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

Exactech, Inc. (NASDAQ:EXAC)

Q2 2014 Results Earnings Conference Call

July 29, 2014 10:00 AM ET

Executives

David Petty - Chief Executive Officer

Jody Phillips - Chief Financial Officer

Bill Petty - Executive Chairman and Founder

Analysts

Jeff Johnson - Robert W. Baird

William Plovanic - Canaccord Genuity

Mark Landy - Summer Street Research Partners

Jim Sidoti - Sidoti & Company

Operator

Good day and welcome to the Exactech Incorporated Second Quarter 2014 Results Conference Call. Please note today’s conference is being recorded.

At this time, I would like to turn the conference over to Mr. David Petty, Chief Executive Officer. Please go ahead, sir.

David Petty

Thank you Joshua, and welcome to everyone attending this conference call. I would like to begin with the forward-looking statement, disclaimer. This release contains various forward-looking statements within the meaning of Section 27A of the Securities Act of 1933 and Section 21E of the Securities Exchange Act of 1934, which represent the company’s expectations or beliefs concerning future events of the company’s financial performance.

These forward-looking statements are further qualified by important factors that could cause actual results to differ materially from those in the forward-looking statements. These factors include the effect of competitive pricing, the company’s dependence on the ability of third-party manufacturers to produce components on a basis which is cost effective to the company, market acceptance of the company’s products, and the effects of government regulation. Results actually achieved may differ materially from expected results included in these statements.

Now having said all of that, I would like to make some opening remarks on the quarter’s performance and then our Chief Financial Officer, Jody Phillips, will make some additional remarks and then we will open it up to questions and Jody and I will be joined by Executive Chairman and Founder, Bill Petty, for that part of the call.

Revenue for the quarter increased 6% from 60.6 million in the second quarter of 2013 to 63.9 million in the second quarter of 2014. Net income increased 12% for the quarter from 2.7 million in the second quarter of 2013 to 4.2 million or $0.30 per diluted share for the second quarter of 2014.

For the quarter, compared to the second quarter of 2013 knee implant revenue was flat at 21 million. Extremity implant revenue increased 17% to 19 million. Hip implant revenue increased 6% to 11.2 million, biologic and spine revenue decreased 5% to 6.5 million and other revenue increased 6% to 6.2 million.

For the first half of 2014, revenue increased 6% from a 119.9 million in the first half of 2013 to 127.2 million in first half of 2014. Net income increased in the first half of this year from $7.6 million in 2013 to $8.4 million in 2014 or $0.60 per diluted share.

For the first half of 2014 compared to the first half of 2013, knee implant revenue was constant at 41.6 million, extremity implant revenue increased 21% to 38.7 million, hip implant revenue increased 5% to 22 million, biologic and spine revenue decreased 4% to 12.3 million and other product revenue increased 1% to 12.6 million.

We were pleased with knee unit growth but experienced pricing pressure that made the results flat compared to prior year. At 17% our shoulder business grew better than two times market growth rate, we were pleased with hip growth and note that we achieved this result in advance of our anticipated positive effect of the Alteon Tapered Wedge hip stem for which we received FDA clearance in the last few weeks.

U.S. sales were up 6% to $42.2 million compared with $39.9 million in the second quarter a year ago and represented 66% of total sales. International sales increased 5% to $21.7 million, representing 34% of revenue for the quarter. For the first six months of 2014, U.S. sales rose 6% to $83.8 million compared to $78.8 million in 2013 and international sales increased 6% to $43.4 million with the mix also being at 66% U.S. and 34% international.

Now, I would like to ask Jody Phillips to make some additional remarks regarding our financial performance for the quarter.

Jody Phillips

Thank you David and good morning everyone. Thanks for joining us for the second quarter 2014 conference call. The second quarter results were consistent with our expectations with our revenue and earnings results being within the guidance that we had outlined before the beginning of the quarter, although there are a couple of areas that want further comment.

I will review our 2Q 2014 operating performance by each of the operating line items from a percent of sales perspective and as usual give some insight as to what we expect for the balance of the year. The gross margin percentage increased to 69.4% from 68.5% during the second quarter, was slightly higher than our expectations due to the positive impact of the mix of domestic extremity business. For the second half of 2014, we expect the gross margin percentage to be flat to down slightly as we have higher gross margin percentage comparables and we are expecting a higher mix of OUS business in the second half of 2014 as compared to the second half of 2013.

Total operating expenses were within our expectations for the quarter with a 7% increase at an increase to 58.7% of sales versus 58.2% in the second quarter of last year. The sales and marketing increase of 7% was primarily due to variable selling expenses and we expect sales and marketing expenses to range from 35% to 36% for the balance of 2014.

