RTI Biologics CEO Discusses Q3 2010 Results - Earnings Call Transcript

| About: RTI Surgical, (RTIX)

RTI Biologics, Inc. (NASDAQ:RTIX)

Q3 2010 Earnings Call

November 4, 2010 09:00 am ET

Executives

Wendy Crites Wacker - Director of Corporate Communications

Brian Hutchison - Chairman & CEO

Rob Jordheim - EVP & CFO

Analysts

Matt Dolan - Roth Capital Partners

Shawn Bevec - Susquehanna Investment Group

Jayson Bedford - Raymond James

Raymond Myers - The Benchmark Company

Chris Cooley - Stephens

Operator

Good day ladies and gentlemen and welcome to the RTIX Q3 Earnings Conference. At this time all participants are in a listen-only mode. Later, we will have a question-and-answer session and instructions will follow at that time. (Operator Instructions) As a reminder, today’s conference may be recorded.

I would now like to turn the conference over to your host for today, Ms. Wendy Crites Wacker, Director of Corporate Communications. Ma’am you may begin.

Wendy Crites Wacker

Good morning and thank you for joining RTI Biologics for our third quarter 2010 conference call. Today we will hear from Brian Hutchison, Chairman and CEO, and Rob Jordheim, Executive Vice President and Chief Financial officer.

Also joining us this morning for Q&A are Tom Rose, Executive Vice President and Chief Operations Officer, and Roger Rose, Executive Vice President and Chief Commercial 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.

I’ll now turn the call over to Brian Hutchison.

Brian Hutchison

Good morning, everyone, and thank for joining us. On our call today, I’d like to begin by discussing our operating highlights and then Rob will review our financial results.

As detailed in the press release issued this morning, we reported revenues of $41.8 million for the third quarter in line with expectation. Sports medicine was again our fastest growing area in the third quarter. The growth in sports medicine and our general business offset revenue declines in spine, surgical specialties, and international revenues.

Due to a non-cash impairment charge to our goodwill, we reported a net loss for the quarter of $133.1 million or $2.43 per fully diluted share based on 54.8 million fully diluted shares outstanding.

As a result of recent external economic conditions and recent decline of RTI stock price, we performed a goodwill impairment test as of September 30th, 2010. This test resulted in a non-cash charge in the third quarter of $134.7 million.

When excluding this impartment charge, adjusted net income was $1.6 million or $0.03 per fully diluted share, which were in line with expectations.

Turning to a review of our business lines, our sports medicine business achieved quarterly revenues of $10.9 million, an increase of 15% over last year. Domestically, sports medicine grew by 20%, which is higher than the overall industry growth rate.

Our distribution force continued to demonstrate strength during the third quarter, which is historically soft as a result of seasonal slowdowns for surgeries in the summer months.

We believe we’re gaining market share due to our superior product quality, well-trained distribution group and excellent customer service as well as demand for our non-irradiated BioCleanse sterilized implants.

In August, we held meetings with two surgeon advisory groups focusing on ligament reconstruction and articular solutions. These meetings were very productive and we’re very excited to be working with a group of top-notch sports medicine surgeons. Their input will be used to help prioritize new product development projects. We expect that our sports medicine business will continue to deliver above industry growth rates through the remainder of this year.

Third quarter spine revenues were $9.7 million, a decline of 10%, as many of our distributors in this line of business are experiencing declines in procedure volumes and pricing pressure.

We are still committed to working with all of our distributors to support their needs and have launched a cervical graft for their largest distributor during the quarter. As anticipated, we showed modest, sequential growth from Q2 to Q3 as orders are normalizing from the inventory management initiatives of the first half.

We anticipate we will see a slight uptick in revenues again in Q4, but total spine revenues for the year will be down. As we said last quarter, we’ve been working to strategically expand our portfolio of spine distributors to positively impact the remainder of this year and 2011.

This quarter, we added SeaSpine to our distributors group and launched a new cervical graft for them. There are possible opportunities for additional grafts in 2011.

