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Orthovita Inc. (NASDAQ:VITA)

Q1 2010 Earnings Call

May 4, 2010 8:30 am ET

Executives

Tony Koblish - President and CEO

Nancy Broadbent - CFO

Analysts

Vivian Cervantes - Maxim Group

Dave Turkaly - Susquehanna Financial Group

Matt Dolan - Roth Capital Partners

Bill Plovanic - Canaccord Adams

Michael Matson - Wells Fargo Securities

James Sidoti - Sidoti & Company

Graham Tenneco

Operator

Good morning, my name is Emily and I will be your conference operator today. At this time, I would like to welcome everyone to the First Quarter 2010 Financial Results Conference Call. All lines have been placed on mute to prevent any background noise. After the speakers' remarks, there will be a question-and-answer session. (Operator Instructions). Thank you.

I would now turn the call over to Tony Koblish, President and CEO. Sir, you may begin your conference.

Tony Koblish

Thank you, Emily. Good morning and welcome to Orthovita's first quarter 2010 financial results conference call. I am Tony Koblish, President and CEO of Orthovita. Our Chief Financial Officer, Nancy Broadbent joins me for today's call.

Today, we will review first quarter financial results and other elements of our operating performance including an update on the US launch of Cortoss.

I will now turn the meeting over to Nancy to review the Safe Harbor and the company's financial performance.

Nancy Broadbent

Thank you, Tony and good morning everyone. I remind you that our discussion today will contain forward looking statements, including but not limited to market acceptance of our products, future product sales and operating results, profitability expectations, optimization of our sales network, product development activity and other aspects of our business, all of which involve risks and uncertainties and may constitute forward-looking statements within the meaning of the Private Securities Litigation Form Act of 1995.

Further information about these risks can be found in our filings with the SEC, including but not limited to risks described in our most recently filed Form 10-K under the caption Risk Factors and we undertake no obligations to publicly update any forward-looking statements.

I will now review our first quarter 2010 financial results.

Product sales for the first quarter of 2010 were $24.1 million, an 11% increase over product sales of $21.7 million during the first quarter of 2009. In 2010, first quarter sales included $1.1 million from the sale of Vitomatrix, a bone graft material used in dental products and $900,000 in US sales of Cortoss, our innovated synthetic biomaterial that was cleared by the FDA in June 2009 for the treatment of vertebral compression fractures, and Aliquot, our Cortoss delivery device.

There were no Vitomatrix sales in the first quarter of 2009, and the $1.1 million of Vitomatrix sales occurred in March 2010 as part of an agreement to terminate our supply agreement for this product.

In July 2009, we initiated a controlled US launch of Cortoss using a subset of 20 of direct sales representative and by the end of the third quarter of 2009; we had rolled the launch out to our sales force.

The vertebral augmentation market has recently started to change as many procedures are shifting from the inpatient setting to the outpatient setting, which is due to several factors. Among these are healthcare cost containment reforms since reimbursement is higher in the inpatient setting compared to the outpatient setting.

In addition, Medtronic as a corporate successor to Kyphon agreed to pay the United States $75 million to settle allegations that Kyphon defrauded Medicare by counseling hospital to perform vertebral augmentation procedures in the inpatient setting in situations when the procedure could have been performed in the less costly outpatient setting.

Several hospitals also paid millions of dollars to settle allegations brought by the Department of Justice related to these Kyphoplasty Medicare reimbursement claim. As a result, there has been a significant shift of VCF procedures to the outpatient setting which represents a new physician customer base for many of our sales force.

Healthcare reforms efforts in the United States have created an acute awareness and sensitivity to price in our healthcare system including hospitals. As we had discussed in earlier conference calls, this has led to more expensive new product reviews by product pricing committees in hospitals.

During the first eight months of US Cortoss launch, many surgeons were willing to try Cortoss and had positive reaction to the product effectiveness, safety profile and ease-of-use. However, we often saw that following trial usage approval of hospital new product committees could be long arduous and issues often revolve around price in the outpatient setting.

In early March, we implemented a new pricing strategy targeted to this outpatient market, where a single level Cortoss procedure could be priced in the range of $1,000 to $1,400. This compares to an average ASP of about $950 for a PMMA vertebroplasty procedure and Medicare reimbursement for one level procedure of about $2,100.

