RTI Surgical's (RTIX) CEO Brian Hutchison on Q2 2014 Results - Earnings Call Transcript

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

RTI Surgical Inc. (NASDAQ:RTIX)

Q2 2014 Earnings Conference Call

July 24, 2014 8:30 AM ET

Executives

Wendy Crites Wacker – IR

Brian Hutchison – President and CEO

Rob Jordheim – EVP and CFO

Carrie Hartill – EVP and CSO

Analysts

Chris Cooley – Stephens

Dillon Hoover – Craig-Hallum

Kyle Rose – Canaccord

Jayson Bedford – Raymond James

Operator

Good day ladies and gentlemen and welcome to the RTI Surgical Second 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 second 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; and Carrie Hartill, Executive Vice President and Chief Scientific Officer.

Before we start, let me make the following disclosure about forward-looking statements. The earnings and other matters we will be discussing on this conference call will involve statements that are forward-looking. These statements are based on our management’s current expectations, but they are subject to various risks and uncertainties associated with our lines of business, and with the economic environment in general.

Our actual results may vary from any statements concerning our expectations about future events that are made during the course of this meeting, and we make no guarantees as to the accuracy of these statements. Accordingly, we urge you to consider all information about the company and not to place undue reliance on these forward-looking statements.

Now, I’ll turn the call over to Brian Hutchison.

Brian Hutchison

Good morning, everyone and thank you for joining us. I will start with an overview of the second quarter, then Rob will review our financial results. I’ll follow-up with financial guidance for the third quarter and full year 2014. As detailed in the press release issued this morning, we reported second quarter revenues of $66 million, a 56% increase over second quarter 2013. We’re pleased to report that revenue exceeded our second quarter guidance of $62 million to $63 million.

Pioneer revenues have been included in the second quarter both 2013 and 2014 worldwide revenues would have increased by 6%. When reviewing each of our lines of business, second quarter spine revenues increased 90% compared to second quarter of 2013.

The increase was primarily related to the addition of revenue from Pioneer acquisition. Our direct spine team is doing an excellent job of converting distributors and surgeons to our broad spine portfolio. Early in the second quarter, we launched Streamline OCT an exciting new spine system designed to promote fusion of the occipito-cervico- thoracic spine.

In the first, 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.

Streamline has been very well received in the market and we continue to see growth as we build our inventory following the launch. Continued traction from our new products, surgeon engagement efforts and investments in surgical sides will drive growth in spine throughout the year.

At this time, we anticipate spine will grow in the low teens for the full year 2014 based on the first quarter of 2013 annualized run rate. Our sports medicine business decreased 2% compared to the second quarter of 2013, but increased 1% sequentially from first quarter of 2014. The year-over-year decrease in revenues is primarily due to an unfavorable comparable in Q2 2013, which was the strongest revenue quarter for sports medicine last year.

The recovery of the sports business is tracking well, but the count recapture and new account development both strong in the first half. The sports business historically experiences seasonality in the third quarter. We anticipate growth in the high-single digits for this line of business for the full year.

Second quarter surgical specialties revenue increased 4% compared to second quarter of 2013. The increases in revenue is primarily, is due primarily to the direct business in the U.S. as well as all U.S. business following CE mark approval for the Fortiva Porcine Dermis implant which we received in the first quarter.

At this time, we anticipate that the surgical specialties business will grow in the low-single digits for the full year with most of the growth coming from the direct distribution globally.

Second quarter BGS and general orthopedic revenue increased 50% compared to second 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 announced the first implantation of our Map3 Cellular Allogeneic Bone Graft strips configuration which took place during an ALIF spinal fusion procedure. This moldable implant is designed for ease of use and is flexible yet cohesive properties make it ideal for filling bone voids. We anticipate that the market launch for the Map3 strips cellular allograft later this year. We’re excited about the positive responses from surgeons for this implant so far.

