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RTI Biologics, Inc. (NASDAQ:RTIX)

Q4 2009 Earnings Call

February 9, 2010 9:00 am ET

Executives

Wendy Crites Wacker - Director of Corporate Communications

Brian Hutchison - Chairman & CEO

Tom Rose - EVP & CFO

Roger Rose - EVP

Analysts

Matt Pommer - Roth Capital Partners

Bill Plovanic - Canaccord Adams

Greg Brash - Sidoti & Company

Brooks West - Craig-Hallum Capital

Jayson Bedford - Raymond James

Raymond Myers - Emerging Growth Equities

Operator

Good day and welcome to the RTIX Fourth Quarter Earnings Conference. Today’s conference is being recorded. At this time, I’d like to turn the call over to Ms. Wendy Crites Wacker. Please go ahead.

Wendy Crites Wacker

Good morning everyone and thank you for joining RTI Biologics for our fourth quarter and year-end 2009 conference call. Today, we will hear from Brian Hutchison, Chairman and CEO, who will discuss operational highlights and future activities for the company, as well as Tom Rose, Executive Vice President and Chief Financial Officer, who will provide an overview of our financial results.

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 our 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. As many of you saw in our press release this morning, we reported quarterly revenues of $42 million. We’ve also achieved net income of $1.5 million or $0.03 per diluted share for the quarter. For the year, we reported record annual revenues of $164.5 million representing growth of 12% over last year. We also reported net income of $5.9 million or $0.11 per diluted share.

Twelve months ago, during a time of full uncertainties, we gave 2009 revenue guidance and maintained that guidance throughout the year. We came within 1% of our guidance for 2009 revenues. Thanks to our ability to control our operating cost, we were able to meet our guidance for earnings.

Throughout the year, sports medicine and surgical specialties have been our fastest growing segments offsetting declines in dental and spine and slower growth in our other markets. Sports medicine revenues reached record levels with an increase of 22% in the fourth quarter and 9% for the year. At the beginning of the year, our sports medicine team launched two new implants, the Fresh OC Talus and Matrix HD.

The Fresh OC Talus is an extension of our Fresh osteochondral program, which has doubled revenues compared to last year. Matrix HD is our first dermis graft used in various foot and ankle procedures, joint repair and superficial wound repair. At the end of 2009, Matrix HD surpassed $1 million in revenues and has been used in some novel tissue repair cases.

We finished the year with about 36 direct distribution staff plus a number of independent distributors, an increase of about 20% from the end of last year. We actively monitor and invest in areas where enhanced coverage is needed to ensure that we best meet the needs of our surgeon.

We plan on adding distribution personnel and resources as needed throughout 2010 to provide additional coverage around the country. Surgical specialties has been the strongest area of growth for the company for the entire year. Revenues increased 86% for the quarter and 71% for the year.

The most significant growth rate in our domestic surgical specialties line are in hernia repair with growth in excess of 150%. Breast reconstruction has also been an area of growth over the year as we completed our exclusive agreement with Davol to distribute these implants. After shipping initial launch quantities to Davol on our third quarter, we increased breast reconstruction revenues to more than 30% for the year.

Our bone graft substitute's revenues were up 58% for the fourth quarter. The increase related to higher export orders and follow on orders from a successful product launch with Stryker in the third quarter.

International revenues, which include export revenues and distribution from our French and German locations, were up 37% for the fourth quarter and up 18% for the year. Fourth quarter international revenue increases were the result of 39% unit volume increase and $542,000 of favorable currency exchange fluctuation.

Over the course of 2009, our team worked diligently to close out some litigation that had been consuming significant company resources for the past two years. In 2009, alone we spent more than $2 million in litigation related expenses and hundreds of hours of staff time. Two significant cases have benefited from this effort; one is the patent case for the Osteotech, which has been resolved under confidential terms.

We've also reached settlement agreements in nearly all of the federal and state cases brought by trial lawyers representing recipients of tissue from the BTS recall from 2005. Throughout the course of this litigation, RTI has maintain the position that there was no risk of disease transmission from these allograft implants due to the sterilization methods that these implants were subjected to at RTI.

We’re very pleased to have the significant chapter in the BTS litigation closed. As you know, we keep our R&D activities confidential until the products are launched, but we do maintain a robust development pipeline of new implants for our direct businesses and our distributors.

