Orthofix International N.V. (NASDAQ:OFIX)
Q1 2016 Earnings Conference Call
April 28, 2016 4:30 PM ET
Mark Quick – Director-Business Development and Investor Relations
Brad Mason – President and Chief Executive Officer
Doug Rice – Chief Financial Officer
Raj Denhoy – Jefferies
David Turkaly – JMP Securities
Jennie Tsai – Gabelli & Company
Hello and welcome to the Orthofix First Quarter 2016 Earnings Conference Call. Today's call is being recorded. I would now like to turn the call over to Mr. Mark Quick, Director of Business Development and Investor Relations. Please go ahead, sir.
Thanks, operator, and good afternoon, everyone. Welcome to the Orthofix first quarter 2016 earnings call. Joining me on the call today is our President and Chief Executive Officer, Brad Mason; Chief Financial Officer, Doug Rice; and Chief Strategy Officer, Mike Finegan.
I will start with our Safe Harbor statements and then pass it over to Brad. During this call, we’ll be making forward-looking statements that involve risks and uncertainties. All statements other than those of historical fact are forward-looking statements, including any earnings guidance that we provide or any statements about our plans, beliefs, strategies, expectations, goals or objectives. Investors are cautioned not to place undue reliance on such forward-looking statements as there is no assurance that the matters contained in such statements will occur.
The forward-looking statements we make on today's call are based on our beliefs and expectations as of today, April 28, 2016. We do not undertake any obligation to revise or update such forward-looking statements. Some factors that could cause actual results to be materially different from the forward-looking statements made by us on the call include the risks disclosed under the heading risk factors in our 2015 Form 10-K, as well as additional SEC filings we make in the future. If you need copies of these documents, please contact my office at Orthofix in Lewisville, Texas.
In addition on today's call we’ll refer to various non-GAAP financial measures in which we exclude certain items from our U.S. GAAP financial results. We believe that in order to properly understand our short-term and long-term financial trends, investors may wish to review these matters as a supplement to financial performance measures determined in accordance with U.S. GAAP. Please refer to today's press release announcing our fourth quarter 2016 results for reconciliation of these non-GAAP performance measures to our U.S. GAAP financial results.
At this point, I'll now turn the call over to Brad.
Thanks, Mark, and good afternoon everyone. I will start by giving you a summary of our first quarter 2016 performance, after which Doug will walk you through the financial results that we reported today. I will then follow up with a few thoughts about our updated expectations for 2016 and beyond before opening up for Q&A.
Q1 was another strong quarter for Orthofix, stronger than we had forecasted. There were a couple of reasons for this, which Doug and I will go into shortly, but the overall takeaway is that we excel in many areas of the business, especially given the seasonal weakness historically experienced in the first quarter of the year.
I will start by giving you a few financial highlights on the first quarter. Starting with the top-line, we are very pleased with our net sales growth over prior year of 11.8% for the quarter on a constant currency basis. This follows growth of 7.6% in Q4 and 4.1% in Q3 of last year, showing a very nice top-line performance trend. I would note however that we had an unusually high cash collection quarter in our extremity and spine fixation businesses that favorably impacted our net sales in the period. But even when normalized for this difference, on a consolidated basis, we still have high single-digit growth over the prior year.
A key driver of this growth came from our BioStim strategic business unit, or SBU, which grew 8.9% over the prior year. This was the third straight quarter of strong performance as our team continues to improve our leadership position in the osteogenesis stimulation market by leveraging our proven PEMF technology and through solid execution of our strategies.
Additionally, both of our hardware businesses performed extremely well during the quarter. Our extremity fixation business grew 8% on a constant currency trailing 12-month basis, which when calculated over this extended time period, minimizes the impact of cash collections as Doug will discuss further.
Our spine fixation SBU increased net sales by 15.8% year-over-year in constant currency for the first quarter, highlighting the continued success of our growth strategy. Adjusted for abnormally high cash collections, this SBU nevertheless grew high single-digits in the period. Our adjusted EBITDA as a percent of net sales for the quarter was 15.7% compared to 9.4% in Q1 of 2015.
