Exactech, Inc. Q4 2009 Earnings Call Transcript

| About: Exactech, Inc. (EXAC)

Exactech, Inc. (NASDAQ:EXAC)

Q4 2009 Earnings Call Transcript

February 23, 2010 10:00 am ET

Executives

Bill Petty – Chairman and CEO

David Petty – President

Jody Phillips – CFO

Analysts

Bill Plovanic – Canaccord Adams

Robert Gold – Brigantine Advisors

James Sidoti – Sidoti & Company

Jason Bednar – Robert W Baird

James Terwilliger – Duncan Williams

Operator

Good day ladies and gentlemen, thank you for standing by. Welcome to the Exactech fourth quarter 2009 earnings conference call. During today’s presentation, all parties will be in a listen-only mode. Following the presentation, the conference will be open for questions.

(Operator Instructions) This conference is being recorded today, Tuesday, February 23, 2010. I would now like to turn the conference over to Bill Petty, CEO. Please go ahead sir.

Bill Petty

Thank you Alicia and good morning from Exactech. We look forward to having a discussion with you this morning. I will open by making some comments, and then David will make a few comments, and then Jody will bring us up on some of the financial details. Before I begin with my comments about 2009 and the fourth quarter of 2009, I will go through the disclaimer.

This release contains various forward-looking statements within the meaning of Section 27A of the Securities Act of 1933 and Section 21E of the Securities Exchange Act of 1934. They represent the company’s expectations or beliefs concerning future events of the company’s financial performance.

These forward-looking statements are further qualified by important factors that could cause actual results to differ materially from those in the forward-looking statements. These factors include the effect of competitive pricing, the company’s dependence on the ability of third-party manufacturers to produce components on a basis, which is cost-effective to the company, market acceptance of the company’s products, and the effects of government regulations. Results actually achieved may differ materially from expected results included in these statements.

I am first going to discuss the full-year 2009. Exactech’s 2009 revenue was $177.3 million, which is an increase of 10% from $161.7 million in 2008. Net income for the year was $8.3 million resulting in diluted earnings per share of $0.65. This compares with net income of $11.1 million or $0.87 diluted EPS a year ago. This reported net income for 2009 includes pretax legal expenses and estimated settlement cost of $7 million related to the ongoing Department of Justice inquiry. We exclude the impact of these legal expenses, 2009 net income was $13.2 million or $1.03 compared to $12.7 million or $0.99 diluted earnings per share in 2008.

I now want to provide a little detail related to segments for the full year. Knee implant revenue increased 4% to $75.8 million. Hip implant revenue increased 18% to $26.8 million. Biologic & spine segment revenue increased 4% to $27.4 million. Extremity implant revenue increased 36% to $22.8 million, and our other revenues segment increased 6% to $24.4 million.

Now, I want to give the detail related to the fourth quarter. For the fourth quarter, revenue was $48.3 million compared to $40.3 million for the fourth quarter of last year. This represents an increase of 20%. Net income for the fourth quarter of 2009 was down 84% to only $0.5 million compared to $3.1 million in the fourth quarter of 2008. This led to diluted earnings per share of $0.04 for the fourth quarter of 2009 compared to $0.24 in the same quarter of 2008. If we exclude the legal costs that I have just mentioned in the estimated settlement of $3.6 million associated with the ongoing DOJ inquiry, the diluted earnings per share for the fourth quarter was $0.25.

Now, for the segment performance in the fourth quarter, knee implant revenue increased 24% to $21.1 million, hip implant revenue up 29% to $6.8 million, biologic & spine segment revenues were flat at $7.0 million, extremity implant revenue was up 29% to $6.5 million, and other revenues increased 17% to $7.0 million.

After a lackluster first half of 2009, Exactech had a strong second half of a revived [ph] growth of 20% compares very favorably with other companies in our segment. This is to mention that Exactech this year will be 25 years old in November. We are pleased with our progress over that period of time and we are motivated by our immediately audacious goal to be the world’s leading provider of innovative bone and joint restoration products that improve patient outcomes. We will continue to work towards that goal.

Now, I am going to turn it over to David and he will make some additional comments. David?