In 2009, we launched 13 new implants and two line extensions in spine and orthopedics, accounting for approximately $6 million of revenue. Our development team for spine and orthopedics added at least one new implant to each of our distributor’s biologics portfolio.

Our surgical specialty team launched five new implants and three line extensions for their distributors. These new products in spine, ortho and surgical specialties are an addition to two new sports medicine implants I mentioned earlier.

For 2010, we’re scheduled to launch a similar number of new products and line extensions over the year throughout all of our businesses, starting with two new sports medicine implants being launched at the AAOS next month.

In addition to new products, business development has been a key initiative in growing our company. As you know, we signed two new distribution contracts this year, one with Aesculap for spine distribution and one expanding the Davol distribution agreement to include both hernia repair and breast reconstruction.

Our management team will continually evaluate new opportunities and seek out ways to maximize our current business opportunity. Through leveraging our current distribution channels, launching new products and taking advantage of business development opportunities, we are confident we have a business model in place that will allow us to grow our company even through uncertain economic times.

At this point I will let Tom discussed our financial results and I’ll come back and talk to you more about expectations for 2010.

Tom Rose

Thank you, Brian. As Brian mentioned, revenues for the fourth quarter were $42 million and $164.5 million for the full year. Both representing increases of 12% compared to the prior year. On a pro forma basis, including Tutogen revenues from the 12-month period, our revenues grew 6%.

Fourth quarter net income was $1.5 million or $0.03 per share based on $54.9 million fully diluted shares outstanding, this compares to a net loss of $102.5 million or $1.89 per share in the prior year based on $54.1 million fully diluted shares outstanding.

Net loss from the fourth quarter 2008 reflected asset impairments and abandonment’s of $104.4 million, or $1.92 decrease per fully diluted share.

Net income for the full year was $5.9 million or $0.11 per share based on 54.8 million fully diluted shares outstanding, this compares to a net loss of over $100 million or $2 per share in the prior year based on 49.9 million fully diluted shares outstanding.

Spine revenues were $9.6 million for the fourth quarter and $41.1 million for the full year, representing a decrease of 21% and 2% respectively compared to the prior year period, primarily due to decreases in unit volumes.

In Q4 2008, we shipped approximately $1 million of new product launches, which impacted our quarterly comparability. In addition in 2009, we began seeing new inventory management activities by our spine distributors, which impacted our revenue levels for the quarter.

Sports medicine revenues were $10.3 million for the fourth quarter of 2009 and $39.5 million for the full year, representing increases of 22% and 9% respectively, compared to the prior year period, primarily due to unit volume increases.

Dental revenues were $8.4 million in the fourth quarter of 2009, and $30 million for the full year, representing an increase of 7% compared to the prior year’s quarter and a decrease of 7% on a pro forma basis for the full year.

In general, the decline for the full year is related to fewer implant procedures being performed as patients deferred surgery due to the economic downturn.

Surgical specialty revenues were $6.6 million in the fourth quarter of 2009 and $26.3 million for the full year, representing increases of 86% and 71% respectively, compared to the prior year revenue.

On a pro forma basis, revenues increased 50% for the full year. The increases were substantially driven by higher amounts of tissue available for distribution, as well as favorable mix and price increases. Unit volumes increased by 41% for the quarter and 34% for the full year.

Revenues for bone graft substitutes were $4.1 million in the fourth quarter of 2009 and $15.7 million for the full year, representing increases of 58% and 9% respectively compared to the prior year revenues.

Unit volumes for the period increased by 32% and 28% respectively, the increase in revenues in Q4 reflect higher distribution of a new BGF implant for Stryker launched in the third quarter as well as increased volumes from several of our distributors. Product mix for the year was impacted by significant distribution of our new paste implants in dental, which ranged from 1.5 cc to 2cc units with low ASP’s.

Revenues for general orthopedic implants were $2 million in the fourth quarter and $7.5 million for the full year, representing increases of 41% and 33% respectively compared to the prior year revenue.

Our pro forma basis revenues increased 11% for the full year. Our largest component of general orthopedic revenues is non-dental distribution throughout Europe via international operations.

Gross margins for the fourth quarter 2009 was 48% compared to 47% for the same time period last year. Changes in product mix resulted in a 1% decline in gross margin in the fourth quarter compared to 2008.

