Orthofix International Q1 2009 Earnings Call Transcript

May. 6.09 | About: Orthofix International (OFIX)

Orthofix International NV (NASDAQ:OFIX)

Q1 2009 Earnings Call

May 06, 2009 4:30 PM ET

Executives

Dan Yarbrough - Vice President of Investor Relations

Alan W. Milinazzo - Group President and Chief Executive Officer

Bradley R. Mason - Group President, North America and President, Blackstone Medical, Inc.

Robert S. Vaters - Executive Vice President and Chief Financial Officer

Analysts

Bill Plovanic - Canaccord Adams

Michael Matson - Wachovia Capital Markets

Spencer Nam - Summer Street Research

Jim Sidoti - Sidoti & Company

Peter Bye - Jefferies & Company

Operator

Good afternoon. My name is Stefanie and I will be your conference operator today. At this time, I would like to welcome everyone to the Orthofix International First Quarter Earnings Results Conference Call. All lines have been placed on mute to prevent any background noise.

After the speakers' remarks, there will be a question and answer period. (Operator Instructions) As a reminder, ladies and gentlemen, this conference is being recorded today Wednesday, May 6, 2009. Thank you.

I would now like to introduce Mr. Dan Yarbrough, Vice President of Investor Relations of Orthofix. Mr. Yarbrough, you may begin your conference.

Dan Yarbrough

Thanks, Stefanie. Good afternoon, everyone, and thank you for joining us to discuss Orthofix International's financial results for the first quarter of 2009.

During this call, we will be making forward-looking statements that involve risks and uncertainties. All statements other than statements of historical fact are forward-looking statements, including any earnings guidance we provide, and any statements about our plans, beliefs, strategies, intentions, expectations, objectives, goals or prospects. Factors that could cause actual results to differ materially from these forward-looking statements made by us on this call include the risks disclosed under the heading Risk Factors in our 2008 Form 10-K and subsequent Form 10-Qs filed with the SEC.

With me on today's call are Orthofix's President and Chief Executive Officer, Alan Milinazzo; our Group President of North America and President of Orthofix Spine, Brad Mason and our Executive Vice President and Chief Financial Officer, Bob Vaters.

First, I'll turn the call over to Alan Milinazzo.

Alan W. Milinazzo

Thanks Dan, and good afternoon, everyone. Hopefully by now you have had a chance to see the press release we issued prior to the call.

We are pleased to report that we exceeded both our consolidated top and bottom line expectations for the quarter, principally driven by the growth in our Spine franchise. This improvement in combination with the continued positive trajectory of our core businesses has given us a great start to 2009.

On today's call, there will be three key areas that we will cover. First, I will start with the summary of the key drivers of our positive first quarter results and then spend a few minutes talking about the early feedback we have on the limited market release our of new Trinity Evolution product. Second, Brad will give us an update on our strengthening spinal implants division. And third, Bob will give us additional details on our first quarter 2009 results, including some key elements of our balance sheet and cash flow.

Let me start off with our first quarter results beginning with the top-line. Total revenue was $129 million which was up 1% over the prior year, but increased 5% on a constant currency basis.

From a product perspective -- product mix perspective, approximately 51% of the total revenue came from our spine stimulation and spine implant businesses which was comprised of $37.2 million from spine stimulation sales and $28.8 million from spinal implant and biologic sales.

We have reported $29.6 million or 23% of total Q1 revenue from our orthopedic division and $24.2 million or 19% from our sports medicine business. The final $9 million or 7% of total revenue came from our vascular and other product categories.

Looking at our key business segments in Q1, sales from our orthopedic products decreased 1% as reported but, increased 10% on a constant currency basis after excluding the impact of the stronger dollar against other currencies during the first quarter. As I noted in our previous earnings call we continue to believe we can grow our orthopedic business at or slightly above the rate of the overall global markets. So, we're pleased with out first quarter constant currency growth of 10% especially, when we consider the current global economic environment.

Our first quarter results were balanced across multiple orthopedic product lines and geographies. Within the international component of our orthopedics business, our external and internal fixation devices increased 7% and 29%, respectively.

Additionally, total sales of Physio-Stim, our bone growth stimulator grew 26% in the first quarter. Though Physio-Stim is primarily sold in the United States, we've had some recent success in penetrating the market in France, and we're hopeful this could bode well for further product sales in Western Europe in the future.

We also increased the sales of our biologics product, Trinity in the orthopedic setting with revenue doubling... more than doubling to $1.3 million during the first quarter. As we previously announced under our collaborative agreement with the Musculoskeletal Transplant Foundation or MTF we have exclusive global marketing rights for Trinity Evolution in the orthopedic and spine market segments.

The initial results from our limited market release of this new allograft are very encouraging. With the U.S. bone growth substitute market estimated to be at approximately $1.3 billion in 2008, we believe Trinity Evolution represents significant growth opportunity for us in the coming years.

Looking next to our sports medicine business, first quarter revenue was up a reported 4%. After adjusting for the sale of our infusion pump line in Q1 of 2008, the year-over-year growth was approximately 8%. This was driven by 12% growth of our bracing products and an 8% increase in the sales of our cold therapy devices.

With growth rates in sports medicine market overall generally running in the mid single-digits, we are pleased with our sustained above market growth rates. As I said on previous calls, this terrific growth is the result of a strong and stable distribution system as well as some outstanding new products we have introduced over the past several quarters.

Moving on to our spine businesses, once again we delivered above market growth in sales of our spine stimulation devices which were up 12% in the quarter compared with last year. We continue to see year-over-year growth in the use of our spine simulators, including a 13% increase in the number of physicians who prescribe our devices. As you know we are still the only stimulator in the market with an FDA approval for the cervical spine indication.

This is also the sixth consecutive quarter of double-digit growth for our spine stimulation business in a market that we estimate is growing at approximately 6 to 7%. Our outstanding performance over the past several quarters has resulted in the growth of our market share, which we believe is currently well in excess of 50%.