We priced our two level and multi-level kits at a similar premiums to PMMA. The response to our new pricing strategy in March was very positive. There were 18 selling days left in March after we implemented this strategy and our dollar sales in March were 45% higher than January the previous highest month of Cortoss sale.

Our number of accounts increased from 151 at the end of February to 186 at the end of March, and our unit volume of Cortoss cartridges nearly doubled from February to March. It is important to note that many of our customers are still in the trial stage, but we have been encouraged that the new pricing strategy is accelerating the rate of approval by hospital committees paving the way for broader usage. We continue to expect traction in Cortoss to occur mainly in the second half of 2010.

Our total orthobiologics business during the first quarter of 2010 grew 11% over the first quarter of 2009. This increase was due to sales of Cortoss and Aliquot in US, which were not available for sale in Q1 of last year, and the sale of $1.1 million of Vitomatrix, a bone graft material used in dental products.

The $1.1 million Vitomatrix sale occurred in March 2010 pursuant to an agreement to terminate our supply agreement with one customer for this product. It is important to note that we have been selling about $600,000 of Vitomatrix annually to this customer for the past several years, although the sale typically occurred in the second quarter as it did in 2009. While the 2010 sale of Vitomatrix marks the end of our supply agreement to this customer, we are in discussions with other dental products companies who have an interest in this material.

Excluding the Vitomatrix, and US Cortoss and Aliquot sales our remaining orthobiologics business, the Vitoss platform declined slightly in the first quarter of 2010, compared to the first quarter of 2009. Since our sales representatives are spending about 50% of their time launching Cortoss, primarily into the outpatient setting, their time working on Vitoss cases is naturally reduced.

We anticipate that the realignment of our Cortoss pricing strategy will reduce the time needed to obtain hospital approvals for Cortoss, freeing up our sales representatives' time to refocus their efforts on or Vitoss products and we expect sales of Vitoss will increase in the coming quarters.

Our biosurgery sales increased 12% during the first quarter of 2010, compared to the first quarter of 2009. Biosurgery offers an important strategic entry to hospitals where our Hemostats product have many application and new sales representatives benefit particularly from this product line as they seek to gain access to new accounts.

Our gross profit during the first quarter of 2010 was $16.7 million, or 69% of sales, compared to a gross profit of $14.7 million, or 68% of sales during the first quarter of 2009. This improvement in gross profit as a percent of sales was due to a more favorable product mix, including the sale of Vitomatrix which has a higher profit margin than our other products.

Our operating expenses during the first quarter of 2010 increased 14% compared to the year earlier quarter. Following FDA approval of Cortoss in June 2009, we expanded our sales force from 86 representatives at March 31, 2009 to 104 representatives at March 31, 2010, and we expanded our general and administrative infrastructure, primarily in the areas of information technology, finance and human resources, to support our current operations and expected future growth. We expect to maintain our current sales force and infrastructure staffing levels through the remainder of 2010.

Our operating loss for the first quarter of 2010 was $0.4 million, which was consistent with our operating loss during the first quarter of 2009.

Our net loss for the quarter was $1.2 million, or $0.02 per share, which was also consistent with our net loss of $1.2 million, or $0.02 per share, during the year earlier quarter. We anticipated a net loss during the first quarter of 2010 and factored this into our full year financial guidance for 2010, which is breakeven to a $2 million net income.

This concludes my remarks on our financial performance during the first quarter 2010 and I will now turn the call back to Tony, who will discuss certain operating elements of our business.

Tony Koblish

Thank you, Nancy and I would like to first expand on Nancy’s comments relating to our commercial organization. We are very fortunate that we have a surface of proprietary and differentiated high value products put into our sale representatives' bags.

Our challenge since the middle of last year is to ensure that our representatives can continue to grow their base Vitoss and biosurgery businesses, which related to hospital inpatient procedures, while launching major new product Cortoss into both the inpatient and outpatient settings of hospitals.

Please note that our customers or hospitals are the same for all of our products and a number of our sales representatives are adopted moving between the new settings were also developing relationships with the interventional spine specialist to perform many of the vertebral compression fracture treatment in the outpatient setting. The outpatient interventional are typically more price sensitive in spine and neurosurgeons, but they have a much higher volume of VCF procedures and typically do not require a high level of sales rep involvement during the procedure after the initial training and start-up phase is complete.