In the fourth quarter, operating expenses totaled $17.5 million, an 8% increase over 2008. During the quarter, fixed cost included in marketing general administrative expenses totaled approximately $10.4 million, representing a decrease of 1% compared to the prior year.

During the quarter, variable incentive compensation declined $100,000 and variable distributor commissions totaled $3.4 million. Research and development expenses for the quarter totaled $3.1 million, compared to $2 million in the prior year. The increase in R&D spending for the quarter was primarily driven by the timing of accruals on various research studies and increased materials used in R&D activity.

Lastly, our tax rate for the quarter was 35%. The quarterly tax rate approximates our effective tax rate while the tax rate for year of 31% was favorably impacted by a non-recurring adjustment to our research and experimentation tax credit.

When reviewing the balance sheet at the end of the year, compared to the December 31st 2008 and cash flow for the full year, 2009 please note the following.

Cash position at the end of 2009 was $17.4 million compared to $20.1 million at December 31st, 2008. Accounts receivable increased to $22.2 million as compared to $14.7 million at December 31st, 2008. Days sales outstanding was 49 at the end of 2009.

Change and receivables related primarily to a fourth quarter increase of $6 million resulting from the timing of both revenues and cash collections. When receivables are normalized, they should average between $19 million and $21 million per month (Audio Gap) compared to $75.2 million at December 31, 2008.

Inventory days outstanding on total inventory were 386 at the end of the 2009. At December 31, 2009, unprocessed donor tissue totaled $27 million, tissue in process totaled (Audio Gap) and implantable donor tissue totaled $24.6 million.

During the quarter, we recognized an increase in inventories of $1.6 million this included a decrease in unprocessed donor tissue of $200,000, a decrease in tissue in process of $2.7 million and an increase in implantable donor tissue of $4.6 including approximately $2.8 million relating to surgical specialties and spine implants for which we had anticipated shipments in Q4.

Working capital at the end of the year totaled $114.9 million, an increase of $24.8 million since December 31, 2008. Total debt is approximately $15 million. At December 31, 2009, we had approximately $2.1 million available under our lines of credit.

As we enter 2010, generating cash flow is a primary focus of our organization. Our operating plan in 2010 includes a reduction in inventories of approximately $5 million. We will attempt to reduce inventories further, but additional decreases could have a negative impact on our gross margins.

To achieve these inventory reduction goals in a short term, we will bring our levels in unprocessed tissue and implantable tissue to optimal levels.

Longer term, as we redesign our inventory management system, we reduce tissue unprocessed to levels that will properly support the needs of our customers. It took us a number of years to build these inventories to the current levels and it will take us several years to reach optimal levels in all categories of inventory.

In closing, after a challenging year in 2009, we’re feeling very good about our liquidity position, our ability to generate cash in 2010 to support our future operations.

I’ll now turn the call over to Brian.

Brian Hutchison

Thanks, Tom. In our press release this morning, we outlined our expectations for revenue and EPS for 2010. We anticipate that full year revenues for 2010 will increase between 6% and 8% or between $174.5 million and $177.5 million.

Full-year earnings per fully diluted share are expected to be in the range of $0.15 to $0.17. EPS is based on $55.7 million fully diluted shares outstanding.

Let me give you a little color on this guidance. We anticipate that revenues will be stronger in the second half of the year, as we begin seeing revenue growth from our new product launches and stronger orders from our distributors.

We believe our sports medicine, surgical specialties and bone graft substitute businesses should achieve above market growth for the year. With our direct efforts in sports, a strong focus in biologics by our surgical specialties distributors and the success of the new implants and BGF, we believe we can achieve gains in market share.

We anticipate our dental businesses will experience softness again in 2010 and be down slightly as unemployment levels tend to be a good indicator for this sector. We believe improvement in the payroll and unemployment statistics would [shadow] renewed growth in this segment.

While we are in still encouraged by relationships with our spine distributors, we feel that a conservative outlook of flat results year-over-year in this segment is appropriate due to our distributors focused on inventory management and uses of cash for their business.

We spent a great deal of time assessing the fundamentals of our markets over the past year, as well as the dynamics that we and our distributors are facing in the coming year. Last year this time, we faced many moving targets and predictions were challenging for all.

While challenges still exist, we believe we've entered a period of relative stability in our markets. We are very optimistic that we can meet our growth objectives and at the market stability we are starting to experience will allow us to focus on improving our profitability and generation of cash.

