Exactech Inc. Q4 2007 Earnings Call Transcript

Exactech Inc. (EXAC)

Q4 2007 Earnings Call

February 29, 2008 10:00 am ET

Executives

Bill Petty - CEO

Jody Phillips- CFO

David Petty- President and Director

Analysts

Jeff Johnson - Robert Baird

James Sidoti with Sidoti & Company

Julie Hoggatt - Noble Financial Group

Bill Plovanic - Canaccord Adams

Presentation

Operator

Welcome to the Exactech Incorporated fourth quarter and 2007 yearend Earnings Call. (Operator Instructions)

And I would now like to turn the conference over to Dr. Bill Petty, CEO. Please go ahead, sir.

Bill Petty

Good morning from Exactech on this. I guess we could call it a Leap Day of 2008. Before we start with our opening remarks, which both I and Jody Phillips will give, I'm going to read the appropriate release.

This release contains various forward-looking statements within the meaning of Section 27A of the Securities Act of 1933 and 21E of the Act of 1934. They represent the company's expectations or beliefs concerning future events of the company's financial and performance measures.

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 regulations. Results actually achieved may differ materially from the expected results included in these statements.

I'll first talk about the full year 2007. Revenue for 2007 grew to $124.2 million, compared to $102.4 million in '06 which represents an increase of 21%. Net Income for the full year was $8.5 million, compared to $7.8 million in the prior year. This resulted in $0.72 EPS for the year, compared to $0.67 EPS per share during '06.

Excluding the impairment charge, which we announced in the middle of the year, which was an after-tax impact of $977,000 was related to our diamond technology investments, but without that the net income for 2007 was $9.5 million, which represents an increase of 22%, compared to the results in 2006.

Now moving to the fourth quarter, our revenue was up 26% to $33.1 million, compared to $26.2 million in the fourth quarter of 2006. Net income for the fourth quarter was $2.7 million, or $0.23 per share, versus net income of $2.3 million, or $0.19 per share in the fourth quarter of '06.

People of Exactech around the world have now produced six consecutive quarters of increasing sequential revenue growth. Strong growth in US sales during the fourth quarter was our best domestic revenue growth in the past four years. Our international business continued to perform well. especially in our European and Latin American markets.

Provide a little product line detail, I mean mostly from our Optetrak platform product, our knee sales increased 18% to $63.4 million for 2007. Hip revenues rose 26% to $22.6 million and biologic sales were up 21% to $16.2 million. Upper extremity product line increased 95% to $9.5 million.

Our international sales for the year were up 24% to $27.7 million, compared to $22.3 million in '06. Our international sales represented 22% of our total sales in '07 which is approximately the same as the percentage in '06.

For the fourth quarter, we finish 2007 with improvement in all of our major product line, knee sales were up 24% to $16.5 million, hip sales up 15% to $5.7 million, upper extremity product line up 132% to $3.2 million and biologics up 25% to $4.6 million.

Fourth quarter was also strong for international revenues, which were up 24% to $7 million from $5.7 million in the last quarter of '06. In addition, on the international front, we were excited about our new business models in France and Japan that we announced recently.

We have entered 2008 well-positioned and with strong momentum due to our strong performance in '07 with increasing performance each quarter throughout that year.

Now going to turn it over to Jody and he will give a little more of the financial details. Jody?

Jody Phillips

Good morning, everyone. Thanks for joining us for our full year 2007 and fourth quarter results conference call. Since Dr. Petty has summarized our sales results, I will focus my comment on balance sheet, gross margin results as well as some forward-looking thoughts for 2008.

From our balance sheet perspective, we ended 2007 with $2 million and cash the same as we ended 2006, and we were able to reduce our total debt by $12.7 million during the year. Our credit line with Merrill Lynch was fully paid off as of year end.

Our 2007 capital expenditures were inline with our expectations at $12.3 million. This significant improvement in the balance sheet was a function of improved profitability, the $6 million reduction in total inventory and accounts receivable management with DSOs at 60 for 2007 versus 62 in 2006. As you can see this is a testament to the efficient work by the employees of Exactech across all of functions.

Now looking forward to 2008, we expect total inventories to increase both as a function of the two acquisitions that have been announced and the general increase in our core product inventories that is necessary to support our current growth rate. We project total inventories to be somewhere between $53 million to $59 million by the end of 2008.

For 2008, we expect total capital expenditures of between $12 million to $15 million due to continued investments in surgical instrumentation, facilities expansion and technology licensing activity.

From a financing perspective, shortly after the first of the year, we used our credit line to fund the balance of the Altiva acquisition of $5 million, and we expect to fund the cash portion of the France Medica acquisition of approximately $7 million on the credit facility as well.