Dental revenues showed an increase of 11% over the previous year to $7.7 million. This increase is primarily the result of the amended exclusivity agreement with Zimmer Dental, which included a $1 million inventory stocking order in the quarter. We are very pleased to complete this, our exclusive 10-year distribution agreement with Zimmer Dental this quarter, which was effective September 30.

Under the new agreement, we will supply sterilized allograft and xenograft implants for agreed upon transfer fees, as opposed to the marketing fee structure of our previous agreement. Zimmer will be responsible for worldwide marketing and distribution of biologic implants for use in dental applications.

The new agreement includes an initial payment as well as annual payments for the length of the contract to secure exclusive distribution rights in dental markets. Additionally, Zimmer is committed to annual order minimums to preserve exclusivity.

Surgical specialty revenues of $6.8 million declined 19% globally compared to third quarter 2009. The year-over-year decrease was primarily the result of a stocking order of $2 million that was included in Q3 2009 as we expanded our agreement with Bard to include breast reconstruction implants. Excluding this stocking order, revenues would have grown 6% year-over-year.

BGS and general orthopedic revenues of $5.6 million were down 3% for the third quarter. The decline in revenue was primarily due to a 29% decrease in international revenues compared to the previous year as a result of economic conditions. This was offset by an 11% increase in domestic revenues, primarily driven by increased market penetration through our direct distribution forces.

The growth in domestic BGS/GO revenues illustrates the continued success of our distribution --direct distribution team and our ability to serve as a total tissues provider to hospitals. This remains an area of opportunity for the company.

Turing to research and development efforts during the quarter, we announced an exclusive agreement with Athersys who will provide us access to their multipotent adult progenitor cell or MAPC technology.

Under the agreement, we have licensed their technology to isolate and preserve cells from organ and tissue donors. With this license, we can expand our capabilities for accessing the fastest growing segment of the bone graft substitutes market.

After significant research in the stem cell and evaluation of multiple technologies, we have determined that the MAPC technology offers the greatest potential to creating high quality, innovative implants for our surgeons and their patients.

Licensing this technology is an important step in enhancing and further differentiating our ortho biologics offering which is an area of strategic focus for us. Based on our current development plans, we anticipate that our initial MAPC technology based biologic implant will be available in the first half of 2012.

At this point, I will let Rob discuss the financial results.

Rob Jordheim

Thank you, Brian. Revenues of $41.8 million for the third quarter of 2010 decreased 2% compared to the third quarter of 2009. Domestic revenues of $37.6 million for the third quarter increased 1% primarily on the strength of a direct sports medicine business.

International revenues which include exports and distribution from our German and France facilities were $4.2 million down 23% compared to Q3 2009. These decreases were directly related to lower export orders from several European countries many of which are still suffering from poor economic conditions.

In addition, the strengthening dollar has negatively impacted international revenues. During the quarter currency exchange fluctuations resulted in a decrease in revenues of $376,000.

Gross margins for the third quarter were 48% which were comparable to the prior year period.

Third quarter results include $134.7 million non-cash impairment charge. The impairment charge is a result of an evaluation of our recorded goodwill in conjunction with ACS 350 and reflects our current stock price and general negative market environment.

Excluding the impact of the $134.7 million goodwill impairment charge, operating expenses totaled $17.7 million, an increase of $585,000 or 3% over the prior year period.

During the quarter, marketing, general and administrative expenses totaled $15.6 million, an increase of $818,000 or 6% over the prior year, primarily due an increase in variable commissions and payroll expenses.

The increase in commissions is a result of increase sports medicine revenues and additional domestic BGS/general orthopedic revenues distributed by our direct organization.

Research and development expenses for the quarter of $2.1 million were comparable to the prior year period. Lastly, our tax rate for the quarter was 0.3% compared to 27% in the prior year period. Our effective tax rate for the quarter was impacted by the non-deductible goodwill impairment charge.