We will do this through operating margin expansion and as Tom mentioned, through reducing our investments in inventories and accounts receivable. Our management team is committed to putting initiatives in place to meet these goals and grow our company.

In closing, throughout last year, we invested in our people and our products in order to be a proven leader and providing biologics for surgical applications.

Our strongest recent channels and robust portfolio of best-in-class products combined with expertise in biologics have allowed us to grow in an unfavorable economic climate in 2009 and will allow us to be successful in the long-term.

At this time, let's open up to questions. Christine?

Question-and-Answer Session

Operator

(Operator Instructions). Your first question comes from Matt Pommer - Roth Capital Partners.

Matt Pommer - Roth Capital Partners

Just a couple of quick questions on products and then turn to guidance. First, can you talk within your spine business; can you talk a little bit more about what you’re seeing in the business and help us understand how to think about the trends you expect for the business in 2010?

Brian Hutchison

Well, I’ll tell you that we see the market the way the public data sees the market. The market is growing very low single digits. Our partners specifically have called for lower than those growth markets in total, led by our biggest distributor saying they are going to grow a little bit slower than market in total for 2010.

Additionally, you’ve to factor in not just one of our players but all of our players are paying a lot attention to their inventory levels and basically trying to reduce the amount of inventory they carry on their shelves throughout their system, which puts additional pressure on us.

So, the bottom line is, for RTI we have taken a cautious position and said that we will be flat, even though we expect to at the end-market to be seeing some growth.

Matt Pommer - Roth Capital Partners

On your dental business, you put up a pretty nice number for the quarter yet in your prepared remarks you talked about seeing continued softness in 2010. Can you help us to understand what happened in the quarter for that segment and how we should think about this in the year?

Brian Hutchison

That’s a very good question, and I thought of it myself as I was preparing these comments. For our guidance, we took a conservative view based on our view of jobs information that came out in the last few weeks in the fourth quarter we had a pretty good performance and our market employees would tell us that they saw a little bit of a pent-up demand in the fourth quarter. So, before we go ahead and change our guidance, we want to see if that continues in the first quarter.

Matt Pommer - Roth Capital Partners

And then turning to gross margins, in the past you’ve talked about the contributions made from your dental and sports medicines business being higher than your highest gross margins, yet there was a sequential decline in gross margin in the quarter. Can tell us a little bit of about the moving parts in that?

Tom Rose

Matt, the gross margins, as I have discussed before, the critical point for us continues to be around $42 million in total revenues where above that point, we start recognizing some of the benefits of leveraging our fixed costs. So, from a quarter-to-quarter standpoint, the decline of revenues did have that negative leverage impact on the margin. I think as we move into next year, we will continue to focus on that $42 million level to see whether the margins grow in accordance with our expectations.

Matt Pommer - Roth Capital Partners

Just a couple of quick questions on guidance. In 2010, the guidance you provided, are you seeing or factoring in specific risks to product categories. Are you seeing just a general softness or do you think there is some room for outside here?

Brian Hutchison

We built this segment-by-segment and we try to talk about the various groups that we seen and you have asked about two of them, with dental and spine. So, we do see that we’re following the job information that could affect dental and sports and general orthopedic cases and we continue to follow that, but clearly if the economy performs better then we expect to do better as well. We are certainly prepared to do that, we have the tissue to do that. So, we feel that we can respond.

Matt Pommer - Roth Capital Partners

With that in mind, how do you think about initiatives to address potential opportunities for cost savings, improve the gross margin or are you willing to go for revenue growth in this.

Tom Rose

Matt, as Brian mentioned in his comments, even through this past year, we continued to make investments preparing us for the future whether it’s the uncertain economic climate or rebound. As I mentioned, on the cost front in the quarter, we saw a 1% reduction in the fixed operating cost to the company compared to the prior year.

Cost control has been a focus all year for us and continues as we go into 2010. Overall for 2010, our fixed costs are anticipated to have either zero growth potentially 1% growth or positively another 1% decline. So, even though we have obviously increases in cost as we grow the business, we are reducing cost in other areas of the company to keep our operating costs flat.

Operator

Your next question comes from [David Turkaly - SIG]

Unidentified Analyst

Thanks guys, this is actually Sean in for Dave. I have a question about the sports med segment. What is your sales covered look like today and what is the target number of reps you guys are sort of looking at longer term?

