Executive
Gary D. Henley – President, Chief Executive Officer
John K. Bakewell – Executive Vice President, Chief Financial Officer
Analysts
Mike Matson - Wachovia Capital Markets
Jason Witties - Leerink Swann
Mark Mullikin - Piper Jaffrey
Taylor Harris - JP Morgan
Philip Legendy - Thomas Weisel Partners
Raj Denhoy - Bear Stearns
Bill Plovanic - Canaccord Adams
Steven Lichtman - Banc Of America Securities
Jeff Johnson - Robert W. Baird & Co.
Robert Hopkins - Lehman Brothers
Wright Medical Group, Inc. (WMGI) Q1 2008 Earnings Call April 24, 2008 4:30 PM ET
Operator
Welcome to the Q1 2008 Wright Medical Group, Inc. earnings conference call. (Operator Instructions) I would now like to read the Safe Harbor from Wright Medical Group.
This conference all may contain forward-looking statements as defined in the Federal Security law, in fact every statement made during this call, except for those of historical fact, will be forward-looking statements. Forward looking-statements reflect the current knowledge, assumptions, beliefs, estimates, and expectation of our management.
They also express our management’s current views of future performances, results, and trends. We caution you that the actual results may differ materially from those described in these statements. Forward-looking statements are subject to a number of risks and uncertainties, including those discussed in the filings with the Securities and Exchange Commission.
These SEC filings include our 10-K for 2007 and our subsequent 10-Qs during 2008. These risks and uncertainties could cause our actual results to materially differ from those described in the forward-looking statement.
Although we believe that each forward-looking statement is accurate, there can be no assurance that they ultimately will prove to be so. You should not view a forward-looking statement as a representation by us that the described results will be achieved. We caution you not to place undue reliance on any forward-looking statement. All forward-looking statements are made as of today’s date and we assume no obligation to update any such statement after this date.
Gary Henley
Welcome to our first quarter earnings call. I’m pleased to share with you the details of our first quarter 2008 financial results, which reflect a quarter of excellent sales growth and operating leverage for Wright Medical as evidenced by both our top and bottom line results, both of which exceeded our communicated target ranges.
With me on the call today is John Bakewell our Executive Vice President and Chief Financial Officer. Together John and I will be discussing our first quarter results and the progress that we’ve been making within our business, as well as the outlook going forward.
Our Q1 performance reflects yet another quarter of continued acceleration in our global sales rate growth rate. In fact this is our ninth consecutive quarter of accelerating global sales growth, which in turn produced an excellent operating performance that exceeded the upper end of our communicated EPS guidance range.
Before we begin, I would like to note that we will be using a number of non-GAAP financial measures to describe our performance. Regarding that, I will refer you to reconciliations that appear in the table of today’s press release, as well as on our web site. Note further that our Form 8-K filed today provides a detailed narrative that describes our use of such measures. Please note that all of today’s discussions regarding results of operations refer to our as adjusted results.
I’ll start today with a summary of our top and bottom line results: first for Q1 and then move into a detailed review of our revenue performance. John will then address the other key line items that make up our financial performance. Together we will wrap up our prepared section of today’s call with some business updates, before we begin taking your questions.
Let’s get started. Net sales for the first quarter 2008 totaled a record of $115.9 million, representing a 23% increase over net sales of $94.3 million in the first quarter of 2007, finishing above the upper end of our previously communicated guidance range of $106 to $109 million.
Excluding the favorable impact of foreign currency on our international revenues, totaling approximately $4.1 million, global net sales increased 19% during the first quarter. We are very pleased with the Q1 sales performance which produced double-digit growth in all of our product lines globally, including the continued outstanding performance of our extremities product line, which posted a 57% global growth rate.
In addition to our excellent sales performance we achieved adjusted net income of $8.9 million or $0.23 per diluted share for the first quarter, finishing above the upper end of our adjusted EPS guidance range. This earnings performance was the result of our strong sales performance combined with outstanding Q1 operating leverage, leverage that we were not expecting to see untilQ2, when the 2007 acquisitions began to annualize. As a result, for the first quarter we achieved adjusted operating income growth of 43%; adjusted net income growth of 34% and adjusted EPS growth of 21%. I think that’s a very nice start to 2008.
