RTI Surgical's CEO Discusses Q1 2014 Results - Earnings Call Transcript

Apr.24.14 | About: RTI Surgical, (RTIX)

RTI Surgical Inc. (NASDAQ:RTIX)

Q1 2014 Earnings Conference Call

April 24, 2014 8:30 PM ET

Executives

Brian K. Hutchison – President and Chief Executive Officer

Robert P. Jordheim – Chief Financial Officer

Thomas F. Rose – Chief Operating Officer and Corporate Secretary

Roger W. Rose Jr. – Executive Vice President – Marketing and Sales, North American and President – RTI Donor Services

Caroline A. Hartill – Executive Vice President, Chief Scientific Officer

Wendy Crites Wacker – Executive Director, Global, Corporate and Marketing Communications

Analysts

Kyle Rose – Canaccord Genuity, Inc.

Matthew Hewitt – Craig-Hallum Capital Group LLC.

Jayson T. Bedford – Raymond James & Associates, Inc.

Chris Cooley – Stephens, Inc.

Operator

Good day, ladies and gentlemen, and welcome to the RTI Surgical First Quarter 2014 Earnings Conference Call. At this time, all participants are in a listen-only mode. Later, we will conduct a question and answer session, and instructions will follow at that time. (Operator Instructions) As a reminder, this conference call may be recorded. I would now like to introduce your host for today’s conference, Wendy Crites Wacker. Please go ahead?

Wendy Crites Wacker

Good morning and thank you for joining RTI Surgical for our first quarter 2014 conference call. Today, we will hear from Brian Hutchison, President and Chief Executive Officer; and Rob Jordheim, Executive Vice President and Chief Financial Officer. Also joining us this morning for Q&A are Tom Rose, Executive Vice President, Administration and Corporate Secretary; Roger Rose, Executive Vice President, North American Sales and Marketing and President of RTI Donor Services; Carrie Hartill, Executive Vice President and Chief Scientific Officer; and Robby Lane, Executive Vice President of Global Commercial.

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 K. Hutchison

Good morning, everyone, and thank you for joining us. Today, I’ll start with an overview of the first quarter; then Rob will review our financial results. I’ll follow-up with the financial guidance for the second quarter, and full year 2014.

As detailed in our press release issued this morning, we reported first quarter revenues of $60.7 million, a 50% increase over the first quarter of 2013. This includes $19.8 million of Pioneer Surgical Technology revenue in the first quarter. Revenue exceeded our first quarter guidance of $58 million to $59 million. When reviewing each of our lines of business for the first quarter, Spine revenues increased 89% compared to the first quarter of 2013. The increase was primarily related to the addition of revenue from Pioneer acquisition.

We continue to see progress in our direct spine business during the quarter, adding more than 30 new customers in Spine. In the first quarter, we added two exciting new Spine systems to our portfolio. The MaxFuse system is used to replace the diseased vertebral body to achieve anterior decompression of the spinal cord, and neural tissues in the thoracolumbar spine. The Aspect system as a versatile anterior cervical plate system designed to meet the varying clinical needs of surgeons performing ACDF procedures.

As you saw on Monday, we launched another new Spine system Streamline OCT. The system was designed to promote fusion of the OCT spine. This is the first system to offer a high-angle pedicle screw capable of achieving 60 degrees of annulation in any direction. This provides greater intraoperative flexibility, and options for screw placement. RTI received 510(k) clearance from FDA for the system in March of this year.

Also in March, we held our first of four surgeon symposium planned in 2014. The first quarter symposium focused on complications and economics of spine surgery. The event was well attended and we received very positive feedback from surgeon attendees, and faculty. The continued focus on our surgeon engagement efforts along with new product launches will drive growth in spine throughout this year. At this time, we anticipate spine will grow in mid-single digits for the full year of 2014, based on fourth quarter 2013 annualized run rate.

Our sports medicine business increased 8% compared to the first quarter of 2013. We continue to see positive momentum in the business recovery and growth of this business illustrated by sequential increase of more than 100 accounts during the quarter. We anticipate the sports medicine will return to growth in 2014. At this time, we expect growth in the mid-single digits of this line of business.