Turning briefly to gross margin and operating expenses, our gross margins during the quarter increased to 66.5% as compared to 65.1% in the fourth quarter of 2006. This was due to the strong growth in domestic sales and continued manufacturing cost improvements due to our internal production efforts.

Looking forward to 2008, we expect gross margins to be approximately 1 to 2 percentage point lower on each quarterly basis during 2008 due to robust international sales growth in the France Medica acquisition as it carries lower gross margins.

We expect to make most of this through offering expense leverage and therefore expect our 2008 net income as a percentage of sales to be roughly 25 to 50 basis points lower than what we experienced in 2007.

Back to the operating expenses, our total operating expenses increased 26% for both the full year and the quarter, primarily due to planned research and development expense increase and sales and marketing activities.

The resulting 2007 net income of $9.5 million which excluded the impairment charge announced in the second quarter represented a 22% increase and was significantly ahead of our expectations due to the sales growth.

We have updated our 2008 revenue guidance to a range of $155 million to $167 million under the assumption that we close the France Medica acquisition early in the second quarter and we confirmed our previously release full year EPS guidance at $0.88 to $0.94, as we expect both Altiva and France Medica acquisitions to be neutral to earnings in 2008.

In summary, we feel that we concluded 2007 with a lot of momentum, and we are confident that we can continue performing through 2008.

Nichole, we are ready for questions.

Question-and-Answer Session

Operator

(Operator Instructions) Our first question comes from the line of Jeff Johnson with Robert Baird. Please go ahead.

Jeff Johnson - Robert Baird

Good morning guys. How are you?

Bill Petty

Good. How are you?

Jeff Johnson - Robert Baird

I am doing well, thanks. I am sitting in an airport, so if I breakup here, maybe I'll have to follow-up offline, but hopefully that won't happen, just couple of questions if I could. Jody, just some clarification on the Q1 gross margin -- Q1, '08 gross margin, if France Medica is not closed at that point, should that be down to one to two points as well, or do you think that happens just starting into Q2.

Jody Phillips

We do expect it to be down in the first quarter as well, because we are expecting some rather robust international sales activity and you know what happens with the mix there, so it really applies to all quarters in 2008.

Jeff Johnson - Robert Baird

Okay, fair enough. And then how aggressively as you go throughout 2008, do you think you could pay down the debt. It sounds to me like you will be back up to kind of the same levels, and again I don't have things in front of me, but correct me if I am wrong, about $25 million or so in total debt.

You aggressively paid down in '07, could that happen again in '08 and really goose kind of as we get into '09, the earnings growth?

Jody Phillips

Yeah, our projected high water mark for the debt in 2008 is currently not as high as we experienced a year or year-and-a-half ago. It is projected to go up to around $22 million to $24 million as you projected.

I would think maybe later in the year, we can start to see some cash flow positive in paying it down, but we got it fully recognized. We are going to experience some inventory increases in the first half of this year as we've got some significant build up due to support of the growth we have been experiencing.

Jeff Johnson - Robert Baird

How are you thinking, Jody, about the cash flow for the year. I understand the timing issues there that you are talking about, but for the year in '08 free cash flow positive and by $5 million to $10 million, is that too aggressive?

Jody Phillips

Probably $5 million in the second half of the year, it's a little difficult to get our hands totally around what's going to be required in terms of investment at some of the acquisitions currently, and also some of the inventory management issues, there is a lot of changes going on there now.

So I am a little nervous to give solid numbers, but I think in second half of the year is when we'll turn cash flow positive again.

Jeff Johnson - Robert Baird

All right, great, and then just last question for me, and again kind of goes to '09, I know you are not giving '09 guidance at this point, but as you layer in France Medica and the lower margin impact there, potentially pay down some debt later or beginning in late '08, as we go to '09 are there both margin extension and debt pay down opportunities both on a combined basis is that a fair assumption, or how do you think that will play out?

Jody Phillips

I think there are. Obviously, we want to be conservative in terms of the expectation that are out there, but on a apples-to-apples basis with having a full year with -- or at least three quarters of the year with France Medica under our belt, and hopefully understanding their inventory requirements a little better and continuing to bring more products in house, there should be some opportunity for some gross margin expansion in 2009.

Jeff Johnson - Robert Baird

All right, great. Well, I'll see you next week and congrats on a strong finish to the year.

Jody Phillips

Thanks.

Bill Petty

Thank you.

Operator

Thank you. Our next question comes from the line of Julie Hoggatt with Noble Financial Group. Please go ahead.

Julie Hoggatt - Noble Financial Group

Yes, hi guys. Congratulations on a good quarter, I was hoping you can give us little color on your hips they increased nicely year-over-year, and I was wondering if you could give any color on what percentage of that was from your ceramic-on-ceramic?