David Petty

Thank you and good morning. We are glad to have each of you on this call this morning. Just following on the most recent comment regarding our audacious goals, we intend to reach the high levels of performance through a growth strategy built on strong corporate values in our customer centered culture, this strategy will be driven by our robust current product line as well as a pipeline of new and innovative products. For example, with our knee line, we will continue with the rollout of what we call the logic knee system if the posterior stabilized knee develops in collaboration with the hospital for special surgery and a continuation of our very successful Optetrak Knee line that is complemented by the continuing rollout of what we call a CR Slope.

We believe this is a revolutionary way, a new way to think about cruciate retaining knees and have a lot of potential. We have a great new instrumentation system that we will launch in the first half of this year for tibial alignment and bone cut called the LPI tibial instrumentation system. We are also happy to announce that in the fourth quarter of 2009, we completed enrollment for the IDE investigational device study related to FDA clearance for a rotating bearing knee under the Optetrak trade name.

On hips, we in the fourth quarter continued the rollout of a fracture system for both cemented and press fit for use under the Novation brand name. Now the Novation hip system has become a very comprehensive in broad range of primary hip replacement products, and obviously our growth rate in the fourth quarter indicates success of the Novation brand name. In the fourth quarter of this year, we intend to launch a new porous metal revision acetabular system, and are hopeful to begin launching what we call the Novation LPI prime hip stem, which is a primary hip stem that is a short bone conserving stem that also will be conducive to use with the anterior approach, which we are seeing more and more success with in our sales and marketing effort.

For shoulders, we are in the midst of launching the platform fracture stem under the Equinoxe trade name. We are before the FDA with a press fit Glenoid and also a fractured plating system under the Equinoxe brand.

In biologics, we will complement the very successful launch in recent years of our accelerated platelet concentrate system with something that we call Accelerate PRP Sport which is an office-based platelet concentrate system intended for use since sports medicine applications which is becoming increasingly popular and in the spine we are excited to be looking forward to launching two new products at that NAS meeting in October, a peak interbody platform as well as a posterior cervical system. Finally, in our bone cement range, we will be launching in the first half of this year a new high release interspace spacer system to complement our current interspace line.

Now, just for a moment, retrospectively looking at the fourth quarter and the year in a little more detail, I want to point out that our growth was strong on both the domestic and international front. US sales increased 11% to $32.2 million and international sales were up 43% to $16.1 million. International sales represented 33% of total sales compared with 28% for the same quarter last year. We recorded fourth quarter sales growth of over 20% in our hip, knees and shoulders segment. For the full year 2009, US sales increased 9% to $122.3 million and international sales were 12%, up to $55 million. International sales represented 31% of total sales compared with 30% for the same quarter last year.

Now, I would like to ask Jody Phillips to make a few comments on the financial front and then we will open it up for questions.

Jody Phillips

Thank you David, good morning everyone and thanks for being on the call today. As Dr Petty referenced, despite a number of one-time charges in the fourth quarter of 2009, we feel like that we have entered 2010 with a significant amount of momentum.

Before getting into some of the details related to the income statement, I would like to briefly review a number of balance sheet trends, and give some indication as to what we are expecting on the cash flow front for this current year. During 2009, we reduced our total inventory by $5.6 million or 9%, this is during a year when we experienced a 10% growth in sales. This improvement was significantly better than our expectations as we formerly have projected approximate $5 million increase during 2009. The primary reasons for this outperformance was better forecasting and planning using more sophisticated planning techniques by our operations team and a high velocity of inventory turns particularly in the second half of the year due to the strong international sales.

Primarily as a result of the inventory decrease, we were able to decrease our total debt to $14.2 million and have only $7.8 million outstanding on our $40 million credit facility as of year-end. Looking forward to 2010, we are projecting an $8 million increase in inventory, and capital expenditures of between $16 million to $18 million. The inventory increase should incur through the end of the third quarter at which time we believe inventory levels will flatten once again. This increase will be due to full scale new product launches, many of which David has referenced, as well as significant inventory additions as we open up new international direct subsidiaries.

Transitioning to the income statement, during the fourth quarter our gross margin of 61% came in lower than we projected for two reasons. First, our international sales mix was significantly higher than expected and this explains about 2% of the gross margin as a percentage of sales difference; and second, we are in an adjustment in our slow moving and obsolete models specifically for raw materials that resulted in about a 1.5% impact on the gross margin percentage as well. Despite the slight reduction in full year gross margins to 63.3%, our internal manufacturing efforts continue to help us improve our cost position, and we are targeting a 1% improvement in gross margin for 2010.