With regard to our spinal implants division, total revenue was down slightly year-over-year by roughly 1%, but importantly, it increased 2% sequentially from the fourth quarter.

This is the second sequential quarterly increase we've reported for this business, and it's especially encouraging in that the growth was driven by our lumbar and cervical spine implants, confirming the reacceleration in sales of our metal implants that began in the fourth quarter of last year.

We believe this is a direct result of the steps we took to correct the course of this business in mid 2008. Brad will go into much more detail about the spinal implant business in just a few minutes.

To finish up on our top line performance, our vascular and other product sales were down 13 and 17% respectively on a constant currency basis. We have forecasted negative growth for these products throughout 2009. However, we have also taken steps to reduce the cost structures supporting these products to maintain the profitability despite, the top-line erosion.

Before I turn to the earnings discussion, I wanted to comment on three recent announcements we made leading up to today's earnings call. On the distribution front, we reported that we had signed an agreement with one of our successful long-term distributors in Europe who will now represent our spinal implants products in the United Kingdom.

The MBA Group has been one of our fixation distributors in Europe for more than 20 years. They began representing our spinal implants in Spain and Portugal last year where they have grown that business to more than $1.5 million during that limited time.

According to our recent market research estimate, the UK market for spinal implant is about $75 million in total. So we're excited about MBA opening this attractive market for our spinal implant products.

A second announcement we made was that one of our current members of our Board of directors will be retiring as of our annual general meeting later this summer.

Peter Hewitt has been a key member of Orthofix Board of Directors for 17 years serving as the Deputy Chairman of the Board since 2005. Peter has had a tremendously positive impact on Orthofix and has been instrumental in helping shape our culture and our strategy over the years.

He will be greatly missed but long remembered as a member of our Board.

Finally and more recently, we announced that we had successfully begun the limited market release of Trinity Evolution as scheduled. Trinity Evolution is our unique, new, next generation adult stem cell based bone growth allograft. As you know, this was developed in collaboration with our partner MTF. Several surgeries using Trinity Evolution have already been completed, including procedures in both spine and orthopedic settings.

We have had consistently positive feedback from the handful of physicians who have implanted the new allograft. One of the specific key comments we have received is that it is easier to use and has superior handling characteristics compared with other allografts they have used including the first generation Trinity Osteocell product. These were two of our key design objectives when we outlined this project with MTF.

Last month, we completed the rigorous cross training of all of our field teams which will represent Trinity Evolution. Our initial focus for the teams will be to begin transitioning our current Trinity users over to our new allograft as well as to begin enrolling patients in three clinical trials that we will be initiating as of part of launch plan.

These three clinical trials will be structured as prospective multi-centered post market observational studies, two of which will be focused in spine and one will be focused in orthopedics. We are sponsoring these studies to significantly bolster the clinical data and experience we already have with stem cell based allograft.

The two spine studies will include an ACDF or Anterior Cervical Discectomy and Fusion study with a 12 month fusion end points for patients undergoing cervical fusion and a T less and T left (ph) study with a 24 month fusion endpoint for patients undergoing lumbar fusion.

In addition to the spine studies, we will also initiate a foot and ankle fusion study with a 12 month fusion endpoint. We expect to begin enrollment in these studies beginning in July.

We will continue to move through the limited market release phase of Trinity Evolution during Q2 and still expect to begin a full market release by July, 1st. As a reminder, the U.S. market for bone growth substitutes was estimated to be approximately at $1.3 billion in 2008.

Moving next to our bottom line results, we reported GAAP net income of approximately 2.9 or $0.17 per share which was just above the high end of the range of expectations we released in our pre announcement a couple of weeks ago. Excluding certain items, our adjusted net income was 6.1 million or $0.35 per share. Bob will go through each of the adjustments to earnings and also discuss some key aspects of our balance sheet and cash flow in just a minute.

Before Bob gets into this detail, I'd like to turn the call over to Brad Mason, for more detailed update on our progress at our spine implants division. Brad?

Bradley R. Mason

Thanks, Alan, and good afternoon everyone.

On today's call I'd like to focus my discussion on our spinal implants division in the four following key areas. First, the drivers of our sequential improvement in the first quarter; second, our distribution network; third, new product launches including the Firebird Pedicle Screw System, PILLAR SA and Trinity Evolution and fourth, the ongoing reorganization and consolidation plan we previously announced last year.

Before I go any further, I want to let you know that for commercial and organizational purposes, I've organized the North America team into four groups: spine stimulation under Eric Brown, spinal implants formerly Blackstone Medical, which I manage myself. Orthopedic North America under Michael Simpson and sports medicines as BREG led by Brad Lee.

Additionally we have the Orthofix biologics group headed up by Mike Finegan which is responsible for managing our biologics product portfolio as well as marketing and sales support to be other North America teams.

Although, I will focus on the spinal implant results on this call, I do want to personally acknowledge the outstanding performances of these teams, all of which are ahead of plan and are performing exceptionally well.

In regards to the spinal implants division, as Alan mentioned, we reported another quarter of sequential improvement in Q1. Revenues were ahead of our expectations, being particularly strong in the U.S. and in fact, our daily average sales exceeded prior year first quarter.

The underlying drivers demonstrated in the first quarter results give us additional confidence in our expectations for the reminder of the year. This included the fact that the Q1 gross margin was 66%, which was ahead of our internal expectations. I will give more detail on that in a few minutes.

As Alan also mentioned, we reported another quarter of sequential growth in our thoracolumbar and cervical spine implants with 5% increase in Q1. This is a very encouraging trend that we've now seen consistently for many months. It reflects strong engagement of our customers, the stability in our distribution network and the strength of our product portfolio.