Looking now at our sales results in detail, first geographically, we had a solid first quarter both in the US and in our international markets.
Domestically, our sales totaled $67.2 million during Q1, representing an increase of 20% over the prior year period. Extremities and biologics led the way in the US during Q1 with extremities posting a 55% growth rate. Our large joint reconstructive business also contributed nicely with a 9% domestic growth rate.
Internationally, we had another strong quarterly sales performance. International sales totaled $48.6 million, representing an increase of 27% as reported and 17% before favorable impact of currency. In particular, we are pleased with the performances of our Japanese business, our continued penetration into Middle East and African markets and by the contribution made to our international extremities line by our DARCO products.
As evidenced by our extremities growth rates during the first quarter, revenues from products acquired in our DARCO, R&R Medical and Bilarge acquisitions benefited both our domestic and international sales performance. Those revenues contributed approximately 6 percentage points of growth to each of our domestic, international, and global consolidated sale performances. Importantly our global sales growth, which as I mentioned accelerated once again during Q1, did so both inclusive as well as exclusive of revenue from products acquired.
I’d now like to discuss our sales by product line. Knee products sales totaled $30.2 million in Q1 an 18% increase as reported and 14% increase over prior year before currency. Domestic knee sales increased in Q1 by 15% over first quarter previous year. This Q1 domestic performance was driven by continued success of our advanced stature specific components, as well as early results from our limited launch of the advanced BIOFOAM Tibial Base.
International knee sales increased by 22% on an as reported basis and 13% in cost and currency driven by strong growth in Japan as well as continued success in some of our newer European markets.
During the first quarter our global hip sales totaled $39.9 million, increasing by 16% as reported and 10% in cost and currency. Domestic hip growth totaled 4% during the quarter, while international hip growth totaled 28% as reported and 16% before currency. International hip growth was broad based with strong growth in certain European markets, Latin America and Asia, most notably in Japan.
Extremity sales totaled $20.5 million during the first quarter, increasing by 57% as reported and 54% before currency. Domestic extremities growth continued to accelerate sequentially to 55% during the first quarter, while international growth totaled 67% as reported and 51% before currency.
As I mentioned previously, the acquisitions are contributing significantly to our extremities growth rates; however, we’re also seeing excellent growth domestically in our core product lines: excluding product sales from acquisitions, our domestic extremity sales increased by 23% in Q1, driven by the continued success of both our new and core products within our Charlotte line of foot and ankle products.
Our global biologic sales totaled $20.7 million during the first quarter, representing a 14% increase over prior year as reported and a 12% increase on cost and currency.
Domestic biologic sales increased 17% in Q1 driven by our PRO-DENSE injectable synthetic bone graft as well as the continued success of our GRAFTJACKET soft tissue repair line.
International sales of our biologics products increased 1% as reported and decreased 6% before currency, primarily due to the disposition of our ADCON related assets in Q3 of 2007. Excluding the prior year sales of ADCON, international biologics grew 13% as reported and 6% before currency in Q1.
In summary, we were very pleased with our financial performance this quarter. Net sales and first quarter earnings exceeded the upper end of our previously communicated outlook ranges, with double-digit growth in our large joint recon business, mid-teens growth from our biologics business and a break out extremities performance.
We’ve propelled ourselves, our overall cost and currency growth rate, into the upper teens range, slightly ahead of our long-term corporate sales objective.
At this point, I’d like to introduce John Bakewell, our Chief Financial Officer, to discuss additional financial details of our first quarter.
John Bakewell
I will follow our usual format and pick up where Gary left off by reviewing with you our P&L components below the revenue line that contributed to our first quarter results, and then I’ll discuss our current financial outlook for Q2 and the full year 2008.
As has been our practice in the past, today’s press release provides you with our P&L results in accordance with GAAP performance and it also includes tables which provide reconciliations of certain of our P&L components from an as reported GAAP basis, the one that’s adjusted to exclude the impact of those items noted.
