutes discussing some of the assumptions that went into our 2013 guidance. As in 2012, our topline guidance reflects the uncertainties surrounding Europe. However, we believe that on a global basis, we can return to double-digit growth, while continuing to improve profitability and generate a considerable amount of cash.

Operating expenses include the investment in SmartPill and an additional expense of almost $2.5 million or approximately $0.08 per share related to the implementation of the medical device tax in the U.S.

I would like to remind you of the traditional seasonality in our revenue generation from quarter to quarter during the yield. The first quarter of each year tends to be our weakest quarter. The second and third quarters tend to be higher than the first quarter, with revenues in the third quarter more or less equal to the second one. Fourth quarter is usually the strongest. As a result, first quarter profitability tends to be lower than other quarters.

We expect GAAP and non-GAAP gross margin for fiscal year 2013 to be in line with gross margin in 2012, and could fluctuate slightly on a quarterly basis due to change in product mix, exchange rates and geographic distribution of revenues. We will continue our efforts to improve profitability and we expect operating margin, both GAAP and non-GAAP, to fairly improve this year.

Moderator, you may now open the call for questions.

Question-and-Answer Session

Operator

(Operator Instructions) And we will take our first question from Jeremy Feffer with Cantor Fitzgerald.

Jeremy Feffer - Cantor Fitzgerald

First, I wanted to talk about Asia-Pacific specifically. First on China, what was the cause of the weakness? And I guess in Japan are you now expecting a normalized run rate with the direct sales model now fully in place?

Nachum Shamir

Concerning China, again, we are using a distributor, and he changed a little bit his model of working and approach to the market. As we said previously in some of the call, this distributor, he is not coming from the med tech device. He is learning, as he keeps going. He invested a lot in the future and he believe in the future. And sometimes he can make mistake and sometimes he changes approach. They are committed to what we need in the market. We have close to 300 installation in China. And we believe that after we change this approach to the market, we will go back to during 2013 to the nice growth that we had in China compared in 2011.

Now, concerning the Japanese market; yes, the second part of the year was a robust second part. The running rate was well for us, especially compared to the first part of the year. And we believe this continuation of good momentum will continue in the next couple of years to come.

Jeremy Feffer - Cantor Fitzgerald

If I look at the functional GI business, the growth is slow to last few quarters, it was basically worldwide it was flat this quarter. What's going to get that moving or what was causing the slowdown, what gets that moving again in '13?

Yuval Yanai

As a matter of fact, if you will look at the GI SB, I think we had a very good year in the manometry business, and what took the numbers back is the Bravo. As we mentioned previously, we had recalling the Bravo that had a (inaudible) end of 2011 beginning of 2012. The product now perform extremely well, but we have to gain back the confidence of the physician. If I'm not mistaken, (GI SBO), basically the manometry business in the USA grew again 30% this year.

So we will continue to see this as a growing part, and we have to bring Bravo back the confidence, back to the physician, and we believe we can do it. The product never performed better than what it's performing while now. And we need to just go back and then the sales force will have to work with the physician to reeducate them.

Jeremy Feffer - Cantor Fitzgerald

And then just one sort of modeling housekeeping question, which line will you be including the device tax? Is it going to be in COGS or will it be a separate line?

Yuval Yanai

Not a separate line, it's going to be part of our operating expenses and not of COGS. And if you take approximately 2% or 2.3%, let's say 2% of the sales in the U.S. that will take you to the right number, but it will be a part of our operating expenses.

Operator

And we will take our next question from Bryan Brokmeier from Maxim Group.

Unidentified Analyst

This is actually Ben in for Bryan. So the first question is, there was a negative impact in SB sales in Europe, was it caused by customers who knew that SB3 was coming?

Nachum Shamir

No, not at all. Basically it was a slowdown in Europe continued, but we see now some recovery especially the southern part of Europe. As a matter of fact some of the country like U.K. and France had a record level of sales, also. Again, it is the southern part of Europe, but we believe now that we are stepping into a right direction and we actually are hoping to return to double-digit growth in EMEA as well during 2013.

Yuval Yanai

The European system is a public one, and during 2012 many governments just stopped funding hospitals, and therefore there was not enough money to buy medical equipment in general and our capsules included. So just to reiterate to what Homi said before, nothing to do with SB3, it all has to do with the internal economic situation in these countries, which looks a little bit better right now.

Unidentified Analyst

Also you mentioned new products you have planned for 2013. In your latest PowerPoint presentation displayed Crohn's ulcerative colitis capsule. Do you know what the timing is for that? Is that still on schedule and on track?

