Seeking Alpha
We cover over 5K calls/quarter
Profile| Send Message|
( followers)  

Executives

Dan Yarbrough - VP, IR

Alan Milinazzo - President and CEO

Bob Vaters - EVP and CFO

Analysts

Bill Plovanic - Canaccord

Raj Denhoy - Jefferies

David Turkaly - SIC

Matt Miksic - Piper Jaffray

Patrick Clingan - Lazard Capital Markets

James Sidoti - Sidoti & Company

Bud Leedom - Global Hunter Securities

Stan Manny - Manny Family Investments

Orthofix International (OFIX) Q3 2010 Earnings Call October 27, 2010 4:30 PM ET

Operator

Welcome to the Orthofix International Third Quarter Earnings Release Conference Call. At this time, all participants have been placed on a listen-only mode and the floor will be opened for your questions and comments following the presentation. It is now my pleasure to turn the floor over to your host, Mr. Dan Yarbrough. Sir, the floor is yours.

Dan Yarbrough

Good afternoon, everybody, and thanks for joining us to discuss Orthofix International’s financial results for the third quarter of 2010.

During this call, we will be making forward-looking statements that involve risks and uncertainties. All statements other than statements of historical fact are forward-looking statements, including any earnings guidance we provide, and any statements about our plans, beliefs, strategies, expectations, goals, or objectives. Factors that could cause actual results to differ materially from the forward-looking statements made by us on this call include the risks disclosed under the heading Risk Factors in our 2009 Form 10-K, and subsequent Form 10-Qs filed with the SEC.

With me on today’s call are Orthofix's President and Chief Executive Officer, Alan Milinazzo and our Executive Vice President and Chief Financial Officer, Bob Vaters.

At this point, I will turn the call over to Alan.

Alan Milinazzo

On today’s call we’ll cover three main areas. First, I’ll start with a summary of our solid third quarter results. Bob will then provide some additional financial details on the third quarter including the key elements of our earnings, balance sheet, and our cash flow, and an update of our expectations for the remainder of 2010.

Finally, I’ll make some comments about how prospects for a continued growth in our spinal implants and biologic business. Starting off with our third quarter results, our spinal and orthopedic business, which represented 80% of our total revenue in the quarter electively, reported solid revenue growth of approximately 10% year-over-year.

Revenue from our Sports Medicine segment, which represented about 70% of our total business, was down slightly as we had anticipated primarily due to the exposure to the weak economy. Excluding the impact of the business (inaudible) since the third quarter of last year, our adjusted total revenue was up 7% when compared with a third quarter of last year.

This revenue growth led to reported third quarter earnings of $0.48 per share which is a 33% increase over the prior year. Excluding the impact of changes in foreign currency, our adjusted earnings were $0.50 per share, which was up 14% year-over-year.

Looking at the performance of our spinal business, we believe we continue to take market share in both our spine stimulation and spine implant and biologic divisions which together grew a total of 14% year-over-year. Our Spine Stimulation segment grew 9% as we continue to benefit from our broad customer base of more than 1500 surgeons around the country.

Also, we continue to benefit from having the only stimulation device, which is improved by the FDA for use on cervical fusion procedures. We continue to believe our spinal stimulation customer base represents an important growth opportunity for our spinal implants and biologic business and we are beginning to increase our focus on the penetration of our spine implant in biologic products into this important customer base. We were very pleased with the operating result in our spine implant and biologic business in Q3 with strong sales growth of 20%. This sales growth was driven by the continue strong acceptance of several products we introduced last year including our Firebird pedicle screw system, the PILLAR SA interbody device, and the Ascent LE system as well as solid growth from our other products including our cervical plates.

These strong results were achieved despite increased headwinds in the market which has been widely discussed. Total revenue from Trinity Evaluation including sales in our orthopedic division was approximately 7.7 million in the third quarter, which was an 87% increase year-over-year.

We’ll remain confident in our full year guidance of $28 million to $30 million based on the run rate of our sales through the third quarter and our experience at the fourth quarter is typically our strongest of the year. We will continue to rollout our newer spine implant products on a limited basis during the fourth quarter. This include our new spinal deformity correction system, which is received very positive physician to feedback as we work through the user preference evaluations and enter into the limited release phase.

Our other new product is Phoenix which is at MIX pedicle screw system currently going through our user preference evaluation phase. Both of these systems are based on our successful Firebird platform and both of them give us new access to important sub-segments within the spine market. We expect to expect to be in the full market release [race] for these devices during the first part of next year.

As you may recall, these two market sub-segments represent in excess of a $1 billion of new opportunities for sales force. Our orthopedic business reported 2% of revenue growth in the third quarter or 6% growth on a constant currency basis. We continue to be pleased with the constant currency growth rates we achieved in certain targeted geographic areas including our Asia-Pacific and Latin-American markets.

In the United States, we continue to channel higher quantities of Trinity Evolution to our orthopedic customers and experienced substantial US growth in this product during the third quarter. Our Sports Medicine division continued to be affected by overall economic conditions with adjusted revenue down about 2% in the third quarter. While we continue to believe that steps we are taking to enhance our products and services as well as our distribution will result in accelerated revenue growth.

We believe these improved results will start to become more evident in the first part of next year. On a consolidated basis, orthopedics posted another quarter of profitability improvement year-over-year primarily as a result of the solid revenue growth in our spine business. The company’s gross profit margin increased to 50 basis points year-over-year to 76.8% and our operating profit margin grew by 60 basis points to 13.7%.

The improved operating margin is especially nowhere, it was achieved despite the fact that we continue to observe increased cost associated with ongoing legal manners which Bob will talk more about in just a minute.

Our increased profitability was due not only to an improved mix of higher margin products, but also as a result of the benefits of our recently completed reorganization in consolidated plan. As a remainder, we expect to realize a net savings of approximately $2 million this year, but the savings increasing to $5 million next year.