We anticipate that BGS GO revenues will grow in the mid-single digits for the full year of 2014 based our fourth quarter 2013 annualized run rate. Second quarter dental revenues increased 3% compared to second quarter of 2013. This is in line with our exclusive distributors 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. Second quarter revenues for Orthofixation were $8.9 million. This is a sequential increase from first quarter of 2014 of 18%. We’re continued to be pleased with the growth in our direct cardiothoracic business, the Tritium Sternal Cable Plating system has been well received in the market and will continue to drive growth for 2014.

In June, we received the CE mark for Tritium and began direct distribution outside the U.S. For our commercial Orthofixation business we renewed our agreement with [indiscernible] synthase to supply trauma plates and cables and associated instrumentation for their trauma business. The agreement is for five years with two year term extension.

At this time we anticipate the Orthofixation will grow in the low-teens based of the fourth quarter 2013 annualized run rate.

At this point, Rob will provide some more detail on our financial results.

Rob Jordheim

Thank you, Brian. Worldwide revenue of $66 million in the second quarter increased 56% compared to the second quarter of 2013. Domestic revenues of $59 million for the second quarter increased 58% compared to the second quarter of 2013.

Our domestic revenues increased $21.2 million primarily as a result for the acquisition of Pioneer. International revenues which include exports and distribution from our Germany, French and Dutch facilities were $7 million for the second quarter of 2014, an increase of 43% compared to the second quarter of 2013.

Our international revenues increased $2.3 million primarily as a result of the acquisition of Pioneer. On a constant currency basis, international revenues for the second quarter increased 37% as compared to the second quarter of 2013.

Net income applicable to common shares for the second quarter of 2014 was $1.6 million or $0.03 per fully diluted common share based on $57.1 million fully diluted shares outstanding. This compares to net loss applicable to common shares of $3 million or $0.05 per fully diluted common share for the second quarter of 2013, based on $56.3 million for the diluted share outstanding.

Gross margin for the second quarter of 2014 was 53% as compared to 45% for the second quarter of 2013. On a non-GAAP basis excluding an inventory purchase accounting adjustment of $5.7 million taken in the first quarter of 2014, gross margin improved 60 basis points on a sequential basis.

During the quarter marketing, general and administrative expenses totaled $27.3 million, an increase of $11.6 million or 74% higher than the second 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 $594,000.

Research and development expenses totaled $3.3 million for the second quarter of 2014, which were comparable to the second quarter of 2013. Operating margin for the second quarter of 2014 was 6.7%, excluding the previously mentioned inventory purchase accounting adjustment taken in the first quarter, operating margin increased 300 basis points on a sequential basis.

Lastly our tax rate for the second quarter of 2014 reflects the tax expense of 40% compared to a tax benefit of 30% in the second quarter of 2013. Our comparative income tax rate was negatively impacted due to recognizing a portion of the 2013 research tax credit in the prior year’s quarter with no comparable credit being recognized in the current period.

Turning to the balance sheet, our cash position at the end of the second quarter was $15.8 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 and investments in spine instruments sets to drive growth.

For 2014 we anticipate being cash flow positive from operations. We are confident that with current cash balances and available debt we have adequate liquidity to support our future operations and meet our financing obligations.

Excluding an inventory purchase accounting adjustment of $5.7 million included in the inventory balance at the end of 2013, inventories of a $108 million increased $7.7 million as compared to the end of 2013. The increase in the inventories is due to set those to support the growing spine business as well as inventory build to support Map3 demand.

Working capital at the end of the second quarter totaled a $133.9 million an increase of $5.3 million excluding the previously mentioned inventory purchase accounting adjustment of $5.7 million. At the end of the second quarter we had $75.3 million of debt and approximately $9.1 million available under our revolving credit facility.

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

Brian Hutchison

Thank you, Rob. During the first half of the year, we made good progress towards our goal. As we’ve stated our key growth initiatives for 2014 are to continue to execute in recovery and growth in direct spine and sports medicine. To gain traction in direct surgical specialties business and to launch key new products for our direct distribution organization.