First quarter surgical specialties revenues increased 5% compared to first quarter of 2013. The increase in revenues is due primarily to the direct U.S. and international businesses offset by a slight decline in our commercial business. Our direct distribution force is consistently gaining traction with first quarter direct revenues exceeding their total revenue for 2013.

We received CE mark approval for the fortiva porcine dermis product, which will expand our opportunity for the implant outside the U.S. At this time, we anticipate that the surgical specialties business will grow in the low single digits for the full year of 2014 with most of the growth coming from direct distribution, and breast reconstruction through our commercial distributor.

First quarter BGS and general orthopedic revenues increased 52% compared to first quarter of 2013. The increase in revenues for the quarter was due to the addition of Pioneer revenue resulting from the acquisition. During the quarter, we had two exciting launches at the American Academy of Orthopaedic Surgeons.

We had a full market launch of Map3 chip cellular allograft. We continue to strategically expand the number of surgeons and hospitals using this implant. We launched NanOss Bioactive 3D. This next generation synthetic allows for precise placement of the graft into bony defects for a wide range of surgical procedures.

Both of these natural bone grafting solutions are gaining traction, and we’re receiving positive feedback from surgeons. We anticipate that the BGS/GO revenues will grow in the high single digits for the full year of 2014 based on fourth quarter 2013 annualized run rate.

First quarter dental revenues increased 11% compared to first quarter of 2013. This is in line with our exclusive distributor’s contracted minimums, which met our expectation. At this time, we anticipate that dental revenues will grow mid-single digits for the full-year 2014 for our contract with our exclusive distributor.

First quarter revenues for Orthofixation were $7.5 million; in our direct cardiothoracic business, the Tritium Sternal Cable Plating system continues to be well received in the market, and should drive growth in 2014. For our commercial businesses, we’ve renewed an agreement in February with Zimmer to supply integrated plates and cables, cannulated screws and instrumentation for Zimmer’s trauma business. At this time, we anticipate that ortho fixation will grow in the high-single digits based on fourth quarter 2013 annualized run rate.

At this point, Rob will provide some more detail on the financials.

Robert P. Jordheim

Thank you, Brian. Worldwide revenues of $60.7 million in the quarter increased 50% compared to the first quarter of 2013. The increase was primarily due to the inclusion of revenues in the current quarter, in the Q3 2013 acquisition of Pioneer.

Domestic revenues of $54.8 million for the first quarter increased 52% compared to the first quarter of 2013. Our domestic revenues increased $18 million, primarily as a result of the acquisition of Pioneer.

International revenues, which include exports and distribution from our German, French and Dutch facilities were $5.9 million for the first quarter of 2014, an increase of 38% compared to the first quarter of 2013. Our international revenues increased $1.4 million, primarily as a result of the acquisition of Pioneer. On a constant currency basis, international revenues for the first quarter increased 33% as compared to the first quarter of 2013.

On a GAAP basis, net loss applicable to common shares for the first quarter of 2014 was $3.1 million or $0.05 per fully diluted common share based on 56.5 million fully diluted shares outstanding. This compares to net income applicable to common shares of $1.5 million or $0.03 per fully diluted common share for the first quarter of 2013 based on 56.3 million fully diluted shares outstanding.

As a result of the Pioneer acquisition, during the first quarter the company recorded a pre-tax inventory purchase accounting adjustment of $5.7 million. Excluding this charge, the company reported a $0.01 profit per fully diluted common share.

Gross margin for the first quarter was 43% as compared to 48% for the first quarter of 2013. The decrease was primarily due to the pre-tax inventory purchase accounting adjustment of $5.7 million. Excluding this charge, gross margin for the first quarter was 53%, which represents a sequential increase of about 200 basis points over Q4 2013.

During the quarter, our marketing, general and administrative expenses totaled $25.9 million, an increase of $10.8 million or 72% higher than the first quarter of 2013. The increase in expenses was primarily due to marketing, general and administrative expenses from Pioneer and includes amortization of acquisition related intangibles of $553,000.