G&A expenses increased 7% as well and remained roughly flat at 8.9% of total sales. We expect G&A expenses to remain in the 8.5% to 9.5% of sales for the second half of 2014.

R&D expenses increased 6% during the quarter versus the second quarter of last year and reflected 7.6% of sales which was more along the lines of our expectations for the full year as compared to what we experienced in the first quarter. We expect R&D expenses to remain in the range of 7.5% to 8.5% of sales for the balance of the year. As a result of these operating items, our second quarter operating profit increased 10% to $6.8 million and was consistent with our expectations.

Our net non-operating expenses decreased 11% to $342,000 for the second quarter, primarily due to lower interest expense. Our 2Q effective tax rate was roughly flat at 36%, the same as the second quarter of last year. And we are currently projecting our full year tax rate to be in the range of 35% to 36%.

In summary for the P&L, the resulting net income of 4.2 million and a diluted EPS of $0.30 was in the middle of our expectations for the quarter due to strong extremities growth and our efforts at operating margin expansion.

From a balance sheet perspective, our accounts receivable increased by 1.9 million during the quarter and our days outstanding for the second quarter actually decreased to 68 as compared to 78 in the second quarter of last year, primarily due to more positive payment trends in Europe on a year-to-date basis. Our total inventories increased by 4.6 million during the second quarter as we prepared for the launch of a number of new products including the Alteon Tapered Wedge hip system.

Looking at our forward-looking guidance, we narrowed our full year revenue and EPS guidance; the revenue front to 249 million to 253 million, and from a diluted full year earnings per share perspective, to $1.19 per share ranging up to $1.23 per share. Our third quarter revenue guidance of 57.5 million to 59.5 million represents an implicit 3% to 7% increase and is expected to result in third quarter diluted earnings per share that will range from $0.24 to $0.26. This translates to a 6% to 15% net income increase for the third quarter.

In summary, we feel that the second quarter was another solid quarter for Exactech and look forward to continuing this performance for the balance of the year.

That is all of the prepared comments that I have at this time and again thanks for joining us this morning; we look forward to your questions.

David Petty

Well Joshua, we would like to invite questions at this time. And as I’ve said before Judy and I and also Executive Chairman, Bill Petty, are available to answer any questions.

Question-and-Answer Session

Operator

Thank you so much, sir. (Operator Instructions). We’ll take our first question from Jeff Johnson with Robert W. Baird.

Jeff Johnson - Robert W. Baird

Thank you, good morning guys.

David Petty

Hey Jeff.

Jeff Johnson - Robert W. Baird

Jody, one to start with you if I could, do you have a free cash flow number and operating cash flow number for the quarter? And then just updated thoughts there, obviously you had a strong cash flow in the first quarter and P&L, or I am sorry the balance sheet largely deleveraged at this point, just wondering kind of thoughts with the cash here over the coming 12 to 24 months maybe?

Jody Phillips

I am not sure I have the operating cash flow number. But I believe the free cash flow number for the first half was $14.4 million that was certainly aided by the large Spanish accounts receivable payment that we received in the first quarter. But the second quarter was pretty good progress as well. The inventory increase was a little bit slighter than we or little bit higher than we expected, but we do expect that increase to not be as high as the balance of the year goes along. And basically our full year projection is for free cash flow of $18 million and our intention is probably to start paying down some of our revolving credit facility. I think as you know we paid off a revolving credit facility in the first quarter and we still have an amortizable piece that we will probably begin to pay down in the coming quarters as well.

Jeff Johnson - Robert W. Baird

We should think of that as kind of an early ‘15 hit there to the P&L or benefits to the P&L?

Jody Phillips

From the pay down of the debt?

Jeff Johnson - Robert W. Baird

Yes.

Jody Phillips

No, I guess to the extent we're reducing at interest expense sure, but it will be a pretty gradual in terms of moving that needle, I think the bulk of impact would be next year, correct.

Jeff Johnson - Robert W. Baird

Yes. Okay. And then on gross margin, I hear your guidance for the back half for the year. But it sounds like maybe in your comments on the knee side that knees pricing got a little bit tougher in the quarter that would be consistent with what we’ve have heard from some of the other companies as well. But your gross margin’s now up three of the last four quarters, I think seven of the last 10 quarters if my count is right. Just wondering what's driving your gross margin? Again I hear you say and it's going to be flat down a little bit in the back half against the tougher comps. But the gross margin performance has been very good here. Kind of what's been driving that and how do we think about that over the next couple of years in a pricing environment that seems like maybe for everyone involved that’s getting - on the increment just a little tougher?