Bill Petty

David, do you want to answer that?

David Petty

Hi, Julie it's David. Yeah, I don't have the precise number of what percentage of ceramic-on-ceramic, but without giving that number I will point out that the most important thing about having that ceramic offering is that it allows our sales organization to approach surgeons who previously were not interested in talking about Exactech hips.

Because, occasionally they would like a ceramic-on-ceramic bearing and to the extent that we didn't have it, they did not want to be switching to different companies based on clinical needs.

So we've expanded the universe of customers that are willing to look at our hips, and absolutely, we have increased our hip sales meaning we're selling more Novation hips, because we have ceramic even if the same customers are not using ceramic on a regular basis.

Julie Hoggatt - Noble Financial Group

Okay. Well, can you give me an idea about percentage of accounts that were gained due to your expansion of products, or I mean percentage of accounts that were gained this quarter? Some sort of color there to quantify it?

David Petty

See, I think it will be difficult to that, Julie. I would be willing to look at and may be try to address it offline, but I am afraid I'll give you the wrong number if I try to give that level of detail on percentage of accounts gained based specifically on ceramic.

In fact, I am not even sure we would have that data, because it's sort of a subjective thing and it's not really a hard data question.

Julie Hoggatt - Noble Financial Group

Sure. Well, have they been increasing is my question?

David Petty

Another way to say it is our sales growth due to adding new customers and hips, and the answer is absolutely yes.

Julie Hoggatt - Noble Financial Group

Okay. And Jody on the gross margin, just to get some color on Altivas gross margin, again you think that that's going to -- is that obviously it's reflecting your guidance, but was your gross margin better or worse than your average company gross margin?

Jody Phillips

It's not a contributing factor to that change that are projected for 2008, its roughly inline with our company average, or we expect it to be I should say, obviously we --

Julie Hoggatt - Noble Financial Group

Okay.

Jody Phillips

Haven't reported any results there on Altiva, but our expectations that it will be consistent with our company average at this point.

Julie Hoggatt - Noble Financial Group

Okay. Thanks so much, guys.

David Petty

Okay, Julie

Jody Phillips

Thanks.

Operator

Thank you. Our next question comes from the line of Bill Plovanic with Canaccord Adams. Please go ahead.

Bill Plovanic - Canaccord Adams

Great thanks. Good morning guys.

Bill Petty

Good morning, Bill.

Bill Plovanic - Canaccord Adams

Hey, just trying to figure out, we have AAOS coming out next week. Just give us an idea or maybe some of the new products we could look for some of the drivers as we head into 2008 and 2009 for the company. Thanks.

Bill Petty

Sure and those are maybe you can -- slightly different questions, at academy next week we are going to be showing -- continuing to focus on some of the things that really developed the momentum last year.

So obviously the Novation here put ceramic offerings and on then the shoulder the addition of the reverse and with the biologics line continuing with the rollout of the Optecure product line as well as the accelerate Accelerate platelet with concentrating system.

On knees, we have as you know focused on the instrumentation side with ligament balancing and low profile instrumentation and outside the U.S. And of course, next week is a U.S. meeting, but outside the U.S. with the rotating bearing knee and to the extent that there are the customers visiting from outside the U.S, We will certainly be focused on the rotating bearing knee.

But your question really then extended into later this year and into 2009, and we will be as this year progress with knee looking at some new implants one been a more of conservative approach to Unicondylar system that can be -- the surgical approach through is an arthroscope.

And it's a more sort of minimally invasive type approach to a Uni as well as a more sophisticated approach to balancing the post posterior cruciate ligament and a cruciate retaining knee and that's an additional offering for the Optetrak system that we are going to be launching later this year.

And on hips we are really focused on continuing to develop a strong platform under the Novation brand, while at the same time looking at some of the different philosophies outside the US that our current systems don't meet.

And so you will see from us over the next year and a half or so, a focus on specific hip designs for outside the US. On the upper extremity line, we are working on a new Glenoid to go with the Equinoxe system as well as the fracture plating system.

Bill Plovanic - Canaccord Adams

And then on the growth in biologics in the quarter that was very solid, is that all the new Optecure products or..

Bill Petty

It's a combination of the Optecure as well as contributions of the accelerate the PRP and the platelet concentrating system.

Bill Plovanic - Canaccord Adams

Okay. Great. Thanks a lot.

Bill Petty

Thank you.

Bill Petty

Thanks, Bill.

Operator

(Operator Instructions) Our next question comes from the line of James Sidoti with Sidoti & Company. Please go ahead.

James Sidoti - Sidoti & Company

Good morning, Jody. Good morning, Dr. Petty.

Jody Phillips

Good morning, Jim.

Bill Petty

Hello.