The interventionist physician groups have been very receptive to our Cortoss pricing strategy and have shown a greater willingness to be proactive with our hospital committee following the re-pricing. With time, we believe this will enable us significant portion of our representatives to effectively sell the whole bag to managing grow the Cortoss business while having sufficient time to managing grow the more service intended to Vitoss and biosurgery businesses.

Early result in March and April indicate that this strategy is beginning to work. We intend to manage our Cortoss franchise in the similar fashion as we have managed our Vitoss business. We launched Vitoss in 2002 into a highly fragmented market and within six years we became a market leader in synthetic bone graft with greater than 35% market share. Our market leadership continues to the present day.

We have developed and maintained this market leadership position through a focused selling effort based on solid science and clinical data and by continually broadening and innovating our product portfolio through an active product lifecycle management program, because our Vitoss products are priced very competitively, while offering strong features and benefits, we have also benefited from hospital cost containment efforts targeting competitive high priced products such as bone-morphogenetic protein. We are continuing our innovation efforts for Vitoss and hope to launch a new Vitoss product in 2011.

Cortoss in 2010, offer similar commercial challenges and we are responding rapidly to adapt to market conditions. We have priced the Cortoss line at levels that are very competitive, but still generate attractive gross margins. We are working to maximize the gross margins for Cortoss by evaluating alternative delivery devices, which we outsource that could offer clinical advantages at a lower cost.

We are also working on improving the yield of certain of our Cortoss batch manufacturing processes that could reduce the unit cost of the Cortoss cartridge. So in the face of healthcare reform and the associated cost containment efforts, we are working very hard to deliver product at an attractive price that we can produce more cost effectively to protect our gross margins on these products. We also continue to evaluate and work on label expansion opportunities for Cortoss in the US.

Another focus of our R&D activity is to maximize the value of our collagen facility, which we anticipate will be approved by FDA in 2010. We intend to use the [bolt-on] collagen produce in this facility and the manufacture of our Vitagel hemostasis product, but we are also exploring other uses for this collagen to extract the maximum leverage from our investment in this facility. Our initial efforts are in products relating to our current product platforms.

With that I will close my formal remarks. Thank you for your attention. We're now pleased to answer any questions. Emily, please open the line to questions.

Question-and-Answer Session

Operator

(Operator Instructions). Your first question comes from the line of Vivian Cervantes.

Vivian Cervantes - Maxim Group

Thank you very much for the color provided particularly for Vitoss and Cortoss and the market that you’re addressing with these two. If I can just drill down, I know the time was taken away from the reps as far as the operating rooms are concern for Vitoss. How comfortable are you about a return to the operating room and then the ensuing kickback of product demand, particularly given a highly competitive marketplace for the synthetic bone graft market?

Tony Koblish

Sure. Well, I think we feel pretty good about the product portfolio working together in the second half of this year. I think we'll start to see signs of that in Q2 and then in the second half of the year I think we'll firmly be in a more positive position relative to the Vitoss product line. I think what’s you have to remember is that really the shortfall on the Vitoss business in Q1, really centered around the first two months of the quarter, January and February. In March, we had a nice performance with both the Cortoss business showing its first uptick post repricing and then also a nice performance with Vitoss business rebounding.

So, if you take a look at January and February, now those were really the crunch month if you will, where we are sending the sales force in to that increasingly outpatient setting and then a lot of back and forth with pricing committees and the price point just being a sort of wall or sticking point and you can appreciate that if you are spending the time and that was an intense management focus pushing the sales force in to that setting with Cortoss with that pricing that you are going to wind up with time away from the [OR] and so I think around the Vitoss business in the first two months, I can’t say that we really lost appreciable number of customers. I can’t say that we lost cases and that was primarily due to the fact that we were not present for as many cases as we usually are.

So, I think that will continue to be an issue although in a less time intended way now that we have the reprice on Cortoss and we expect that once we get the product established more firmly in hospitals and so the transition in Cortoss from its sporadic or intermittent trialing type usage to more regular usage that for 5 to 10 to 15 many case, the time crunch of servicing those cases is going to be much less and that’s going to free our sales force up to do what they do best, which is to serve one hospital with all of our products and work that hospital horizontally. So, we view that to start to happen in the second half of this year. It should start to show signs of it in Q2 however.

