Exactech's (EXAC) CEO David Petty on Q1 2016 Results - Earnings Call Transcript

| About: Exactech, Inc. (EXAC)

Exactech Inc. (NASDAQ:EXAC)

Q1 2016 Earnings Conference Call

April 27, 2016 10:00 AM ET

Executives

David Petty - Chief Executive Officer

Jody Phillips - Chief Financial Officer

William Petty - Executive Chairman of the Board

Analysts

Jeffrey Johnson - Robert W. Baird & Co.

James Sidoti - Sidoti & Company, LLC

Jennie Tsai - Gabelli & Company

Operator

Good day, ladies and gentlemen and welcome to the Exactech Inc., First Quarter 2016 Results Conference Call. Today's conference is being recorded.

And at this time, I’d like to turn things over to Mr. David Petty, Chief Executive Officer. Please go ahead sir.

David Petty

Good morning, everyone and welcome to the Exactech first quarter results conference call. We are happy to have you all on the phone with us. And I will begin with the disclaimer statement and then get into the substance of our call and discussion this morning.

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 achieved may differ materially from expected results included in these statements.

Now I have some additional prepared remarks, which I will make and then I am here as usual with our Chief Financial Officer, Jody Phillip and Executive Chairman, Bill Petty and when I am finished with some opening remarks, I will ask Jody to make additional remark and then we will open it up to questions where the three of us will answer whatever questions you may have.

So the first quarter revenue was $65.3, up 6% from $61.4 million in Q1 of last year, and constant currency revenue increased 7% and net income was $4.4 million or $0.31 per diluted share compared to $4.1 million or $0.29 per diluted share for last year.

I will now highlight revenue performance by segments starting with extremities which increased 15% to $24.2 million and the same constant currency growth percentage. Knee revenue increased 5% to $19.4 million, up 6% in constant currency and [Hip implant] revenue increased 4% to $11.3 million, up 5% constant currency.

Biologic and spine revenue increased 5% to $5.4 million, up 7% in constant currency and other revenue decreased 13% to $5 million, down 12% in constant currency. We were generally happy with the results for the quarter. Worldwide sales were up 6% as I said to $65.3 million and breaking that down to the U.S. and international they were up 8% to $44.6 million in the U.S. with $41.2 million in the first quarter a year-ago.

International sales increased 3% to $20.7 million and U.S. sales represented 68% of total sales, international was 32% of the total. Things continue to go well with our three revision system launches with the hip stem and knee system still in pilot launch. We will be ramping up availability of both of those systems in the second and third quarters and expect them to increasingly contribute to revenue as the year goes along.

The proximal humeral reconstruction stem is fully launched and also improvements we have made in our U.S. sales organization are starting to make a difference, we expect that to continue and increase throughout the year.

Now I'd like to ask Jody to make some additional remarks. And then we'll open up for questions.

Jody Phillips

Thank you, David. Good morning, everyone and thanks for joining us for the first quarter 2016 conference call. The first quarter produced results that were above our expectations due to strengthening a number of our product segments in the U.S. sales in general. In order to review our first quarter P&L performance, I will review each of the operating line items from a percent of sales and change versus prior year perspective and add some commentary.

We experienced the gross margin percentage decreased to 68.8% versus 69.6% during the first quarter. This decrease was higher than our expectations due to the worldwide pricing impact. On a go forward basis, we expect gross margins to decrease between 20 to 80 basis points on a comparative quarter basis and this was slightly higher than what we expected at the beginning of the year.

Total operating expenses grew 5% due to higher variable selling and product development costs and were consistent with our expectations. As a percent of sales, total operating expenses decreased to 59.2% versus 59.7% in the first quarter of last year. Sales and marketing expenses were roughly flat as a percentage of sales at 35.7% during the first quarter of this year compared to 35.6% in the first quarter of last year. And we expect full-year sales and marketing expenses to range from 35% to 36% for the balance of 2016.

G&A expenses increased 1% but decreased as a percent of sales to 9.1% during the first quarter and we expect G&A expenses to remain in the range of 8.5% to 9.5% of sales for 2016.

R&D expenses increased 12% to 7.8% of sales and were within our expectations for the quarter and we expect R&D spending to continue in the range of 7% to 8% of sales and likely in the double-digit, low double-digit type increase year-over-year as we continue to invest in the product pipeline.

As a result of these operating items our first quarter operating profit increased 4% to $6.3 million and represented an operating margin decrease of 20 basis point to 9.7% of sales from 9.9% in the first quarter of last year.

In our non-operating area we experienced $494,000 currency gain primarily due to the strengthened Japanese yen impact on intercompany receivable. Our first quarter effective tax rate was approximately 33% versus 26% in the first quarter of last year. And on a going forward basis we expect the tax rate to range from 31% to 33% for the balance of 2016.