Looking at operating expense area, there are clearly a number of moving parts that make a good apples-to-apples comparison a little difficult but I will attempt to give you key elements in order to give a clear picture on our operational aspects. GAAP reported operating expenses increased by 26% to $27.6 million for the fourth quarter, and by 15% to $97.6 million for the full year. DOJ inquiry related expenses in the accrued settlement estimate totalled $7 million for the full year and $3.6 million for the fourth quarter. Excluding these costs, operating expenses increased 15% for the fourth quarter and 11% for the full year. From a net income perspective, the adjusted net income excluding the impact of the DOJ inquiry expenses for the year increased 5% to $13.2 million and decreased 2% to $3.2 million in the fourth quarter.

I will remind you that in the fourth quarter of 2008, we experienced a full year reinstatement of the R&D tax credit resulting in a 25% effective tax rate for the fourth quarter of 2008. If you were to use a more normalized full year rate of 37% in the comparative for the fourth quarter of 2008, we experienced a 14% increase in adjusted net income in the fourth quarter of 2009.

One last significant operating expense number to discuss here is our FAS123R equity compensation related expenses, which increased to $600,000 for the fourth quarter of 2009 as compared to $290,000 in the fourth quarter of 2008. As indicated in our guidance, we are expecting these costs to increase on a full-year basis with a full-year projection of $2.2 million for 2010 as compared to $1.4 million recorded in 2009.

We released our full-year 2010 revenue guidance of $188 million to $196 million, which represents 6% to 11% topline growth. In consideration of this guidance, we are taking a rather tempered approach as it is not likely the growth rate that we experienced in international sales in the fourth quarter will be as robust for the full year 2010. From a net income standpoint, our GAAP EPS guidance of $0.90 to $0.96 is contingent on a $2 million compliance cost estimate for 2010. Our first quarter 2010 guidance of $46 million to $48 million in revenue represents a 6% to 11% increase as does the full year revenue guidance. Our first quarter GAAP EPS guidance is for diluted EPS of $0.21 to $0.23 per share. This guidance number does assume that there is a reinstatement of the R&D credit, which has currently expired.

Those are all of the prepared comments that I have at this point, and again, thanks for joining us and we appreciate your interest.

Bill Petty

Yes, Alicia, we can go ahead with the questions now.

Question-and-Answer Session

Operator

Thank you sir. (Operator instructions) Our first question is from the line of Bill Plovanic with Canaccord Adams. Please go ahead.

Bill Plovanic – Canaccord Adams

Great, thank you. Good morning.

Bill Petty

Good morning.

David Petty

Good morning Bill.

Bill Plovanic – Canaccord Adams

Couple of questions here, first of all, just one to make doubly sure, I am doing the math right on this, the assumed cost for the DOJ this year, given the guidance that you are providing of kind of adjusted earnings of $1.10 plus would be about a $4 million for the year for DOJ, is that correct?

Jody Phillips

No, it is $2 million in total.

Bill Plovanic – Canaccord Adams

Okay, I have to check my math on that. Okay, I will go back and look at that. The GM, I think you said it was about 1.5 points, so that gets us to about $800,000 or something for the write-down of the inventories and what have you?

Bill Petty

That is the approximate amount that that translates to. Bill, back to that compliance number we have got out there, you fully realized that our best estimate at this point, we want to get back to GAAP type guidance and so there is a lot of contingency in that number, but $2 million is our best guess at this point.

Bill Plovanic – Canaccord Adams

And if you took a write-off at year end, that means you are getting close to settling this, and I guess my question is, is that more so the kind of monitor an ongoing cost rather than the legal expenses associated with it going forward, is that the thought process?

Bill Petty

The thought process from our perspective is that what it will take to run the compliance program and any required monitoring that would be in place that is correct.

Bill Plovanic – Canaccord Adams

Okay and is that tax deductible?

Bill Petty

To the extent that it is a monitoring cost, it would be tax deductible.

Bill Plovanic – Canaccord Adams

How much was that tax impact in the quarter?

Bill Petty

It was not significant, it was around – it was probably less than 1%, it had a 1% impact on knee implant revenues on a constant currency basis. So that revenue growth for the fourth quarter was 23%. It did have a somewhat more material impact on the other revenue increase on a constant currency basis the other revenues increased 13%.