As a result of the benefits from these steps as well as additional opportunities for cost savings that we believe still exist. We continue to feel confident about our ability to region operating margin in the range of 18 to 20% as we look forward over the next several years.

At this point, I’ll turn the call over to Bob for some additional details on the quarter. Bob?

Bob Vaters

Thanks, Alan. Let me focus on three primary areas. First, the income statement including the only one item in the earnings reconciliation and the continued improvement in our operating results. Second, I’ll talk about EBITDA, cash flow, and the balance sheet as well as the positive impact of the debt refinancing we completed during the third quarter.

Lastly, I’ll talk about our revenue and earnings guidance for the fourth quarter. Starting off with the third quarter results. Total revenue was up 3% year-over-year as reported and 4% on a constant currency basis. Excluding the impact of our previous exit from two non-core businesses concluding the sales of our vascular business in the first quarter and the expiration of two distribution networks related to our anesthesia business in UK and Italy. Revenue increased 7%.

In the Sports Medicine division, we reported a revenue decline of almost 4%. However, if we adjust for the revenue recognition change related to our distributors that we previously explained. Total adjusted sports medicine revenue in the third quarter was down approximately 2% year-over-year.

Moving to the gross profit margin in the third quarter, this year we reported a 50 basis points increased to 76.8%. This improvement is primarily due to an improved mix of sales of our higher margin products including those in our spine stimulation and spinal implant and biologic division.

Looking at the consolidated operating profit, we reported $90 million or $30 million of 30.7% margin in Q3 this year which is a 7% increase over our operating profit in the prior year. The improvement was driven mainly by our spinal implants and biologics division, which generated an operating profit of approximately $1.9 million in the quarter versus an operating loss in the prior year.

The overall improvement in the company’s consolidated operating margin was achieved despite the negative impact of decreased legal expenses year-over-year including 2.6 million in legal expenses related to the DOJ investigation of the bone growth stimulation industry and 1.1 million related to our internal [SEPA] investigation related to our Mexican subsidiary.

Without the legal cost associated with these two specific matters for G&A as a percentage of revenue would have been about 12.9% versus the 15.4% in the prior year. So, notwithstanding these legal costs we begin to have sales of the benefit we’re seeing from our recent reorganization and consolidation.

Conversely in Q3, we also experienced lower than usual FAS 123 (R) expenses related to stock awards and that we do not award the normal major clearance, which we will continue to evaluate. Our consolidated tax rate in Q3 was approximately 40%. By comparison, our year-to-date tax rate is approximately 37%, which is consistent with the year-to-date tax rate through the first three quarters of last year and is also within the range of our full year guidance of above 37 to 38%.

Moving on to earnings if we look at the reconciliation included in today's release, we reported $0.48 of earnings per share in the third quarter excluding an unrealized non-cash foreign exchange loss of $0.02 during the quarter. Our adjusted earnings were $0.50 per share. This represented a 14% increase and adjusted EPS year-over-year and a 17% increase in adjusted total net income.

Now, let’s look at the balance sheet. Our total cash balance improved at June 30, 2010 to $37.2 million which compared to $25 million at the end of 2009. The cash balance at June 30 is after a 4.8 million repayment, we made late in the second quarter to payoff our interest rates slot of approximately one year prior to the maturity.

Additionally, the cash balance at September 30 reflects a total of 30 million in debt repayments through the first three quarters this year including a $4.3 million repayment in the third quarter in conjunction with the refinancing outlook of our long-term debt. We made an additional 5 million repayment subsequent during the third quarter. So, in total, the year-to-date, we produced our outstanding term debt by approximately 14% from the end of last year to a current level of about $217 million.

Lastly, we are pleased with these actions we have taken to reduce our interest rate and expense including the payoff of the interest rate slop and the refinancing of our credit facility, which together have lowered our interest rate by some 500 basis points since the first of this year.

Looking at the statement, our cash flows in the third quarter we reported net cash from operations were about $7.6 million which compared with cash flow of 11.2 million last year. The decrease is primarily due to changes in our restricted cash balance on our cash flow statement.

As a remainder, our restricted cash is available for the payment of operating expenses as well as for debt repayments. Our third quarter EBITDA defined in our new credit facility was $26 million, which is comparable to EBITDA in the third quarter last year and resulted a leverage ratio at September 30 of 2.0 whereas the maximum on the ratio of 3.25. EBITDA in the third quarter this year included the $3.7 million in legal expenses that I previously mentioned related to the DOJ investigation on the bone growth stimulation industry as well as our internal SCPA investigation.

DSOs were 88 days at September 30, slightly up from 82 days from in the previous quarter but comparable to 87 days at the same time a year ago. The sequential increase is primarily related to normal and customary build up of receivables in Italy which are typically factored at year end. Our inventory turns at September 30 were 1.5 which compared with 1.3 in the prior year and 1.6 at the end of the second quarter.

In closing, I would like to go over our revised earnings expectations for the full year. We now expect to report fourth quarter revenue of $144 million to $148 million, which would now give us between $564.5 million and $568.5 million for the full year. We also expect to report fourth quarter earnings of between $0.59 and $0.62 per share which would bring our full year earnings to between $2.62 and $2.65 per share.

Now, I will send it back to Allen to wrap us here. Thank you.

Alan Milinazzo

Thanks Bob. Before we take some questions I would like to comment on the market conditions we see in spine and our plan to execute a sustainable growth strategy. As discussed on previous calls, we are monitoring the spine market carefully and we have clearly experienced some of the same issues noted by many of our competitors. We are extremely proud of the 20% growth we reported in Q3 in spinal implants and our 14% in the total spine franchise.

During our attendance at two recent industry conferences NASS and CS, we had the opportunity to speak with a number of surgeons and get their perspectives on current market dynamics. What we heard in many of those conversations was consistent with the issues that have been impacting other spine companies and have led to growth estimates for the spine industry to approximate low single digits for the near term.