Nachum Shamir

Yes, those are on track. Ulcerative colitis is primarily a capsules that we're targeting the Japanese market. It's a request actually done by the Japanese authority. And we're planning to start clinical trial on this product during this year. And hopefully when the clinical trial will be successful, we will launch it in Japan. Probably, we'll not be seeing any sales effect till the end of 2014, beginning of 2015.

But again, it's a very natural expansion of our product line for the PillCam COLON technology, in which I don't know how much you guys know about ulcerative colitis, but it's a disease of the colon and the patient suffering. Basically it's very hard to do colonoscopy to them. And again, it's a very good way to use a noninvasive technology to monitor ulcerative colitis that is close to 130,000 patients in Japan, who more than annually have to do this test. And actually as I mentioned, we have been approached by the authority to bring out solution to them.

Unidentified Analyst

And if I can sneak one more in, you mentioned the uses of PillCam SB to the Crohn's disease. What was the contribution to the 2012 growth and how do you see that trending for 2013?

Yuval Yanai

The only, I would say condition we hear right now, that's quite difficult to measure the real utilization of PillCam SB as a monitoring tool for Crohn's patients. Because the physicians are not using a separate CPT code for this disease, this is the same one for reimbursement purposes.

Therefore it is our estimate, based of course on discussion with the physicians across the U.S. that in 2012, using SB capsule for monitoring Crohn's patient contributed somewhere between 15% to 20% of our small bowel revenues. And within that, I would say, the growth that we anticipate for 2013 in the U.S. market consist on increased utilization of small bowel capsule for monitoring Crohn's patients.

Operator

And we'll go next to Steven Tepper with Harel Finance.

Steven Tepper - Harel Finance

I just want to continue the previous question. You mentioned double-digit growth for 2013. So could you sort of break it down, like you mentioned the Crohn's utilization in the American market, where else do you see the growth coming for that double-digit estimation?

Nachum Shamir

Firstly, looking at the international market, both in the EMEA and also especially in Asia-Pacific, to go back to the double-digit growth, I think to mention that for years, and I think with the exception of last year, we enjoyed out in international market a nice double-digit growth, and which obviously was effected during 2012 because of all what we mentioned.

So first, we believe we are going back to this, a growth during 2013. And again repeating China, going back to the normal way; Japan, accelerating growth; and again in EMEA, recovery in spite of Southern Europe, but overall a better execution also in our operation there. Beyond that, we see that the trend and we overall had a 6% growth in America, and we believe that we will maintain or even grow this further. Again, I cannot say that we will be in the double-digit in the America but we'll try to reach close to that. So that's where we see the double-digit growth coming.

Steven Tepper - Harel Finance

Just one more question regarding the PillCam COLON 2. You mentioned that the fourth quarter of this year, you expect approvals? And is that also for Japan and also for the U.S.? I mean, you mentioned previously that it was a direct de novo process and you were sort of expecting that the process would be shorter than what you originally expected. Are you on track with the timelines or is there some kind of delays or are you getting some kind of questions from the different authorities that you are responding to? How are things going?

Nachum Shamir

We are tracking as we say it on the timeline. Obviously, we are in discussion with the FDA, which I cannot elaborate further but yes, it is moving in the right direction and in the right track that we've talked about timeline.

Operator

We'll go next to Debbie Wang from Morningstar.

Debbie Wang - Morningstar

My question has to do with a little bit of perspective on the practitioner response to being able to use PillCam SB to monitor the Crohn's condition. Can you give us any sense of what gastroenterologist, how are they reacting to that idea? Is there something they are embracing or is there some sense that maybe they feel like they don't really need to do that for many of their patients, just curious?

Nachum Shamir

Firstly, the physician who are using it, and Yuval mentioned, we believe that there is today 15% or 20% of our utilization coming for that (inaudible). And what makes here the difference between the monitoring Crohn and LGIB is we have also the patient need. A patient who is suffering from Crohn, a fully educated patient with media or through the social media, and they have to do this procedure almost on an annual basis.

And it's not like an LGIB patient that coming once to the doctor and then is going, oh man, he would do whatever the doctor would like to do, is also a Crohn patient would like to educate himself, and sometimes talk with if issued with the physician and also to email, also what he is feeling about.

So we see two things happening, yes, the physician like our idea with monitoring Crohn. Obviously, we need to and to remind all of you, we still don't have a complete coverage on monitoring Crohn. We have roughly about 55 million patient covered with that, and obviously we have the Medicare coverage. But behind it, the patient is driving the physician to do that.