Vivian Cervantes - Maxim Group

So, it sounds like one that January-February timeframe were the big transition time, the big investment month then we began to see the fruits of that labor kick in the March?

Tony Koblish

Yes, I think that’s right. If you look at our per month sales the damage to the Vitoss business was appreciably done in the first two months, not the third month.

Vivian Cervantes - Maxim Group

If you don’t mind I asking how was April looking? It is pretty much on par or neutral just slightly up from the March level do you think or?

Tony Koblish

As I said in the scripted comments, April seems to be a continuation and look more similar to March.

Operator

Your next question comes from the line of David Turkaly.

Dave Turkaly - Susquehanna Financial Group

In terms of the compensation for the rep side, can you remind us if there is any incentive in place for maintaining the Vitoss levels they had, and then in terms of is there a goal in terms of numbers of guys selling Cortoss or what you think you can get to on a per rep basis looking ahead?

Tony Koblish

Our commission structure is developed to ensure balanced selling of the whole bag. We developed that structure at the start of this year, and that's essentially the structure that remains in place today.

We certainly have set the quota high, which is appropriate with the addition of a new product, and from a management perspective, we certainly are pushing our sales force to drive and develop their Cortoss business and then the incentive package is certainly developed to allow them or incent them to defend and maintain and grow their base business.

I feel like we have the incentive structure in place to be able to do this, and going forward that like I said, we should start to see the elements of that in Q2 and we should start to see it more firmly in the second half of the year.

What was the second part of your question, Dave?

Dave Turkaly - Susquehanna Financial Group

I just said, I think you hit it with the quota I assume. It is their goal out there for some of these guys. For a follow-up, I think you talked in the past about some guys giving up without anniversarying, over a year you got 104 reps now. How many of these guys would you say are kind of at the high end or at that kind of $1 million on an annualized basis income reps?

Tony Koblish

I'll give you some color on that Dave. The average annualized sales productivity per rep is about $900,000 or so, and that includes the new reps that were brought on in the back part of the year.

Operator

Your next question comes from the line of Matt Dolan.

Matt Dolan - Roth Capital Partners

Just to follow-up on prior too. Can you maybe comment on your outlook for 2010, Tony? Are you comfortable with the prior guidance that you've given and maybe you can help us with how that tracks through the year, this year?

Tony Koblish

I think guidance remains unchanged for the 2010, Matt. I think Q2, taking a look at this quarter, I think what's going to be more meaningful based on how we are tracking is to take a look sequentially in comparison to the Q1 performance versus the Q2 performance.

I think if you look year-over-year, you'll recall that we did have massive step-up in Q2 last year in 2009, which also included that Vitomatrix sale the year before, so I think what you'll see is a modest top-line growth for year-over-year, but what we are focused on more is that sequential performance given that we had Cortoss pricing matter, the re-pricing and so the retrench of the sales was to just to focus on the whole sales bag, but I think what we are looking forward to is a nice comparison relative to Q1 and then start to really see the business gain some traction second half of this year. I don’t know if that provides the color you were looking, but.

Matt Dolan - Roth Capital Partners

No, that's helpful. On the base Vitoss business, can you touch maybe on how your account base has tracked in this environment? Do you feel that existing book of business has been fairly stable and the performance just relates to not expanding either new accounts or utilization or have you lost a few to maybe competitors given the near-term refocus of the sale force?

Tony Koblish

I think it's more of the latter that we lost a few accounts, but you always a lose a few accounts given the competitive nature of the business, but that really wasn’t the main driver.

The main driver I think was the amount of same-store usage per account was down a bit and I think that really is to tied to our presence any given day, any given bone graft, possibly could be used if the hardware rep has the some an interesting product, some do some don’t.

I think having that presence there is really probably where that shortfall came. Given the over all nature of that market that business and the history of our business I think it's fair to say that we didn’t really lose customers. I think we lost cases in those first couple of months.

Matt Dolan - Roth Capital Partners

Okay, great.

Tony Koblish

Second people too get them back, I mean obviously not right away, but I think over time that will come back.

Matt Dolan - Roth Capital Partners

Nancy, can you perhaps quantify the benefit that you saw on the gross margin line from Vitomatrix and just help us understand the real normalized level?