Therefore, as Bob explained, we have made what we believe are appropriate adjustments to our full year revenue guidance based on trends going into the fourth quarter. Having said that, we do feel well positioned to outperform the market in both the short and the long term. We have just entered very exciting segments of the spine market with our deformity correction product and our new MIS system and both have had very positive early feedback.

Also and importantly, our inventory of Trinity Evolution continues to improve which allows us to expand our customer base which is a key part of our growth strategy. This improved inventory gives us the confidence to reaffirm our full year guidance of $28 million to $30 million in Trinity Evolution sales.

Finally, as I have previously articulated, our spine growth strategy has four key elements. First, we will continue to methodically expand our distribution footprint which will bring us into new geographic areas both in United States and in key international markets. Second, we will continue to upgrade the distribution talent in existing geographies. Third, we are launching new products and entering new subsegments of the spine space. To reiterate an earlier point, deformity systems and MIS systems represent an additional $1 billion of new segment selling opportunities for our distributors. Finally, we will successfully leverage our surgeon relationships from the stimulation side of the business and create new implant and biologic users from this loyal customer base.

These four elements of our growth strategy are beginning to produce positive results for us and we believe they will continue to fuel our growth going forward over the coming quarters and years.

With that, operator, I think we are ready to open the line for questions.

Question-and-Answer Session

Operator

(Operator Instructions). We will take our first question from Bill Plovanic from Canaccord.

Bill Plovanic - Canaccord

I will start off with EZ and then kind of work my way, but really on spine, Bob, it sounds like on the operating profit margin you said 1.9 and if we add back to 2.6 for legal we get to what $4.5 million on the 77 or about 6% operating margin. Is that the way to look at that?

Bob Vaters

No, because you wouldn’t put all that legal into that business.

Bill Plovanic - Canaccord

That was the 2.6 with the DOJ of the 3.7.

Bob Vaters

Yeah, that would be fair.

Bill Plovanic - Canaccord

You were at a higher operating margin in previous quarters, is it a lot of investment as we move forward in this business or is there anything specific going on?

Bob Vaters

I don’t think the third quarter is indicative of the spine margin overall. You're going to have to look at the whole year and import backwards. As you know, for example, last quarter had a higher operating margin. So, it's not quite an upward slope. I think there's some variability but overall we're profitable now and we're moving it up.

Bill Plovanic - Canaccord

I was wondering if you could just give us a little clarity behind the decreased growth numbers for bone stent in spine. You are clicking along at 12% for a while and now you have clicked to 9 this quarter and you definitely telegraph that but I was wondering if you could give us a little color behind that trend?

Bob Vaters

Just one thing, we also had some BGS in that number 2 so.

Alan Milinazzo

Just on the spine stent, right, we have been talking about this every quarter and we mentioned that we will continue to grow about market rates but we don’t see double digit growth for this business over the coming quarters and years. Nothing extraordinary. We have commented recently even at NASS that is increased pricing pressure for us across all of our businesses and particularly you see it in spine, you guys reported on it what we have. So, nothing extraordinary just sort of looking at increased pricing pressure.

I also mentioned in the past we've got some of our competitors who have historically asking three years not done well have started to get their act together. One of our competitors reported 8% growth. So, not surprising to us, Bill, but it is pretty much inline with what we thought.

Bill Plovanic - Canaccord

Volumes remain fairly steady, or did those come off a little as you competitors tick back up again?

Alan Milinazzo

No, our volumes have been pretty steady although as we look forward and really what we are talking about here 9% is still well above market growth rates especially from a procedural standpoint just looking at all the data that’s coming in from other competitors reporting as well as other analyst’s reports. Our 9% would be substantially higher than the traditional cervical or lumbar fusion cases. As we look at it we expect pricing to be an issue going forward. It really hasn’t been an issue for us but it will be going forward.

Additionally, competitors are starting to get their act together and we are approaching 60% market share. So, all those things sort of conspire to tell us that we expect growth to be in the single digits. This is the first quarter in about probably 12 quarters that it was below but we were not surprised by it.

Bill Plovanic - Canaccord

Last question, on the ongoing legal issues with DOJ and even Foreign Corrupt Practices, I was just wondering any clarity regarding time lines on completion of those?

Bob Vaters

It's to be specific, I will say we're short about a high expense time for both having the same quarter. This is why our total expense went up, but it's really hard to speculate on the timing of the resolution.

Having said that, we obviously had a pretty hefty document required in [face] and that’s why the expenses were higher.

Operator

We will take our next question from Raj Denhoy with Jefferies.

Raj Denhoy - Jefferies

What if I could ask a about the operating margin expanding bit on those question. So, the overall operating margins for the company is 13.7%, I think it was a number was down year-over-year, I think it was the first time in probably year and half you’ve shown kind of a down year-over-year operating margin and I’m curious what’s behind that in a quarter if there anything which we concerned about.

Alan Milinazzo

The biggest issue is the legal expenses for both matters heading in the quarter for the higher level.

Raj Denhoy - Jefferies

Sure, it’s really simple is that just hired legal expenses.

Bob Vaters

Yeah, I mean if you are one of the things that pointed out on G&A as we just adjustment, G&A at a percentage of revenue would have been about 12.9 for last year, 54, if you were not to include those legal expenses.

Raj Denhoy - Jefferies

Okay, fair enough. On the spine business, Trinity Evolution I think you mentioned the couple of times it was quite strong outside of spine. I don’t expect we’re going to give us any exact numbers there, but could you just provide some colors to what’s driving that you is just more of a focus now for the sales force outside of the spine give more supply available.

Alan Milinazzo

Both of those things are actually we have more focus in the sales and we have more supply. So, again both spine and ortho had terrific increases over prior year, but specifically in the US market, we had a very, very good quarter from the US orthopedic standpoint led by the Trinity Evolution and again with supply improving monthly we just been able to open up some new customers there.