Our year-over-year adjusted growth rate of over 80% clearly demonstrates our operating margin expansion opportunity and given the historical lower top-line and margin performance of the first quarter of each year, we are very pleased with this performance. As of April 25, 2016, we have purchased accumulative total of approximately 1.1 million shares of our common stock for $43.8 million as part of our ongoing $75 million stock repurchase plan. The repurchase plan remains in effect and we believe it will continue to be an effective way to return capital to shareholders.
I will now review a few of our key operating accomplishments for the first quarter. As we have mentioned over the past few quarters, we have fundamentally changed our new product development processes to accelerate the pace and significance of new product launches. For example, in the first quarter, we launched FORZA PTC, a unique and proprietary technology that combines PEEK and titanium into an interbody solution for the lumbar spine.
Unlike PEEK alone or PEEK interbody products with titanium coated surfaces is hybrid designed using two porous titanium endplates that are injection molded with PEEK into a composite structure that allows the patients’ bone to grow into the implant. Our spine business also released several specialized instruments to simplify and improve procedures from our lateral and midline fusion product lines.
In our extremity fixation SBU, we released the next generation of software to expand the use of our true lock hex system. With this addition, which extends the system to now also include the foot and ankle, we believe that is the most complete system available on the market with functional advantages both mechanically and with the software that drives it.
With our controlled systems and process improvements, now nearing completion, which I will discuss in a moment, we are in a better position to support the integration for inorganic opportunities to grow our existing businesses. We are accelerating these efforts and in the last two quarters have obtained the rights to manufacture, acquire or distribute products for our biologics, extremity fixation, and spine fixation businesses.
In biologics for example, we recently acquired the rights to an MIS delivery system that we expect to release later this year. We believe this product could meaningfully expand the market opportunity of Trinity ELITE. In the first quarter, we also saw concentrated activity related to project Bluecore, our infrastructure improvement initiative including the preparation for implementation, of the Oracle R12 ERP system. We’re very pleased to report that on April 4, we went live on Oracle R12 in the U.S. with no downtime or significant issues. We’re now operating on our new environment with efficient new processes and systems.
Additionally as a part of Bluecore, over the last two quarters, we successfully launched a new accounting consolidation software, human resource management system and automated commissions program. The implementation of Oracle R12 at our subsidiary in Verona, Italy, which is the final piece of the Bluecore project, is scheduled to go live on July 1 and wrap up in the third quarter. We expect the project Bluecore will then be complete ahead of our original timing expectations and within our original budget. The first quarter showed a strong start to 2016 both in our financial and operational performance.
After Doug’s more detail comments on our Q1 financial results, I’ll discuss what we see ahead for the rest of this year and beyond. Doug?
Thanks, Brad, and good afternoon, everyone. I’ll start with providing details into our net sales and earnings results and then discuss some of our other financial measures. Total net sales in the quarter were $98.7 million, up 9.9% from the first quarter 2015 total net sales of $89.8 million, on a constant currency basis net sales increased by 11.8%. Starting with our BioStim SBU, 2016 first quarter net sales were $41 million, up 8.9% versus the same period in the prior year. Looking at the big picture of this business, the significant growth in the last several quarter has been driven by our efforts that we started over two years ago focusing on operational improvements throughout the order to cash process, clinical support of our technology and expanding and better educating our salesforce.
The result has been consistent growth in the number of physicians prescribing our market leading PEMF technology. We have experienced eight straight quarters of year-over-year customer base expansion. The growth rate has been particularly strong for the last three quarters. As we begin to annualize our results in future quarters, we expect to see our topline growth rate returned to mid-single digits, but still outpace the overall market growth rate.
Turning to our Biologics SBU, 2016 first quarter net sales were $14.1 million an increase of 1% versus the same period in the prior year. The positive effects of our clinical study publications and salesforce expansion uptake have been somewhat offset by additional competitors entering the market and low-single digit pricing headwinds. We continue to believe we can overcome these headwinds with our differentiated tissue form Trinity ELITE and achieve mid-single digit growth for the year.