Brian Hutchison

I’ll allow Roger Rose to answer that question, he is in the room.

Roger Rose

As Brian mentioned, we have about 36 people on the street right now and we’ll add as we need to over the course of the year. We believe we’ve got enough people in place right now for us to certainly get through the first quarter, but Rod and his team are looking to expand in a few key markets and we’ll do that as the year progresses with an upside of somewhere probably between five and ten people.

Unidentified Analyst

And what kind of growth are you guys seeing in the sports med segment right now. I know you said that you think you can grow above the markets, so where is the market right now?

Brian Hutchison

Again in the 10% range.

Unidentified Analyst

10%. And then can you guys talk a little bit more about the receivables and why that picked up so much in more detail there?

Tom Rose

My comment on receivables and we had a significant December shipping month, which really caused the blip. We also had some actual changes from some of our customers on payment terms that impacted the timing of receipts, right around the end of the year. So, again following-up on my earlier comments that should normalize itself within a matter of months and we would expect that our days outstanding, our receivables would be on the 35 to 40-day range as we move forward.

Operator

Your next question comes from Bill Plovanic - Canaccord Adams.

Bill Plovanic - Canaccord Adams

A couple of questions on; first just to talk about the inventory reduction strategy, I was looking at this; I think your inventories are up about 25% year-over-year. I know you had mentioned that it looks like you’ve taken down some of your unprocessed and in-process, but I think you said you’re going to try to take it down by $5 million overall this year, if you take it down more that negatively impacts your gross margin significantly, is that basically why you can’t bring it down further?

Tom Rose

I would say that the impact on gross margin again if you start producing obviously it will have an impact on our gross margin, but I think what we’re trying to balance is we’ve been continually reducing our production activities for the past couple of quarters and we’ll continue to do that in the next couple of quarters, but the main focus of that balance is we still have to meet the growing orders on the revenue side. So, the balance is; can you slowdown manufacturing activity, don’t need the order flow, but the other piece of that puzzle is reducing cost within cost of sales, which we’ve made strides on that this past year and we’ll continue to make strides on that as we go forward?

Brian Hutchison

If you follow the company trends over a period of time, you know that we made a strategic investment in the unprocessed donor tissue in 2009. We did that consciously knowing we had to build out post the merger; we had to build out membrane inventory, so that we could increase those levels of production and we’ve been doing that consciously.

That also has a fairly long cycle time, which drove up the tissue in process inventories to pretty high levels as well and then you take on all of this inventory management that is going on from basically every distributing partner we have, which is forced us to carry larger finished goods, because they expect us to have 95% to 99% service level even though they are carrying less and less inventory.

So it's a bit tricky, the bottom line is we believe we can reduce our inventory carefully without impacting service levels or anything else, but it shouldn’t impact cash flow. If we try and do it too rapidly, obviously it will impact service level and profitability and we don't want to do that. So, the message is we’re very well aware that it's too high and we’re going to work on reducing it, but we’re just going to do it carefully so that we don't destroy the P&L.

Bill Plovanic - Canaccord Adams

I mean when you talked about receivables at the same time they are asking you to carry more inventory for them they are also asking you to extend out the receivables for them as well, what's going on?

Brian Hutchison

Yes sir.

Bill Plovanic - Canaccord Adams

And then just jump back; kind of trying to find the lever points in the P&L, you mentioned the legal was about $2 million in 2009 for the litigation you discussed. What do you expect for that number for 2010? Does it all go way, do we have some flow through into the first quarter. How much was is it in the fourth quarter just to kind of figure out how much comes out in the P&L for those things?

Tom Rose

I think as we talked about on our calls, we identified legal expenses and some of the earlier calls and it was the averaging in the early part of the year 500,000 to 700,000 a quarter. In Q4, still a fair amount of time working on the BTS settlement issues, but it probably came down to the 200,000 to 300,000 range in Q4. Anyhow, as we go into next year, legal expenses should average around the $100,000 a month and hopefully less.

Bill Plovanic - Canaccord Adams

100,000 a month, so basically the range that we are shooting at in the fourth quarter, it will maintain that through 2010?

Tom Rose

And it should come down a little bit, but in general I would say that’s on a go-forward basis, that’s what we’re looking at.

Bill Plovanic - Canaccord Adams

Are there any other cost savings that could add incrementally to the P&L in 2010 versus Q4'09 kind of using that at your base run rate on a cost standpoint?