Jody Phillips

Sure. It’s good question. And the guidance is specifically related to that comparable. I believe our gross margin percentage for the entire second half of last year was nearly 70%, so that is higher than we've been reporting on a year-to-date basis.

And you're correct, we have been doing better than we have projected, the assumptions that bake into that is that we're going to have an increase in knee sales specifically outside the U.S. in the second half of the year.

And specifically to answer your question about how we've been able to do better - in the past that it's been pretty much due to that mix of extremity business, specifically in the U.S. where it's very attractive margins. And we continue to make progress with our internal manufacturing efforts where we've been investing over the last few years to bring a number of products in health and improve our cost position.

So to this point we have been able to offset those knee price reductions.

Jeff Johnson - Robert W. Baird

Yes. And I guess my question - if I look past the 2H tougher comps, if I take a 12, 24 even the kind of one, two, three year view on things given the environment we are in, do you think there is still gross margin to be had or should we be thinking about it now after you have made some improvements over the last couple of years that’s kind of treading water going forward?

Jody Phillips

I think if the pricing pressure maybe remains where it is and doesn’t get any worse we could still look to a full year expansion of zero to 50 basis points in terms of the gross margin and that’s primarily due to the manufacturing efficiencies.

Jeff Johnson - Robert W. Baird

Yes. And then still assuming a little bit of G&A and probably other leverage within there as well?

Jody Phillips

That’s correct. We have not - while our expenses were close to our revenue growth we (inaudible) leverage that we had hoped at the operating expense line and that’s something we are keenly focused on, but hopefully there is opportunities for leverage there as well.

Jeff Johnson - Robert W. Baird

All right. That’s all I have got. Thanks guys.

Operator

And we will take our next question from William Plovanic with Canaccord Genuity.

William Plovanic - Canaccord Genuity

Hi great, thanks good morning, can you hear me okay?

David Petty

Yes sir. Good morning Bill.

William Plovanic - Canaccord Genuity

I’d like to ask on knees. So we saw incremental pricing come in. My first question is I thought that typically Exactech was priced at the mid to lower point of the range, so I am curious why you are seeing such an impact in pricing? And then secondly I was wondering if could give us an update on both GPS and the rotating bearing knee in the U.S. timing?

David Petty

Absolutely. I don’t know that I would characterize our pricing as mid to low compared to industry average for the same products and nowadays, I don't think many of us are getting premiums for specific products like [poly] [ph] or whatever for knee. So, for us we are as we bring on new customers, where they are tending to come on at lower prices than our existing ASPs so that puts a little bit of pressure on us and too just on the environment as I guess you’ve heard on other calls that pressure is out there.

It's manageable as Jody said and maybe to expand the conversation -- well you also asked about RBK and we are due to submit that to the FDA in September or October. We had intended to do it before then, but our regulatory team lost a couple of months focused on re-certifications in Europe for our existing products and that's unfortunate, but we're confident we'll get it in here in September or October. So we're thinking about that as 2016 impact on revenue.

And to go back to the knee question specific to just the performance, we're very focused on that and both hip and knee and we're pleased with where we have come with hip in terms of growth without the Alteon Tapered Wedge stem, which we'll start with a pilot launch in this current quarter.

And I also just want to point out that with knees, June was substantially better than April and May and was a lot closer to our internal goals for growth rates. We did have a little bit of pressure outside of the U.S. particularly in Europe and when you look at the quarter all in as you’ve pointed out and we have pointed out in the release 2% to 4% growth was offset with some pricing pressure.

So GPS, actually we feel very good about; I think I’ve made comments before about the fact that it’s a different process and that process takes longer than typical sales cycle for a total knee. Just want everyone to know, we did over 400 cases with GPS during the second quarter which is good. We have a number of systems on trial; we have proposals out to hospitals; and we’re feeling confident that the Exactech GPS will lead to improved knee sales in the second half of the year.

Bill Petty

Bill, this is Bill Petty. I think maybe where you got the impression at least from us that maybe some of our ASPs were a little lower than industry average or mid to low, it was probably on the hip side back when the metal-on-metal was a very important part of many of our competitors hip sales which did certainly enjoy a premium in the marketplace; Exactech never had that product. Of course we're happy we never had that product. But I think that was maybe how we gave you that impression but more on the hip side.