Moving onto our Extremity Fixation SBU, 2016 first quarter net sales were $24.7 million, an increase of 13.3% in comparison to the same period in the prior year. On a constant currency basis, this SBU increased net sales by 20.9%. The growth in the quarter was primarily driven by strong performances in the U.S. and Brazil as well as higher than expected international cash collections offset by a negative foreign currency translation. We mentioned on our last call that we believe that Brazil had bottomed up and would begin to recover in 2016. So we’re pleased with this early indication.
Since we’ve recognized revenue from a large portion of our stocking distributors only upon cash collections, we believe that at constant currency trailing 12-month revenue growth rate gives our investors the best measure of the performance of this business. In constant currency, at the end of the first quarter, the trailing 12-month year-over-year growth rate in this SBU was 8%.
And lastly, our Spine Fixation SBUs 2016 first quarter net sales were $18.8 million, an increase of 15.6% in comparison to $16.3 million for the same period in the prior year. On a constant currency basis, the business grew 15.8%, the growth in this quarter was primarily driven by the expansion of the U.S. salesforce and the uptake of new products launched in 2015. We’re pleased in particular to see our U.S. business achieve mid-to-high single digit growth in the last few quarters. This SBU also benefited from higher than expected international cash collections in the quarter. We’re normalized for this variance the year-over-year growth rate was in the mid-single digits.
Now, I’ll move onto the rest of the P&L. First quarter gross profit was $76.5 million, up $6.1 million from the first quarter 2015. Gross margin in the first quarter 2016 was 77.6%, down 90 basis points compared to 78.5% in the prior-year period. The decrease in gross margin is primarily due to the increased proportion of sales from our fixation products, which have lower gross margins compared to our regenerative solutions. In the first quarter of 2016, fixation products were 44% of net sales versus 42% in the prior year period.
Sales and marketing expenses were $44.8 million or 45.4% of net sales in the first quarter of 2016, compared to $44.3 million or 49.3% of net sales in the first quarter of 2015. This decrease as a percent of net sales was primarily due to increased operating leverage of our fixed sales and marketing expenses as well as a decrease in commission expenses as a percentage of net sales.
Net margin, which we define as gross profit minus sales and marketing expenses was $31.7 million or 32.2% of net sales in the first quarter of 2016, up $5.6 million from $26.1 million or 29.1% of net sales in the first quarter of 2015. The improvement as a percent of sales was due to the improvement in sales and marketing expenses as a percent of sales, offset somewhat by the decline in gross margin.
General and administrative expenses were $16.7 million or 16.9% of net sales in the first quarter of 2016, which was a decrease of $4.9 million or 22.5% compared to $21.6 million in the prior year period. When excluding cost related infrastructure investments, G&A expenses were 16.0% of net sales versus 21.6% in the prior year, which was mostly driven by reductions in finance and accounting expenses.
Research and development expenses were $7.6 million or 7.8% of net sales in the first quarter, which was up $5.8 million or 6.5% of net sales in the prior year. This increase was primarily driven by $1.3 million investment to expand the processing and storage capabilities of MTF, the supplier of our Trinity Evolution and Trinity ELITE tissue forms. This payment was made pursuant to the terms of a recent amendment to our existing marketing services agreement with MTF. This amendment also extended the term of our existing agreement by two years to July of 2025.
Adjusted EBITDA during the first quarter was $15.5 million or 15.7% of net sales, compared to $8.4 million or 9.4% of net sales in the prior year. The significant year-over-year increase in adjusted EBITDA was primarily due to higher gross profit and increased operating income resulting from lower operating expenses.
Income tax expense from continuing operations for the first quarter was $4.3 million or 48.1% of income – before income taxes as compared to income tax expense of $1 million or minus 14.2% of income before income taxes in the same period of 2015.
We currently believe that our long-term tax rate will be 38% and in order to eliminate tax rate volatility in our quarterly non-GAAP reporting we will apply this tax rate to derive adjusted net income perspectively.