When reviewing the balance sheet at the end of the quarter compared to December 31st, 2009 and cash flow for the first nine months of 2010, please note the following. Our cash position at the end of the quarter was $15.5 million compared to $17.4 million at December 31st, 2009.

Subsequent to the end of the quarter, we received $13 million distribution rights payment in connection with the new distribution agreement with our dental distributor.

Accounts receivable decreased $21.5 million as compared to $22.2 million at December 31, 2009. Day’s sales outstanding were 48 at the end of the quarter compared to 49 days at the end of 2009.

Inventories decreased by $4.3 million to $89.6 million compared to $93.9 million at December 31, 2009. We are on target for our anticipated inventory reduction for the year in the range of 6 to $7 million.

For the nine-month period, on process donor tissue decreased $2.3 million to $24.7 million. Tissue in process decreased $6.4 million to $34.4 million and implantable donor tissue increased $4.1 million to $28.8 million. A portion of the increase in finished goods is related to inventory built during the quarter for our dental distributors.

In closing, we are feeling very confident about our liquidity position and our ability to generate cash in 2010 while meeting our operating goals for the year. I will now turn the call back over to Brian.

Brian Hutchison

Thanks, Rob. In our press release this morning, we reaffirmed our 2010 guidance that full year revenues were estimated to be between 165 and $168 million. Full year earnings per fully diluted share are expected to be in a range of $0.10 to $0.12, excluding the impact of the goodwill impairment charge based on 55 million fully diluted shares outstanding.

Although we are seeing slowdown from some of our markets, we believe that the diversity of our business portfolio and the strength of our distribution force will allow us to meet our goals.

We look forward to seeing some of you next Friday, November 12, at our Analyst Day being held here at our Florida headquarters. For those of you who cannot attend, webcast information can be found on our website. We will also be presenting at the Stephens Fall Investment Conference in New York November the 17. You can find more information about these meetings in our website or by contacting our Investor Relations department.

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

Question-and-Answer Session

Operator

(Operator Instructions) And our first question comes from the line of Matt Dolan from Roth Capital Partners.

Matt Dolan - Roth Capital Partners

Maybe first question on the revenue guidance just now that we’ve got the new Zimmer deal in hand, looking to Q4 even though low end a nice sequential tick up in sales, in the face of dental probably coming down sequentially, so can you help us with the moving parts there, what specific lines should we see that sequential increase driven by?

Rob Jordheim

Hey Matt, this is Ron. The big growth drivers in Q4 are going to be continued growth in domestic sports medicine business of 20 -- we are expecting 15 to 20% growth there, and also in the BGS/general orthopedic area.

Matt Dolan - Roth Capital Partners

Okay. And then may be on the spine side specifically, can you just help us on the trajectory there? You’ve had a few challenging quarters, do you have any better visibility from Medtronic and then any updates with them considering the Osteotech acquisition?

Brian Hutchison

Well, the acquisition is still not closed and so the party line is still the same that is business as usual. We don’t expect that to change certainly not in this quarter.

In terms of our visibility for Q4, that’s already locked down. So we pretty well know where that’s going to be for this quarter at this point in time. So Rob, if you can give him the number.

Rob Jordheim

Yes, well, I think we are going to be looking at probably low single digit growth for Q4 for spine, for Medtronic, for spine.

Matt Dolan - Roth Capital Partners

Okay. And then moving to the balance sheet, Rob, there is a pretty nice spike in other assets and deferred revenue. Maybe you can just point that out, walk us through the moving parts there, assuming the number is related.

Rob Jordheim

Right. At that point in time, we received the payment for the Zimmer deal. But at the end of quarter it’s accounted for in other prepays and other assets in deferred revenue. So you’re seeing $13 million in there and then you are seeing another 4 million related to the payment we are going to get January 1, which is the first exclusivity payment, first annual exclusivity payment.

Matt Dolan - Roth Capital Partners

Okay. And then last one on the gross margin, nice sequential tickup in Q3, now under the new Zimmer negotiation. What’s the pro forma gross margin in Q3 or better yet, what’s a good number to base off of in Q4? Thanks, guys.