Bill Plovanic – Canaccord Adams

Okay and then just on the international, that is a big number and I was just wondering if you could give us a little incremental color on the amount of maybe stocking distributors versus direct subsidiaries that the revenues were sold through, anything that can give us some level of comfort that while that is a big number and (inaudible) level, it is still – we are not going to see a huge dip in the next quarter.

David Petty

Yes Bill, it is David, a couple of comments about that. Number one, note that the international growth all end for the year was 12% and the quarter was huge and so we need to think about reality being somewhere in between those numbers and to give you a little more color on the quarter itself, we were actually pleased that the growth was fairly well spread out across the three different regions we think about our international business. We certainly had strong performance both from direct operations and our distribution channel in Europe, two of those strong areas were areas that are either new markets for us or markets where we have changed distribution in the last two years and that the distributors are starting to hit their stride.

We happily are starting to see a little bit of a benefit from our two-year investment in our Japanese operation in the Asia region and so that was a contributor to the fourth quarter as well as to the year in terms of growth. And in Latin America, one of our longstanding markets had a very, very strong performance both for the year and for the quarter and one of the markets that we have been working on and investing a lot in over the last year and a half started to hit their stride in the fourth quarter. Still happily, it was fairly well spread out across the different regions, and across both direct operations, and distribution operation.

Bill Plovanic – Canaccord Adams

Okay and then my last question, this is going to be more housekeeping, what do you expect for D&A in 2010, depreciation and amortization, because you already gave a stock comp and I think you already gave us CapEx.

Jody Phillips

The depreciation number is projected to be in and around the $9.7 million range.

Bill Plovanic – Canaccord Adams

Great, that is all I had, thanks a lot.

Bill Petty

You are welcome.

Operator

Next question is from the line of Robert Gold with Brigantine Advisors. Please go ahead.

Robert Gold – Brigantine Advisors

Thank you and good morning guys. Some of my questions were just answered, but I guess if you could just talk about again the gross margin, I know you mentioned that the OUS mix has a lot to do with the kind of compression in the quarter, but can you just maybe touch on what you are seeing in terms of ASPs, are there any specific pockets of pressure on pricing, and when you look out to 2010, what are you assuming in your guidance in terms of pricing, and if there is any ForEx impact built in also?

Jody Phillips

What we are seeing Robert is we are seeing quite a bit more pricing activity in the form of request for proposals and tactic pricing situations and things like that. Fortunately, to this point, it has not had a significant impact on our ASPs and therefore has not impacted our gross margin percentage. We anticipate to kind of see a higher level of activity there. We continue to make strides with our internal manufacturing so what is baked into that plan for 2010 is the assumption that we still have relatively flat pricing and we continue to make some strides in our cost reductions.

Robert Gold – Brigantine Advisors

Thanks, that helps. Just again, on kind of a housekeeping thing, I know you mentioned $8 million to $10 million I believe it was in CapEx, is that the right number?

Jody Phillips

It was $16 million to $18 million.

Robert Gold – Brigantine Advisors

$16 million to $18 million and what was the 2009 number?

Jody Phillips

2009 number I believe was around $18 million, I do not have that one right in front of me, I will have it in a few minutes.

Robert Gold – Brigantine Advisors

Great, thank you.

Operator

Next question is from the line of James Sidoti with Sidoti & Company. Please go ahead.

James Sidoti – Sidoti & Company

Good morning Jody, good morning Dr Petty, can you hear me?

Bill Petty

Yes sir, good morning.

James Sidoti – Sidoti & Company

Okay, Jody, just real quick off the top, is the R&D tax credit (inaudible) past, what would the impact be on the bottom line?

Jody Phillips

On a full-year basis, you are probably talking somewhere the 4 to 6 pennies [ph].

James Sidoti – Sidoti & Company

Okay and the $2 million compliance cost that you gave, that is after tax?

Jody Phillips

No, that was a pretax number.

James Sidoti – Sidoti & Company

That is a pretax number.

Jody Phillips

That is about $0.10 after tax.

James Sidoti – Sidoti & Company

Okay, now you have been dealing with this DOJ investigation now going on two years, what made you take the torch this quarter?

