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RTI Biologics Inc. (NASDAQ:RTIX)

Q1 2013 Earnings Call

April 25, 2013 8:30 AM ET

Executives

Wendy Crites Wacker – Director, Corporate Communications

Brian Hutchison – President & CEO

Rob Jordheim – EVP and CFO

Roger Rose – EVP and Chief Commercial Officer

Analysts

Matt Hewitt – Craig-Hallum Capital Group

Matt Dolan – ROTH Capital Partners

Kyle Rose – Canaccord

John Gillings – JMP Securities

Michael Rich – Raymond James

Operator

Good day ladies and gentlemen, and welcome to the RTI Biologics Q1 Earnings Conference Call. At this time all participants are in a listen-only mode. Later, we’ll conduct a question-and-answer session and instructions will follow at that time.

(Operator Instructions)

I would now like to introduce the host for today’s conference call, Ms. Wendy Crites Wacker. You may begin ma’ am.

Wendy Crites Wacker

Good morning, and thank you for joining RTI Biologics for our first quarter 2013 conference call. Today, we will hear from Brian Hutchison, President and Chief Executive Officer; and Rob Jordheim, Executive Vice President and Chief Financial Officer.

Also joining us this morning for Q&A are Tom Rose, Executive Vice President and Chief Operations Officer; Roger Rose, Executive Vice President and Chief Commercial Officer and President of RTI Donor Services and Carrie Hartill, Executive Vice President and Chief Scientific Officer.

Before we start, let me make the following disclosure about forward-looking statements. The earnings and other matters we will be discussing on this conference call will involve statements that are forward-looking. These statements are based on your management’s current expectations, but they are subject to various risks and uncertainties associated with our lines of business and with the economic environment in general.

Our actual results may vary from any statements concerning our expectations about future events that are made during the course of this meeting, and we make no guarantees as to the accuracy of these statements. Accordingly, we urge you to consider all information about the company and not to place undue reliance on these forward-looking statements.

Now, I’ll turn the call over to Brian Hutchison.

Brian Hutchison

Good morning, everyone. And thank you for joining us. On our call today, I’ll discuss our operating highlights and then Rob will review our financial results. As detailed in our press release issued this morning, we reported first quarter revenues of $40.4 million in line with our expectation and exceeding our first quarter guidance of $38 million to $39 million.

Turning to a review of our lines of business. Our direct sports medicine business had a quarterly revenues of $10.5 million a decrease of 22% compared to first quarter of 2012. The decline in this business in the first quarter was the result of continued customer reaction to the FDA warning letter received in October last year.

Our field personnel continued to work with our customers to clarify the content of the letter and to reiterate the fact that there is no safety issue at our implants. We will continue to actively communicate with our customers to keep them informed and to provide them with accurate information. We believe some customers are waiting for a formal close out letter from FDA.

As we mentioned last quarter we would expect after the FDA conducts a follow up inspection of our Alachua facility, we do believe that we’re starting to see recovery as we regain some accounts. We’ve also established new relationships adding more than 100 new accounts in the quarter. Based on results from the first quarter we are anticipating sports medicine will grow low single digits for the full-year of 2013. The majority of this growth will occur in the back half of the year.

First quarter spine revenues increased 18% compared to first quarter 2012. The increase was primarily related to the timing of orders from our commercial partners. Currently we’re experiencing favorable comparable year-over-year in the first half of 2013 that will balance out for the remainder of the year. Due to this, we feel that we will mirror the spine market for our full-year 2013 which continues to be flat to low single digit growth.

First quarter surgical specialties revenues decreased 11% compared to first quarter of 2012. The decrease in revenues was due to the decline in hernia revenue as our commercial distributor is focusing more on xenograft for hernia repair. The decrease was offset by growth in breast reconstruction and urology

Moving forward in surgical specialties, we are now co-exclusive with our distributor in human dermis for the hernia market. In the first quarter of 2013 we launched our direct distribution group for surgical specialties. We have the leadership in place and we have been hiring and training new biologics reps.

This team introduced our new biologics portfolio for hernia repair in March at the American Hernia Society Meeting. The portfolio includes the Cortiva human dermis implant and Tutomesh, Tutopatch bovine pericardium implants.

As of today surgeons have begun using both implants in the US. For porcine dermis. We are extremely pleased to have received 510(k) clearance in the first quarter of the year. The implant called Cortiva is intended for use in soft tissue repair procedures such as hernia repair. Stored hydrated and ready-to-use Cortiva is comprised of non-crosslinked porcine dermis designed to act as scaffold that allows for near vascularization and reincorporation of patient’s own tissue.