Rob Jordheim

Well, the stocking order in Q4 is going to impact. And there’s going to be an additional stocking order to Zimmer in Q4 of approximately 3 to $4 million, so that’s going to impact the margin there. I guess when you look at how dental’s going to impact the financials, you are going to look at -- on the gross margin, we are probably going to shave, probably three to four points off that. But we are going to make that up on the operating side, so the net operating margin should increase 1 to 1.5%.

Operator

Our next question comes from the line of Shawn Bevec from Susquehanna Investment Group.

Shawn Bevec - Susquehanna Investment Group

Thanks, guys. Are you guys still planning on launching some spine products in the fourth quarter?

Brian Hutchison

Shawn, you’re pretty faint there. The answer is that we did launch some that are out there now and there will be -- I said in my comments we will launch one for SeaSpine, but that’s about it for this quarter.

Shawn Bevec - Susquehanna Investment Group

Okay. And then you said low single-digits growth from Medtronic in spine, what was the 4Q number last year? I think it, in my notes I had about, Medtronic’s about 75% of spine revenues last year, is that about right?

Brian Hutchison

Yes, let me correct that. We’re looking at low single-digits for all of spine, I incorrectly said Medtronic, so -- but what I meant there was all of spine. I think -- can you repeat your question real quickly?

Shawn Bevec - Susquehanna Investment Group

I was just asking about the -- how much of that was Medtronic last year, but since you clarified that, that it’s all spine and not just from Medtronic, that’s answers my question.

Brian Hutchison

Okay, good.

Shawn Bevec - Susquehanna Investment Group

And then can you discuss any more details about the minimums to Zimmer for the dental segment? In terms of like volumes, are we going to be looking at volumes somewhere around where they have been trending now for the minimums or is it going to be significantly lower?

Brian Hutchison

The minimums are based on experience that we’ve had and they increase every year based on market growth rates that was based on published data that both companies had during the process of discussion. It’s a 10-year agreement, with growth expected every year.

Shawn Bevec - Susquehanna Investment Group

Okay. And then that 4 million exclusive -- $4 million exclusivity payment that you expect January 1, you’re going to get, is it 4 million every year for the whole life of the contract or does that vary?

Brian Hutchison

That varies.

Shawn Bevec - Susquehanna Investment Group

And then my last one, can you provide an update on the number of reps in the sport med segment and then how many of those are currently selling the bone graft subs?

Brian Hutchison

We don’t give out the details in terms of how many are distributing the bone graft substitutes material as of this time. However, the feet on the street is still very near the same number, it’s just over a hundred at this point in time, with the expectation that we will expand that as described in the past and we will give more information on that at the Analyst Day next week.

Shawn Bevec - Susquehanna Investment Group

So there’s over 100 reps selling the sports med products?

Brian Hutchison

That’s correct.

Operator

Our next question comes from the line of Bill Plovanic from Canaccord.

Unidentified Analyst

I just want to know if there was any re-registration on allografts O-US during the quarter, and if so has that fully played out?

Brian Hutchison

Re-registration? I’m not really sure -- there is certainly – I mean we are certainly continuing to grow both allo and xeno in Europe, not sure exactly what the question was, Mark.

Unidentified Analyst

Yes. I think we just heard some of your competitors mentioning that. That’s fine. And then also with the new product launch from Medtronic, was there any stocking this quarter or should we expect some next quarter?

Brian Hutchison

No and no.

Unidentified Analyst

Very good. And also before, you had mentioned possible -- looking into possibly getting two new distributors in spine, and I just wondered if you are still looking to getting another one and if -- should we expect that to be about the same size as SeaSpine? And that’s all, thank you.

Brian Hutchison

Sure. We have ongoing dialogue with a number of other players, I can’t predict at this time, when they will be added. I do not expect they will added in Q4 at this point in time but we have ongoing dialogue with a few more players, mostly what I would describe as smaller players, certainly in relative size to Medtronic, Zimmer, Stryker, as of right now.