Bill Petty

Jim, this is Bill speaking, it is more than two years, it started December 2007 and the reason is that we are quite far along in our discussions with the US Attorney’s Office. So we derived these numbers based on discussions with the US Attorney’s Office as well as our attorneys representing (inaudible) and their estimated cost for bringing this to closure to the point that we have a finalized agreement with the government.

James Sidoti – Sidoti & Company

Okay. Jody, on the cash front, if you are going to spend about $8 million on inventory, $16 million, $18 million in CapEx, it sounds like you are going to pay out about $3 million to the government, are you going to dip into the line in 2010 and is it available?

Jody Phillips

It is certainly available. We are projecting to be back into it probably to the tune of somewhere between $15 million to $18 million or so in terms of total borrowing on the credit line pursuit of $8 million that we have currently.

James Sidoti – Sidoti & Company

Okay so off about $10 million.

Jody Phillips

That is correct.

James Sidoti – Sidoti & Company

Alright.

Jody Phillips

Just as a reminder, that facility is a total of $40 million.

James Sidoti – Sidoti & Company

Okay. And then the last question I had is, on the international front, did you open any new direct territories in the fourth quarter and do you have plans to open any new direct territories in 2010?

David Petty

Jim, it is David, the answer to the first question is no. The answer to your second question is, I will just get a little bit broader perspective and that is that we are very focused on international channel development. We certainly remain committed to the independent distributor model, which has been very successful for us in a number of markets. On the other hand, we also understand that in certain markets, given specific effects of circumstances, that a direct operation makes a whole lot of sense. And so, you will see as we go into this year and our guidance reflects this that we are making an intentional strategic progress in establishing a more robust international sales channel and that will include establishing direst operations, I would anticipate something on the order of two new operations during the course of this year.

And I think it is important to point that out because as we have learnt from our investment in Japan, which is now starting to pay off, that is going to put some pressure on the P&L during 2010 as we hire the people and set up the operation and it is also going to require us to deploy a lot of inventory, so that is going to put a little pressure on the cash plan which Jody has already mentioned and all of these endeavors are in our plan.

The other thing that could happen is if we are in a market where we previously had distribution and there might be consideration of inventory returns and all of that is considered in the plan. The other comment I will make and I want to be careful here because we are not in the habit of ever giving guidance beyond the current year but the investments that we are intending to make with a strategic endeavor in 2010 should allow us to guide to higher growth rate guidance on the topline in 2011. Certainly we are not prepared to put that guidance out there but just we are thinking over the longer term here with very specific intent.

James Sidoti – Sidoti & Company

So if some of these costs start to tick down in 2011, and then you would imagine the compliance cost would start to tick down in 2011, it sounds like that you are setting up to be pretty good growth wise on the bottom line?

David Petty

We think so but again, we do not guide in future years. And the other point is, I think we feel confident and comfortable with our 2010 guidance and we feel like the performance that we guided during 2010 is also a strong performance.

James Sidoti – Sidoti & Company

Okay then just the last question, in the beginning of the year when you saw your growth rate slow down, it seemed like your doctors might have been slowing down a little more than some of the others in the industry, and now you see your growth rates picking up a little bit faster. Do you think it is just a reverse going on or have you picked up new accounts?

David Petty

I think it is actually a combination of things. I think it is not the reverse as you said, but rather, we have absolutely picked up new accounts. I think in the first half of the year, we were very, very focused on some fundamental sales and marketing efforts but those were not bearing fruit based on the uncertainty in those difficult economic times, and as the year progressed, we started to bear fruit from a lot of the efforts, significant efforts in the early part of the year. So that is number one that is how we added new accounts. Number two, do not forget that we launched a number of new products in the second half of the year. So when we combine the new products with the new customers, you start to see a pretty significant search.

James Sidoti – Sidoti & Company

Alright, thank you.

Bill Petty

Thank you Jim.

Operator

Next question is from the line of Jason Bednar with Robert W Baird. Please go ahead.

Jason Bednar – Robert W Baird

Thanks for taking the questions. Jody, I appreciate the color on the stock comp expense, but just taking that one step further, what is driving the big increase for 2010?