Our focus on expense control and developing a strong cash position have also been successful and we’re continuing to the second half of this year. While we gain positive momentum in the first, third quarter as traditionally been impacted by seasonality trends and surgery.

At this point, we expect that trend to continue and reflected that in our guidance for the slight decrease quarter-over-quarter followed by return to growth for the latter part of the year.

This morning, we outlined expectations for guidance in our press release for revenue and EPS for the third quarter and full year 2014. For the third quarter 2014 we expect revenues to be between $64 million and $65 million. This would result in an 18% increase in revenues compared to Q3 last year at the midpoint of our guidance.

We expect net income per fully diluted common share for the third quarter of 2014 to be approximately $0.02. Based on the results from the first half of the year, we are raising our full year revenue guidance. We now expect full year revenues to be between $258 million and $261 million, an increase from our prior guidance which was between $248 million and $253 million.

This represents an increase of 31% 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 $0.09 to $0.11 based on $57 million fully diluted common shares outstanding, an increase for prior guidance of $0.07 to $0.09.

We hope to see you, some of you this quarter we’ll be presenting at the Canaccord Genuity Growth Conference August 14th in Boston.

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

Question-and-Answer Session

Operator

Thank you. [Operator Instructions] Our first question will be coming from the line of Chris Cooley from Stephens. Your line is open.

Chris Cooley – Stephens

Hey, good morning, can you hear okay.

Brian Hutchison

Yes.

Rob Jordheim

Yes.

Chris Cooley – Stephens

I apologize if can’t hear, but congratulations on a great quarter. I just want to look forward for the full year, and if you can give me some color, can you just think about the incremental growth how much of that is coming from Pioneer from the new products and from let’s call it base business, just want to make sure I fully understand the drivers? And then I have one follow-up, thanks.

Rob Jordheim

Hey Chris, this is Rob. It’s really balanced growth between the two businesses. I would highlight that the spine business, especially the spine hardware business is gaining a lot of traction and momentum, as you can see in our Q2 numbers. And then on the Map3 in the porcine dermis side we’re excited about the growth prospects in the back-half of the year. So to answer your question it’s really a balanced growth.

Chris Cooley – Stephens

And I apologize, you may have touched on this, but there is [indiscernible] but when I look at the guide for the quarter the 3Q specifically this full year it doesn’t look like there is as much leverage coming to the bottom-line as what we’re seeing on the top-line I would think this step up in inventory and [indiscernible] that we would see a little bit more of that did I missed on the inventory adjustment is there more that in the second half maybe not [indiscernible] offset of that [indiscernible] investment, I’m just trying to get when we start to see a comparable acceleration at the operating margin part? Thank you so much.

Rob Jordheim

Chris, this is Rob. The inventory adjustment was done at the end of Q1. So you’re going to see normalized gross margin numbers going up for the remainder of the year. We are really going to see the uptick in margin is going to be in Q4. We have a little bit of an offset in Q3 and a little bit in Q4 related to some OEM business that we have with one of our commercial partners that relatively no margins. So it’s a slight drag on our gross margin and operating. But I still believe that in the next two quarters we are going to see sequential up picks in margin.

Chris Cooley – Stephens

Okay. So just one of the [indiscernible] congratulations on the first [indiscernible] of Map3, can you just update us there like what it’s kind of additional data and how we should think about the product offering moving out in terms of its availability in the international markets? Thank you so much.

Rob Jordheim

Well, as we said, we’ve been accelerating our approach the surgeon community now and with the addition of the strips product line we’re actually in a control launch on that product right now, the actual launch we will have to tell later this year. But we’ve been in a mode where we’re building inventory and we’re now approaching significant numbers of surgeons to convert and we’re seeing that success start to grow. We’re still, we’re not going to breakout the individual product line revenues, but we do see that beginning to accelerate and that will help us both in biologics and metals as we go forward.