As I have been reporting for the past several quarters, our distributor network is very stable, and I'm very pleased with the performance they're delivering. We continue to add new distributors regularly to both upgrade our sales force and fill open territories as appropriate and typical for medical device company.

In regards to our new product introductions in the first half of 2009, the Firebird Pedicle Screw System and the PILLAR SA interbody devices are both generating significantly better sales pre set in the field than anticipated.

We continue to add more sets weekly in our full market releases and expect to have all instrument sets for these products in the field by the middle of the summer. As mentioned in our last call, the market acceptance of these products has been excellent by both the surgeons and distributors.

As we announced earlier this week and Alan mentioned, we have released on a limited basis the new Trinity Evolution tissue form. The initial feedback from surgeries performed thus far is extremely positive. Improved handling characteristics were reported by surgeons as one of the number of significant advantages over previous allografts that they had used.

We remain on target for full market release and are confident that we will have sufficient inventories of Trinity Evolution on hand to support the transition of our current Trinity customer base.

We are also in a very good inventory position on our previous Trinity allograft and do not expect any significant shortfall or excess inventory on June 30th.

Shifting gears now, we continue to execute our North America reorganization and consolidation plan during the first quarter, as we broke ground on our new facility in Louisville, Texas near Dallas. This new 150,000 square foot facility will ultimately house our spine stimulation, spinal implants and North America orthopedics operations when the building and consolidation is completed next spring.

As we have previously indicated the new facility will not only allow us to capture operational synergies, but it will also include a new state-of-the-art Orthofix National Education and Training Center to train physicians and our sales teams.

Our next important date in the consolidation is the relocation of the Springfield, Massachusetts operations to our current McKinney, Texas plant on July, 1st. The team in Springfield continues to perform exceptionally well despite the pending move to Texas.

Our spinal implants division will also go live on our Global Oracle ERP platform at that time, which will significantly improve our information services for that division. Overall I'm very happy to report that every key aspect of this major initiative is on schedule and on budget.

In summary, as I discussed on our previously earnings call, we expect to reach operating profitability in our spinal implants division in the fourth quarter of this year. And as I also indicated during our last call, there are three primary keys that will lead to this result. One is revenue growth, the second is gross profit margin improvement, and the third is lower SG&A ratios as a result of leveraging the expected revenue growth and the positive impact of the reorganization and consolidation plan.

Let's look at how we fared during the first quarter with regard to each of this three keys. First, with regard to revenue growth as already mentioned, we reported our second consecutive quarter of sequential revenue increases and total Q1 revenue was ahead of our internal expectations.

Importantly, this sequential revenue growth in Q1 included an increase in our core lumbar and cervical implants. We expect this momentum to continue particularly in light of the Firebird and PILLAR SA successful product lunches.

The second key driver to profitability is gross margin expansion. As I mentioned earlier, gross margin in Q1 was ahead of our internal expectations and the positive impact from the introduction of Trinity Evolution and the full market release of Firebird and PILLAR SA are expected to improve gross margins significantly in Q3 and Q4.

Remember that while our revenue recognition per CC of Trinity Evolution will be only 70% of what we have been recognizing with our current Trinity allograft, because of the terms of our partnership with MTF, the gross margin on our new allograft will be effectively 100%.

The third key is our SG&A ratios. Our adjusted operating expenses as a percent of spinal implant revenue in Q1 remained essentially, flat with prior quarter which we consider a good very result. Why? As Bob will explain shortly, some of the costs relating to both MTF project and then North American consolidation were accelerated into the first quarter, meaning more of the total costs expected for the full year were recognized Q1 versus our original expectations of Q2 and Q3.

Additionally, a milestone payment to Intelligent Implant Systems which was originally forecast in Q4 2008 was paid and included in our Q1 results. With our reorganization and consolidation and the launch of Trinity Evolution on schedule and on budget, we're very pleased with Q1 SG&A ratios at our spinal implants divisions and feel confident that we are still on plan to reach operating profitability in the fourth quarter.

At this point, I will hand the call over to Bob.

Robert S. Vaters

Thanks Brad and good afternoon everyone. I would like to cover two areas during my discussion; first, I will focus on the income statement giving some additional detail on revenue and the items included in the earnings reconciliation in today's press release. Second, I will talk about EBITDA and the balance sheet, including our cash and debt balances and our financial covenants.

I'd like to start with a brief note about our total first quarter revenue. Our financial plan for 2009 was completed at the end of 2008 and so the foreign currency exchange rates we use for guidance were the rates in effect at year end.

During the first quarter, the dollar strengthened against certain foreign currencies which had a negative reporting impact on revenue generated outside the U.S. For example, the Euro which was trading at 0.716 versus the dollar at December 31 was trading at an average of 0.762 during the first quarter of 2009.

If we apply this average first quarter rate along with few other currency differences, our first quarter revenue was negatively impacted approximately $1.1 million. Simply stated the effect on the first quarter 2009 top line was a negative $1.1 million, when applying year end FX rates used in our guidance and 5.1 million when applying constant currency FX rates from the same period in 2008.

We don't attempt to predict future FX rates, but it's important for anyone estimating our quarterly revenue to take into consideration the changes in the relative values of currencies that occurred since the end of the prior year. As Alan mentioned, our GAAP EPS was $0.17 per share and our adjusted net income was $0.35 per share.

Now move on to items in the earnings reconciliation included in today's release, when we issued our 2009 guidance earlier this year, we anticipated that there would be two adjustments to our reported GAAP earnings. Those two adjustments were costs associated with the reorganization costs related to our strategic investments meaning the MTF project and the development milestone payments to the previously announced agreement with Intelligent Implant Systems.

In Q1, we recognized approximately 1.3 million or $0.05 per share of costs related to the reorganization and approximately 2.8 million or $0.11 per share of costs associated with our strategic investments. It's important to note that some of the costs we've recognized for these items in Q1 were accelerated from the second and third quarters when we had originally expected them to occur.