Raj Denhoy - Jefferies

Okay and just a couple on the sports medicine again it’s still relatively weaken I know you’re blame in the economy maybe no pickup until next year, but what’s maybe could drive a complexion to what’s happening or you’re seeing patients is off for lower price standpoint or lower price prices or we’re not just getting braces and really what’s happening in that business.

Alan Milinazzo

Yeah, I mean it’s a little bit of only above, I mean the patients are coming in post-surgical braces as supposed to be in custom braces are now after sale braces that takes you from a $350 price down about $120 or $140 product. We mentioned our called therapy business against pricing in called therapy is the bulk of our business. Called therapy units are not reimbursed and hospitals have been sort of cutting back.

For us, we’ve brought new products in both areas to help improve our performance. We see this clearing for us. We think we’ll expect another soft quarter in Q4 where we expect the business in normalize really going into next year and I say normalized and we’re talking low single digit growth, which would be in line with the market.

Raj Denhoy - Jefferies

You gave fourth quarter revenue guidance and we’ve given revenue guidance for several quarters now even going back to the fourth quarter of last year. The reduction which you spoke about, I think you said it is was spine business, but is it also sports medicine, is there a number of things that are working against that guidance.

Alan Milinazzo

Yeah, I am where we’ve launched product [insurance] sports medicine that we haven’t seen the uptake yet again. I think it’s largely procedural and buying patterns. I think we’ve got a very strong management team, very good distribution system that’s work on this. So, we’d expect some softness to continue in Q4 so, that’s part of it and part of it’s in spine Raj, we spend a lot of time with customers in NASS and CNS and some of the trends again they’ve not impacted us, I mean clearly 20% growth, 14% overall growth in our spine business were significantly outperforming the market. Having said that it’s prudent for us to look at our business in Q4 with a little bit more caution just given the feedback that we’ve heard from our competitors and from some of our customer so, although, we haven’t felt that yet would be [foolish] not to plan on some compression.

Raj Denhoy - Jefferies

Okay. Just last that is a point clarification is there an IIS payment that is still due this year or we out of those.

Bob Vaters

It’s still scheduled to be paid this year.

Raj Denhoy - Jefferies

So, is that about a $1 million during the fourth quarter.

Bob Vaters

It was still in our forecast.

Raj Denhoy - Jefferies

That’s in the guidance as well I guess or you guys just screwed in.

Bob Vaters

Raj, (inaudible) question.

Raj Denhoy - Jefferies

This payment for IIS I think of a $1 million perhaps is still due this year and I’m just curious that’s in the guidance now for the fourth quarter and not.

Bob Vaters

It’s not in the guidance at that point, but most likely we’ll not be in the fourth quarter.

Raj Denhoy - Jefferies

Though won’t be in the fourth quarter.

Bob Vaters

Yes.

Operator

We’ll take our next question from David Turkaly with SIG. Your line is live.

David Turkaly - SIC

Thanks. Sorry for the confusion there. When you look at the spine numbers again, the growth you put up, can you talk about the new products you have, are those - everyone else is talking about lot of pricing pressures, obviously procedural pressures, and I mean are those things are for these new lines, are they all premium priced? Are you still gaining, putting things out there and seeing limited push back on these new products?

Alan Milinazzo

It’s a very aggressive pricing environment Dave. I would say that the products, the Firebird system which has been out there a little over a year and we got terrific uptick on Firebird. We’ve replaced pretty much entirely our SFS system. But, we are discounting the product, sure, to be competitive with the markets. So, there is no freebies out there, but we can still discount the product and get mid 70s gross margin in this environment. The Pillar SA again it’s competitive, but we still have, we still have good margin on that product.

The new products that were in limited release on, user preference evaluation limited release on, the deformity system and the MIS system, those carry high margins, as you could expect in deformity system. Those are very big cases, expensive, 30,000, $40,000 cases. They have very good profit profile and they are not as price competitive. Same with MIS. So, when we talk about new products, the ones we launched a year ago versus the ones that we are launching as we speak right now, really all four of them have good profit profiles. The Firebird and Pillar are more competitively priced, but all have good profit profiles. We’ve had great success so far with limited releases of deformity and MIS.

David Turkaly - SIC

Let me flip over to the stem side, similar there, I mean are you still - what does pricing contribute there and there has been pressure or is that stable?

Alan Milinazzo

No, there is pricing pressure there. There is always pricing pressure there. We’ve got a lot of independent contracts with payors and they’re regularly being reviewed. So, we model pricing pressure and we are consistent year-to-date in terms of what we thought that pricing pressure would be. Having said that, again listening to the market, we would expect that’s going to increase, so we want to be prepared for that.

David Turkaly - SIC

Then just quickly, I know, remind us in terms of your distribution force, what is direct versus distributor? I know historically you've been paying some folks, I think little bit higher than maybe the norm across the industry and I think there was some opportunity there that you hope to maybe tone it down, but maybe give us an update on where that stands.

Alan Milinazzo

Are you talking specifically about the Spinal implant business, Dave?

David Turkaly - SIC

Yes, the spine reps.

Alan Milinazzo

Yeah, so as we bring out new products and we look for opportunities to get our commission rates competitive, we inherited some pretty higher rates, but that made sense given the size of the organization that we acquired four years ago. Their opportunity per physician was much smaller than it is today. We think it’s 3X. So, our opportunity to bring commissions down for new products is there. Having said that, I know it’s not something that’s going to be an overnight thing, it will be something that we work on over time.

We have mentioned that we’ve implemented some discount sharing as the markets gotten more price competitive and we have to discount. Our distributors understand that and they participated with us.

David Turkaly - SIC

Just the size of the force, like distributor versus direct.

Alan Milinazzo

Well, in the US, we are all distributor, outside the US we have a very small group in Germany, otherwise we are really distributor everywhere on spinal implant side. On the spine stimulation side, we are all direct. It’s a primarily US business.