Cortiva will be made in various sizes and shapes and is sterilized through the Tutoplast process. The implants will be processed at RTI’s facility in Neunkirchen, Germany. The facility has completed all qualifications for processing and has begun production of the implant. Commercial distribution for the US will begin around our official launch which is planned for the abdominal wall reconstruction conference, the week of June 6 through June 8.

Our newly developed surgical specialties direct distribution team is eager to add the porcine dermis implant to their biologics portfolio. With the introduction of our new distribution team and the launch of new products into this market. At this time, we anticipate growth in surgical specialties to be in the low to mid teens for 2013.

First quarter BGS/General Orthopedic revenues decreased 24% compared to the first quarter of 2012. The decrease in revenues for the quarter was due to weaker than expected orders from our large commercial distributors. Additionally, we had weakness in domestic direct BGS/GO due to customer reaction to the warning letter as discussed earlier.

This was offset by strong performance in our international direct exports. Because, a significant portion of the BGS/GO is distributed to our direct distribution channel. We anticipated that the warning letter would have a negative impact on revenues in this business for the first half of 2013.

At this time, we anticipate that BGS/GO revenues will decline in the high single-digits for the full-year. First quarter dental revenues decreased 22% compared to first quarter 2012. Declines in domestic dental revenues were due to inventory rebalancing at our commercial distributors. The decline in international dental revenues was primarily due to regulatory reaction to inaccuracies in European media coverage about the company and the tissue industry that occurred in late 2012.

While we’ve started to see some recovery, we continue to work through these issues and bring them to resolution. We anticipate that revenues will decline mid single-digits as we’re conservatively projecting that our distributor will only take their contracted minimum since 2013.

As you know, we have been actively working on business development opportunities. We continue to seek the right deal that will fit our long term strategic plan and be financially attractive. We remain confident that we will find the right fit to grow our business and enhance shareholder value.

Looking ahead, we continue to progress down this path to commercialization of the MAP3 cellular allogeneic bone graft. As we mentioned in our last call, we’re continuing to work on the transition from an R&D initiative to commercialized line of implants. We’ve made progress on these efforts in the quarter. We must optimize the complex operational logistics that will enable us to meet initial and ongoing demand from surgeons.

We anticipate that MAP3 will launch in 2013. As we have consistently said this is a startup year for MAP3. We’re currently in the process of building a facility that will allow us to scale the business to full commercial production that facility will be complete sometime in early 2014. Apart from MAP3 and the Cortiva porcine dermis implant, we’re also investing over the course of this year in xenograft tendon for ligament reconstruction.

The xenograft tendon – for the xenograft tendon, we are nearing the end of our one year evaluation of implant safety in large primate study. The results so far are encouraging and we look forward to seeing the final results in coming months. The study supports our progress in the longer PMA regulatory pathway in the US.

At this point Rob will provide more details on the financials.

Rob Jordheim

Thank you, Brian. Worldwide revenues of $40.4 million for the first quarter of 2013 decreased 8% compared to the first quarter of 2012. Domestic revenues of $36.1 million for the first quarter of 2013 decreased 5% compared to the first quarter of 2012 primarily based on weakness in the sports medicine, BGS/GO, dental and surgical specialties businesses and offset by strength in the spine business.

In addition, domestic other revenue was positively impacted by approximately $1.7 million due acceleration of deferred revenues resulting from our commercial distributor relinquishing their exclusive distribution rights to our human tissue implant in the hernia market.

International revenues which include exports and distribution from our German and French facilities were $4.3 million for the first quarter of 2013 a decrease of 27% compared to the first quarter of 2012. As stated earlier the decrease was primarily due to regulatory reaction to inaccuracies in European media coverage from late 2012 which we are working through. On a constant currency basis, international revenues for the first quarter of 2013 also decreased 27% as compared to the first quarter of 2012.

Net income for the first quarter 2013 was $1.5 million or $0.03 per fully diluted share based on 56.3 million fully diluted shares outstanding. This compares to net income of $2 million or $0.04 per share for the first quarter of 2012 based on 55.9 million fully diluted shares outstanding.

Gross margin for the quarter was 47.5%, which was an increase of approximately 150 basis points from first quarter 2012. The increase was primarily due to the previously mentioned recognition of $1.7 million of additional deferred revenue in the other revenues category with no associated cost of processing and distribution.

During the quarter, marketing, general and administrative expenses totaled $15 million, an increase of $649,000 or 5% higher than the first quarter of 2012. This was primarily due to higher spending related to the build out of our general surgery direct distribution organization offset by lower variable compensation as compared to the first quarter of 2012.