William Plovanic - Canaccord Genuity

Okay. And then just clarification on the knee, you’ve basically for the last couple of years -- I know the European business had challenges and then the U.S. business had challenges and you don’t break it out, so it's difficult for us to see. But it looks like I mean given the growth rate you've reported, you've probably been losing share in the U.S. for the last couple of years. What is going to turn that around? I mean it's the largest component of your business; it's been a challenge for you for multiple years now, what is going to get that back on track?

David Petty

There are a couple of things. Certainly, I mean we look back a couple of years and say that we were losing share that maybe a debatable point but it’s let’s just say we’re not satisfied with it. And as I said a moment ago, we have some confidence that the Exactech GPS, the appeal of the Exactech GPS to surgeons may have the opportunity to understand what it really can do. It’s strong enough that it does motivate surgeons to change knee systems. Share is hard to move in knees as you well know and this is the first thing we’ve had in a while that really seems to have the potential to do that.

And of course there are other things. I mean as we continue to expand the roll out of the logic system and add all the different components to it that are available on other systems that makes it easier for us and you’ve already asked about the rotating bearing knee which we think is absolutely unique. When it becomes available in the U.S. market following the GPS, it makes us feel some measure of confidence about our knee business over the next 24 to 36 months.

And in addition to that our revision system is due to be updated. And so concurrent with the RBK and the GPS within the next 12 or so months, we should be beginning to roll out a new revision knee system under the Logic brand.

William Plovanic - Canaccord Genuity

Okay. And then last question if I may, just on the shoulder market, the extremity business growth slowed to 17% year-over-year; I mean that’s down from 20s. I know you had very difficult comp on Q2 ‘13, typically I don’t think the business was up but it was the last year. Is this slowing of the growth more reflective of the competitors that are entering the market, the fact that you’ll hit 15 percentage share roughly, is it just getting harder to find new customers? Just curious if kind of this sub-20 is what we should expect going forward? That's all I have. Thank you.

David Petty

Thank you so much Bill, good talking with you. And it's an interesting point and question. And I think you well know that for about four years, I've said we cannot sustain these growth rates with our shoulder business. And as I said it on the last call, the team continues to prove me wrong. And like the knee, when we look at June versus April and May for shoulder, it was substantially better. And our team remains confident that we're going to continue doing the same things we have been doing, which is continuing to offer innovative solutions for clinical problems that are appealing to shoulder specialists and ultimately to surgeons to do shoulder arthroplasty. And that strategy has worked very well over a long period of time. We certainly think that our cage glenoid has been a key revenue driver here in this current year. And even things that are fully launched are still giving us some mileage with the Equinox platform fracture stem, the posterior augment and glenoid, the augmented reverse base plate. And we had some other things coming in the near future with the scapular preserving, total shoulder arthroplasty instruments and resurfacing product in the pipeline.

So our strategy of differentiating with technology and offering superior medical education opportunities for difficult shoulder problems continues to bring customers to us at 17% or better than two times market growth rates on an $80 million base. And our team feels confident that we can sustain that going forward and I’m hopeful we can do better.

William Plovanic - Canaccord Genuity

Great. Thank you.

Operator

And we will move on to Mark Landy with Summer Street Research Partners.

Mark Landy - Summer Street Research Partners

Good morning folks, thanks for taking my question. A little bit on spine, the biologic side, you did referenced that biologics was weak and probably a good reason why the combined business was down year-over-year. Could you share with some of the factors that create the weakness this quarter and what can be done to try and turn that around or is the market in that segment just [weak] [ph] that you are just waiting for that market to turn until you start seeing some growth?

David Petty

Yes, I think the main driver or the main challenge with the biologics business, particularly in the U.S. is our platform is dominantly DBM bone paste product of course supplemented with our cell therapy product or platelet concentration systems under the Accelerate brand, and that DBM bone paste market has changed substantially over the last five years and it’s really unfortunately become more of a commodity market. We have very good clinical information about our DBM bone paste products and at the same time that information has become less important or less relevant in the comprehensive decision making process to buy bone void cellular product. So we have that battle; we fight that battle every day, we do protect our price reasonably effectively but there has been erosion. And as we continue to develop our sales organization, we are hopeful that just expanding that footprint can get us back to growth in biologics, but that’s process and it takes time.

Meanwhile, the spine business is starting to be a positive contributor on top line growth. And so, we'd like to stabilize biologics and continue to benefit from the spine business, we're now in the pilot release of our new elevated expandable interbody which has had very good initial surgeries. We're not singing from the mountain top yet, because we've only done a handful of cases, but we are hopeful that that can help fuel the growth we're already seeing in our spine business.