Primarily the impact of restructuring charges related to the initiative we announced in June of last year to close Toulon, non-cash stock-based expenses and charges relating to the ongoing Department of Justice inquiry.
We recognize that most of you evaluate our performance on a basis that excludes non-cash stock-based expense, as well as these other non-recurring items, so we provided you with all the information necessary so that you can model our P&L on that adjusted basis.
With that, let’s move into the discussion of our as adjusted results. I’ll begin with review of our gross margin performance and from there work down through the rest of our P&L.
Beginning with our Q1 gross margin, overall we achieved 72.4% for the quarter, which is a 50 basis point improvement from the 71.9% posted in prior year Q1. We continue to have expectations for overall gross margins in the 72% range for the full year 2008 although, as has been the case in prior years for the second quarter of 2008, you should expect to see a gross margin performance a little bit below that full year expectation: closer to 70% during Q2.
As we pointed out in the past and we’ll continue to remind, our gross profit percentage often varies by quarter due to the seasonality of our sales and other mix considerations; so as we move from quarter to quarter through out 2008, you should plan to see those sorts of variations once again.
Turning to our operating expenses, on an as adjusted basis, total operating expenses for the first quarter totaled $70.7 million or 61% of sales compared to $58.6 million or $62.2% of sales for Q1 of last year, a 120 basis point improvement, which was considerably better than our expectations going into the quarter.
Sales over achievement and solid expense control during Q1 enabled us to create good leverage despite the annualizing of last year’s acquisitions not beginning until Q2 next quarter. We’re very much committed to improving our operating leverage this year and therefore, particularly with respect to the leverage contributions from SG&A.
Our performance during Q1 provides us with reassurance that our leverage plans for the rest of the year are definitely on track.
As for the line items making up our Q1 operating expenses, on an adjusted basis selling, general and administrative expenses totaled $61.9 million or 53% of sales for the first quarter, compared to Q1 ’07 SG&A expense of $51 million or 54.1% of sales, a 70 basis point improvement. We’re particularly pleased with the SG&A expense leverage produced this quarter, again given that we have not yet annualized the investments made in connection with our ’07 acquisition.
As adjusted our R&D expense totaled $7. 8 million in Q1 or 6.7% of sales, compared to $6.8 million or 7.2% of sales in Q1 of last year. On a full year basis you should continue to expect R&D spending of approximately 7% of sales overall for 2008, although, as has been our history, there will always be variations from quarter to quarter.
Our final operating expense is amortization. Amortization expense totaled approximately $1 million for the quarter, compared to about $855,000 in Q1 of 2007. Through out the remainder of 2008 you should expect quarterly amortization levels of approximately $1.2 million, which reflects some incremental amortization from our INBONE acquisition.
To summarize our performance of the operating income level, our first quarter operating income as adjusted was $13.2 million or 11.4% of sales, up from $9.2 million or 9.7% of sales in Q1 of ’07, reflecting operating margin expansion of 170 basis points overall and resulting in a very strong operating income growth outcome of 43% for the quarter.
Below the operating income line, adjusted net interest income totaled approximately $363,000 for Q1, which was lower than originally anticipated for the quarter, as we began to experience the effect of short-term interest rate reductions. This lower than anticipated interest income was offset in Q1 by better than anticipated other income, however, with approximately $235 million of cash on our balance sheet, we’re quite a bit more sensitive to interest rate fluctuations than we’ve been historically and the recent rate reductions have created a headwind for us, which I’ll elaborate on further during the outlook section.
Moving now to taxes, our Q1 effective tax rate as adjusted was approximately 38.5% for the quarter as compared to 31.9% in Q1 of ’07. The wide variation between this year’s and last year’s ETR is the result of a couple of factors: first last year’s Q1 2007 effective tax rate included a benefit realized upon the completion of a US federal tax audit, which as you may recall provided an incremental $0.01 of earnings to Q1 of last year and second, this year’s effective Q1 effective tax rate does not include any benefit from the research and development credit, as that credit has once again expired and is now awaiting legislative action in order for it to be restated once again.