Research and development expenses totaled $3.1 million, an increase of $284,000 or 10% higher than first quarter 2012 primarily due to higher research study expenses related to new product initiatives. Lastly, our tax rate for the first quarter 2013 reflects a tax benefit of 38% compared to a tax provision of 32% in the first quarter of 2012. The tax benefit results from the entire 2012 research tax credit plus a portion of the 2013 research tax credit being recognized in the first quarter of 2013 with no comparable credit in the prior period.

Turning to the balance sheet our cash position at the end of the first quarter was $38.8 million compared to $49.7 million at the end of 2012. The decrease was primarily due to strong tissue procurements lower implant distributions, investment in our direct surgical specialties distribution force and the timing of tax payments. For the remainder of 2013, we anticipate being cash flow positive from operations and we are confident that with current cash balances and available debt we have adequate liquidity to support our future operations.

Accounts receivable was $21.5 million compared to $21.7 million at the end of 2012. Day sales outstanding was 45 at the end of the quarter compared to 44 days at the end of 2012. Inventories of $78.3 million increased $1.8 million as compared to 2012 year-end. More specifically at the end of the first quarter, unprocessed donor tissue increased $2.2 million to $28.1 million. Tissue and process increased $721,000 to $29.1 million and implantable donor tissue decreased $1 million to $19.1 million.

Working capital at the end of this quarter totaled $130 million an increase of $653,000 compared to 2012 year end. At the end of the quarter total debt was $38,000 and we had approximately $16.4 million available under our revolving credit facilities. Taking into consideration where the company is today and the opportunities in front of us, we are confident we can achieve our operating goals this year and beyond.

With that, I will turn the call back over to Brian.

Brian Hutchison

Thanks, Rob. In our press release this morning, we announced guidance for the second quarter and narrowed revenue guidance for the full-year 2013. For the second quarter of 2013 we expect revenues to be between $42 million and $43 million. This would result in a 6% decline in revenues compared to Q2 last year at the midpoint of our guidance, but up sequentially from first quarter 2013. We expect EPS for the second quarter to be approximately $0.03 per fully diluted share.

We’re raising the low end of our full-year guidance for 2013 from $178 million to $179 million. We now expect full-year revenues to be between $179 million and $182 million up slightly from last year.

Full-year net income is expected to be between $0.17 and $0.19 per fully diluted share based on 56.7 million shares outstanding. We’ve taken a conservative approach to our guidance for the first half of the year due to the impact from the warning letter. All this impact is difficult to predict and quantify, we currently anticipate that revenues for the first half of the year will be negatively impacted by approximately $4 million to $6 million.

We expect that with the close out of the warning letter from FDA, we will be able to further regain business based on our implant quality and excellent service that our clinicians have been accustomed. Additionally, with higher new product revenue for the second half, we believe we will return to growth in latter part of the year.

We estimate that we will have approximately $6 million in new product revenue, which will be distributed through our direct distribution organization. The majority of this revenue will be recognized in the second half of 2013. We continue to focus on our very active business development strategy, which we anticipate will accelerate our future revenue growth.

We are confident about our corporate strategy that it will deliver results for the long-term growth. We hope to see some of you this quarter, we will be presenting at the Craig-Hallum Institutional Investor Conference on May 29 in Minneapolis and the Benchmark Company one-on-one Investor Conference on May 30 in Milwaukee.

At this time, let’s open up for questions. Kevin?

Question-and-Answer Session

Operator

(Operator Instructions) Our first question comes from Matt Hewitt with Craig-Hallum Capital Group.

Matt Hewitt – Craig-Hallum Capital Group

A couple of questions first, the deferred revenues that you recognized here in the first quarter, is there going to be any more in the second quarter or was that the end of it?

Rob Jordheim

Matt, this Rob. That should be the end of it and as I stated, it was related to Davol relinquishing their rights to our product for the hernia market.

Matt Hewitt – Craig-Hallum Capital Group

Okay, all right. And then secondly, you did launch a couple of new products – well three new products essentially have been launched already, the porcine dermis that you received early. Could you please give us a little bit of detail as far as the initial reaction from customers. I know that there is a process as far as you need to go in, get on the approved product list. Was that acceleration of the FDA approval did that help? Any details regarding those new products would be helpful?

Brian Hutchison

Well, Matt, this is Brian. To start with, we have not launched the porcine dermis to the field to actually implant yet. We’re manufacturing launch quantities now. What we did launch was the human dermis and the bovine pericardium products, both of which have been implanted.

At this stage, we can say that people are very happy about things, they’re very excited about things but the reality is for the hernia business porcine is becoming the preferred product primarily based on size and strength. And so our people are very excited about it, yes they can get started on getting those approvals early and they are working on them. But until we have the product in the market and in our hands, we can’t really give you any more than that right now.