Research and development expenses totaled $3.8 million for the first quarter of 2014, an increase of $721 million or 23% higher than the first quarter of 2013. This increase in expenses was primarily due to research and development expenses from Pioneer.

Lastly, our tax rate for the first quarter 2014 reflects a tax benefit of 40% compared to a tax benefit of 38% in the first quarter of 2013. Our comparative income tax rate was negatively impacted due to recognizing the entire 2012 research tax credit, plus a portion of the 2013 research tax credit in the prior year’s quarter with no comparable credits being recognized in the current period.

Turning to the balance sheet, our cash position at the end of the first quarter was $15.5 million compared to $18.7 million at the end of 2013. The decrease was primarily due to the construction of our new logistics and technology building. For 2014, we’re anticipating cash flow positive from operations. We are confident that with the current cash balance and available debt we have adequate liquidity to support our future operations and meet our financing obligations.

Excluding the inventory purchase accounting adjustment of $5.7 million included in the inventory balance at the end of 2013. Inventories of $104.5 million increased $4.1 million during the quarter, excluding the $5.7 million inventory purchase accounting adjustment, included in the 2013 year-end inventory balance working capital at the end of the first quarter was $132.1 million, an increase of $3.5 million compared to the end of 2013. At the end of the first quarter, we had $74.3 million of debt and approximately $10.2 million available under our revolving credit facilities.

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

Brian K. Hutchison

Thanks, Rob. We are pleased with our progress that we’ve made during the first quarter. And so we’re on the right path to reach the goals we shared with you during our 2013 year-end conference call. As we stated, our key growth initiatives for 2014 are, to continue to execute on the recovery in direct spine and sports medicine. To gain traction in our direct surgical specialties business, and to launch key new products for our direct distribution organizations. As we gain momentum with the new products launched in the first quarter, we should start to see the impact on revenues in the second half of 2014.

Turning to guidance in our press release this morning, we outlined expectations for revenue and EPS for the second quarter and full-year 2014. For the second quarter of 2014, we expect revenues to be between $62 million and $63 million. This will result in a 48% increase in revenues compared to Q2 last year at the midpoint of our guidance. The increase is primarily due to the addition of Pioneer year revenues.

Next quarter we expect net income to be per fully diluted common share for the second quarter 2014 to be approximately $0.02. Based on the first quarter results, we are raising our full year revenue guidance. We now expect full year revenue guidance to be between $248 million and $253 million, an increase from our prior guidance, which was between $245 million and $250 million.

This represents an increase of 26% year-over-year at the midpoint of our new guidance range. On a non-GAAP basis, full year net income per fully diluted common share is expected to be in the range of $0.07 to $0.09 based on $57 million fully diluted common shares outstanding, an increase from our prior guidance of $0.06 to $0.08. We hope to see some of you this quarter, we will be presenting at the UBS Global Healthcare Conference on May 20 in New York.

At this time let’s open to questions. Charlotte?

Question-and-Answer Session

Operator

Thank you. (Operator Instructions) Our first question will be coming from the line of Bill Plovanic from Canaccord. Your line is open.

Kyle Rose – Canaccord Genuity, Inc.

Very good morning. This is actually Kyle on for Bill. Can you hear me all right?

Dean H. Bergy

Morning, Kyle.

Brian K. Hutchison

Morning.

Kyle Rose – Canaccord Genuity, Inc.

Good morning. Just wanted to kind of start off here, obviously very happy to see a strong quarter in sports medicine, Just wondering if you could talk to us about, how that business looks now it sounded like you added some new accounts in the quarter, just if we could break out. What is – how much of that was you’re converting new accounts versus some organic growth with some of the customers that’s dates on?

Robert P. Jordheim

Kyle, this is Rob. We did see some nice growth in the sports business in Q1 of the new accounts. It’s roughly a third – two thirds between recovered in new. When you look at that 100 new accounts – 100 increased accounts.