The total costs for these items are not expected to be greater than the original expectations. The strategic investments are contractually set and we are very much on track with the reorganization plan. Simply this is just an acceleration of a certain portion of the total strategic investment costs, which we have expected to occur in subsequent quarters this year.

On our last call, we also indicated that we expected to realize costs totaling approximately $0.03 per share in connection with the proxy contest and special general meeting that we held at the beginning of April. As expected, we did, in fact, incur cost of about $0.03 during our successful proxy contest against the dissident swing (ph).

On our previous call, we highlighted an unrealized non-cash fair value adjustment related to an interest rate swap we put in place in June of last year. Mark-to-market adjustments are required to be reported each quarter for our income statement until the expiration of the swap in June, 2011.

In the first quarter, our earnings included a non-cash gain on this interest rate swap, which we have excluded from our adjusted net income. The swap continues to provide a hedge against interest expense on the 150 million of outstanding debt it covers should live arise above 3.73%. Since this represents an unrealized non-cash item, both gains and losses, are excluded from EBITDA as calculated in accordance with the company's amended credit facility. And therefore it does not affect the calculation of our covenants.

Finally, as we've been reporting last quarter, we incurred foreign exchange losses of approximately 164,000 pre-tax or about $0.01 per share. We incurred gains and losses primarily due to unrealized non-cash foreign currency adjustments resulting from the changes in the value of the U.S. dollar against various foreign currencies. As a reminder, a number of Orthofix's foreign subsidiaries have inter-company and trade accounts payable that are held in currencies other than the home currency, and the movements in the relative values of these currencies result in foreign exchange gains or losses. To the extent the U.S. dollar strengthens in the future, we can continue to report this unrealized non-cash foreign exchange adjustments as other expense. If the dollar weakens we can report foreign currency adjustments as other income.

As we think about adjustments to GAAP net income in the second quarter, we estimate that our pre-tax reorganization costs will be about 1.7 million and we expect to recognize or maintain the costs associated with the MTF agreement, which will be approximately 2.1 million on a pre-tax basis.

We also expect second quarter costs associated with equity compensation to be about 2.8 million pre-tax which is consistent with our actual expenses in the first quarter.

Now, let's move onto the balance sheet. Our total cash balance at March 31, 2009 was approximately 7.6 million, lower than our cash balances at the end of the prior quarter. The lower cash balance at March 31st, included the impact of two first quarter repayments on senior debt ahead of their scheduled maturities totaling $12 million.

Our total long-term debt at March 31 was approximately 268 million which is down from 293.4 million a year ago and 280.9 million at the end of 2008. The first quarter debt repayments ahead of the scheduled maturities were consistent with our desire to continue de-leveraging the balance sheet giving us more room under the leverage ratio requirement to our amendment credit facility.

Our first quarter EBITDA as defined in our amended credit facility was 21.3 million, resulting in a leverage ratio at March 31 of 3.5 versus maximum allowable ratio of 4.0.

We also announced in today's press release that earlier this week we made an additional $3 million debt repayment ahead of schedule maturity which obviously reduces -- further reduces on our maturities. Our ability to repay debt ahead of scheduled maturities is a reflection of our improved cash flows.

This is demonstrated by our higher cash flow from operations in the first quarter of 2009 of approximately 11.1 million which compared to cash flow of approximately 900,000 in the prior year. This increase in cash flow was due primarily to improved working capital management. Our DSO at March 31st was 76 days which is down from 82 days a year ago and from 77 days at the end of 2008.

Our inventory turns at March 31st were 1.4 compared with 1.3 a year ago and 1.5 at the end of 2008. At this point I will hand call back over to Alan.

Alan W. Milinazzo

Thanks Bob. As you just heard from Brad and Bob we had a very good Q1 and the trends are becoming more positive for us in a number of key financial and business metrics. As such I want to take this opportunity to reaffirm our full year guidance of 535 to $545 million in total revenue and GAAP earnings of $1.38 to $1.48 per share.

Operator, with that I think it's a time we can open up the call for questions.

Question-and-Answer Session

Operator

(Operator Instructions). Your first question comes from the line of Gerard Holt (ph) with Thomas Weisel Partners.

Unidentified Analyst

Thanks a lot for taking the call. Alan, I think you had mentioned previously that you expected the Blackstone or the Orthofix spine division to grow at around 8 to 12% year-over-year in 2009. I was wondering if that's still applicable?

Alan Milinazzo

Yeah, Gerard it is and you are right, exactly we refer to that as Orthofix spinal implants business now. Yes, 8 to 12 we still feel comfortable, I think the overall guidance we just reaffirmed 535 to 545 incorporates the 8 to 12%. And we certainly are off to a good start.

A lot of things that Brad's working on in the U.S. the Trinity sales, the current Osteocell version as expected. So overall, I think the 8 to 12% number is still a very good number.

Unidentified Analyst

Do you expect sequential improvements from here on out throughout the year?

Robert Vaters

We do.

Unidentified Analyst

Okay. And then can you talk about the distributors that you are picking up? You mentioned that you are upgrading and then also filling up some gaps. And in your distributorship, can you talk about where they are coming from? There has been a lot of movement, obviously in the spine industry over the past year, can you provide any color on that?

Alan Milinazzo

Sure. Let me actually let Brad, step in on that one.

Bradley Mason

Sure. Gerald, nice to talk to you today. They are really coming from all over. We have -- we have added eight new distributors in just recent months and we have a number of new ones that are ready to come on board and we are getting them from all over.

We are at a position now that's I think a little bit unique for the last year to where distributors are approaching us. I think they feel, they hear about the energy out there and what's happening with the spinal implants division and they are coming to us.

So overall it's from all over, you can, from large companies, from smaller companies we're picking them up wherever we can.