Nancy Broadbent

Sure. Our gross margins on Vitomatrix are in excess of 90%, so, $1.1 million of sales that had some impact, the over all corporate gross margin that was also affected positively by Cortoss, where our gross margins are certainly higher than the 68% even with the new pricing.

The Vitomatrix part was, you start to calculate the math, which was some part of it. The other part was strong Cortoss margins and I would expect that for the rest of the year the gross margins would probably be in the range of about 68%.

Matt Dolan - Roth Capital Partners

Last one, Tony. On the next-generation Vitoss product next year, any chance we can get some color on what that is?

Tony Koblish

No, not yet. There are a couple of things going on there. One, we're just going to be very conservative in our public commentary about any 510(k) product going forward, given that the FDA is in the process of re-examining their 510(k) process, so we've been working on several different versions of Vitoss for the last 18 months to 24 months, essentially since Vitoss BA was launched, and we feel that we have at least one maybe two shot-term goal, we're very interested in continuing to evolve and adapt our Scaffold technology. We're interested in the area of handling properties and characteristics and we're also highly interested in the area of stem cells via autologous bone marrow, concentration management, efficient harvest etcetera, so those are generally directionally the areas that we're focused on, but I really don't feel comfortable discussing almost any of our 510(k) initiatives until we get a very, very clear read on what the timing would be.

Operator

Your next question comes from the line of Bill Plovanic.

Bill Plovanic - Canaccord Adams

Tony or Nancy, have you seen any impact on pricing over the last couple of quarters?

Nancy Broadbent

In terms of our other products, Bill?

Bill Plovanic - Canaccord Adams

Yeah, in terms of the Vitoss line.

Nancy Broadbent

No, we have not. The performance in Q1 was entirely volume-related.

Bill Plovanic - Canaccord Adams

Have you chance of lot more RFPs coming through, or do you expect pricing to kind of come into play or is that mostly focused on the metal market do you think?

Tony Koblish

I think spine in general is tightening up, but I would really consider us having seen those trends starting to hit last year though, so this year it feels to us similar to last year, maybe the bone grafting or the biologics business was ahead of the curve, perhaps compared to the metal, but we certainly have been following commentary by other companies that are more focused on metal hardware and appreciate their commentary, but like Nancy said our ASPs were pretty stable, our discounting rate really wasn't up appreciably and I think we have been seeing that pricing sensitivity maybe from mid last year forward though it doesn’t feel all that new to us, although we certainly are conscious of we're hearing from others, describe out there.

Bill Plovanic - Canaccord Adams

Nancy, what percentage of the sales were OUS this quarter?

Nancy Broadbent

OUS were 5% of sales.

Bill Plovanic - Canaccord Adams

Then on the distribution work, what percent of sales were from direct versus distributors? Was there any impact there?

Nancy Broadbent

Our direct sales reps contributed 69% of sales and the remainder was from the distributor, so that is pretty consistent with last year.

Bill Plovanic - Canaccord Adams

That's not changed much. You made a big portion expanded the distribution that was pretty significant over the last six to nine months. We are going to see more folks at it as we are setting gear or we're kind of stabilizing gear at 104ish? What's your distribution plan?

Tony Koblish

Now we are going to hold that about 104, 105 Bill. Last year we ran actually the fourth Cortoss approval maybe for nine to 12 months before approval. We were sort of in that mid-80s range, Bill, pretty consistent and we really like the leverage that we are starting to see as the sales were growing and so the decision was made that we would wait till Cortoss approval and then step-up into that 100 or so rep range and we did that and so now we anticipate holding at that level until we get that productivity out of the sales force, out of the Cortoss launch and start to see that leverage again. So, we will not be adding sales infrastructure for the rest of this year.

Bill Plovanic - Canaccord Adams

Nancy, I think you mentioned that at this point, gross margins for Cortoss were above corporate, I was wondering if you could give us a little more color on that maybe put a tighter number on that. Then you talked about reviewing those manufacturing processes to get that margin. I guess actually to go back what is your ASP on Cortoss in the month of March as we're moving forward?