Kyle Rose – Canaccord Genuity, Inc.

Okay, great. And then how do you guys view the overall market dynamics as far as the Q1 with – any impacts on weather or are there any extra selling days year-over-year?

Brian K. Hutchison

No, we didn’t have – I wouldn’t say we saw anything directly weather related nor do I think we are in the extra days in there.

Kyle Rose – Canaccord Genuity, Inc.

Okay and then just as we – as we move forward and look towards the end – the remainder of 2014, is it fair to say that, this is the new base that we can start building on from here or is it – should we still expect some of the regular lumpiness in seasonality?

Robert P. Jordheim

Kyle. This is Rob again. I think this is really the new base, but we would expect to see some step up in the next couple of quarters. Q3 obviously with the seasonality is typically a little bit lower than Q2, but we expect to finish strong in Q4.

Kyle Rose – Canaccord Genuity, Inc.

Great. And then just one more question here on the surgical specialty side. We almost – the full year in the launch of the direct team and Fortiva. I just wondered if you could update us on how your thoughts changed on that opportunity and where we stand now.

Robert P. Jordheim

Well right now, we’re just starting to see what we thought we would see a year ago. So we’re in the first quarter of this thing. So it took us longer to get into accounts where we are now seeing a lot more success in getting that door opening hunting license, if you will, the opportunity to go in, getting through committees and starting to see results, and we are actually talking now directly with doctors who are using the product. Who are sharing clinical experience and they really like it.

We had a doctor and recently they told us, that he’s been doing these surgeries for 20 years and likes the results of our products, the best that he’s seeing for many products. Now it’s early, but I still think the signs – the signs are all positive for us in that segment. So we’re going to continue to press on.

Kyle Rose – Canaccord Genuity, Inc.

Okay, fantastic. And then just one last question and then I’ll hop back in the queue. Big things going on in the industry, just as it relates to when your distribution partners. Wondered if you could just remind us how long your dental agreement extends with them are right now.

Robert P. Jordheim

There’s about seven more years left on that agreement, Kyle.

Kyle Rose – Canaccord Genuity, Inc.

Great. Thanks a lot. I appreciate for taking the questions.

Robert P. Jordheim

Thank you.

Operator

Thank you. Our next question will be coming from the line of Matt Hewitt from Craig-Hallum Capital. Your line is open.

Matthew Hewitt – Craig-Hallum Capital Group LLC.

Good morning everyone and congratulations on the good start to the year.

Robert P. Jordheim

Good morning.

Matthew Hewitt – Craig-Hallum Capital Group LLC.

As far as the last quarter, we talked about this a little bit. I was just hoping for an update, with warning letters that you and the rest of the industry had received over a year ago. Now with, you and others starting to get the all clear. Are you seeing a pick-up in the allograft market and how is that affecting you, specifically obviously there were some switching to autograft because of those warning letters, but how has that conversion kind of shake out so far?

Brian K. Hutchison

This is Brian. I really can’t speak to anybody else in the industry, but for us, we are seeing – as we said, we brought back over 100 counts in the first quarter. We are seeing success getting back in. And as I said, I think before we’re trusting off the old approach to surgeons to go back in and talk about our BioCleanse allograft tissues versus autograft tissues. So we are working on our own and we are seeing a nice response. I really can’t speak for the rest of the industry at all.

I don’t believe there is been any significant shifts and I don’t expect any. So we’ll just continue to look at our approach, we’re not viewing ourselves as competing with other tissue banks. We will review ourselves competing with autograft.

Matt G. Hewitt – Craig-Hallum Capital Group LLC

Okay. And as far as where you stand today versus maybe where you were before that warning letter, would you say that you’re – you’ve gotten most of the doctors back or where are we in that conversion timeline do you think?

Brian K. Hutchison

I would think, we’re fairly close, but we’re not 100% there yet. We are seeing doors open up again as recently as this week from accounts that were shut out of for more than a year now. So we are seeing results. We’ve got ways to go yet, but we’re getting close.