Alan Milinazzo

Yeah, and just a further point on that, Gerry, we were just in Florida at the National Sales Meeting for Spine Implants group and distributors are very excited about the PILAR SA, the Firebird Brad talked about.

Obviously Trinity Evolution and sort of the preliminary feedback we're getting the group very excited. Many of these distributors are quality folks are bring along people with they know from prior companies. And so it's really become a very positive situation for us, both in terms of stability of the distribution system as well as opportunistically looking at markets that we don't cover or wanting to upgrade where we cover with some of these other distributors.

Unidentified Analyst

Okay, great. And then just lastly on the cost structure. Sounded like a lot of these expenses in the first quarter are front-end loaded, meaning they should decrease as we go through the year. So if you look at the after tax impact of these charges in the first quarter it was about 3.2 million. So they should tick down from here on now that should be the biggest number?

Robert Vaters

This is Bob, are you talking about spinal implants?

Unidentified Analyst

I'm talking about the strategic investments, the reorganization costs. The proxy all of that should be lower going-forward.

Robert Vaters

Yes, well in the second quarter, we expect 2.1 million for strategic investments and that would be the last payment for the strategic investments for '09 and we're hopeful for no more proxy contests in Q2.

Unidentified Analyst

Right, okay great. Thanks a lot

Operator

Your next question comes from the line of Bill Plovanic with Canaccord Adams.

Bill Plovanic - Canaccord Adams

Thank you, good evening.

Alan Milinazzo

Hi Bill.

Robert Vaters

Hey bill.

Bradley Mason

Hey Bill.

Bill Plovanic - Canaccord Adams

Couple of questions. First you mentioned, Trinity Evolution was 1.3 million in the first quarter, was that correct?

Alan Milinazzo

Yes, Bill the number I gave you was the orthopedic sales. So recall that we have primarily spoken in the past about the spine implant sales. But the note that I was making was that we've begun to turn on our orthopedic sales force, which is in itself a pretty good group of reps. So that group doubled their business to 1.3 million in the quarter. So we do see that as a new channel for us if you will. So that's on the spine business.

Bill Plovanic - Canaccord Adams

Okay. That's helpful. And then Robert, at spine you gave us a couple of metrics, I think last quarter, you might have shared that I think operating was a loss of couple million in spine in the fourth quarter. What was that number in the first quarter backing out the one time charges for the MTF and the rear (ph).

Robert Vaters

It's approximately 4 million, just below 4 million.

Bill Plovanic - Canaccord Adams

It was the loss of 4 million in the first quarter backing those costs out?

Robert Vaters

Yes.

Bill Plovanic - Canaccord Adams

Okay. And why would that have gone up sequentially?

Robert Vaters

I'm not sure - I don't think it did go up sequentially, I'm not sure your first quarter numbers is right. I think it's actually about the same, may be slightly below, 4 million - 4.2 million in the first quarter.

Bill Plovanic - Canaccord Adams

Okay. I was mistaken there. And then on the gross margin, that was a impressive pick-up. What is driving that? I mean that was a pretty big jump sequentially year-over-year, any which way you slice it?

Alan Milinazzo

Yeah, I'll let Bob jump in at second here. But certainly on the spinal implant side, Bill, we have seen a really nice recovery. Brad noted it in our metal implant products, which obviously have a -- carry a higher margin. And so the U.S business picking up overall month-to-month as Brad has noted. And the fact that the metal implant products in particular have come up has been a significant part of that improvement. Bob --

Robert Vaters

Yeah, it still, it's simply mix.

Bill Plovanic - Canaccord Adams

Okay. And did you say, I'm sorry the thoracolumbar and cervical were up 5% year-over-year or sequentially?

Alan Milinazzo

That's a good question, I think it's year-over-year. I think we said year-over-year, Bill.

Bill Plovanic - Canaccord Adams

And then lastly, I promise. On the IIS product, you're paying that check in the first quarter, rather than the fourth quarter. Why is that and what exactly is that product and when can we expect to see it?

Alan Milinazzo

Well, just on the numbers, we originally expected the fourth quarter, we actually -- the milestone was actually met late in the first quarter. So, we've just paid when the milestone is met. Do you want to Brad you want to about that?

Bradley Mason

Yeah. It's very unique pedicle screw system that we've been working on collaboratively. And we're targeting probably second half of 2010.

Bill Plovanic - Canaccord Adams

Okay. So still not near-term. That's all I had. Thank you very much.

Alan Milinazzo

Thanks Bill.

Operator

Your next question comes from the line of Michael Matson with Wachovia Capital Markets.

Michael Matson - Wachovia Capital Markets

Hi. I guess my first question would be on the studies that you're going to be running on Trinity Fusion. Did you give the sizes of those. I apologize if you did, I missed it. But and then I just wondering, I would assume that the cost of those were baked into your R&D guidance or your -- it's not R&D guidance but your overall EPS guidance?

Alan Milinazzo

Michael you didn't miss numbers, we didn't give the specific numbers. I can tell you that the ACDS study will have about 200 patients in it. The foot and ankle will have about 100 and then the tibia will have about 200. And all those costs are factored into our guidance for the year.

Michael Matson - Wachovia Capital Markets

Okay. And the tibia, is that a single study or it was both two studies of 200 each.

Alan Milinazzo

It's a single study.

Michael Matson - Wachovia Capital Markets

Okay, all right. And then I guess my second question would just be on the given the subpoenas on the stimulation products that you and some of your competitors have got. Do you think that you're going to have to change the way that you're selling or marketing those products. In other words, I guess the plaintiff is alleging that you guys are selling the products when they should really be rented and are you going to have to move to a rental model or would you just wait to see how the case plays out?

Alan Milinazzo

Our business model is selling that devices. We don't expect that to change, we'll certainly cooperate with the government and walk them through our rationale which we've done actually before in prior instances, just hasn't been as part of a key time (ph) action. So we have been through a few of these with different payers in the government as a player in fact. So we are fairly comfortable that our business model in terms of selling the product will stand up.