Jody Phillips

Sure. Couple of things there, one is from a positive standpoint as you probably know in the (inaudible) model, there are some assumptions in there based on forfeitures, historical stock options grants, and due to the stability of the management of the exact debt, we have outperformed to those forfeiture assumptions and so we had a little bit of a hit there in the fourth quarter in terms of the true-up on those expenses, and then we have had some recent issuances that have just kind of increased the amount of stock options that are out there. So those are the two primary reasons.

Jason Bednar – Robert W Baird

Okay, great, and then for the 2010 guidance, there are several new products obviously to be launched throughout 2010, you just got a 20% growth in this quarter on top of a 20% growth from the prior year’s quarter, comps over the next two quarters have become increasingly favorable. It just seems like guidance, especially the revenue line is a bit conservative, I was just wondering if there is something I am missing or is there any color you have got there?

David Petty

This is David, I will make a couple of comments about that. Number one, if you reflect back on the last five or six quarters, and I will sort of attribute this to the roller coaster of the world-wide economy, recall that in the last five quarters or so, there has been a lot of what we thought were anomalies, a lot of patterns in growth as compared to the prior year that were non-traditional. And so now we have just had a very, very strong quarter. It looked very strong compared to the first half of the year and to the prior year, but I think we need to be careful not to then suddenly say, well, everything has changed, everything is better, and we are at 20% on a go-forward basis. I think we need to get another quarter under our belt with demonstrating that there is traction here, number one. Number two, recall that we have a significant international market development effort underway and depending on how that process goes, there very well may be some hits to the topline as we get into some of the transition. So we are trying to accommodate for that in our guidance.

Jason Bednar – Robert W Baird

Yes, understood. And then I guess some other questions have been answered already, so just last one here, I appreciate all the color you gave in the prepared remarks on the products pipeline, is there anything else that you could add there or is that pretty much summarized there?

David Petty

I think that I have hit them all but if there is any specific thing because I was moving pretty fast, if there is something I was moving too fast on, I would be happy to circle back and cover it.

Jason Bednar – Robert W Baird

I guess specifically on the shoulders, you mentioned you are working with the FDA right now on the two products, any timeline there that we should be thinking about or just –

David Petty

Okay, so you are referencing the fact that we are before the FDA with the 510(k) submission for a press fit Glenoid and a fractured plating system both of which will be under the Equinoxe trade name. And we just always hesitate to predict the timing of the FDA clearances. I can tell you that our internal plans called for us to have those products available in the first quarter. So that is what our timeline said but again we do not control the FDA timeline so we are just hopeful. And I will also point out the fact that we have continued with very strong growth rates in the last two quarters with the Equinoxe brand, all of that growth has been derived from products that have now been on the market for a couple of years. So, just recall that while we have got these new products coming, we have got a lot of tailwind still with the existing Equinoxe platform, and we feel good about our guidance and our aspirations for shoulder sales for 2010 whenever these products clear.

Jason Bednar – Robert W Baird

Okay, great, that is all I have got guys, thanks.

Bill Petty

Thanks Jason.

David Petty

Thank you.

Operator

Next question is from the line of James Terwilliger with Duncan Williams. Please go ahead.

James Terwilliger – Duncan Williams

Hi guys, can you hear me?

Bill Petty

Yes sir.

James Terwilliger – Duncan Williams

First of all, very nice job in terms of the revenue number for the quarter, I have got a couple of housekeeping questions for Jody on guidance, and then a couple of questions on the nature of the business looking forward. Jody, you talked a lot about the number of new products you have either on the verge of being approved your launch next year. As we look into 2010 from a housekeeping perspective, what should we be looking for as it relates to R&D expenses?

Jody Phillips

That is a number we expect to continue to increase slightly higher than the sales growth. It is a number likely that will increase somewhere between 15% to 23% in 2010, and hopefully get up to somewhere around 8% of sales all assuming that we can effectively manage those projects.

James Terwilliger – Duncan Williams

Okay and we have talked a little bit arguably about the international initiatives and again you had a great quarter and I congratulate you, what is the (inaudible) as it relates to the sales and marketing infrastructure that Exactech currently has in the US? Are you going to make significant investment in that in 2010 or do you think that infrastructure is well placed and well supported for these new products coming out in 2010?

Jody Phillips

We feel like the basic infrastructure will support the intended growth rate. Having said that, we do have staffing increase plan in marketing to support the new product efforts and also bear in mind that our marketing team is really a global marketing team, so they also will be supporting the international efforts. We will continue to invest in development of the sales organization as well and we have a very specific goal for this year with respect to improvement of the sales organization with respect to effectiveness. So all of those investments are contemplated in the guidance that we give.