For the first quarter 2016, we reported net income from continuing operations of $4.6 million or $0.25 per diluted share as compared to a net loss from continuing operations of $7.7 million or $0.41 per diluted share for the first quarter of 2015. After adjusting for certain expenses including foreign exchange impacts, strategic investments, restatement and related costs, Bluecore infrastructure investments and gain on sale of assets, adjusted net income from continuing operations was $5.3 million, or $0.28 per diluted share, compared to $700, 000 or $0.4 per diluted share in the first quarter of 2015.
Moving on the balance sheet highlights. Days sales outstanding, or DSOs, were 51 days at March 31, 2016, down from 59 days at March 31, 2015. Our inventory turns at the end of Q1, 2016 were 1.5x, which was down from 1.7x at the end of Q1 2015. This decrease in turns was driven by the additional inventory needed for new product launches during the year.
Cash and cash equivalents at the end of the first quarter, were $39.8 million compared to $63.7 million, as of December 31, 2015. This change in cash was primarily driven by the execution of our stock repurchase program. We continued to have no long term debt on our books.
As of March 31, 2016 the Company had repurchased accumulative total of approximately 970,000 shares of common stock for $38 million under the $75 million share repurchase program, of which approximately 676,000 shares of common stock were repurchased for $26.5 million in the first quarter of 2016.
Cash flow from operations for Q1, 2016 was $4.4 million compared to $2.5 million during Q1, 2015. The increase is primarily reflective of the year-over-year increase and net income of $12.3 million, and non-cash items of $3.6 million, partially offset by an $14 million decrease in cash provided by changes in working capital.
Capital expenditures for Q1, 2016 were $6.4 million versus $5.1 million in the prior year. As I noted on the last call, we anticipate we will incur approximately $6 million of Bluecore expenditures in 2016, and our current expectation is that the mix of these costs will be recognized as approximately 25% operating expenses and 75% capital expenses.Free cash flow, defined as cash flow from operations minus capital expenditures was outflow of $2 million for the quarter compared to an outflow of $2.6 million from the prior year period. The year-over-year improvement in free cash flow is primarily driven by the operating cash flow increase partially offset by an increase in capital expenditures.
In 2016, we expect to see our free cash flow generation improve as a result of both our margin expansion strategy and a significant reduction in capital spending relative to 2015.
I will now turn it back to Brad.
Thanks, Doug. Looking ahead now in 2016 we will continue to focus on executing the three key objectives I outlined previously, accelerating the rate of our topline growth, expanding our margins and continuing to invest in clinical research to drive future growth.
We plan to accelerate the rate of our annual topline growth by continuing to expand and optimize our salesfroce, drive market acceptance of our technologies through clinical support and field trading and launch new and innovative products throughout the year in all four of our SBUs.
In addition to our internally generated new product lanuches we will be more active in looking for complimentary products and technologies that we get add to our product portfolios.
In regards to expanding our margins with our infracture improvement projects now nearing completion, we can focus on continuous improvement initiatives in all areas of the company. In order to become more effective and efficient in particular in our SG&A expenses.
We expect the resulting cost savings coupled with absorption of fixed costs by increasing our topline to drive improving margins over the next four to six quarters. As I previously stated our expectation is to achieve greater than 20% adjusted EBITDA margin for the full year of 2017.
In 2016 we will continue to work on a variety of pre-clinical and clinical studies that are currently in process. These studies support both the use and value of our existing products as well as the potential for new indications for use of our core PEMF technologies, such as for treatment of rotator cuff injuries and knee osteoarthritis.
Additionally, we will continue to evaluate and initiate new pre-clinical and clinical studies through the year, not only for PEMF, but for all of our businesses and technologies to help drive long-term growth. These are exciting times for Orthofix and well and is often said by companies that they are “well positioned for the future”. The truth is we are. To illustrate this we have four profitable and growing businesses. The most extensive pipeline of new products under development in our history.
Clinical research studies creating future opportunities and restructured foundation including systems, controls, reporting processes, margin expansion opportunity, a solid balance sheet, strong free cash flow generation capability, robust compliance program and an exceptional team of directors and executives.
Based on our Q1 performance and momentum, we are updating our guidance as follows. We expect to achieve net sales at today’s FX rates in the range of $412 million to $416 million as compared to prior guidance of $407 million to $412 million. This represents a year-over-year growth rate of 3.9% to 4.9%. Additionally, we anticipate year-over-year growth in each of our four SBUs for the year.