Operator

Thank you very much. We’ll take our next question from Matt Miksic with Piper Jaffray. Your line is live.

Matt Miksic - Piper Jaffray

Hi, guys. Thanks for taking the question. So, one follow-up on spine, you talked about some of the industry trends impacting the market. I wanted to get a sense of, you saw some nice acceleration Q2 to Q3, listening to the rest of the players in the market, that isn’t what you would expect really. Maybe give us some color on how it is you’re breaking into these accounts, what, how is this environment favorable for you, how is this environment allowing you to sort of pickup business when so many other folks are having trouble?

Alan Milinazzo

Are you referring to the sequential growth from Q2 to Q3?

Matt Miksic - Piper Jaffray

Both sequential and also just some year over year acceleration.

Alan Milinazzo

Yeah, I know, we are delighted. I mean four elements to our growth strategy. We’ve probably executing more on the second element which is the upgrading and adding talent to our current distribution. We pretty much roughly the same number of distributors that we inherited when we acquired Black four years ago. There has been a reason why we stayed relatively constant with the move into Louisville and sort of getting our operational house in order. We’ve been selecting adding to those distributors. A lot of our distributors made commitment to bring on new talent to their groups which is helping us. Another element of our strategy is going to be to increase the number of distributors we have both in the US and outside.

So, I think those two elements have certainly been helping. The third element is new products and obviously the two that we have mentioned before have had an immediate impact on us, although not huge dollars but important dollars for us because it also us to get into physicians before really not on our radar school. Those docs that are doing deformity corrections, those docs that are doing MIS. That’s been a really nice entrée into some new physicians.

Then finally the fourth element of our strategy really is leveraging those stimulation customers. Although we’ve done it on a very limited basis, at this point we’ve been very successful with that and that’s really targeting a handful of current stimulation customers where we can introduce our biologics and implant products.

So, all four elements really, Matt have led to that growth, but I say probably it’s just upgrading and adding talent to our existing distributors that’s leading the way. But, I know as we go forward what keeps us sort of confident about our ability to grow double digits even in the single digit market are that all four of those element are going to successful for us.

Matt Miksic - Piper Jaffray

So, I guess the disruption, and I guess what I’m getting at also is in addition to new products, upgrading some of the reps and getting into new types of accounts, we’re hearing awful lot of across the board mid single digit pricing pressure, docs or selling their practices back to hospitals, hospitals trying to call down the number of distributors, number of providers they have for spine. I guess where in there is this opening up an opportunity for you or does it, or is it just purely the things you are describing, in other words, is this disruption just location around the hospital relationships among larger players? Does that somehow open up the door for you?

Alan Milinazzo

It does, but I would say that’s more of a Bluebird, sort of opportunistic situation that arises. We had our share of our existing customers call us and say we want you to commit and have discussion around pricing or vendor limits, you hear a lot of about capitation, which means that a hospital is going to dictate a certain price that they will pay for a screw or rod or hug. So, we get our share of indications for those as well. So, on an aggregate basis, I would say, it could be helpful to us, but that’s not one of the four elements of the strategy that we are pursuing.

Notwithstanding these pricing pressure, we are 2% share player on implant and biologics. We now have a much broader portfolio. We have differentiation with our portfolio. Trinity evolution is flowing which has given us an opportunity to go into some new accounts and we’ve got these 1500 discrete spine stem customers where, again our expectations are fairly modest, but we think that we can bring a handful of those docs on over to our platform every year.

Those sort of combination of things are really what give us our confident. While we think we can outgrow the market and outgrow a lot of the competitors in this market over the coming months and quarters.

Matt Miksic - Piper Jaffray

Okay. One on just the gross margin and follow-up to one earlier questions, it sounds like mix, it sounds like restructuring, I guess if I listened to Bob and your comments on what the FX impact was negative in the quarter. That sounds like it was maybe, it was maybe a 50 bps negative to gross margin, I don’t know if that’s accurate, which would suggest that year-over-year your gross margins were up like somewhere 250 and 300 basis points.

Bob Vaters

No.

Matt Miksic - Piper Jaffray

Or is the other way?

Bob Vaters

Frankly, we don’t really have - because we have local costs, we don’t really have at the profit level a big FX swing. The reference on the difference of growth from three to four and then seven for the, without the vascular and the businesses we sold was simply FX that was non-transactional non-realized that the gross profit or operating profit, it was minor.

Matt Miksic - Piper Jaffray

It was neutral. All right. So, then I guess my question is that remaining year-over-year increase, can you give us some color as to how much of that was driven by restructuring, how much of that was maybe driven by mix some way of parsing that out?

Bob Vaters

Most of it frankly was mix with the increase of Trinity Evolution and stem which are higher margin products.

Matt Miksic - Piper Jaffray

(Inaudible) something like one-thirds, two-thirds mix being the bigger piece?

Bob Vaters

I think mix is bigger piece yes. Again, we continue to meet the consolidation hurdles that we set in the past. So, that will continue to benefit us.

Matt Miksic - Piper Jaffray

One follow-up on stem. When you talked about not growing in the double digits there and not expecting to going forward. From this 9% level should we be thinking mapping a way down to sort of the mid-single digits or is 8, 9% the right number? Any color there?

Bob Vaters

No, it is a little too early to give you any sort of visibility from a forecast standpoint. We are obviously watching the market growth and there people are telling us the market's growing anywhere from 1 to 3% depending upon whose report you read, and we have already got close to 60% market share. We will give you formal guidance when we get ready to do that in 2011. we have been seen this coming, as Bill said earlier, we've been telegraphing this for a while and we still feel very, very good about share position here and our ability to grow faster than the market.

Matt Miksic - Piper Jaffray

Suffice it to say (inaudible) going forward should be a double digit number. Then finally, Bob on tax. Looking at the number in the quarter and your guidance it looks like tax has to dip significantly in the fourth quarter maybe color on what goes into that and more on some of the other initiatives you can do with tax going forward?