Operator

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

Jayson Bedford - Raymond James

So just on the Zimmer, so I can understand it, it sounds like you had a million stocking order in the third quarter, you expect three to four in the fourth quarter. Is there anything -- is that kind of, is the stocking complete after that or will that spill over into 2011?

Brian Hutchison

We expect that the stocking will be pretty much complete in Q4. There is a possibility that a small amount will go into Q1, and if it were, I would say it would be a million or less.

Jayson Bedford - Raymond James

Okay. And then I don’t know, if you can provide any more dynamics around the Zimmer deal, I know this may be overly simplistic, but if you had $100 of revenue under the old agreement, how does that equate under the new agreement?

Rob Jordheim

I will speak in terms of percentages here. Under the old agreement our gross margin was roughly 56%, okay. Under the new agreement, accounting for the product margin plus the amortization of deferral, we are looking at a gross margin of roughly 25%. So the gross margin as I said earlier is going to be declining. However, on the operating expense side, we will no longer be paying Zimmer the marketing fee which was roughly 40-some-percent. And we will no longer have the credit card charges that were relatively substantial to the business. So as I said earlier, we are going to make it up on the operating margin side. On the operating side, we will jump from roughly 10% to 22 to 25.

Jayson Bedford - Raymond James

Think I can do most of the math on that. The only thing, the credit card payments, is there any way to quantify that.

Rob Jordheim

Yes, it fell into other expenses.

Jayson Bedford - Raymond James

Okay. I can probably back into that. Okay. That’s helpful. Couple of other quickies. You mentioned you expect to grow sports medicine faster than the industry, what do you think the industry’s growing at right now?

Brian Hutchison

Single digits, I would guess in the 5 to 6% range right now.

Jayson Bedford - Raymond James

Okay. And then lastly for me, on the surgical specialties, the growth that you are seeing now, is it fair to assume it’s largely from breast and not hernia?

Brian Hutchison

Yes.

Operator

Thank you. Our next question comes from the line of Raymond Myers from The Benchmark Company.

Raymond Myers - The Benchmark Company

I am hoping you can break down the dental business a little better so that we could get some visibility to the run rate business excluding these stocking orders that you’ve had this quarter and expect next quarter?

Rob Jordheim

Ray, I’m not sure what the question is.

Raymond Myers - The Benchmark Company

What is the run rate of sell-through to the end market excluding the stocking orders?

Rob Jordheim

Well, I mean for us it’s completely different. Our model -- our revenues are going to reflect a transfer fee. So if you took it units wise, if you came up with whatever ratio you wanted to come up with the unit price, and base it off units, units will grow next year over this year end markets in the mid single-digit range, which is expected to be representative of what dental companies are supposed grow next year for Biologics. So we expect that we’ll see that growth. Obviously, there will be -- when you get to the third and fourth quarter next year, certainly fourth quarter of next year, we will have to talk about how big the inventory transfer happens to be that we record in this fourth quarter. Other than that, I don’t expect anything unusual to show up. We will probably have to provide some pro forma information next year to you guys, but we don’t have that available today.

Raymond Myers - The Benchmark Company

I guess what I’m trying to understand is that if you had a $1 million of stocking in the current quarter, should we take a $1 million off the 7.7 million that you’ve reported in the quarter and assume that the run rate business was 6.7 million?

Rob Jordheim

Yes.

Raymond Myers - The Benchmark Company

Okay. That helps. Thanks. And one other question, foreign exchange negatively impacted your business, why is that? Are you sourcing material in Europe?

Rob Jordheim

Yes, we do.

Raymond Myers - The Benchmark Company

Okay.

Rob Jordheim

It’s really the year-to-year revenue impact of FX in the foreign markets.

Raymond Myers - The Benchmark Company

Okay. So revenues go down, usually revenues go up with the weak dollar.

Rob Jordheim

Yes, really kind of depends on the year-to-year comparison.