James Terwilliger – Duncan Williams

Okay but overall in the US you think you have got the distribution infrastructure to support these new products and it is really a question of effectiveness in execution.

David Petty

That is true but bear in mind that as a relatively smaller company compared to the multi-national, multi-billion competitors that we are all aware of, Exactech sales organization while we think it is very effective for our size is still relatively small compared to our competitors. And so we have got two things we need to do there. One is always strive for qualitative improvement, and two, yes, we do need more feet on the street. We are up to 243 strong as of the end of the fourth quarter and with qualitative improvements we also want to continue to put more feet on the street.

James Terwilliger – Duncan Williams

Okay, thanks. Going forward, two questions if you could comment on, one would be an update on your internal manufacturing initiatives, and the second one would be an update or some color on the spine business, and again, I thought you had a great revenue and a good quarter, so thanks, and I will jump back in queue.

Jody Phillips

Okay. I will fill the internal manufacturing one and then I will ask David to speak about the spine. We continued to make progress on the internal manufacturing element. We brought in-house our first shoulder system during 2009. We currently project that we are manufacturing around 67% of our hip, knee, and shoulder implants at this time. That is a number that we hope to continue to increase modestly, but we are projecting some pretty significant volume increases for 2010. So, on a pure-units produced basis, the number will continue to increase probably higher than our sales growth.

And also I will mention that we have made some strides in our operational now with our Sarasota instrument facility. That will not necessarily show itself significantly in the gross margin line but I think it does allow us to be more nimble and get our instruments on the market to support our products quicker and more efficiently and take more risks at our supply chain. So, we think we are well on track in that area and have a number of different initiatives for 2010 that we think can continue the momentum.

David Petty

On the spine side, we feel good about where we are and I do not want to get too deep into the history here, but recall that in the summer of 2008, we identified that we had two major efforts that really were going to be important to Exactech establishing a successful spine business. One was to get a product development pipeline started with an appropriate product strategy for our spine business unit, and two was to develop a sales organization. We also said at the time that that would be about a two-year effort.

Happily now, we are entering, I guess, we are approaching the end of the second year meaning that by the time we enter the third quarter this year, it will have been two years, and happily shortly thereafter, as I mentioned earlier in the call, we will be launching two important products to our spine business at the NAS meeting in the first week of October. Concurrent to that, we continue to work on development of the sales organization and we believe those two things go very much together. So, by the time we launch those products in October, we expect to be more effective at identifying and recruiting more sales people. Also what is working in the background in our favor is that we do have some favorable comparatives regarding the topline. So we expect our second quarter of this year to be seeing growth in our spine business on a go-forward basis.

James Terwilliger – Duncan Williams

Alright, thanks guys for taking the questions and congratulations on a nice quarter. Thank you.

David Petty

Thanks James.

Operator

(Operator instructions) The next question is from the line of Mark Bleek with Canaccord Adams. Please go ahead.

Bill Plovanic – Canaccord Adams

This is Bill with a follow-up. Just a question I had was –

David Petty

Bill, you are breaking up on us, we cannot hear your question.

Bill Plovanic – Canaccord Adams

Can you hear me better now?

David Petty

Yes sir.

Bill Plovanic – Canaccord Adams

So with the DOJ expenses, typically once we have gone to settlement and oversight lasted I believe about 18 months for the larger companies, is there any reason that that would not be the case for you?

Bill Petty

Bill, this is Bill Petty, let me just say that we would not expect it to be any longer than that.

Bill Plovanic – Canaccord Adams

Okay, great. Thank you very much.

Bill Petty

You are welcome.

Operator

I am showing there are no further questions at this time.

Bill Petty

Thank you Alicia, and thank you to everyone for joining us. We appreciate your continued interest in and support of Exactech and we wish you a great day. Thanks again, bye, bye.

Operator

Ladies and gentlemen, this concludes the Exactech, Inc. fourth quarter 2009 earnings conference call. If you would like to listen to a replay of today’s conference, please dial 1-800-406-7325 or 1-303-590-3030 and entering in the access code of 4215810. Exactech would like to thank you for your participation, you may now disconnect.

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