Matt G. Hewitt – Craig-Hallum Capital Group LLC

All right. And then, I guess, shifting to map3. You’re making progress there. How does the inventory sit for that product? How should we think about that ramping over the course of this year?

Brian K. Hutchison

We are going to let both Carrie and Roger talk to that. Roger will start.

Roger W. Rose Jr

I think we’ve got plenty of inventory to hit the goals and objectives we got in place for the company for the year. As with any product launch, there is pacing that goes into that. And I think the ramp up that we’ve got right now underway is very appropriate. And I think our results are in line with our expectations.

Brian K. Hutchison

Carrie? You can talk to the floor.

Caroline A. Hartill

Yeah. I can discuss where we are in terms of serving the pipeline as it were with inventory. I describe this as being ahead of our expectations. We’ve certainly placed enough inventory on the shelf and available for our salespeople to become a much more confident in opening what are potentially fairly large new accounts. And so I think we’re very well positioned as we go into the second quarter.

Matt G. Hewitt – Craig-Hallum Capital Group LLC

Great, great, okay. Maybe just a couple more for me. Obviously, actually accounting adjustment here in the first quarter, Rob, how should we think about gross margin over the remainder of the year? Before the Pioneer acquisition, your target was 50% gross margin, obviously this quarter would have been fantastic 53% ex that adjustment. Is that sustainable, I mean, can we see a time maybe in a couple of years where you’re approaching 60% gross margin?

Robert P. Jordheim

Yeah, I think that is possible. I think what you’re going to see this year is, you’re going to see steady improvement in gross margin over the next three quarters. Fortunately, the purchase accounting implications are now gone. So it will be easier to report. But yes, depending on the revenue mix as you look out over the next three to five years, I think 60% is possible.

Matt G. Hewitt – Craig-Hallum Capital Group LLC

Okay, great. And then maybe one more, obviously on the news this morning. Regarding the Zimmer Biomet transaction, is there any risk or is there any opportunity with those two companies coming together where either you had been selling some products into Zimmer that maybe Biomet can now supply or conversely where that creates a disruption in the marketplace that allows you to get into maybe some new accounts?

Brian K. Hutchison

I’ll start with that, Matt. As this is brand new news, it just hit this morning at 7:30, none of us have fully absorbed it yet. Of course, we haven’t talked to any of our contacts inside of, we know people inside of both companies frankly, and I’m pretty sure this was kept at a high level. So I doubt that, I am pretty sure they’re all reading it this morning too. And I know it doesn’t close until Q1 of 2015.

So there’s a long, long way to go here. My past experience in orthopedics over 20 years is, every time these situations happen there is both risk and opportunity and that’s kind of how we have to look at it right now. But from our standpoint at RTI, we’re going to keep a positive outlook on this and try to take advantage of every opportunity we can.

Matt G. Hewitt – Craig-Hallum Capital Group LLC

Okay, great. Thank you. I’ll hop back in the queue.

Operator

Thank you. Our next question will be coming from the line of Jayson Bedford from Raymond James. Your line is open.

Jayson T. Bedford – Raymond James & Associates, Inc.

Good morning and thanks for taking the questions and congrats on the progress here. I guess just a follow on one of the last questions there on gross margin, obviously a nice sequential increase. Is it just mix? It looked like you managed inventory a little bit better, but is there anything else to the gross margin improvement?

Robert P. Jordheim

Well, I think it is mix and if you look at the amount of spine revenue, especially the hardware revenue, that’s in our spine revenue line. They had a really good quarter and that’s the highest gross margin product we have in the company. Now, there are some offsets to that that we had in Q1. But that’s why I’m optimistic about how Q2 through Q4 is going to increase because the hardware is really going strong.

Jayson T. Bedford – Raymond James & Associates, Inc.

Okay. And if we normalize for the Pioneer deal, what was the impact of price year-over-year?

Robert P. Jordheim

Yeah, the pricing within our spine division has been relatively flat frankly for us.

Jayson T. Bedford – Raymond James & Associates, Inc.

Can you say that Rob across the organization. Did you see much pricing pressure at all?