Brian Hutchison

Well on the operating cost, I would highlight legal, on the operating cost up in cost control, I think there is many opportunities and we’re attacking a number of them right now. I can’t predict exactly how fast they will show up or to what magnitude yet, as we progress through this year, I intend to get more and more open on these calls trying to share. Our main objective is to significantly improve gross margins.

Bill Plovanic - Canaccord Adams

And then to circle back, actually since we are on this, just some housekeeping, what do you expect D&A to be in 2010, stock comp expense and CapEx?

Tom Rose

On the depreciation and amortization side, it’s about $7.5 million and on the stock compensation side similar level to this year around $1.7 million.

Bill Plovanic - Canaccord Adams

And then CapEx?

Tom Rose

CapEx, we planned this year includes about $6.5 million of CapEx.

Bill Plovanic - Canaccord Adams

And then the last question, I’ll jump back into queue is; just on dental, that was a big jump sequentially. I think you said that you thought there was some pent-up demand, was there something else in there that drove it up so much sequentially?

Brian Hutchison

Not really, in fact I was watching in and there was daily volumes. So, it didn’t just start in December, it actually started mid-to-late October and it kept going. So, we’re going to continue to watch it as this quarter unfolds and see exactly where we go.

We took a conservative stance in budgeting and guidance, and I think that was appropriate and the job numbers came out last week and sort of made me sit back and say okay, we are not there yet, but we are going to continue to watch this carefully if the numbers continue on in the first quarter then we will share that with you.

Bill Plovanic - Canaccord Adams

And then actually one last question is (Audio Gap) mentioned if you have the 36 direct reps, I think Roger answered the question. What’s the production, the average production of those reps today and where do you think that can go?

Tom Rose

Well, honestly it depends on territory-to-territory, but our metric really is we want to get people past the year. Once we get down to that point, they are pretty self-sufficient and they are earning the kind of money that you need to be able to survive in the orthopedic market place. And for us, an average territory is after a year is north of $0.5 million and usually within a couple of years it is north of a $1 million. Now, we have some territories where we have turn over and we have got people to bring relationships and obviously those was very different, which is why I say every territory is a bit unique that way.

Fortunately for us, the territories that are performing well, we don’t see turnover. It is more in the territories where, if we have added somebody in a place and we have made a mistake then we have to make move on that, but by and large, if we get people to that one year hump, they stay with us forever.

Bill Plovanic - Canaccord Adams

How many reps are over a year at this point?

Tom Rose

Probably in the neighborhood of 20 to 25, I don’t know the exact number Bill.

Operator

Your next question comes from Greg Brash - Sidoti & Company

Greg Brash - Sidoti & Company

I just want to touch on the spine segment a little bit, the inventory reductions you saw in the quarter. Do you think that was just typical fourth quarter reductions or have you seen a slowdown in recent months in procedure volumes where maybe we see these reductions continue for another quarter or two?

Brian Hutchison

It is not procedurally related, this is internally related and I can tell you, we’ve been in dialog with them regarding specific inventory reduction plans that they have in place for our planning to put in place throughout the first part of this year. So it's not (inaudible) these are plans that have been worked on for quite sometime and we’ve agreed in certain cases the hold more of the inventory and in other cases, we’ve agreed just to have if you will, longer holding periods between shipments, but at the end of the day, I think this is going to continue, this inventory movement is going to continue for the first at least quarter if not two quarters of this year, before really settles out and we should be done and for those of you that have followed the company for years. We've talked about this for years, but the levels of inventories that are now in our distributors hands are very, very low in many cases down to less than eight weeks.

Greg Brash - Sidoti & Company

Is that anything you can do to prevent this from occurring, I mean it seems like this happens almost every year and in the fourth quarter?

Brian Hutchison

We've tried various ways to prevent it and the answer is nothing has worked and when we get push at the end of the year, we build to forecast, we’ve managed these guys to forecast. We attempt to get as much visibility as we possibly can, but in many circumstances there is not much we can do.

Tom Rose

I will just add to that though Greg, I would say that as the distributors try to continue to bring their inventory levels down again without impacting their end market, there is more dialog than we’ve had in the past as they understand what our inventory levels are and how that interfaces with their inventory management.