The physician has a really huge benefit here, because he can see how the medication is working. He really can monitory it with the right medication, the right dose. And as we know the biologics are very aggressive and they are also very expensive. And it's giving the physician a better way to look out because of his healings. And I think they really appreciate it.

And as a fact, we need to get more reimbursement across the U.S., say for monitoring Crohn. Obviously, for non-Crohn or suspected Crohn we have 220 million patient covered. But the monitoring, we need to continue to welcome that and hopefully in the next year or two we will have everybody covered, and then obviously we'll see continuation of the growth in this market.

Debbie Wang - Morningstar

Homi, you mentioned that there is a pull factor coming from the patients themselves. Does that suggest that you might be doing any sort of DTC in the future?

Nachum Shamir

No, but we are working altogether with the Crohn's and Colitis Association, for example, and participate in their activity. We participate in other activity. We are not ready to go DTC. I don't think that's Given, but basically yes, based on education, for example, if you would look at our website, we have there special area for patient. We're educating more patients. We are doing some of our media.

For example, a few weeks ago, a few months ago, I was in L.A. A very nice TV coverage about the patient who was suffering from Crohn, a young patient, that they decided to take the PillCam instead of having colonoscopy and that was later on broadcast in a lot of other part of the USA. So those are the kind of activity we are trying to promote and to bring, but no, we will not go directly into advertising to the patient but we will try to educate them.

Operator

And we'll go next to Jeremy Feffer from Cantor Fitzgerald

Jeremy Feffer - Cantor Fitzgerald

I just had one quick follow-up. I was curious about PillCam COLON sales in Europe. Have there been any pick up from the SG guidelines last year or is it really going to be a function of once it is approved in the U.S. and Japan there will be a carry-over effect in the Europe.

Nachum Shamir

Jeremy, there was a pick up, but really the pivotal year for selling the capsule and reaching on a significant number is this year. We are really pushing the PillCam since we got the guideline. And as a matter of fact, I will be in Europe next week, we are launching there SB-3, but we are also launching and continuing to push our COLON product, and obviously the new acquisition of the SmartPill.

So I think that we start seeing the right movement, the Center Of Excellence in Rome is looking very busy. They have a lot of physician coming and educating on the PillCam COLON. So I think this year of 2013, hopefully we'll deliver a significant number that we can share it with you, both in quantity at least and also in maybe numbers.

Operator

And we'll go back to Steven Tepper from Harel Finance.

Steven Tepper - Harel Finance

Just a follow-up on the SB3, what is the clinical advantages' to the using physicians for that capsule and how is that going to create additional revenues using the new capsule?

Nachum Shamir

From competitive reason, I would not go to the all detail because we would like to launch it in Europe first, and then in hopefully around the DDW timeframe. So we would like to make it big as much as we can, a nice surprise, but we believe it's a product that will take the competitor completely and don't forget, we have 85% market share, so whatever left there.

But what it's making it is the physician will see much better to the SB capsules, compare to what they're used to see in the SB1 and obviously, SB2. Even if I compare it, the step we took between SB1 to SB2, this is a much larger step of advancement and a better product between the SB2 and SB3 compared to SB1 and SB2.

I think the physician will be delighted. It will give them a better tool, and to diagnose their patient in much more productive tool and not hopefully, but efficacy, we tested it in the few market, we tested it with physician and the result or the feedback we got from physician are outstanding. So again, I'd like to launch it and I'd like to do it correctly and I don't want to disclose all the information now, so I'd like to keep the surprise as a result when we launch it.

Operator

And we'll go back to Bryan Brokmeier from Maxim Group.

Unidentified Analyst

This is Ben, so just a quick follow-up, more of a financial question. Last quarter you mentioned the gross margins remained relatively high for the foreseeable future. I know you mentioned the acquisition and also mix had a negative impact. Do you see margins bouncing back?

Yuval Yanai

Yes, I think I said it during my portion of the script, I said it we are certain that we can maintain the high level of gross margin. And despite the quarterly fluctuation, the gross margin in 2012 was at the same level of the year before. And hopefully with the additional revenues that will get and the efforts that we'll put in bringing down the cost of SmartPill, the new acquired business, we will may even to somehow improve the gross margin.

Operator

And there are no further questions. I will turn the call back to Mr. Shamir for closing remarks.

Nachum Shamir

Thanks everyone for joining us today. Yuval and I will be meeting with members of the financial community in several cities in the U.S. in the next few weeks as part of non-deal road show, and we look forward to seeing many of you then. Thank you.

Operator

This does conclude today's conference. And we thank you for your participation.

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