Mark Landy - Summer Street Research Partners

Just extracting a little from that. I appreciate the comments of adding customers for growth. But do you think that perhaps you have to look at other products that do carry a little bit more of a premium or is it [inaudible] time to stabilize biologics and then have the remaining part of the spine business produce the growth?

David Petty

That's certainly a current consideration of ours and that really has a lot to do with aligning channel development strategy with product strategy and biologics, and there are some choices for us to make there and we're focused on getting the right pathway there.

Mark Landy - Summer Street Research Partners

And just a quick question for Jody. Jody, you did mention I think that you are expecting the O-US part of the business be a little bit stronger, perhaps maybe having some contribution to the gross margin flattening, my words not yours. In terms of forecasting that, you said on current strength of the U.S. markets and have you thought about perhaps maybe a slightly weaker first half driven by high deductibles in the U.S. and perhaps maybe the second half being a little bit stronger than anticipated? Just interested to get your thoughts on the dynamics of it.

Jody Phillips

I'm sorry, I didn't hear that last point.

Mark Landy - Summer Street Research Partners

I said just interested to get your thoughts on the dynamics of the U.S. market in your forecast and then also the U.S. versus the European position.

Jody Phillips

The comments related on the gross margin and what we expect to see in the second half of the year again pretty much specifically due to the comparative last year where we had very strong gross margins in the second half of the year. Our knee business outside the U.S. was actually down in the second half of last year so that's something that we are projecting to rebound and with that carrying lower gross margins. That going into the mix is one of the contributing factors in the statement that we expect those gross margin percentages to be down. I think the U.S. pricing is also an issue as David mentioned our units were up but there is a little bit of an impact there on a year-over-year basis with our pricing being down.

And so those are probably the two factors that are going into the projection that our gross margin percentage will be down in the second half of the year. And again we're talking something modest but that would be flat to down 50 basis points. And as Mr. Johnson pointed out, a number for the past few quarters we'd outperformed that so hopefully we'll do better than we're projecting.

Mark Landy - Summer Street Research Partners

I appreciate your comments about at the margin, I think all of these discussions are at the margin. So congratulations on another good quarter and we'll speak soon.

David Petty

Thank you Mark.

Operator

And we'll take our next question from Jim Sidoti with Sidoti & Company.

Jim Sidoti - Sidoti & Company

Good morning can you hear me?

David Petty

Yes sir, good morning John.

Jim Sidoti - Sidoti & Company

Hip sales have been pretty good beginning of this year, it seems like they're going to stay good and maybe get a little better with the release of the new stem. Based on your comments and margins, should we assume that the new stem will have similar margins to what’s currently being sold?

Jody Phillips

Yes. We are not projecting it to be an impact on the gross margin mix. Initially it will be launched in the U.S. but we don’t expect it to move the gross margin needle for the balance of this year.

Jim Sidoti - Sidoti & Company

Okay. But if it does do well and absorb additional overheard, so you could see some improvements going forward I would assume.

Jody Phillips

If we have a rather successful launch of that stem in the second half of the year, especially with that being largely a U.S. launch, it could improve our margins.

Jim Sidoti - Sidoti & Company

All right. And then final question just on the environment, in the industry there has been - Biomet is about to be acquired by Zimmer, there has been talk about Smith & Nephew being up for sale. Are you finding it easier now to recoup some of these independent reps that in the past maybe weren’t taking your calls?

David Petty

So, a couple of things, I’ll maybe give a bigger picture than that and remind everyone that the channel development particularly in the U.S. is very important opportunity for us. And even the question about knee sales with the technology strategy around GPS, that’s absolutely important but channel development is another key to growing both hip and knee sales. So, then to get to your specific question and not with respect to any company, absolutely we are -- it’s not even a matter of people taking our calls, people are calling us, experienced people are calling us from within the industry. And so that aligns nicely with our strategy of channel development. And I can just tell you that our sales management team is very focused on further developing our sales organization and we view that as an important opportunity.

Jim Sidoti - Sidoti & Company

All right. Thank you.

Operator

(Operator Instructions). And there are no further questions at this time. I would like to turn the conference back over to our speakers for any closing remarks.

David Petty

Just want to thank each of you for taking the time and for interest in Exactech. And you all have a great day. This concludes the second quarter of Exactech results conference call.

Operator

And this concludes today's call. We appreciate your participation.

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: Exactech's (EXAC) CEO David Petty on Q2 2014 Results - Earnings Call Transcript

Check out Seeking Alpha’s new Earnings Center »

This Transcript
All Transcripts