So, I think the dialog is a little different than we’ve had in the past, just because they need more information from us to accomplish their goals and really vice versa. So, I would say that's the one change, in the dynamic compared to prior years and at some point in time, as Brian mentioned, they get to their lowest reorder point.

Greg Brash - Sidoti & Company

On sports medicine, just to switch topics here, you mentioned last quarter procedure volumes were starting to come back in September and October just curious how that's been trending? Is it gotten better every month or are we still in the same level where we were back in October?

Brian Hutchison

We had a very strong finish November and December as well, and that showed in our sports numbers and so far in January things are continuing to move along fairly well on the sports area, but we’re very optimistic.

Greg Brash - Sidoti & Company

Just two more from me, one quick one on the R&D. Do you expect and was that unusually high here in the quarter, expect that to comedown on a quarterly basis next year? If you could mention maybe the amount of xenograft revenues you had in the quarter and if there any plan launches for 2010?

Brian Hutchison

I think on the R&D numbers, we’ll see a slight increase in R&D for next year, but you should see the quarterly numbers kind of normalizing compared to the full year R&D spend this year. The bovine front, we continued to have 35% of our international revenues from German and French operations in bovine. In the U.S. this past year, probably 2% to 3% bovine in total. I think from a strategic standpoint, bovine continues to be a focus for us in surgical specialties both U.S. as well as international.

We have had some 5-10-Ks approved in the last 18 months that we still don’t have distribution strategies for the products in the U.S. but they are being marketed internationally and still a major part of research dollars are going into bovine and other animal tissue development activities.

Operator

Your next question comes from Brooks West - Craig-Hallum Capital.

Brooks West - Craig-Hallum Capital

Brian, I wanted to push a little bit on your dental guidance I’m trying to understand given the year you had last year, how that goes down potentially or stays flat and maybe you could walk me through the moving parts between Zimmer and the U.S. your OUS distributors and then lastly on dental where are you with the renegotiation of the Zimmer contract?

Brian Hutchison

Well, your last point in your whole question is really one of the keys and that is; in 2010 we’re negotiation with our worldwide exclusive distributor, which is Zimmer. That agreement expires late summer of 2010 and we are in negotiations and discussions about what to do going forward so therein lies also one of the keys why we are being conservative right now and we are going to stay there until we are certain of where that’s going to go.

I can just say that the dialogue is open and there is conversation going on, but we certainly don’t want to do that in public. So we won’t be talking about that very often, but the dialogue has began so we will see how that plays out. As dental procedures increase we are certainly expecting to be there and be involved, but December and Q4 demand was pretty good, but I would tell you that right now I feel like that’s more pent up demand then a new trend in dental, but we’ll will see how the first quarter unfolds and will go forward.

I’m seeing a significant difference outside U.S. versus inside U.S., but both suffering economically and our business looks similar. So at this stage we are continuing to manage that closely, but I just don’t feel comfortable giving your big growth number there with the all the variables that we just talked about.

Brooks West - Craig-Hallum Capital

Sure, okay. Then the Hernia repair and breast recon at Bard, can you give us a flavor of how to think about the timing and the magnitude of the pull through at Bard. I mean, you were the feature of their Analyst Day, they are throwing selling assets out, I think they were up 80% in 2009 and they set up 50% at latest in 2010. I know we have the stocking order in Q3, how should we think about that pull through at Bard and maybe where are they with that stocking order and could there be sometime pent-up demand there in first half?

Brian Hutchison

I think demand in surgical essentially is going to be strong this year as we said in our guidance I think if will grow as the year unfold. I think the way Bard describes it, they’ll hire the reps, will train the reps and then so the reps are similar to what Roger said, they get better with time, so expect that the second half of the year will be very, very strong. They are committed to this as they told you they told us the same thing. We are optimistic about this moving forward, we think it’s a very good thing and I've hired a new individual to work for us, his name is Mike LaPrade, which we announced that’s always focused on is surgical specialties, he has been out talking to all of the customers since he joined us and he’ll continue to try to build that business and make it grow to significant numbers.

Brooks West - Craig-Hallum Capital

Okay, then I guess last question just on quarterly cadence, you said you are going to re-back, weighted to the back of the year, are there any major product launches that we should be paying attention to? Should we see kind of normal seasonality through the first half or is there something that could throw a quarter one way other the other?