We do anticipate that the R&D credit will be reinstated at some point during 2008 and that it will be retrospectively applied for the full year; therefore, our expectation for a full year effective tax rate of 37% remains unchanged; however, as some of you may recall was the case back in 2006 when this happened once before, we will continue to report an ETR that excludes the R&D credit in each quarter going forward, until such time as it is reinstated. At that time a full year catch up will be reflected in that quarter of reinstatement. Consequently, while you should continue to expect our effective tax rate to be 37% for the full year, at least for Q2 you should expect us to report something closer to the 38.5% that we saw here in Q1.
To wrap up our P&L reviews Gary reviewed with us earlier, net income as adjusted totaled $8.9 million or $0.23 per diluted share for the quarter. On the strength of 23% top-line growth, first quarter adjusted operating income grew by an outstanding 43% while net income in earnings per share as adjusted grew by 34% and 21% respectively over the prior year, despite a difficult effective tax rate comparable.’
Briefly, regarding share count, our first quarter per share results as adjusted are based on an adjusted diluted share number or $3.4 million for Q1 of this year and an average diluted share count of $36.0 million for Q1 of last year. Growth going forward, we expect that our average share count for 2008 will be approximately $44.1 million shares diluted, reflecting the additional shares represented by our new convertible debt offering. Note that this 2008 share count makes no consideration for additional issuances that could result from significant business development events.
Before we get into our guidance review, let me point out that our balance sheet continues to remain very strong. The cash balance totaling $235 million as of March 31, reflecting the additional cash from the $200 million issuance of convertible notes. We ended up with approximately $9.9 million in capital expenditures during Q1.
The final topic of my portion of the call today is our current sales and earnings per share outlook for the remainder of 2008 and then specifically for the second quarter.
We have upwardly revised our anticipated target for full year 2008 net sales to a range of $455 million to $465 million, reflecting a sales growth objective of approximately 18% to 20% for the full year. This new sales target reflects our over performance during the first quarter, an improved outlook for anticipated foreign currency exchange rates and approximately $4 million of incremental revenue associated with our recent INBONE acquisition.
We’ve also narrowed and adjusted our previously communicated full year 2008 as adjusted earnings per share outlook to a range of $0.87 to $0.91 per share, down from our previous range of $0.90 to $0.96 per share. A Q1 over performance enabled us to offset entirely the $0.03 of dilution that we previously announced associated with our INBONE acquisition; however, the significant reduction in short-term investment returns in recent months has impacted our outlook for non-operating interest income for the rest of 2008, accounting for a $0.05 non-operating reduction to our full year guidance range.
Importantly, our expectation for a very strong performance of the operating income level remains unchanged. For the full year 2008 we continue to expect that we will deliver adjusted operating income growth of at least 30%, ranging to as much as 40% compared with 2007 and that’s inclusive of the one year diluted impact of our INBONE acquisition.
As for our guidance regarding the second quarter of 2008, I’d like to recap with you what we’ve stated in the outlook section included in today’s press release. Our anticipated target for second quarter of 2008 for net sales is in a range of $113.5 million to $115.5 million, representing growth in a range of 16% to 18% for the quarter, with adjusted EPS results ranging from $0.17to $0.18 per diluted share.
Included in the second quarter guidance is approximately 40.02 of dilution rate related to the INBONE acquisition, which is the majority of the full year solution that we anticipate from that acquisition. Our Q2 guidance also reflects our reduced expectations for short-term investment returns, representing approximately $0.02 of earnings for the quarter, as well as a slightly higher effective tax rate related to the R&D tax credit that I noted earlier, representing roughly $0.01 of earnings in Q2. While interest income and taxes do impact our bottom line outlook, at the adjusted operating income line you should continue to expect annual growth between 20% and 27% for the second quarter. Again, even after the inclusion of a majority of the dilution we anticipate from INBONE.
Please note that these targets, both for the upcoming second quarter of ’08 and the full year of ’08 exclude the effect of possible future acquisitions or other material business developments, restructuring charges associated with our Toulon closure, acquisition related inventory step up charges, the impact of non-cash stock based expense as well as special costs associated with our current DOJ inquiry.
