RTI Biologics (RTIX) is a small player in the big dollar healthcare supply industry. According to its website "RTI Biologics, Inc. is a leading provider of sterile biological implants for surgeries around the world, with a commitment to advancing science, safety and innovation. RTI prepares donated human tissue and bovine tissue for transplantation through extensive testing and screening, precision shaping and proprietary, validated sterilization processes. These allograft and xenograft implants are used in spine, sports medicine, orthopedic, dental and other surgical specialties."
RTI has had small but steady revenue growth for the past several years. Earnings per share have also been steadily growing except for two irregularities in 2008 and 2010. Per the 2008 letter to shareholders, the reason for the large EPS drop was due to a goodwill impairment test that resulted in a non-cash charge of $103M or $2.00 per share. Excluding that, EPS would have been $0.10. According to its letter to shareholders, in 2010 there was a one-time non-cash goodwill impairment of $134.7M or $2.46 per share. Excluding that, EPS would have been $0.10. Cash on hand has grown and the company currently holds no long-term debt.
For the most recent quarter (see call transcript), revenues were down 7.6% year-over-year. Within that, the company reports revenues in six categories: sports medicine, spine, surgical specialties, BGS & general orthopedic, dental, and other. By segment, the percentage of revenue increase or decrease is -21.7%, 17.9%, -10.8%, -23.7%, -21.6%, 105.5% respectively. In the four segments with decreases, the company noted a decrease in unit sales as the main cause. On the call, the CEO noted first quarter revenues beat the high end of guidance by $1.4M. He also reported that the drop in the sports medicine segment mentioned above was a "…continued reaction to the FDA warning letter…" Due to this, the CEO expects to see growth in the back half of the year for the sports medicine segment. The company just rolled out a new portfolio in the surgical specialties segment. The CEO noted he expects to see segment growth for the year to end up positive in the low-to-mid teens. The company is expecting negative annual growth for the BGS & general orthopedic and dental segments.
The xenograft tendon is a new product in the pipeline. The company has almost completed a one-year evaluation with encouraging results. We should see the results sometime during the third quarter if I had to guess. It also has a new MAP3 product and porcine dermis product. With these two products, RTI is currently building initial inventory for an official launch at a conference this month. Recently launched products are the human dermis and bovine pericardium products. Both recent launches have already been implanted and the results are positive.
Despite the setbacks from the warning letter, the company provided annual revenue guidance of $178M - $179M and annual EPS between $0.17 and $0.19. At the high end, that means a revenue increase of barely 1% and an EPS increase of 26%. Despite the warning letter, the company has added approximately 100 new accounts, although some of them are quite small. Once the FDA warning is cleared, I would imagine the business from those new customers will grow and some of the old business will return.
As we know, in this industry there are many risks that could put a company out of business overnight. A few of the risks to be considered with RTI are as follows: competition/technology, legal regulations, and litigation.
In RTI's SEC filings, it reports its main competitors as: "Musculoskeletal Transplant Foundation ("MTF"), AlloSource, LifeCell, Inc., a subsidiary of Kinetic Concepts Inc. and LifeNet. Among our competitors in precision machined allograft are MTF, LifeNet and AlloSource. Other companies who process and distribute allograft pastes include Medtronic, AlloSource, Integra, Wright, and MTF. Companies who process and distribute xenograft tissue include Synovis, LifeCell, Cook Surgical and Medtronic." Many of these companies are non-profit companies or privately held. The only publicly traded companies are Medtronic (MDT), Wright [Medical Group] (WMGI), Integra (IART), and Synovis, which was just acquired by Baxter (BAX). Of these companies, RTI is the baby with a market cap of only $241M. Integra and Wright have market caps right around $1B and Medtronic and Baxter are the big boys with market caps of $52.31B and $37.67B respectively. Based on the competition, I do not think that RTI would be competed out of business. As long as it continues successful R&D and resulting innovation, I would see this company more as a takeover target. This is an excellent exit path because it greatly reduces the downside risk. RTI just reached a milestone of distributing over five million implants sterilized with its patented tissue sterilization process with zero incidence of implant-associated infection. That is a remarkable statistic and proves that the process must truly be good. I would think that patent alone would be worth a fair amount to a larger company that could use the process on multiple medical products.
During the fourth quarter of 2012, RTI received a warning letter from the FDA. Here is the statement from the 2012 10-K: "On October 23, 2012, we received a warning letter from the FDA related to environmental monitoring activities in certain areas of our processing facility in Alachua, Florida. We are currently working with the FDA to resolve their concerns. The warning letter does not restrict our ability to process or distribute implants, nor does it require the withdrawal of any implants from the marketplace." A response posted on the company website shows that the company has taken corrective actions, no recalls are necessary, and there is no patient safety issue. The FDA response was acknowledging the corrective actions and reporting that it will inspect them during its next regular inspection. If this letter takes longer to clear or does not clear, this would have a substantial negative impact on quarterly revenues for the company. Management expects the letter to be cleared reasonably soon. I can't think the infractions were too serious if no recalls or stop production orders were issued. I feel confident the company will be cleared and things will improve as guided.
The company is currently involved in 39 pending cases. There was no material discussion on any of them. The company only noted it is currently battling with its own insurance company to get all of the legal fees for all cases covered by insurance company. Obviously, here any substantial judgments could prove problematic, but at this time, I don't see any reason these should keep the company from being invested in and provided growth.
Currently RTI has a P/E of 30, which is higher than its big competition but in line with Integra. I think it's a fair P/E for the company given the growth expectation after the warning is cleared up and with the new products being rolled out. If the company meets the EPS guidance, keeping P/E the same, the share price should see between $5.10 and $5.70 by the end of this year. I think shares could then approach the $7.00 mark by the end of 2014. This would return 18%-32% for the rest of this year and 60% by the end of next year. If the FDA takes longer to provide the clearance due to the federal budget issues, as long as the clearance comes, I don't see a large overall impact to the annual results, it would obviously hurt any quarters' individual results. I only see minimal downside risk because of the good patented technology and processes which could easily be the target of an acquisition. I am not a fan on buying based on acquisition speculation, but I do like it there to provide a way to reduce downside risk. Shares are near the middle of their 52-week range. You could start into your position here and then ease in the next few times it has a decline.