Nancy Broadbent

I will back up a little bit. When we launched the product for the first six months, our ASP was in the $2000 range. When we launched the 5cc, in November our average ASP drop to about $1600 and in March our ASP was about $1300. Now a couple of things I would point out is that the 5cc, which as I said in my remarks is priced between $1000 and $1400 is our product that really addresses the most price-sensitive part of the market and what I would say is that in March that still only accounted for about a third or so of our sales. We continue to get strong pricing and very strong margins on both the 10cc and the 20cc. So all totaled, our margins on Cortoss in the first quarter were in the high 70s. I would expect going forward and it all depends on product mix, I would expect going forward that we should continue to be able to get gross margins on Cortoss above our corporate gross margin, but I'd rather not be more precise about that, while we're in this stage of seeing how the repricing is playing out.

Tony Koblish

I think we are on the right track there Bill. We are working both sides of the fence, if you will. We're making sure that we're not giving up on the margin and that's why we're introducing different batch processes and efficiencies to make sure that we maintain or have an opportunity with scale to improve our margins, no matter where the pricing goes, Bill.

Nancy Broadbent

The other thing I’d add to that is, that we get very, very strong gross margins on the Cortoss cartridges we manufacture ourselves. Our most expensive component as part of the whole procedure are the delivery devices, which we outsource. So there are clearly opportunities to identify lower cost providers of those outsourced materials and also to develop delivery devices that are just simpler and less expensive to manufacture. So we're addressing all of those fronts with a great deal of energy.

Bill Plovanic - Canaccord Adams

Then last question and I'll jump back, is in your prepared comments, Tony, you had talked about for Cortoss, you can do competitive pricing alternative delivery and then remanufacturing, but lastly working on the label expansion, are you willing to expand on that right now?

Tony Koblish

Not yet. My comments around the Vitoss range also hold Cortoss is a 510(k) Class II product. However, you do know that the first label indication clearance for VCF treatment was an arduous clinical program, so I think that a menu possible label expansions that we have in front of us, we are engaged with FDA on one of them pretty firmly, but again we're waiting until we have absolute clarity on timing before we start public commentary on that. I think some of the label expansion opportunities that we'd like to pursue Bill, we'll look our clinical trials and we feel that we had at least one that maybe not and so we are going to focus on the low hanging fruits first if you will and then just continue as we usually do to just chip away at that and make sure that we have Cortoss clear for as many clinical indications as possible. We certainly believe that Cortoss had a tremendous amount of utility and potential outside of VCF and perhaps even virtually and every bone in the body in time with label expansion.

Bill Plovanic - Canaccord Adams

The ASPs, given that the 5cc is only a third of sales, where you think the 5cc settles out it is a mix of overall sales and I’m asking that just trying to give a figure out what I should use for ASP in model going forward and that is my last question?

Nancy Broadbent

It’s a little bit difficult to predict, but we think that it would probably end up in the 50% to 60% range of total sales, total forecast sales of course.

Operator

Your next question comes from the line of Michael Matson.

Michael Matson - Wells Fargo Securities

I just wondering if you could clarify the comment you just made to Bill about the high 70s gross margin, was that for the first quarter overall or was that what it was after you made the latest around of price cut?

Nancy Broadbent

That was for the first quarter overall.

Michael Matson - Wells Fargo Securities

Okay. So, it could potentially be lower than that like in March in other word is probably lower than that?

Nancy Broadbent

Well, it was lower than the high-70s, but I still pretty sure it was probably still about 70%.

Michael Matson - Wells Fargo Securities

Given the issues with the sales force splitting it times between the inpatient and outpatient setting and so forth. Have you considered setting up a separate sales force for Cortoss or at least having some special reps that would only focus on Cortoss?

Tony Koblish

Well, I can say this that we have a hybrid sales organization that forces us tremendous amount of flexibility. We have an infrastructure that encompasses direct sales reps, associate sales reps, clinical product specialists, clinical selling specialists, area sales managers and then a range of agents in the form of small geography agents and larger geography agents. So, there is a tremendous amount of built-in flexibility there Michael that we have been taking advantage of I’d say quietly behind the scenes over the last several years tweaking up here with some agents and some key geographies converting to direct, converting to agents. We have been very, very flexible with that approach and we have done that when we just had Vitoss and Vitagel really and it worked quite well. So, we will have the same mindset and we already making some moves to continue with that highly flexible hybrid network now that Cortoss is in the mix as well. So, yes behind the scenes we are making some tweaks.

Michael Matson - Wells Fargo Securities

I think I might have asked you this question last quarter, but I thought I would ask it again. Just with the lower pricing, are you still going to have to go through new product committees, or if you're now priced at least at the lower end on par with traditional vertebroplasty kits, does that kind of give you path around the committee without having to go through the new product committee?