This updated range includes $900,000 of net sales in Puerto Rico that we recognized in the first quarter. Due to the continuing economic uncertainty at Puerto Rico our previous annual guidance did not include any net sales for Puerto Rico nor have we included any for the remainder of the year in the guidance we are giving today.
We expect adjusted EBITDA for the full year to be between $69 million to $72 million as compared to prior guidance of $67 million to $70 million this expected result reflects an increase of 13.7% to 18.6% over 2015. We expect full year 2016 adjusted diluted earnings per share to be in the range of $1.35 to $1.45 using weighted average shares of $18.7 million and a long-term tax rate of 38% this is an increase from prior guidance of $1.25 to $1.35 per share.
And we continue to expect capital expenditures to be in the range of $15 million to $18 million for the year, of which approximately $5 million will be related to finalizing our Bluecore initiatives. From a capital investment standpoint, in 2016 we plan to continue to implement our stock repurchase plan while investing in clinical research and the acceleration of new product launches.
With our foundation now rebuild we intend to be more aggressive in finding licensing and tuck-in acquisition opportunities with the intention of leveraging our strong distribution channels, operational competencies and management expertise while remaining mindful of returned on invested capital.
With that, operator, we can open up the lines for questions.
Thank you. [Operator Instructions] And we will go first to Raj Denhoy with Jefferies.
Hi, good afternoon.
Hey, Raj, how are you?
Doing great. How you guys doing?
We are having a good day. Thanks.
What if I could ask a bit about some of the commentary around the expenses and it sounds like your – perhaps more so than in times past really willing to entertain the idea that maybe to have your expending is kind of behind us, we will be behind us very soon. Use words like leveraging fixed expenses and things like that. So as we move through 2016 into 2017 is there any better guide post you can provide for us in terms of how much spending we can expect to start to bleed out here now that Bluecore is nearing completion and you do start to leverage some of the investments you’ve made.
I think, Raj, I think our best opportunities really are in the sales and marketing area we still have opportunities in a number of areas including just leveraging the capacity we have today as we expand our sales some of this is just going to be a fixed cost absorption that’s going to be help us we also have opportunities in – still in commissions, yes, you’re going to see higher commissions for a period of time as we bring on new distributors as you know we bring them on into higher commission rate to being with, they get a higher percentage on growth. So as we absorb those the new distribution that we brought on in the last year or so, that will begin to trend down a little bit.
And also in G&A we still have a lots of opportunity, we are just beginning there we just went live with Oracle, are 12 in the states we are going to finish that off in Q3 in Verona. And so as I said in my script I think four to six, another four to six quarter so really kind of ring out the rest of the juice in the orange and by the end of next year, we should be – we’ve got enough room that I think we will be in a really good place by them.
Okay, maybe I could just ask one other one on a – on one of the SBUs the spine business I think you noted the part of the growth, the acceleration growth there has been the additional sales people you’ve been adding as you start to anniversary some of those additions is there a possibility the growth could slow there or do you plan to kind of continue to invest in that sales force with the correlate and will the leverage become less tangible?
In the spine business actually the growth is going to come from I mean, we really haven’t ramped up the new distribution we brought on that usually takes nine to 12 months to ramp it up, so that’s still we still have headroom there. And additionally we got a great string of new products coming out that will accelerate as well. We are not getting even in the numbers you’re seeing today you’re not seeing much of the benefits the new products yet a lot of them are – have been released on limited market basis, they are just rolling into full market release and that will happen through 2016 and you will start to see more in 2017. Additionally, we are going to continue to add to our sales force over time. So it will be a little bit, to be a little bit choppy from quarter-to-quarter but its going to be the trend will be good.
Great. Thanks, congratulations on the progress.
Thank you, Raj. Appreciate it.
Thank you. [Operator Instructions] We will go next to David Turkaly with JMP Securities.
Hi, how are you guys?
Good, Dave, how are you?