I think may be some of the confusion is that as part of a as a DME supplier, the provider gives you a rental amount and because we haven't studied our product, we haven't approved our product for anything other then a one patient use and we haven't studied our signal beyond the wear time listed in our clinical trials. We just haven't felt comfortable in the rental model. But again, we have been through this a few times. We feel like we have sufficient data to support our position in terms of billing and we don't expect any change for our business model.

Michael Matson - Wachovia Capital Markets

Okay and then just a question related to Bill's earlier question. Can you give us the overall Trinity number for the quarter, including the spine sales?

Robert Vaters

7.3.

Michael Matson - Wachovia Capital Markets

Okay.

Robert Vaters

So 1.3 was pedicle and 6 was spine.

Michael Matson - Wachovia Capital Markets

Okay, all right I think that's all I've got. I appreciate it.

Alan Milinazzo

Thanks Michael.

Operator

Your next question comes from the line of Spencer Nam with Summer Street Research.

Spencer Nam - Summer Street Research

Thanks for taking my questions. Just have a couple of questions for you guys. First one is Trinity Evolution and I was just curious how you are planning to what specific things your doing with your Trinity customers to transition them from Trinity to Trinity Evolution and how have customers have so far taken this news and how are they reacting to that?

Bradley Mason

Hey Spencer, without going into a whole lot of the specific details around how we are converting accounts, I mean really we're targeting the current users and we have talked many times and we have a very manageable number of current users because in the past we had supply constrains. So we've had a very targeted approach to those customers. We've put together entire teams effectively that are composed of our biologics group, the implant reps as well as the MTF folks. And so we've begun to target all the activities necessary at the hospital level to convert them over from the current Osteocell platform to the MTF.

Most physicians we've spoken to have been delighted that our partnership is with MTF. MTF has a pristine in the industry as I am sure you will find out when you do some further diligence on MTF. And then further validated by the cases that we've performed so far with the limited number physicians but all physicians you have a very good understanding of the allograft market, the Trinity Osteocell version and have walked away from... their initial case is very impressed with the handling characteristics between the Trinity Evolution. So our expectations are that we will focus on those key customers, ensure we transition them over within the timeframe that we have got. And then begin to move away from their current customer base into those that we see as opportunities down the road.

Again very big market opportunity as I mentioned. This is... the U.S. market is estimated to be $1.3 billion in total biologic product. So, we just expect that this product will continue to gain traction and support and we'll get to participate in a much bigger slice of the pie.

Spencer Nam - Summer Street Research

Great. That's helpful. And related to that, to some extent the trials that you will be running, why three trials -- and I understand that one is orthopedics and two in spine but why did you pick this specific number? And number two is, when you think about these trials, there is going to be post market studies, most likely, and how do you think that... there is a some level of skepticism, if you will, out there --- that post market studies often... data are overlooked for example. How do you plan to use, utilize these data points in establishing the efficacy of Trinity Evolution? And if you could just make some comments on that I'd appreciate it.

Alan Milinazzo

Sure. I mean when you think back to when this product, the original stem cell product, they Osteocell product, first generation was launched and we came to market with a much thinner data package than what we're coming to market with MTF. So number one is we have a better data package than we had a few years ago when this was launched. The second is we have three years of experience in terms of understanding, where customers are interested in seeing the clinical evidence before converting from whatever short of -- whether it's an autograft procedure or some other biologic agent.

So, I think the three studies that we've designed really speak to what the customers have told us are the areas they're most interested in getting some clinical evidence in, and because the product is a transplant, we're obviously not required to do the same sort of FDA studies. And nonetheless we wanted to do clinical studies over the past couple of years but have been limited given the relationship we had at the time with SIRIUS (ph). And obviously the past year or so knowing that we're going to transition the relationship, we haven't started any clinical trials.

So, I think first and foremost MTF has a pristine reputation. Most surgeons you'll talk to will tell you they are very comfortable with MTF. The second is the data package that will come to market with will be far better than what we had when we first launched. Third is we have a whole lot of experience in the three years we've been selling stem cell based product. And then fourthly the studies that we designed, were designed with physician input to address the key clinical areas that they'd want to see focused on in the study.

Spencer Nam - Summer Street Research

Appreciate that and then final question is with the economy right now are you seeing any impact in any part of your business right now? If so, what kind of impacts you're seeing? How are your customers, the demands as well as the willingness to pay -- how, whether you see any changes in that right now?

Alan Milinazzo

Spencer, we monitor that very closely. Obviously, we just finished our business reviews with our team globally. By and large, we haven't heard anything significant with our sports medicine business. Brad's team noted that they may be see a little bit less custom orders and braces. Maybe a little more off the self brace that could be molded as opposed to a custom product. But beyond that I really haven't seen anything. We're watching it carefully, but at this point I can't really report any significant impact.

Spencer Nam - Summer Street Research

Okay, thanks very much.

Alan Milinazzo

Thanks Spencer.

Operator

Your next question comes from the line of James Sidoti with Sidoti & Company.

Jim Sidoti - Sidoti & Company

Good afternoon, Allan and good afternoon Brad. Can you hear me?

Alan Milinazzo

We can hear you, Jim.

Bradley Mason

We can, Jim.

Jim Sidoti - Sidoti & Company

I just wanted to clarify a couple of things. One, when you gave the numbers for Trinity sales for the orthopedic and spine that was the Osteocell (ph) Trinity right?

Alan Milinazzo

Exactly. So, all of the Trinity sales that we reported in Q1 were the Trinity Osteocell platform first generation.

Jim Sidoti - Sidoti & Company

Okay. And you don't expect to have significant sales of Trinity Evolution until Q3?

Alan Milinazzo

That's right. We expect -- we'll have some in Q2 obviously because we've -- and we're in a limited market release, but nothing meaningful.