Tony Koblish

I'd say no. The new product committees, the tightness that we're seeing for new technology at the hospital level is pretty high, the resistance is much lower now that the pricing is more in line with what else is out there.

However, it's not going to eliminate that. No. In some cases it will be free and easy, but in most case it will not. I think that's the times we live in right now. The environment that we live in is just that way.

Just a little bit extra commentary here that you take a look at this interventionist physician group, and I think they are very interested in our data, our product, our handling and delivery and everything that the product offers.

I think, with it's re-pricing, they are much more willing as we said in our commentary to go to [bet] for the product at these committees. However it doesn't change the fact that you still have to physically go through the committees, and then the adoption profile of this physician group is going to be thoughtful and careful and they are going to transition their business slowly but surely over time, I think from routine usage in PMMA to interment usage of Cortoss and then eventually to routine and then complete conversion usage to Cortoss. It's going to take time, but it's going to happen.

We feel very confident that with time, pressure and execution that we are going to move this market in this direction.

Michael Matson - Wells Fargo Securities

Then my final question, just I'm wondering if you could provide an update on what you are seeing out there in the VCF market following the New England Journal of Medicine trials, I know that the market seem like it. They are acquiring a little bit, at least the procedure volumes, but are you seeing any of that come back at all, now that its six months or more post the trials.

Tony Koblish

Most of the commentary that we get from physicians that attend our training events or presentations; it still remains a conversational topic at the meeting as you can imagine. Most of physicians that we speak to indicated that they did see a drop-off in their procedure volumes, but they are seeing it rebound, and if they aren’t seeing it rebound, yet they expect that it will rebound.

I think we probably had 300 to 400 physicians through various training programs and that sort of the direct exposure we've had to asking those questions, so that's kind of where we are. I think there are certainly was a procedure to volume impact, many physicians feel like, it's coming back and those that hasn’t seen a comeback yet believe that it will come back in time as we get some distance here.

On the other hand, yeah, there are some areas of the country where there was no impact, so a little bit of a mix bag on that tour, Michael.

Operator

Your next question comes from the line of James Sidoti.

James Sidoti - Sidoti & Company

Just following up on the question on the new hires, is there incentive structure or programs? Is that the same as the existing hires or are they more focused on the Cortoss than the Vitoss and the biosurgical products?

Tony Koblish

No, one comp structure for the whole sales force, Jim.

James Sidoti - Sidoti & Company

So, they are 18 new people that you brought in, they are selling everything.

Nancy Broadbent

Yes.

Tony Koblish

Yes

James Sidoti - Sidoti & Company

How long do you expect to take for them to ramp up to that level of sales that you want as a corporate goal?

Tony Koblish

Typically I think we start to see production out of new sales reps in that six to nine months window.

James Sidoti - Sidoti & Company

So, we should really see them having an impact probably by your third quarter?

Tony Koblish

Yes, the second half of the year I think that’s fair, Jim.

Operator

The next question comes from the line of [Graham Tenneco]

Graham Tenneco

Just on the whole Cortoss re-pricing, what is this telling us about the products superiority, the perceived superiority and advantages what was originally thought? I think there is a lot of optimism and I’m just wondering is that the environment and the economy and then the lack of procedures or is it really science-type thing or perception thing on the part of physicians? What is it that had required the re-pricing and then what is the possibility that might change favorably in the future?

Tony Koblish

Well, I think its environmental Graham. We have been very pleased with the interest in the products, the respect for the clinical data and the ease of use profile being better than we could have ever hoped for or imagined. When we did a conservative launch, it was really to get pass the first 200 cases with no adverse events, no problematic cases and you can imagine that that’s important given that you're replacing a product that's been around for 20 years, PMMA. We're now well over 1,000, maybe, 1,200 to 1,500 cases with no adverse events, and the ability of physicians to adapt to the product, its different handling and injection characteristics has been excellent.