For those of you who do consider stock-based expense in your models, our estimated full year ’08 impact of expenses associated with the FASB 123(R) is a range of approximately $0.27 to $0.30 per diluted share for the full year 2008 and $0.07 to $0.08 for Q2. Applying the $0.30 high end of our stock-based expense range to our adjusted EPS outlook f or 2008 implies an EPS outlook inclusive of stock-based expense in the range of $0.57 to $0.61 per diluted share, which represents a year-over-year earnings growth rate of 30% to 39% for 2008: that’s even better than the earnings growth rate we’re expecting excluding stock based expense, which of course reflects the success we’re having in controlling and leveraging our stock compensation costs.
With that, I’ll conclude our financial review and turn our call back over to Gary for his additional comments.
Gary Henley
I have a few closing comments regarding some key events and developments that occurred in the first quarter and then we’ll move into the Q&A section.
First I’d like to spend a few minutes discussing our recent INBONE acquisition, which we closed in early April, this month. We anticipated the sales impact of this acquisition to be approximately $4 million in 2008 and somewhere in the range of $10 to $12 million in 2009. From an earnings perspective, the acquisition is anticipated to be $0.03 dilutive in 2008 and in the range of $0.02 accretive in 2009.
The INBONE ankle features novel tibia and Taylor fixation a well as a proprietary intermedullary alignment system that facilitates superior placement accuracy and most importantly, very reproducible results. This key strategic acquisition provides us an entry into the total ankle replacement market with a proven product with proprietary features. Additionally, this high ASP product helps us to continue to drive specialization of our sales force and increase the number of foot and ankle sales reps.
Our goal is clearly to be the definitive market leader in foot and ankle surgical products and the addition of the total ankle to our product portfolio represents a major milestone in our progress towards that goal.
The closing of the INBONE acquisition in early April marks our seventh business development initiative in the foot and ankle surgery market during the past 12 months. Through the integration of these acquired products and our ongoing internal development efforts, we have created the most compelling portfolio in the foot and ankle market sector.
In addition to significantly expanding our foot and ankle product portfolio, we have also created specialization within our sales force, including dedicated foot and ankle focus sales reps. These efforts have produced outstanding growth in our extremities franchise, as well as in our biologic line and have positioned us to achieve our goal of being the leading supplier of foot and ankle surgical products.
While putting tremendous focus and efforts on the foot and ankle market, we have also made significant progress in the large joint reconstructive market, with significantly higher large joint growth rates, both in the US and internationally, as compared to a year ago: this is impressive.
On the operational front, we have successfully closed our Toulon manufacturing logistics and administrative facility, resulting in more streamlined operations and more efficient manufacturing. The result of all these efforts is that the company has now been reinvigorated from a single-digit, top-line growth and low double-digit operating income growth a year ago, to a company growing in the upper teens with significant operating leverage today.
To recap, we’re very pleased with our record setting Q1 performance, especially the balance we achieved between the product lines, as well as geographically. We will remain focused on the performance of our core business, while continuing to work on the developmental activities that will position us for a very successful 2008 and beyond.
In closing, I would just like to say how every proud I am of what we’ve achieved as a company in the past year or so. We worked hard to develop a vision backed up by a strategy. To have achieved that vision and then assembled a great team of individuals who have worked together to execute that strategy and make it happen. Wright Medical is a very different company today from what it was just one short year ago. There is excitement in every corner of this company. We truly are a company on the move.
We’re now ready to take your questions.
Question-and-Answer Session
Operator
(Operator Instructions) Your first question comes from Michael Matson - Wachovia Capital Markets.
Mike Matson - Wachovia Capital Markets
Regarding the guidance for Q2, given where you’ve guided relative to consensus, it looks like the mid-point is about $0.05 below consensus. Your overall guidance you took down a little bit, but it looks like you’re implying that there’s going to be a pretty big ramp in EPS between Q2 and Q4. Is that the case and is that because of the INBONE products gaining momentum over the course of the year?
John Bakewell
You can reconcile pretty easily from where consensus was for Q2 to where the range is, that we just put out there today. The delta’s about a $0.05 difference and you can account for that with $0.02 of INBONE dilution, that I don’t believe most people have in their models as of yet. Another $0.02 related to the reduced interest income below the line, and then lastly we’re taking our effective tax rate up by about a $0.01 impact: those three items together, collectively are the $0.05 that gets you from where consensus was to where our range is today.