James Sidoti - Sidoti & Company

Question on distribution over Altiva, now that you've closed the deal, are there opportunities now to start to put some of those products through your existing channels, or do you see any big changes there?

Bill Petty

That's not our strategy, Jim. As you well know the call patterns, the knowledge base etc cetera for spine are quite different compared to major joint replacement, which is where Exactech's expertise is.

So I won't say that we won't have some of our stronger agencies who may represent both product lines. Those decisions will be made separately by the management of Altiva and the management of Exactech.

So I guess maybe just a way to summarize that is, our strategy is not to try to push the spinal products through our current sales force.

James Sidoti - Sidoti & Company

So in general you are basically going to run both businesses were around the way they've been run in the past couple years no major changes?

Jody Phillips

Well, from the standpoint of what we were just discussing, we believe that we can bring a lot of enhancement to Altiva if you remember its not being too long it Exactech was the same size that Altiva is, and we've been able to go through various stages of growth.

We certainly had some systems in some other activities in Exactech that we think are very synergistic in working with Altiva, and will enhance their ability to grow.

James Sidoti - Sidoti & Company

And then on the international side, I know you went direct in the UK, I think a year or two ago you are going direct now in Japan and France, do you think this trend will continue, do you see other territories where at some point you will be direct in 2009 and 2010?

Bill Petty

I'll ask David to respond to that Jim.

David Petty

Hi, Jim. If you look at longer-term look, I would say almost certainly, we'll have a direct model in other territories. I will also say that we have no plans to have any more direct operations for example 2008, we feel like it's very important that we focused on the Japan and France Medica opportunities currently.

In both of these cases, we had a specific opportunity based on availability of a very good team in Japan that allowed us to focus on Exactech products under a direct model and in France really quite simply the personal plans of the individual who primarily own that business and being ready to exit the business, it was a good opportunity.

We still are big believers in the distribution model, at the same time opportunistically we certainly will be looking at opportunities where it make sense for Exactech to be direct over a period of years.

James Sidoti - Sidoti & Company

Okay, great, thank you.

Operator

(Operator Instructions). Our next question comes from the line of Jeff Johnson with Robert Baird. Please go ahead.

Jeff Johnson - Robert Baird

Hi guys, just one quick follow-up here. Obviously a lot of new product launches over the last year helped revenue growth accelerate here. As we start to anniversary some of those, and I know there is a lot of good things going on with France and what have better could help push it even further.

But how do we think about the gating in each of the four large segments, if you will, now of your business just qualitatively more than anything I guess, do they all stay in kind of that upper teens and beyond or and even that range, or there are one or two areas that you would expect higher growth and may be some moderation in others?

Bill Petty

Jeff, obviously, shoulder growth of a hundred and something percent last quarter, we expect that to be above the teens or the low 20s in the near-term and probably in the immediate-term. I am certainly not promising a 132% growth going forward on a shoulder side.

And I think the other thing about that is, I think we can see some movement up and down within specific product launch. Frankly, our goal is for the company, to keep our growth at least in the range that you've asked about, but we'll maybe one quarter, for the one-half of the year the knee be up a little more, and the next one the biologics up a little more.

Yes I think there is no question that's true and that's not only depended on product launches, it's also depended on our training programs with our sales organization and improvements in our sales organization.

And I think that we've done I think a great job with introducing new products that surgeons are accepting, and we have a strong product pipeline to continue to do that. Another major reason for our success is the improvement in growth in our sales organization, both domestically and internationally.

If you ask me numbers of sales representatives, we have in the U.S, frankly they have been steady for the last two or three years. While our sales have almost doubled, that's because we have higher quality reps, stronger reps focusing more of their attentions in many instances, complete attention on Exactech products.

So we believe that it's really a two-prompt approach. One is very strong product offerings that surgeons believe will approve their patients' outcomes in the other is a very strong emphasis on improving the quality and of course also the size of our sales organization.

Jeff Johnson - Robert Baird

Great, and I guess, if I just boil all that down Dr. Petty it sounds to me it should on an annualized basis stay pretty broad based across all segments to growth.

Bill petty

That is certainly our strategy and that's what we have planned for, and that's the way we divide up our development resources.

Jeff Johnson - Robert Baird

All right, Thanks guys.

Dr. Bill petty

You're welcome.

Operator

Thank you. There are no further questions. I would like to turn it back over to Dr. Bill Petty for closing remarks.

Bill petty

Thanks to all of you for been with us this morning. I hope you have a great weekend. And look forward to seeing at least some of you next week at the AAOS meeting in San Francisco. Bye.

Operator

Thank you, ladies and gentlemen. That does conclude our Exactech Incorporated fourth quarter and 2007 year end earnings conference call. Thank you for your participation and have a great day.

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