In summary, for the P&L the resulting net income increase of 7% to $4.4 million and diluted EPS of $0.31 was ahead of our expectations, primarily due to the sales performance and the currency gain. From a balance sheet perspective; our cash position decreased by $3.6 million during the quarter due to stock repurchases and the acquisition of our Australian distributor. Accounts receivable DSOs improved to 74 versus 75.

Beginning in the first quarter we have re-classed onsite surgical instrumentation of $14.4 million that was formally classified in inventory. This is reflected in the attached financials on a retrospective basis and we feel this will give a more clear view of our implant inventory and be more consistent with industry practice.

Total implant inventory increased by $4.5 million during the quarter as we are in the process of significant set build for some of our newly launched products as well as our existing product line. Based on the first quarter performance we increased our full-year revenue and EPS guidance to $250 million to $257 million and diluted EPS to a range of $1.14 to $1.19.

Our second quarter revenue guidance of $63 million to $65 million represents roughly a 2% to 6% increase and is expected to result in 2Q diluted EPS of $0.29 to $0.31. This is all of the prepared comments that I have at this time. And again thank you for joining us this morning.

David Petty

Okay Greg so we are ready to open it up for questions.

Question-and-Answer Session

Operator

[Operator Instructions] And first from Robert Baird we have Jeff John.

David Petty

Good morning, Jeff.

Jeff Johnson

Thanks. Good morning, guys can you hear me okay.

David Petty

Yes, sir.

Jeff Johnson

Good. Jody I want to start with you with a couple of margin questions and then David I'll swing back to you for maybe a bigger picture and some revenue questions. But Jody on the margin side you know little bit softer this quarter I think when you went through things that makes sense.

But it does look like your G&A guidance is going up by about 50 basis points, your gross margin guidance down by maybe 10 or 15 basis points, but if I kind of roll together your guidance as of a quarter ago it felt like there was about a 100 basis points maybe a little more potential operating margin expansion this year, rejiggering the math quickly or this morning maybe 50 basis points is what I am coming to, but do you still expect operating margins in the next three quarters over the balance of this year to have a slight upward bias or should we think about it being down again like we saw in the first quarter?

Jody Phillips

I think when you look at the balance of the year; we are expecting operating margin expansion. The first quarter was one of our stronger operating margin comps and so when we got – when we get into the second and third quarter those operating margin by comparisons are easier and we are projecting to deliver some leverage there. You are on track I believe with that 50 basis points target. And the key probably is in that G&A area where we would expect it hopefully to be at the low end of that range with percentage of sales that I gave.

Jeffrey Johnson

Okay. And it’s higher because the Australian distributor purchased number one and number two the higher tax rate guidance on the year, is that just a business mix with the U.S. coming back stronger or how should we think about that?

Jody Phillips

So the Australian purchase definitely contributed to a little bit of the increase in the sales and marketing expenses and that was a contributor to the total operating expense increase, it was not a contributor to the operating margin decrease. And as we look forward for the balance of the year again I think we would expect that operating margin to expand.

Jeffrey Johnson

Okay. Thank you and then David…

Jody Phillips

I’m sorry Jeff, and to the taxes, they increased in that rate is relative to the mix of the U.S. business that we're currently seeing and what our expectations are for the balance of the year.

Jeffrey Johnson

Yes, makes sense. David maybe bigger picture than – last year struggled maybe with some account issues and sales rep issues late 2014 into early 2015 that that kind of hit for the year. It sounds like to us maybe you've had some success on back filling not only that, but maybe filling in with some new accounts in a few areas, anything you can talk about on the surgeon count side or account wins or anything like that.

And then as I look at revenue guidance, you put up a good solid 7% number this quarter, it seems like guidance implies revenue growth over the balance of this year closer to 3% to 5%. And I just have a hard time to getting there is comp stay pretty favorable and with the new products that are launching, so maybe just some help on the revenue guidance as well? Thanks.

David Petty

Yes, sure. I think that's appropriate that you pointed that out and just that big picture as you ask, we are seeing traction and grow from specifically improvements in the sales organization, in the territories where we actually took a step backwards in a couple of territories as you point out and for late 2014 and first half of 2015. We’ve gotten those territories stabilized and we have additional territories where we've made changes that are contributing nicely to growth particularly in our Hip and Knee business, and our longstanding existing territories were also picking up new customers.

And you're right to point out that the revision systems are helpful. An interesting thing that may help give some color on the guidance is that we're going to ramp up the reversion Hip and Knee systems slowly than we planned and that simply because of the demand for our existing products, notably our primary Hip and Knee products. And so we're really working hard to meet that demand and really at full capacity to keep up, which is to the extent you want to talk about good problems I guess that would be categorized as one.

And so to the extent that we need the same equipment and/or vendors to build that to ramp up the revision Hip stem and Knee product, the Knee system and we're using that capacity to meet demand in primary, we're going to roll those out a little bit not later, but more slowly than we intended. And in the meantime, we're also investing heavily and this may speak to the cash and CapEx spending this year. We are investing heavily in equipment and hiring people and doing some redundant capacity with vendors and things to prepare ourselves to meet higher demand going forward. So that may really speak to what would appear to be conservative guidance when it seems like we were firing on all cylinders.