Bob Vaters

Obviously, we do a full review at the year end, but your assumption is true because we've got three quarters under our belt. I don’t see any significant change unless we do something by the year end which is I think is going to be tough.

Matt Miksic - Piper Jaffray

It's going to be like 35%, 36% tax rate in the fourth quarter. Is that right to get to your number?

Bob Vaters

Say that again?

Matt Miksic - Piper Jaffray

It's going to be a mid-30 tax rate in the fourth quarter to get to your full year guidance. Am I not looking at it the right way?

Bob Vaters

Expect that we have several one time write offs in Q3.

Matt Miksic - Piper Jaffray

That mid 30s number is a more normalized number which will hit Q4 without any changes. Is that the right way to think about?

Bob Vaters

Yeah, we (inaudible) our full year guidance.

Matt Miksic - Piper Jaffray

One last one on the legal liabilities you have or ongoing cost that you have related to FCPA and DOJ. Any color as to how long these can go on or should go on, modeling through the middle of next year, the end of next year, any color there? I know it’s a tough one.

Bob Vaters

It certainly is a tough question to answer. The FCPA is an internal investigation. At this point, we are getting towards the end of our internal investigation at which point we will present our results to the government and then we will see where we go from there. I see that that one looks to have a more finite forecast.

The BGS which is an industry wide investigation, although we are certainly at a high point in the third quarter from where we've been, in the fourth quarter we think we will continue to be in that high point but you would hope that you move into a phase where you are out of discovery and you can move towards some sort of conclusion whatever that means.

Operator

We will take our next question from Patrick Clingan with Lazard Capital Management. Your line is live.

Patrick Clingan - Lazard Capital Markets

First question I want to ask is, understanding that you brining your guidance down particularly first some of the weakness we deserve in spine this year. You guys, at least on the implant side it seems like buck the trends in the most part impacted some of your peers, I just wanted to get your thoughts specifically on the $48 million is it more on the implant biologic side or is it more on the stimulator side? What’s weaker than what’s you might have expected at the beginning of the year?

Alan Milinazzo

One is we did raise our guidance and earnings, Patrick so we will come back to that in a minute. We had just an outstanding quarter. Our 20% growth is I’m sure surprise a lot of folks and even our growth and stimulation continues to outpace the market. As much as we feel good about those results and we are just coming out of announce we are reading all of the results coming from our competitors talking to doctors. It’s prudent to take more conservative approach relative to our spine expectations. It doesn’t mean we are not going to continue to work hard to get to that high end of the number, which would be within the annual range that we provided.

The market circumstances really have changed. We hear it from all corners and so for us not to at least put that out there as a caution would be in prudent. Put it out there, we are going to continue to run hard through the finish line. We have incentives in place where people to finish the year on a very, very on high note on spine and stem as well as on spine implants and biologics.

Inventories flowing, we reaffirmed our guidance, our full guidance on Trinity Evolution. From where we sit, we are still going to outperform the market pretty substantially. We are just taking the prudent approach based upon feedback from a lot of corners, professional corners, physician’s corners etcetera.

Patrick Clingan - Lazard Capital Markets

Understood, so that impact both businesses and we shouldn’t read more in to just the Implant Biologics business, Stimulator business, one or the other?

Alan Milinazzo

Not at all. It’s really an industry I’d say it’s an industry edge on our part as we look at the industry. Going back to the question you asked earlier, we do still expect to see some softness on our Sport Medicine business through the remainder of the year. Based upon our results to-date and what we are hearing we think its prudent approach. Having said that, we plan on running to the finish line and all our incentives are in place to finish strong.

Patrick Clingan - Lazard Capital Markets

You mentioned Trinity Evolution’s supply situation getting better. Do you guys think you will be in a position sell to demand in 2011, I know you limited some of the customer base in terms of who you are actually do you caring the product to?

Alan Milinazzo

We would hope so Patrick. We would hope so.

Patrick Clingan - Lazard Capital Markets

Under that scenario what sequential growth rates do you think we should be thinking about relative to how it has been this year?

Alan Milinazzo

Too early to give you that, Patrick. I appreciate the try, but a little too early to give you that. It’s going to be important as we go through Q4 based upon the feedback that we are getting in the market to really keep it very close silence, so we now more than ever would be a bad time to be forecasting anything in to next year.

Patrick Clingan - Lazard Capital Markets

Last one from me, it seems like the Orthopedic business and I know that certainly currency translation has an impact here, but even on a constant currency basis that the core business slow down a little bit excluding some of the impact of Trinity. It something there I know we always thought about that faster growing segment. It looks like it maybe even been somewhat flattish excluding Trinity. Did anything change in the quarter, anything reset in terms of what our expectation should be going forward for that segment?

Alan Milinazzo

You are right. Currency certainly made an impact it’s a much bigger business for us outside the US, timing of some orders from last year we have pretty uncharacteristically big Q3 last year. I wouldn’t say there is anything happening in the market that we didn’t forecast what happened this year.

We had a good quarter as I mentioned on Trinity Evolution and so our core products are in line with expectations. Our core products being Exfix, InFix products some of the deformity correct it’s in line with our expectations and we are taking up any market box that would suggest otherwise for us.

Operator

We try the next question coming from James Sidoti with Sidoti & Company.

James Sidoti - Sidoti & Company

Just a couple of questions, one on the Stimulation business I know few years ago you had to provide your growth margin guidance, when we negotiated the contract with many large customers. I just wondering how the way (inaudible) looking forward, are there any big contracts coming up in the fourth quarter, most of those down in the first and second quarter of the year?

Alan Milinazzo

They happen all the time, Jim. There is no specific season to them and again people can put this on our radar screen at anytime. As you know we have been growing at substantially at greater rates in the market and we expect as we just start to approach 60% share, we will be more along lines with the market growth is.