Jim Sidoti - Sidoti & Company

Okay. And can you tell me what the Trinity sales were a year ago in the first quarter?

Alan Milinazzo

I think there are 5.2 million roughly.

Jim Sidoti - Sidoti & Company

Okay. So it seems like you haven't seen any impact from new bases and your customer bases of yet, in the those numbers?

Alan Milinazzo

Yeah. We haven't Jim. I mean we know they got great sales force and a customer base that doesn't overlap ours. So, I suspect that their team is focused on bring in the technology to their customer base, and I think we had done some analysis. I think there is 5 to 7% overlap of customers. So at this point, we haven't seen any impact.

Jim Sidoti - Sidoti & Company

Okay. And then on the reorg costs -- reorganization costs, you said you are going to have another 2.1 million or 1.7 million, in the second quarter?

Alan Milinazzo

In the second quarter, we said we have 1.7 million pre-tax.

Jim Sidoti - Sidoti & Company

Okay. Then how much is left for 2009 beyond there?

Alan Milinazzo

Well, we said 3.3 that's for the full year.

Jim Sidoti - Sidoti & Company

So that's still the same.

Alan Milinazzo

Yes, on schedule.

Jim Sidoti - Sidoti & Company

Okay. And just a follow-up on the EPOJ (ph) issue are there any extra legal costs as a result to that or is that immaterial?

Alan Milinazzo

Jim, it's a good question. And one I would say we're watching that very carefully. So, right now we feel confident enough in where we are that we reaffirmed our guidance. So, whatever expenses we would expect to incur we'll manage within our current plan.

Jim Sidoti - Sidoti & Company

Okay, great. Thank you.

Alan Milinazzo

Thanks Jim.

Bradley Mason

Thanks Jim.

Operator

Your next question comes from the line of Peter Bye with Jefferies & Company.

Peter Bye - Jefferies & Company

Thanks guys. And I want to apologize, if you've talked it already but just some quickly how much of your spine growth is dependent on adding distributor -- if you were to add another new distributor, now what will the growth be?

Bradley Mason

Yeah, Peter this is Brad. Our growth really hasn't come from adding the distributors per se. The ones we've added are just beginning to ramp up. So, we're seeing the growth based on products and the energy that we're getting in the other distribution out in the marketplace. So this has not been significant effect to take.

Peter Bye - Jefferies & Company

Right and then post -- so going forward, you acknowledge that patients that's going to be any specific now if you add 30 or if you add zero. It's not really the delta into the growth rates going forward?

Bradley Mason

Well, there's no question there. No question, we'll have some added growth because of the distributors we're adding. I don't have that number off hand as to what that percentage would be but they'll definitely be part of future growth plan. Absolutely.

Peter Bye - Jefferies & Company

Because -- you put out some pretty ambitious targets, I know comps that easy. And you're starting this quarter but you're facing a pretty big headwind with the revenue conversion over to Trinity Evolution even if you are going to replace the 100% of the products in terms of units which is probably ambitious just now right out to execute but -- maybe if you could give us any more color on how you're going to get there on the top?

Bradley Mason

Well, we're on pace to get there as we speak, in fact maybe little bit ahead of pace. So, we expect that we'll achieve those numbers. Certainly adding new distributors as part of it, adding the new product, the new Firebird and PILLAR SA or big part of it, and several other things that we have going on. So I'm very comfortable with a 12% number at this point and our first quarter will indicate that I should be.

Alan Milinazzo

Yeah, and I think Peter, Brad noted in his opening remarks that if you look at his average daily sales our -- first quarter --

Peter Bye - Jefferies & Company

Yes.

Alan Milinazzo

Even though our first quarter in 2008 was actually good quarter. He had consistent average daily sales, which we all watch very carefully above prior year. So you're exactly right. The big watch out for us is obviously in the conversion of Trinity Evolution. But we're on schedule, we're actually ahead of schedule from where -- what we first predicted in terms of launch. Customer input has been very positive obviously about the transition. So it's not without risk but I can tell you all the metrics that would tell us we're going to get there, are green right now.

Peter Bye - Jefferies & Company

All right. Great. And then just on stimulation, how much of that business is Medicare?

Alan Milinazzo

On which term sorry?

Peter Bye - Jefferies & Company

Stimulation.

Alan Milinazzo

Oh, it's less than 10%.

Peter Bye - Jefferies & Company

Have you had any response from the private payers -- for the acquisition of the Ricky Combsut (ph)? Have they ever talk to you -- have you had conversations with payers?

Alan Milinazzo

We....

Peter Bye - Jefferies & Company

Was the conversation relative?

Alan Milinazzo

We've had conversations, we have conversations with everyone, so this hasn't created any additional noise with payers Peter. I mean it is something as we talked about before we employ over 60 people in Texas who do nothing but focus on patient, on reimbursement and focus on the patient for reimbursement purposes.

So now, it really hasn't had a significant impact. We've been through a handful of discussions over the years relative to our model with rental. And we consistently come back to selling the unit, they are advantages to the patient on the unit. And so we really don't expect to have any major disruption of our business at this point and the normal discussions around reimbursement rates, that's sort of an every month thing with different payers. But Medicare is well below 10% of our overall business today.

Peter Bye - Jefferies & Company

Okay. Just a quick follow-up, on the clinical trial, is that a real world for its all commerce -- is it randomizing against anything? And how -- are there any major exclusions, inclusion -- exclusion criteria and tick up in Q2?

Alan Milinazzo

I lost the last part of that question, Peter.