Raymond Myers - The Benchmark Company

Okay. Well we can take that offline. Maybe we can conclude with kind of a general commentary on how the U.S. business is trending versus Europe, I can understand why the European business would be declining now with the difficulties that occurred there over the summer. How is the U.S. business trending?

Brian Hutchison

Actually Ray, this is Brian. The U.S business is starting to trend nicely in the markets where we have great visibility, such as sports and general orthopedics. We feel very good about what we’re seeing there. I would say spine is still the wild card in terms of what’s happening in the end market, although we’re protected primarily from price, so we don’t see that as an issue. As volumes decline, we certainly will be impacted by that, and there is still some vintage out there that says spine volumes will be impacted for coming quarters. So for us, I don’t see that leveling off although we don’t have any inventory adjustments coming our way again, so we should start to see things go the right direction. We do expect to see dental continue to improve in that mid single digit range as we go forward. And surgical specialties, I would say certainly that’s getting a lot of press in terms of what’s going on in the hernia side of things. I would say that we’re more interested at this point of time in what’s going on in the breast reconstruction side, and what we’re learning is the market opportunity is bigger than originally anticipated, and the growth rate is better than that of hernia. So we felt pretty good about directionally where that’s going as well for us. So, looking into the next 15 months, if you will, we are starting to feel pretty good about, the markets we are in, the base business we have, and where we are trying to guide ourselves.

Operator

Thank you. Our next question comes from the line of Chris Cooley from Stephens.

Chris Cooley - Stephens

Can you just remind us a little bit just kind of a roadmap when you think about the MAPC offering? You mentioned first half of 2012 in terms of production there, but just could you remind us kind of the clinical roadmap what we should be looking for going forward, and also the related R&D cost there, how we should kind of think about that in the model, although you haven’t established 2011 guidance yet? But just if you can kind of maybe broad brush thinking about that, and I had one follow up, thanks.

Brian Hutchison

First, we haven’t given out the timeline in very specific detail, we will do a little bit better job of that next week at the analyst day, but we don’t expect it will give out a tremendous amount of milestone data next year. This is a tissue product, so we are not looking for a regulatory pathway here, for us. So its really incumbent on us to do our launch process which is we tend to like to once we make sure we have the product and we can manufacture the product then we like to go to a small -- I won’t call it -- its more of a marketing opportunity, a study, if you will, a small study with our key clinicians to make sure that we understand all the handling characteristics and technique and all of things that go with it. And then, traditionally we do product launches at meetings, so Roger Rose and his team will be working on a commercial launch strategy with his group, that’s already underway. So right now, we fully expect that we are on track and what we will report on a quarterly basis is that we, whether we are on track or whether we fall behind, right now we are completely on track, so we feel very good about what we have told everyone so far.

In terms of the R&D dollars, we will keep you posted on that at this point in time. There is no major dollars to notify you.

Chris Cooley - Stephens

Okay. Super. And then just a quick follow up. You mentioned in the prior question, that the growth rate in post mastectomy reconstruction for biologics was stronger than hernia. Would you give us maybe your rough idea of where you think penetration is of the current -- for biologics within breast, and then how we should think about that just in terms of the market penetration rate going forward? Does it gain five points within that category, does the category grow by 10 share points. I am just trying to get a feel for how you see the category shifting as we out over the 12 to 18 months?

Brian Hutchison

Well, I am still trying to get a firm grip on exactly the size of the category. The initial information we had versus what we are today is significantly different by a magnitude of more than 25% difference. So we believe that the opportunity is bigger which would also then tell you that the penetration rate is pretty low. We believe that the penetration rate that we and Bard are experiencing are relatively small today. But the opportunity is big.

Operator

I show no further questions in the queue. And I’d like to turn the conference back to Brian Hutchison for closing remarks.

Brian Hutchison

Thank you, Mary and thanks, everyone, for joining us. We look forward to speaking with you either later today or next week here in Florida or at upcoming meetings. Thank you. Bye, bye.

Operator

Ladies and gentlemen, thank you for your participation in today’s conference. This does conclude the program, and you may all disconnect at this time.

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