We are not giving you any deep analysis of pricing trends etcetera. We are just looking what the markets doing and what the impact could be on us. There is nothing significantly different today, relative to contracting and pricing from these GPO type organizations or pay organizations.

James Sidoti - Sidoti & Company

On the Trinity, are you aware of any new competitors in to this market in the near-term? Do you think it still just you and (inaudible) or very soon?

Alan Milinazzo

For the foreseeable future it’s going to be Orthofix and NuVasive?

James Sidoti - Sidoti & Company

Finally, this question, I have asked you couple of times. With the tax rate up here in the mid-30s high 30% area, what the advantage of been registered in another line of Achilles?

Bob Vaters

Certainly not what was history the advantage.

James Sidoti - Sidoti & Company

When do you evaluate whether or not to continue that, is that an annual thing?

Alan Milinazzo

We evaluating it regularly, so its parts of it, it conclude where you don’t want to be, then you got to include and where you want to be. That’s on going right now, but clearly the benefits that we had in the past are not there anymore.

Operator

We will take our next question from Bud Leedom with Global Hunter Securities.

Bud Leedom - Global Hunter Securities

Just been shuttling between couple of cultures, but I apologize if you answered it. I know you are taking about your sell in to the spinal stimulation installed base and I know you mentioned that you are targeting handful surgeons initially. Maybe if I could just get a little bit more granular in that. Can you talk about the initial uptake and utilization there? I know it has been a couple of quarters since you have targeted that.

Just on a go-forward strategy for more deeply penetrating that base, can you provide any particulars on the plan of attack for that?

Alan Milinazzo

This is one of four key elements we have in terms of our growth strategy for our spinal implant biologics business. It’s an important one, but some of the other three. What we have tried to do is first and foremost is make sure that the spine stimulation organization continues to deliver the result we’d expect to deliver and very important that whatever we do does not dilute their efforts.

We have seen some of our competitors combined their organizations and not have success and so we continue to maintain a dedicated and direct sales organization. Response stimulation, which is one of the key reasons, why it outperformed the markets so handily.

Really our expectations are pretty modest. We have got 1500 discreet prescribers that number grows every month. We would like to target a handful initially to see whether or not they would be interested in our implant and biologics product. Key trigger for us was the availability of Trinity Evolution inventory, which a lot of customers have expressed interesting.

We are really beginning with that platform introducing that product in to some of those new customers, which we were not able to do until really last quarter. The uptakes has been good, but again we are talking about handful of customers and handful reps. We will report back to you, but as we go forward it will be one of our four elements of our growth strategy.

We just don’t expect that it will be half of our strategy. We think it will be a part of our strategy going forward and a very successful part of our strategy.

Bud Leedom - Global Hunter Securities

Just moving over to find itself obviously new products, new focus on deformity and MIS, is there any insight you can give obviously as you expand your account base in to other sub-verticals you might look at just from a new product perspective?

Alan Milinazzo

We are going to have our handful I mean that’s a good thing relative to these particular products, deformity cases are big very, very long cases, very expensive, it can be very profitable cases. We are only in the [UPE] for us that are our first phase of launch. So, we won’t even fully launch this product until early next year same at the MIS, they’re not as valuable to us, but they’re certainly more valuable than traditional cases.

So, we expect that kind of consumers are little bit. We’re looking at expanding our deformity line. We’ve got at a less than an adult, we’d like to have pediatric. We’re looking at tumor, trauma opportunities we even think that lateral approach for us to something in the future that we’re developing a product. So, we’re starting to fill our pipeline with products at the sales organizations getting excited about and we’re seeing it immediate uptake on the two products that we have got in UP. So, we’re pretty excited about these products as well as the pipeline.

Operator

Thank you very much. We’ll take our next question from Stan Manny with Manny Family Investments. Your line is live.

Stan Manny - Manny Family Investments

Hi, gentleman congratulations. Several questions most of me relatively easy. On Trinity Evolution, are you currently on backwater?

Alan Milinazzo

No.

Stan Manny - Manny Family Investments

You’re not.

Alan Milinazzo

No.

Stan Manny - Manny Family Investments

So, you’re in a add customer mode.

Alan Milinazzo

Correct. The investment we made at the end of last year was intended to start to trigger inventory improvements in the middle of this year, which would allow us to expand our customer base and so we have been executing on that in Q3 and that will increase in Q4. So, we don’t have any backwaters right now on Trinity Evolution.

Stan Manny - Manny Family Investments

Okay. You’d mentioned in the prior call doing product development in the Trinity Evolutionary, is that something we should except in the near-term or next five quarters?

Alan Milinazzo

Not that soon. We continue to look for ways to expand our relationship with MTF and we’ll certainly be excited to tell you when that happens.

Stan Manny - Manny Family Investments

The market outlook for as far as the expansion, do you have any field for size of market that you’re going out right now in Trinity Evolution?

Alan Milinazzo

Well, this is sort of a little bit of debate, they’re only two companies and so collectively we probably represented about $100 million of opportunity today. We think that probably could grow as high as $200 million or $300 million. It’s always going to be constrained because it’s the cadaver, a donor-based product. We also think that there are other products that are coming out that we’ll be competitive although, not from a stem cell standpoint pursue. So, our stances that this is today $100 million market that could get to $200 million or $300 million, those are big swags relative to the size of the market. We think it’s always going to have some constrains based upon being a donor-based product.

Stan Manny - Manny Family Investments

Is that an infuse competitor in anyway say perform the electronic [confused]?

Alan Milinazzo

It can be preceded that I mean as we’ve talked about in the past, this product was initially targeted as an alternate to autograft procedures. Some customers have migrated to this platform based upon issues with infuse and so, we have had some infuse customers come on board. So, it can be perceived as a competitive product infused.

Stan Manny - Manny Family Investments

Okay next few questions are easy. Is the R&D tax credit included the fourth quarter projection?