My view is, is that clinical data, product attribute, scientific differentiation, etcetera are as good as or better than we thought. I think what we are seeing is, is we're seeing a diversion or herding of these patients towards the outpatient setting, which is a much tighter reimbursement box than in the inpatient, so our first approach to the market given where our sales force was in that inpatient setting, and we always figure that it would be a mix of inpatient procedures and outpatient procedures and you could present a credible pricing package to a hospital based on their individual mix between in out in terms of where the procedures were done, especially if a large percentage of those inpatient procedures were Kyphoplasty around $4,000 to $5,000 level. As the inpatient market is shifting, you wind up with the controlling factor being that outpatient reimbursement and that outpatient reimbursements for Vertebroplasty is 2100, for Kyphoplasty, it's about 5,900, and that compares to an average of about 11,000 in the inpatient, so just simply program, there is just no room. The room is the room under that reimbursement cap, and so once a higher percentage of the procedures were going to happen in that setting, you really have no choice, so I think it's more environmental, it's more setting.

I think the factors that have pushed the procedures to the outpatient are as we described in our prepared comments, but also I think that the New England Journal of Medicine articles had an impact there as well, where we're starting to see the physicians, who do these procedures inpatients be less willing to go back out and re-engage with their referral base and discuss the articles given that it’s a small percentage of their income and what they do in comparisons to these interventionist physicians, who work outpatient, it’s a very important piece of their practice and so they are much more likely to reengage with their referral base and so I think we’re seeing not just a shift, but a consolidation of the referrals more towards the outpatient setting as well. So, I think the motion to the outpatient started at the end of last year with the elements from our prepared comments and then the New England Journal of Medicine articles I think helped consolidate that this year perhaps it can accelerate.

Graham Tenneco

What is the direction or do you think drift going to be or trends based on the Obama's healthcare plan and what might meaningful procedures and where an ASP basically?

Tony Koblish

We can't know all of that what's going to happen. However, I think the concept of evidence-based medicine and clinical data and clinical value proposition to the patients; I believe is going to be more and more important as we go forward. I think that we are exceptionally well positioned across all of our product platforms for that day, not just with Cortoss, which happens to have superb therapeutic benefit, value proposition to the patient, subsequent fracture benefit to the patient also reduced healthcare expenditure and re-hospitalization as shown in our clinical data, but we have an excellent proposition around the Vitoss business relative to more expensive therapies in bone grafting and our Vitagel business is also plays to demonstrate some effected clinical data around knee replacements etcetera. So, I think we are very well positioned in terms of comparative effectiveness, clinical data value proposition that one trend that’s not going to go away and I think that’s going to just be the price to play going forward. We are not going to get there all at once, but it’s going to happen and so I think cost effective, clinical value proposition we are very well situated for that eventuality, which is I think going to be the major fallout long-term.

Operator

(Operations instructions). There is a follow-up question from the line of Vivian Cervantes.

Vivian Cervantes - Maxim Group

I’m trying to drill down on some new one this year as far as the selling cycle is concerned. Now that you've retriggered your pricing are you seeing a marked difference in terms of how long it takes you to clear committees at this point?

Tony Koblish

In some cases, yes. Yes, frictional force is lower.

Vivian Cervantes - Maxim Group

It's roughly like 20%, 30% decline instead of taking six weeks to clear your committee or are you taking three weeks or?

Tony Koblish

It’s hard to say Vivian. I just think sometimes there was timing issues are controlled by how often the committees meet. So, we are more interested in level of resistance more than time. I think that’s the way we look at it.

Vivian Cervantes - Maxim Group

Nancy just to follow-up on the increased spending in IT, finance and HR, are we looking at an ERP system here that should scale over time and help leverage a bit?

Nancy Broadbent

Well, we actually have an ERP system already and we are making some enhancements to that, but I would just describe it as more broadly based investment in our IT infrastructure, which we are probably under spent in, in recent years. So, it's more of an issue of by catching up. It will make us more efficient, but I wouldn't be able to quantify that at this point.

Vivian Cervantes - Maxim Group

Yes, but I guess it focuses on increased productivity?

Nancy Broadbent

Yes.

Operator

At this time there are no further questions.

Tony Koblish

All right, Emily, we're going to close the meeting then. So, thank you all for attending our first quarter 2010 financial results conference call. This is the conclusion of this quarter's call. We look forward to speaking with you all again next quarter. Have a good day. Thanks.

Nancy Broadbent

Thank you, bye.

Operator

This does conclude today's conference call. You may now disconnect.

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Source: Orthovita Inc. Q1 2010 Earnings Call Transcript
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