Matt Hewitt – Craig-Hallum Capital Group

Okay. And I guess maybe one follow-up to that. There are a number of competitors with porcine product, what is going to be the differentiating features or factors that you’re going to you to help take share in that market as once you do launch?

Roger Rose

Yes, this is Roger. We prefer not to get into those details until we launch the product into the marketplace. But though we think we got a very competitive product portfolio that has three distinctly different options which will give the surgeon choice and each different material has different characteristics that we think provide significant benefits to the patient.

Matt Hewitt – Craig-Hallum Capital Group

All right, fair enough, thank you.

Operator

Our next question comes from Matt Dolan with Roth Capital Partners.

Matt Dolan – ROTH Capital Partners

Hi guys, good morning. I wanted to just look at the full-year guidance, for a second here. It looks like a pretty healthy step up in the back half of the year and Brian I know you gave us some numbers on what you expect from new products and so forth. But can you just maybe tell us when you think the warning letter comes through and why? Anything with your interactions that give you confidence that, that will resolve?

Brian Hutchison

Well Matt this is Brian. We have confidence that in dialogue with FDA that we will see them relatively soon and we have great confidence in our – what we’ve done in our facility that we are going to clear all those items related to the warning letter. So internally we have as much confidence as we could possibly have. Obviously, we don’t control the agency. So in our forecast, is the assumption that they do come in relatively soon and then we do get this clearance. So that’s what we’re expecting and anticipating. They’ve not been here yet. We literally check the parking lot every morning hoping to see them.

As soon as they are here that’s the positive and then we will push as hard as we can following that to get the official clearance letter from them. By their own regulations they have up to 65 days to give that letter to us, but we will attempt to get it as fast we can that’s really what we can do.

Matt Dolan – ROTH Capital Partners

Okay, fair enough. And can you – do you expect all of your customers to return those that have opted to not order from you during this phase?

Brian Hutchison

We expect that we will ultimately recover all of them and have built new customer relationships by then as well.

Matt Dolan – ROTH Capital Partners

Okay.

Brian Hutchison

We’ve already started to build new relationships. Hope that helps.

Matt Dolan – ROTH Capital Partners

Okay. And then as these new products layer in, how should we think about seasonality for your business this year versus what we’ve seen historically as kind of a flat Q3 and then a bigger Q4 is that the same or should Q3 have an increase due to the new surgical specialties portfolio?

Brian Hutchison

Yes. I think what you’re going to see is, you’re going to see some seasonality in our base business, but you will see a sequential step-up in Q3 and then again in Q4 and a lot of that will be related to two things, recovery of the business and the launch of the new products.

Matt Dolan – ROTH Capital Partners

Okay. And then on the international side, what are you assuming happens with the negative perception there?

Wendy Crites Wacker

We’ll continue to – this is Wendy. We’ll continue to work through those. We’ve been meeting with various stakeholders and have already started to see some recoveries in clarification and it just takes a little bit of time and we’re working through it.

Matt Dolan – ROTH Capital Partners

Okay. And then last one Rob on the gross margin. I think you mentioned this in your prepared remarks. But was there a benefit from the deferred revenue and maybe just tell us what you’re seeing for gross margin for the rest of the year in your guidance?

Rob Jordheim

Yes. There was a benefit from the deferred revenue because the full $1.7 million fell to the gross margin line. So that did help us out, no question. Having said that, we expect to see our gross margin tick up over the remaining three quarters. Hopefully at the end of Q4 it will be up near that 50% mark.

Matt Dolan – ROTH Capital Partners

Great, thank you.

Operator

Our next question comes from Bill Plovanic with Canaccord.

Kyle Rose – Canaccord

Great, thanks. This is actually Kyle on for Bill. I wondered if you could talk a little bit about porcine dermis. You are building inventory right now, what does the cadence of that launch look like? And with that I mean, did they go out to KOLs first and then when do we see full commercialization to the broader sales force?

Brian Hutchison

Kyle, this is Brian. Yes it will go to KOLs first. They’re being identified right now, being lined up right now. So we would expect that that’s what we’ll start with and then the official launch as we’ve been saying is at the June conference in Washington DC that sort of will be the official unveiling of the product to the full sales force, at that point in time. And by then we’ll have launch quantities available for everyone so we’re rapidly building those now.

Kyle Rose – Canaccord

So full launch quantities available to support the launch at the conference in June?

Brian Hutchison

Yes that’s correct.

Kyle Rose – Canaccord

And then on the MAP3 side, 2013 seems more of a, how do we get ready to build supply. When will you be building launch inventory and when can we expect the first inhuman cases and then as far as full commercialization from there?