Jeffrey Johnson

Very helpful. Thank you.

Operator

[Operator Instructions] And next from Sidoti & Company we have Jim Sidoti.

James Sidoti

Hi, good morning. Can you hear me?

David Petty

Yes, sir. Good morning, Jim.

James Sidoti

Great. Two questions, one just more on the sales force. There were a lot of changes in 2014, which impacted results in 2015 and it seems like now you started to see the benefit of that. So my question is are you continuing to make those changes and at the same pace as you did in 2014?

David Petty

We are with the caveat related back to what I just said, when we're struggling to meet demand. We really need to make sure we get supply in line with the rate of adding new customers and so we're a little bit dependent on that right now. But the intention is, yes we believe we can add customers I am talking about surgeon customers at a similar or increasing rate as we are able to ramp up capacity.

James Sidoti

All right. But are you continuing to upgrade or…

David Petty

So the sales force development is a perpetual and important strategy for us and so the answer to your question is yes and yes we're definitely focused on that.

James Sidoti

Okay. And then my second question is for Jody. When do you think you'll start to see the benefit of the temporary suspension of the medical device tax start to hit your P&L?

Jody Phillips

We’re projecting we’ll start to see the benefit of that in the first quarter of 2017. There was about a year's amount of that that was built up into inventory and we burn through about a quarter of that in the first quarter. So it's right on track to kind of run out by the end of the year. So we're expecting to see a benefit of that in the first quarter of next year.

James Sidoti

And I know it's early to start thinking about next year but just in general terms do you expect to reinvest that or do you think that some of that will flow through to the bottom line?

Jody Phillips

I think the big factor there is what's going on with worldwide pricing; we certainly will continue to heavily invest in R&D in our new product rollout. Hopefully that will give us a chance to offset some of the pricing pressure that we have and it be nice if we could have gross margins that remain flat or were slightly up in 2017. So we’re just kind of have to wait and see.

James Sidoti

Okay. All right, thank you.

Operator

[Operator Instructions] Next up we have Jennie Tsai of Gabelli & Company.

Jennie Tsai

Hi, good morning.

David Petty

Hi, Jennie.

Jennie Tsai

It’s great to see the ex-Germany is growth double-digit this quarter. I just wanted to get more details on what drove the strong sales growth in ex-Germany?

David Petty

So that I mean we continue to benefit from having some differentiated things our competitors don't have like the augmented baseplates and glenoid products that we've talked with you before about. And across the Board our sales organization we think continues to be the most clinically competent sales organization out there.

We've added some new folks to the sales organization who are contributing but across the Board I think dipping into temporarily and the single-digit growth rates really kind of got the attention of a competitive bunch of people who went out there and redoubled their efforts and we gave them a great new products that nobody else asked like the humeral reconstruction stem, which is another new thing to talk about. And all of that is complimentary to a foundational system that we think clinically doesn't really have a peer on the market. And so we're really just delivering what we think we should be delivering.

William Petty

Jennie this is Bill speaking – this is Bill Petty speaking I would add that we now have lots of literature that demonstrates the efficacy of the Exactech Shoulder System and we hear a lot today about Evidence Based Medicine. We have the evidence and we hear about our competitors who are introducing new products they don't have the evidence we do. It’s being well publicized in a lot of different meetings and lot of different areas I think that’s a huge boost for our extremities group

Jennie Tsai

It was great to see double-digits and I hope it continues through the foreseeable future. I just wanted to get a little bit more detail on price for the quarter for the various segments, extremities knees and hips any color on there?

David Petty

Yes. The knee was relatively stable, flat maybe slightly down, but call it flat and then I'm talking globally the hip mid single-digits down and extremities about 3% down.

Jennie Tsai

Okay, great. That's helpful. So for the rest of the year in terms of thinking about additional working capital needs and instruments that for the new product launches, do you think you'll have efficient operating cash flow to meet those incremental capital requirements?

Jody Phillips

It’s Jody, Jennie. Good morning. I think you are going to see us dip into our credit facility a little bit over the next three quarters and it’s just all of a factor of building the next wave of these major new revision products and increasing our launch quantities on those, as well as rolling out additional sets of our existing products to some of the new field sales force opportunities that we have. So we're likely going to be in a cash burn situation over the next couple of quarters, but I think it's a great opportunity and we're well financed to do that and so we're going to execute on that.

Jennie Tsai

That makes sense. Thank you.

End of Q&A

Operator

[Operator Instructions] All right, gentlemen it looks like we have nothing further from the audience. I'll turn it back to you for any additional or closing remarks.

David Petty

Thank you, Greg and thank all of you for joining us on this call this morning. And we appreciate your interest in Exactech and look forward to being with you again after the second quarter is over. Have a great day.

Operator

And ladies and gentlemen that does conclude today's conference. Thank you for your participation.

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