Chris Cooley – Stephens

Thank you very much.

Operator

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

Dillon Hoover – Craig-Hallum

Hey, good morning. This is actually Dillon on for Matt, but congratulations on another great quarter. Kind of dub tailing off the new products, I don’t mean to handcuff with a specific number, but I know you guys had mentioned, you’re targeting 20 new products for the full year, some new product introductions since we last got an update, is 20 still the number or could you do even more than that?

Brian Hutchison

I would let Carrie Hartill, our Chief Science Officer answer that question.

Carrie Hartill

Good morning, Dillon, its Carrie, we are still following around 20 products some of them are for our OEM distribution partners. So the actual launch state of handful of those is they will be dictated by timing at the OEM partner and to the business, but for our internal products all is the one is that we are planning to launch this year are on track. But the majority of them on the spine side are pretty much down now and we’re cutting our focus to a couple of other things.

Dillon Hoover – Craig-Hallum

Okay, great and then just paroling of that and Carrie you can probably help me on this one as well. What segments are you guys really trying to target as far as new product introductions, is it going to be mostly in spine and sports med?

Carrie Hartill

Actually mostly in spine and then with ortho biologics and a little bit sports med and more in the general surgery business.

Dillon Hoover – Craig-Hallum

Okay. And then really just last one from me, as far as the gross margin structure goes, you know what the acquisition of Pioneer you guys are getting a little bit higher gross margin products what gross margin do you guys see being comfortable running the business where there is maximum amount of leverage to the bottom-line and how fast you guys think you can get there?

Rob Jordheim

From a gross margin perspective. We’re expecting to end this year kind of in that close to mid 50s range. And then our plan is that the new products the porcine dermis, the Map3, the new spine hardware all the time high margin. We expect that is that becomes a bigger part of our mix that our gross margins in the next three to four years would approach about 60%.

Dillon Hoover – Craig-Hallum

Perfect that’s all from me. Thank you and congrats again.

Brian Hutchison

Thank you

Rob Jordheim

Thanks.

Operator

Thank you. Our next question comes from the line of Bill Plovanic from Canaccord. Your line is open.

Kyle Rose – Canaccord

Hey this is actually Kyle on for Bill, can you hear me all right.

Rob Jordheim

Yes Kyle good morning.

Kyle Rose – Canaccord

Great, good morning and congrats on a great quarter. Just I wanted to kind of dig in on the spine segment there, I just wanted to see how should we really think about the growth from the – in the first half as we think about the second half, is that more of a returning to the normalized levels when you originally went into the acquisition of Pioneer or should we think of this as really adding on new physician customers or more of product launches really trying to breakout those drivers of the spine segment there?

Brian Hutchison

Okay, I’ll start and Rob can certainly take on. I would say that we’ve already gotten back to where we were when we made the acquisition and actually have now passed it on an average daily billing basis. And we are seeing a lot more traction with our full product line including the biologic products with the metal, we have much more attractive portfolio we are seeing significant uptick both in U.S. and outside of the U.S. in conversion activity and it’s been very, very successful.

Now the new products are absolutely helping with that with MIS and lateral and cervical, we’re seeing a lot of interest in our portfolio and thus far it’s been very, very good and the indications are it’s going to get better.

Kyle Rose – Canaccord

Great and then just from a broader market respective, I mean you guys have now been in a hardware business for almost nine months, how do you guys view the market broadly but then also from, headwinds standpoint as far as pricing and procedure rates?

Rob Jordheim

Well I think pricing and procedure rates have been pretty steady for us. I think the market appears to be steady to maybe even rebounding some. So we’re quite – we’re quite bullish on the market right now for spine. We’re not seeing any of the pricing degradation that we thought we might see and it’s been pretty good so far. Same with the procedures they’ve been steady also.

Kyle Rose – Canaccord

And then, moving to the Map3 it sounds like, moving through the controlled launch, but just wanted to get an update on where you guys stood from a manufacture and capability standpoint as far as getting the new facility up in running it online and then when we can expect inventory levels capable of supporting and maintaining the full commercialization just kind of opening the flood dates there?