Alan Milinazzo

No.

Stan Manny - Manny Family Investments

No, so that could add conceivably how much?

Bob Vaters

I think it was calculated (inaudible).

Stan Manny - Manny Family Investments

Well, he has no estimate of what it could be.

Bob Vaters

I think we have it in the context of overall tax rate, but at this point we haven’t finished our year end tax calculations.

Stan Manny - Manny Family Investments

So, you have no idea of what federal tax credit, R&D credit would add to the earning.

Bob Vaters

Yeah, I don’t think it’s going to be the bigger deal of percent to be frank, to be honest with you.

Stan Manny - Manny Family Investments

It’s addictive.

Bob Vaters

Yeah, that’s [addictive].

Stan Manny - Manny Family Investments

Great, G&A is it increasing with this relocation or the investment should made or is it in the same area of $21 million annually?

Bob Vaters

It’s increasing but not materially.

Stan Manny - Manny Family Investments

So, we’ve got another dollar in D&A over a dollar per share.

Bob Vaters

Perhaps, I mean I really haven’t taken a look for the future but as you can see, it's increased but not that much for this year.

Stan Manny - Manny Family Investment

Tax rate, you discussed it with in the previous questioning. Do you have any agenda or timing or a feel for doing something with this high tax? You are all over the world, you're in others.

Bob Vaters

I mean we are but again we divested an asset overseas. Our total percentage of overseas business is less now than it was by about 4%. I mean, we look at it all the time and we certainly are looking at ways to go to other jurisdictions, but with that there is risk. So, at the moment we are sitting where we are.

Stan Manny - Manny Family Investment

Last question, cash usage. We assume that the largest percentage of cash going to be used for debt pay down.

Bob Vaters

That's been case, but I don’t want to commit to that. We certainly are in that pair of cash and including some more this week and $30 million to date used for debt repayment.

Stan Manny - Manny Family Investment

So, we can say you lean towards debt repayment?

Bob Vaters

I look at that and balance it against other investments.

Operator

Thank you very much, gentlemen, I'm showing no more questions in queue.

Dan Yarbrough

Thanks Dave. Well, I want to thank everyone for joining us on the call and we look forward to speaking with you again on our fourth quarter conference call. Thanks again.

Operator

Thank you very much, ladies and gentlemen. This does conclude today's presentation. You may disconnect your lines and have a wonderful day.

Copyright policy: All transcripts on this site are the copyright of Seeking Alpha. However, we view them as an important resource for bloggers and journalists, and are excited to contribute to the democratization of financial information on the Internet. (Until now investors have had to pay thousands of dollars in subscription fees for transcripts.) So our reproduction policy is as follows: You may quote up to 400 words of any transcript on the condition that you attribute the transcript to Seeking Alpha and either link to the original transcript or to www.SeekingAlpha.com. All other use is prohibited.

THE INFORMATION CONTAINED HERE IS A TEXTUAL REPRESENTATION OF THE APPLICABLE COMPANY'S CONFERENCE CALL, CONFERENCE PRESENTATION OR OTHER AUDIO PRESENTATION, AND WHILE EFFORTS ARE MADE TO PROVIDE AN ACCURATE TRANSCRIPTION, THERE MAY BE MATERIAL ERRORS, OMISSIONS, OR INACCURACIES IN THE REPORTING OF THE SUBSTANCE OF THE AUDIO PRESENTATIONS. IN NO WAY DOES SEEKING ALPHA ASSUME ANY RESPONSIBILITY FOR ANY INVESTMENT OR OTHER DECISIONS MADE BASED UPON THE INFORMATION PROVIDED ON THIS WEB SITE OR IN ANY TRANSCRIPT. USERS ARE ADVISED TO REVIEW THE APPLICABLE COMPANY'S AUDIO PRESENTATION ITSELF AND THE APPLICABLE COMPANY'S SEC FILINGS BEFORE MAKING ANY INVESTMENT OR OTHER DECISIONS.

If you have any additional questions about our online transcripts, please contact us at: transcripts@seekingalpha.com. Thank you!

Copyright policy: All transcripts on this site are the copyright of Seeking Alpha. However, we view them as an important resource for bloggers and journalists, and are excited to contribute to the democratization of financial information on the Internet. (Until now investors have had to pay thousands of dollars in subscription fees for transcripts.) So our reproduction policy is as follows: You may quote up to 400 words of any transcript on the condition that you attribute the transcript to Seeking Alpha and either link to the original transcript or to www.SeekingAlpha.com. All other use is prohibited.

THE INFORMATION CONTAINED HERE IS A TEXTUAL REPRESENTATION OF THE APPLICABLE COMPANY'S CONFERENCE CALL, CONFERENCE PRESENTATION OR OTHER AUDIO PRESENTATION, AND WHILE EFFORTS ARE MADE TO PROVIDE AN ACCURATE TRANSCRIPTION, THERE MAY BE MATERIAL ERRORS, OMISSIONS, OR INACCURACIES IN THE REPORTING OF THE SUBSTANCE OF THE AUDIO PRESENTATIONS. IN NO WAY DOES SEEKING ALPHA ASSUME ANY RESPONSIBILITY FOR ANY INVESTMENT OR OTHER DECISIONS MADE BASED UPON THE INFORMATION PROVIDED ON THIS WEB SITE OR IN ANY TRANSCRIPT. USERS ARE ADVISED TO REVIEW THE APPLICABLE COMPANY'S AUDIO PRESENTATION ITSELF AND THE APPLICABLE COMPANY'S SEC FILINGS BEFORE MAKING ANY INVESTMENT OR OTHER DECISIONS.

If you have any additional questions about our online transcripts, please contact us at: transcripts@seekingalpha.com. Thank you!

Source: Orthofix CEO Discusses Q3 2010 Results - Earnings Call Transcript
This Transcript
All Transcripts