Peter Bye - Jefferies & Company

Is there a tick up in Q2 with probably zero to $0.20 --

Alan Milinazzo

We'll start enrolling in July and again I won't go through all those specific inclusion exclusion criteria, we can talk with you about that offline, maybe give you more detailed response. But again the sort of the key design here is get it into settings where physicians have access that they think it would be best to get that data pull back in. Second is areas where the product can perform extremely well, maybe there are some suggested areas where physicians think that they'd like to see the product tested if you will. And recognizing that this is not a randomized, blind clinical trial and within the expectations of our physician basis is exactly what they want to see from us. And so you need to make the clinical hurdle exactly what your customers wanted to be and we think based upon the input we've had these three trials sort of represent the clinical hurdles that they want to see crossed.

Peter Bye - Jefferies & Company

My last one. What's your optimal capital structure ideally?

Robert Vaters

This is Bob, Peter. Well, what we said, I mean, we're obviously in a structure that we're going from leverage to less leveraged. I think it's hard to answer what the optimal structure is right now. A lot depends on the acceleration of the cash flow from spinal implant business. But I certainly think it's at a lower leverage than it is and that's not only been our plan but it's been what we've been doing. And I see it continuing to do this though this year. And then, as we go into next year, we'll take a hard look at capital structure and look at the financing alternatives we have and plan accordingly.

Peter Bye - Jefferies & Company

All right, great, thanks guys.

Alan Milinazzo

Thanks Peter.

Operator

Your next question comes from the line of Stan Manny with Manny Family Investment.

Alan Milinazzo

Hey Stan.

Unidentified Analyst

Several questions. One Alan, you gave guidance for '09, 2009 which was basically reinforcing your guidance of I think February, my question first question is what is the adjusted EPS on top of those 138 to 148?

Robert Vaters

Stan, this Bob, 171 to 181.

Unidentified Analyst

Okay. Now, just to finish my numbers depreciation this year is expected to be 21 to 24 million? I think that's what was in the previous in that release?

Robert Vaters

That depreciation for the year -- we'll get that for you Stan.

Unidentified Analyst

Well I am trying to convert the number, the 123R annual?

Robert Vaters

22

Unidentified Analyst

22, okay.

Robert Vaters

And the 123 is that 2.8 million per quarter.

Unidentified Analyst

Okay, which is 11.2. So, what I come down is that a non-cash charge of depreciation, 123 are of over 32 million. Positive 33 million, which is a $1.89 a share. So on a cash earnings basis, we're over $3, substantially per share on a cash earnings basis?

Robert Vaters

Yeah, I mean we haven't given guidance on cash earnings but --

Unidentified Analyst

No, I know but I am just adding the numbers on your guidance.

Robert Vaters

Yeah.

Unidentified Analyst

So, your adjusted EPS is 171 to...

Robert Vaters

181.

Unidentified Analyst

181. Okay. Second question is on Trinity Evolution. And my basic question is you've got a $1.2 billion market. I know that you're really are after segments. So what capacity you've got in '09 and then '010, assuming the product is equal or better than the prior Trinity or Osiris product. What kind of capacity have you got to handle in coming customer sales? Is that 100 million, 200 million, what can you handle with your relationship with MTF?

Alan Milinazzo

Well, it's a great question, its improving all the time. Obviously we've sort of gone from zero to market launch in about 14 months. But it's improving all the time as MTF continues to improve their processing of donors and their processes overall. We would expect this market for us and it should certainly be a north of $100 million market hopefully soon. But of that 1.3 billion how much of that will be stem cell based technology, I don't know but certainly each quarter we will give you an update relative to how our capacity is going with MTF, but part of the reason that we chose MTF is they represent over 50% of the market in the U.S. and they've got solid relationships with all the donor locations or excuse me half the donor locations in the U.S. and so we thought we think we chose absolutely the right partner in terms of getting the capacity for this business to realize a 100 or $200 million in size, that's the right partner.

Unidentified Analyst

Okay. The reason I asked that is it seem that on the Osiris relationship, you had a limit, they're always kind of capacity constraint. Was that because of tissue acquisition? And that your current supplier really gives you a lot more upside potential to increase sales of Trinity Evolution versus the previous relationship, prior relationship you followed what I am...?

Alan Milinazzo

I do yeah, and again we've -- Brad and I spend a lot time obviously Mike Finegan, he's our President in Biologics spent a tremendous amount of time with MTF. One of the nice things here is that here the Trinity Evolution product actually is processed with donated tissue that otherwise would not have been used. And so for MTF this is a terrific opportunity for them, because their intention is really to give to human life.

So, they are taking tissue that otherwise would not have been used and now are able to process it and use it for us. So, that's on your current donor base. Now if they increase that donor base, as you look it donor criteria and we will talk more about that as we get further into launched and we see great upside for them to increase their capacity, but right now they're working hard to meet the demand plan that we put together for the full year. And as Mike Finegan starts to roll-out sort of with 2010 and with 2011, looks like, it's little like the Captain in the movie, Jaws. They start to thinking they need a bigger boat so.

Unidentified Analyst

Okay. But they do -- you are now in a relationship were you have more upside capacity potential in the future than you had.

Alan Milinazzo

Absolutely.

Unidentified Analyst

That's what I'm trying to get. The MTS is a leading tissue processor probably in the world.

Alan Milinazzo

Yeah we think that the capacity constraint that sort of characterize the relationship we have with Osiris for three years are no longer going to characterize this relationship.

Unidentified Analyst

Okay. So, there is really a game changer for us.

Alan Milinazzo

We believe it is.

Unidentified Analyst

Okay. Thank you, good job gentleman.

Alan Milinazzo

Thank you.

Unidentified Analyst

Bye.

Operator

There are no further questions at this time.

Alan Milinazzo

Okay. Thanks operator, everyone thanks for joining us today and we're pleased to deliver a very strong first quarter for all of our shareholders. Our employees remain very committed to delivering strong and consistent financial results and Q1 was the start of what we expect to be a very good 2009. Thanks for dialing in. I look forward to speaking with many of you over the coming days and weeks. Thanks operator.

Operator

This concludes today's conference call. You may now disconnect.

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