Pretty good. Just in terms of your guidance for the SBUs I just want to make sure, I heard this right in terms of your expectations if we – look at the quarter and then sort of the commentary would be expect the fixation part, extremity and spine to kind of stay slightly above your guidance of kind of 4% at the midpoint revenue growth for the year would it be fair that those will be the leading categories as we go to 2016?
In general, they’ve got more probably more opportunity to grow a little bit faster than our regenerative businesses for the rest of this year at least. So yes, I think that’s a fair statement, Dave.
And then to follow-up and sort of Raj was asking on the leverage side of the sales and marketing side. I think you have a big push and that is I think fixed cost. And I was just kind of wondering 45%, have you thought it all or talked all about sort of where you think that could go, say, even if you're looking over the next 12 months. I know that you try to want to give a specific guidance number, but I know it's coming down a lot, but it still seems kind of high. I guess if you could just remind us of if there's any kind of target longer term where that could go that would be helpful.
On the last call I gave guidance and generally for this year – excuse me, Dave, 44% to 45% for our sales and marketing expenses. That's just for 2016. I think we have more room than that. I really don't want to get too specific about it. But we certainly feel like you do that we have more room there for improvement. And particularly when you think about the fixed cost absorption that you mentioned and also the absorption, the higher commission rates due to that impact of distributors that we've added recently.
And overall would you say your sales and marketing feet on the street have increased, despite the leverage that you show in this quarter? I mean your headcount is higher. Would that be a fair statement?
Yes. The headcount is quite a bit higher, but remember we have a hybrid sales force. So most of our sales reps if you think in the U.S. across all of our businesses are distributors, so there’s, yes, the cost of adding new distribution for us is increased instrument sets in the field and it's higher commissions for a period of time and then it drops off. So we don't have a huge expense or adding more distribution, but yes, we have a lot more feet on the street.
Great. Thank you.
You’re welcome, Dave. Thank you.
Thank you. [Operator Instructions] We will go next to Jennie Tsai with Gabelli & Company.
Hi, good afternoon.
Hey, Jennie, how are you?
Good thanks. I wanted to ask you a question about the biologics, it was up 1% this quarter, and you talked about additional competitors and pricing pressure. But do you do expect that business to be up mid single-digits for the year? I just wanted to get some more commentary on that…
Sure, Jennie. Yes, absolutely. It's a great question. So we were up 1% in Q1. That was not that far off of our expectations, a little bit short, but not that far off. We still believe with [indiscernible] with the things that we're doing, the sales force that we're adding, the strategies that I won’t talk about necessarily on the phone, that we will get to mid single-digit growth for the year.
Bob Goodwin, our President on that division assures me that's going to be the case at minimum. No, I’m just teasing, he’s in the room actually. So, he assures me that they're going to get there and I absolutely agree with him, so we will.
Okay, great. Also you talked about price pressure, where there – did you see it in any of the other segments?
Not that it was particularly noticeable for the quarter that we saw. No.
Okay, good. And I guess on the operating expenses, you talked about your goal of 20% EBITDA margin in 2017 as some of your expenses roll off and let's say you get there. And I know you don't want to – it's hard to go too far out. But just kind of thinking, if your organic growth was growing, let's say, mid to high single-digits combined for the businesses, what kind of aspirational operating margin improvement sort of do you have on an annual basis? What do you think you can get with the fixed cost leverage?
Well, that's good question. So we know for – we know what we talked about for 2017 and we don't – I don't have any thoughts beyond 2017 and specifically around that leverage. But certainly I've seen in the past in with companies of this size in this position, it’s going to continue to increase as time goes on. Obviously, there's going to be a limit. And there's going to be a sweet spot where we want to be, where we're still investing in the business, and not borrowing against the future of it. And so I think if somewhere worth 20% and then EBITDA is going to get us in that sweet spot.
Okay, great. Thank you.
You’re welcome. Thanks for calling.
Thank you. And with no further questions in the queue, I'd like to turn the program back over to Mr. Quick for any additional or closing comments.
This is Brad, I just wanted to say thanks for joining us on the call today, we appreciate it, and we look forward to seeing you out in the field, and talking to you next time a quarter from now. Take care.
That does conclude today's call. Thank you for your participation.
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