Robert P. Jordheim

I think we’re seeing a little bit in sports. On the sports side, spine like I said is okay and all the other divisions are really holding their price. So I think sports is the one area that where we’re looking at.

Jayson T. Bedford – Raymond James & Associates, Inc.

Just in terms of the guidance, it looks like you’re bringing down the assumption around surgical specialties bringing up BGS, just on the surgical specialties, is it a function of lower direct or lower commercial sales?

Robert P. Jordheim

It’s the latter. It’s a function of lower commercial sales, especially in the hernia area.

Jayson T. Bedford – Raymond James & Associates, Inc.

Okay. And then just I guess lastly from me and it’s for you Rob. Just on R&D, a little lighter than we had modeled kind of down from the last couple of quarters, how does this line item look going forward? Is this kind of your the rate we should look at?

Robert P. Jordheim

Yeah, I think it’s going to creep up a little bit in the back half of the year, some of the projects that we’ve got ongoing kind of start to ramp up through the year. First quarter is usually a little bit lighter.

Jayson T. Bedford – Raymond James & Associates, Inc.

Well, thank you.

Operator

Thank you. Our next question will be coming from the line of Chris Cooley from Stephens. Your line is open.

Chris Cooley – Stephens, Inc.

Thank you. Good morning. Just a few questions, just one quick follow-on and then may be a balance sheet question. If I may, when you look at the decline in commercial sales in the Hernia segment, is that come from migration with different products are you just seeing (indiscernible) what you are seeing there from a volume standpoint and kind of a little bit more color on what’s behind that?

I mean around just – when you look at the balance sheet, as you mentioned at the announcement, about $74 million in debt excluding cash, [$16 million] (ph) available capacity, can you just talk to us about how you think about the capital structure over the back half of the year as you think about moving to better margin, what kind of debt to cap kind of structure you are looking forward contain that down and maybe a possibility (indiscernible). Thank you so much.

Brian K. Hutchison

Hi, Chris. I’ll take question number one, it was a little difficult to hear you but, I think I got it. Question number one dealt with the hernia space and since we just talked about our drop in the allograft tissues going there, do we see a shift to different material as well.

We do, and others have been reporting that shift has been to forcing dermis and frankly to some synthetics in certain cases, so we are seeing that shift continue and we expect that it will continue.

So, at least that’s what Bard has told us on the commercial side. So we continue to expect that to be the case for the rest of the year. In terms of the balance sheet, I’ll let Rob jump on that one.

Robert P. Jordheim

Yes, Chris, I think the capital structures you look out is going to be strong. There is a little bit of pressure on cash in the first quarter, basically in the first half of the year that’s going to improve in the back half of the year as revenue ramps up. If you look at our debt deal, we are really not required to pay any principal back until the first quarter of 2015, and by that time our cash flow should be very strong. So I’m not really concerned about at least the debt part of the equation. Also on the debt covenant ratios, we’re very solidly in line and in compliance with our covenant. So we should be in good shape.

Chris Cooley – Stephens, Inc.

But do you have (indiscernible)?

Brian K. Hutchison

Well, I mean from a debt perspective, it’s a five-year loan and we expect to pay the principal of it. It’s a very good rate and we’re very comfortable with the rate. At this point, we haven’t really decided as we go through if we generate cash to repay it down. I don’t know, we’ve got a pretty attractive rate here that we can take advantage of.

Chris Cooley – Stephens, Inc.

Understood. Congratulations on the great quarter and (indiscernible).

Robert P. Jordheim

Thank you.

Brian K. Hutchison

Thanks.

Operator

Thank you. And at this time, I’m not showing any further questions. I would now like to turn the call back over to Brian Hutchison for any closing remarks.

Brian K. Hutchison

Thank you, Charlotte, and thanks everyone for joining us today on this call. We appreciate the time and we will talk to you again in about 90 days. Thank you.

Operator

Ladies and gentlemen, thank you for participating in today’s conference. This does conclude the program and you may all disconnect. Everyone have a great day.

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