Rob Jordheim

Well it is the flood dates aren’t fully open yet, but there the valve is been open significantly we are ramping up our activity and monitoring it region-by-region and we are seeing significant opportunities emerge. In terms of the inventory bill it’s been going very, very well where actually as Carrie said at the end of the last quarter and probably we would say again now, we’re actually ahead of plans slightly, the things are going very well. In terms of the new facility I would say that the construction is complete and we’ve entered the validation stage which will take several months. So we’ll complete the validation and then we would begin ramping that slowly through the later part of this year which is what we said we would do. So everything on that category is on track.

Kyle Rose – Canaccord

Okay and then just one last question on margins, I know a lot of questions have been asked this morning. It is you are really trying to get a understanding for, what we should expect on the cadence of gross margins moving forward to the year, kind of like you are going to end in the mid 50s, we thought 60 bps increased quarter-over-quarter here, I mean how should we think about that going through the year, should we expect similar quarter-over-quarter sequential increases it sounds like there might be a step down in Q3 just trying to really understand, what mid 50s looks like?

Rob Jordheim

Well I think over the next couple of quarters, you are going to see about what you saw from Q1 to Q2, I think you are going to see it probably somewhere around the 50 basis point increase through the back-half of the year. So nice steady increase and of course that will accelerate as the new products gain traction.

Kyle Rose – Canaccord

Great, thank you very much. Congrats on a great quarter.

Rob Jordheim

Thank you.

Operator

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

Jayson Bedford – Raymond James

Good morning. And thanks for taking the questions, I would characterize it more as housekeeping, but how much of your spine business is direct?

Rob Jordheim

That’s an interesting question. If you’re talking about the hardware business, we would describe it is all being direct and then it is controlled through our direct distribution group which is hybrid of, it’s based on traditional spinal groups which are made up of independent agents that work with us. We are talking about our overall spine category of course we have significant commercial relationships with approximately 9 final companies the leader of that is – is still Metronic. So that’s still a significant portion of our business, our commercial business still represents nearly 50% of our overall business than I would think it’s similar in this – by category.

Jayson Bedford – Raymond James

Okay, so and just looking at the 21 million you reported, half of that I can characterize is direct?

Rob Jordheim

A little less than half.

Jayson Bedford – Raymond James

Yes, okay. That’s helpful. And can you just remind me there was a, I think there was up a little bit sequentially but a big a year-over-year other revenue, what’s the key contributors in other revenue and how should we model this for the rest of the year?

Rob Jordheim

Other revenue, you should model it about approximately 2.5 million for the remaining two quarters of the year. The increase is related to some OEM pre-processing issue that we’re doing for a commercial partner.

Jayson Bedford – Raymond James

Okay.

Rob Jordheim

And we would expect that there has been a bit of a ramp between Q1 to Q2 but we expect it to be relatively steady in Q3 and Q4.

Jayson Bedford – Raymond James

And then finally just looking at the distribution and surgical specialties, are you adding to that team and can you just remind us as to the approximate size?

Rob Jordheim

Surgical specialty is right now is relatively steady as we seek approval in the hospitals, once we start getting those approvals and traction with the product, we’ll start adding.

Jayson Bedford – Raymond James

Okay and when you say Rob seek approvals is just getting through the various committees?

Rob Jordheim

Yes, right now we’re in front of a lot of tech committees and some over the hospital systems to get the product approved in the hospital.

Jayson Bedford – Raymond James

Got you.

Rob Jordheim

And we have a certain rep days out there right now, but as soon as we start getting approval we expect product sales to accelerate rapidly.

Jayson Bedford – Raymond James

Right, okay, thank you.

Operator

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

Brian Hutchison

Thank you all for joining us this morning and for your interest in RTI Surgical. We look forward to talking with you soon.

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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