Tom Rose

I think, we’ll see the new product launches kind of for this coming year reflect similar timing to last year could be some changes in quarter-to-quarter. But we do have a couple of fairly significant launches relating to the spine distributors targeted for Q3 and Q4. And we’ll try to give heads up to the street on our calls prior to those launches, so you can have some feel for how that’s going to impact the quarterly numbers.

Brooks West - Craig-Hallum Capital

Great. Are you guys going to do anything to [academy] this year?

Brian Hutchison

No, I will be there, Wendy is going to be there as well, so if you want to talk to Tom or I just let us know and we will certainly be in our booth everyday.

Operator

Your next question comes from Jayson Bedford - Raymond James.

Jayson Bedford - Raymond James

Just a couple of questions, first on the guidance, surgical specialties and BGS you mentioned they’ll grow above market rates. Can you just give us what your expectations for the market growth in those two areas are?

Tom Rose

The surgical specialties, we’re seeing 13% to 15% that how we peg that market growth rate. And on bone graft, we peg that market growth rate of about 8% to 10% for our products, Jayson.

Jayson Bedford - Raymond James

Sorry, are those market rates that you are expecting?

Tom Rose

Those are market rates.

Brian Hutchison

Those are markets rates, we will grow faster than those.

Jayson Bedford - Raymond James

Okay. And then maybe I missed this, but what’s your expectation for gross margin in 2010?

Tom Rose

Right now based on the revenue guidance we’ve given, we’re going to see a small increase in gross margin for the full year, some of that relates to our inventory management procedures that we discussed. And that’s kind of where we see it today.

Jayson Bedford - Raymond James

Okay, and then just a couple housekeeping on the quarter, the buildup in AR, did that occur in certain segment of your business?

Tom Rose

I would say it was just with timing of distribute orders. It wasn’t really one segment or the other.

Jayson Bedford - Raymond James

Okay. When you look at the spine business down 2% for the year, any idea of what end user demand was, I’m just trying to kind of see through the inventory changes?

Brian Hutchison

I think end-user for the market, I think it was up low single digits for fusion procedures. For our distributors I would say that two of them lost market share, and three of them grew, but that the three that grew were very small.

Jayson Bedford - Raymond James

Okay. Last one from me. Can you just give us the contribution in the quarter from your two largest customers?

Tom Rose

Yes, we can, just bare with me.

Brian Hutchison

Tom has got to sit through the papers and find that one.

Tom Rose

Jayson, we’ll have that disclosed in the K. Obviously dental is Alzheimer.

Brian Hutchison

Right.

Tom Rose

And on the spine front…

Brian Hutchison

Spine side, Medtronic was 80% of 2009 revenues.

Tom Rose

And I think it was similar for the quarter as well.

Operator

Your next question comes from Raymond Myers - Emerging Growth Equities

Raymond Myers - Emerging Growth Equities

I wanted to ask you what if you anticipate for 2010 operating cash flow?

Tom Rose

We’re currently anticipating operating cash flow of around $15 million based on the guidance that we provided.

Raymond Myers - Emerging Growth Equities

And then what euro dollar exchange rate is baked into the 2010 guidance?

Tom Rose

$1.50.

Raymond Myers - Emerging Growth Equities

So since we’re below that now, how would that impact your guidance that you’ve given, if it were to stay flat with the current rate?

Tom Rose

If we stay flat with the current rates, it probably has less than $1 million of impact on the top line. From a profitability standpoint, the way we manage our international operation, there is kind of soft hedges with revenue and expenses, so it wouldn't have any impact on our profits.

Raymond Myers - Emerging Growth Equities

The way that you stated your guidance was that they would be 1% contribution from FX anticipated in the year, are you saying that if the rates were to stay the same as currently that would actually be roughly not a 1% positive impact, but less than $1 million negative impact?

Tom Rose

Yes, that's would be my guess right now.

Raymond Myers - Emerging Growth Equities

Okay. Of course we never know where those would, it change daily?

Tom Rose

Correct.

Operator

This will concludes today’s question and answer session. At this time, I'll turn the conference back over to Mr. Hutchison for any additional or closing remarks.

Brian Hutchison

Thank you all for joining us this morning and as always you can find information about RTI on our website or by contacting our IR department. Thank you, bye-bye.

Operator

That does conclude today’s conference. Thank you for participation.

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Source: RTI Biologics, Inc. Q4 2009 Earnings Call Transcript
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