Brian Hutchison

Well, the question is this – that’s a trickier question to answer. We’ve been working through the logistics of this for quite some time. We think we have solved the riddle. We will begin building first implants for first inhuman soon and we’ll, as we’ve said many times this when we’ve done that implant we’ll talk about it, but we expect it will come in and we have said publicly the first implants will be foot and ankle.

So that plan is still in motion, there has been – the only change since we spoke last is that we’ve made more progress and we feel more confident. So we should be moving forward with that. If those initial cases go well, we’ll begin building launch quantities. And it doesn’t take a lot of tissue to make a large number of implants available, so we would expect that we would have launch quantities on the shelf for late this year and we should be implanting on a regular basis late this year.

Kyle Rose – Canaccord

Great. And then just one final question on the M&A and business development. Lots of talk about tuck-in acquisitions and things of that sort. How do all the moving pieces and new initiatives in 2013 affect either your expectations for M&A or tuck-in acquisition or your appetite moving forward? And what evaluations look like for some of the opportunities out there in the market?

Rob Jordheim

Kyle, this is Rob. We, like we said before on another call, we have a very active business development program. We have a dedicated person who – that’s what they do every day. So we are out there scouting and assessing deals. Obviously with the launch of the new products that drives resources from us, from management to look and evaluate these deals. But I don’t see it being an impediment to keeping to moving forward on some of our tuck-in acquisition strategy here.

So from our point of view, we continue to assess the deals and like I’ve said before, we’re going to be pretty disciplined in our approach about these deals. We are not going to do deals that are dilutive or compromise the business going forward. So it still fits very much into our strategy.

Kyle Rose – Canaccord

Great, thanks a lot.

Operator

Our next question comes from John Gillings with JMP Securities.

John Gillings – JMP Securities

Hi guys thanks for taking the question. You mentioned you’ve been continuing to build out your direct sales force and I think on the last call you mentioned, you had 16 direct reps, can you tell us where you are now on that?

Roger Rose

Yes. This is Rog. The numbers are still the same, okay, and we’ve not only got 16 direct individuals but we’ve also got several 1099s of about a similar number and we’ll continue to add as we ramp up revenue throughout the year.

John Gillings – JMP Securities

Okay, that’s helpful. And then we’ve been hearing this quarter a lot of people talking about fewer selling days, shaving a percentage or two off of growth. Did you experience any of that this quarter?

Brian Hutchison

Certainly, we are impacted as everybody else is by the number of days to sell. That coupled with the FDA warning letters contributed to the results that we’ve shown.

John Gillings – JMP Securities

All right, thanks. I’ll jump back in queue.

Operator

Our next question comes from Michael Rich with Raymond James.

Michael Rich – Raymond James

Can you hear me okay?

Brian Hutchison

Yes.

Michael Rich – Raymond James

Okay thanks, just calling in for Jason here. Most of my questions have been asked, but just a couple of quick ones on the guidance, in terms of second half of the year, is there any impact expected or built into that guidance in case of warning letter duration spans into the second half of the year?

Brian Hutchison

There is a little bit of conservatism built into that number, but as we stated we’re confident that the FDA will be in here soon and we’ll have it closed out sometimes towards the end of Q2 or Q3.

Michael Rich – Raymond James

Okay. It sounds like you’ve been adding a decent amount of new customers, do you feel like there has been upside to that, that if that does come into the second half of the year, will be to offset that?

Brian Hutchison

Yes. I think – I mean we have added like you said, 100 additional new counts but the business has been relatively small, but it’s definitely showing promise. So if you take the new accounts that we’ve added plus the recovery of the business, it really puts us back on a growth path for the second half of the year.

Michael Rich – Raymond James

Okay. Great. And then just to be clear, in terms of the deferred revenue it sounds like the timing and the size of that was a little bit earlier than expected, but was any of that built into your initial guidance or is that bulk of that unexpected?

Brian Hutchison

A small amount was built into our initial guidance, but as we did the analysis with our auditors it ended up being a larger amount than we initially contemplated, so that – it was about roughly about a third of what we actually recognized was contemplated in our guidance.

Michael Rich – Raymond James

Okay, great, that’s it from me. Thank you.

Brian Hutchison

Thank you.

Operator

And I am not showing any further questions at this time, I’d like to turn the conference over to Brain for closing remarks.

Brian Hutchison

Thank you, Kevin. And thank you everyone for joining us. We appreciate your interest and we will talk to you again in about 90 days.

Operator

Well ladies and gentlemen that conclude today’s presentation. You may now disconnect and have a wonderful day.

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