Above the line, we’re still in pretty good shape even with dilution from INBONE.
Mike Matson - Wachovia Capital Markets
The INBONE ankle, does that require extensive surgeon training and is that something that you’re going to have to roll out before you can really get a lot of momentum in the sales of that product?
John Bakewell
It does require training. We had that program in place, in fact we began training surgeons the day after we acquired it; we are in that process and we will continue to do that. The good news is we have a very capable staff; we have a mobile lab that we can take around the country and facilitate those trainings. We have a very aggressive plan that, you’re right it does take some training.
Mike Matson - Wachovia Capital Markets
Are the DHA related expenses being recorded in SG&A?
John Bakewell
Yes, they flow through SG&A.
Mike Matson - Wachovia Capital Markets
Can we expect I realize it’s a non-operational expense, but can we expect similar levels of spending on that through out the remainder of the year?
Gary Henley
It’s hard to say. We didn’t have a way of judging what those costs were going to be in Q1 and we honestly can’t predict it for Q2.
Mike Matson - Wachovia Capital Markets
The seasonality you mentioned in gross margin in the second quarter, is that due to product mix or geographic mix or?
Gary Henley
It’s largely related to the timing of when inventory charges are required pursuant to some of the formulas that we have to apply. Q2 is usually a very heavy launch quarter, usually that’s when academy falls and consequently that’s when we have historically had a lot of product launch activity and as a result there’s certain products that drop into our calculation in the second quarter every year, meaning that our cost of goods is going to be just a little bit higher typically in Q2 than it is in other quarters.
That’s why if you look back over our history you’ll see a gross margin in the second quarter that’s usually a little bit lighter than some of the other quarters of the year.
Operator
Your next question comes from Jason Witties - Leerink Swann.
Jason Witties - Leerink Swann
In your closing comments I did notice a change in maybe your parent strategy here and that is, even say two or three quarters ago you would have said that you’re trying to grow your hip and knee business at market rates and focus on extremities and biologics and with that you should get to, I think a mid-teens top line and from that get leverage of about 100 to 150 basis points.
It sounds to me like now you’re saying you’re high teens and I don’t know if you specified what operating leverage you could eventually get from that: I know it’s muddled this year by acquisitions, but is there a change now in the outlook, especially in the outer years.
Gary Henley
No, I think we’re experiencing very significant growth in our extremities and biologics and the foot and ankle and those comps become harder and harder over time, but I think we still are going to hold to our vision of this. We’re still pushing hard on growing our hips and knees at or above market rates and enjoy the benefit of the faster growth in our extremities and biologics products.
Jason Witties - Leerink Swann
So you’re saying that we should maybe in the outer years still assume that 15% or so top line and 100 to 150 basis points proven.
Gary Henley
I think that’s a good model. We’re going to continue to push to over achieve, but those are good models, good goals to still model for us.
Jason Witties - Leerink Swann
Also sales force, it sounds like you’re going to be building. Do you care to give us a little more color on that in terms of percentages or number of reps you look to add this year?
Gary Henley
I shy away from giving empirical numbers of the sales force. I will tell you that we are expanding it and we are working hard to focus that, where we have people that are dedicated to the foot and ankle area, that’s all they do and we have people that are sales reps that are just large joint and recon. I think you can see the results of that here. The growth rates on both of them, hip and knee, and foot and ankle, and biologics, we’re pretty happy with it. I think that’s good growth and I think it’s reflective of the products, having great products and a great portfolio and that specialized focused sales force.
Operator
Your next question comes from Mark Mullikin – Piper Jaffrey.
Mark Mullikin - Piper Jaffrey
What’s the amortization on a quarterly basis going forward?
John Bakewell
Going forward it should be about $1.2 million a quarter.
Mark Mullikin - Piper Jaffrey
Obviously you put up a phenomenal top line this quarter and the outlook looks very bright on the top line. Can you just comment a little bit about the profitability issue here? It seems like the top line is going up, bottom line is going down and this is one of the issues people raise about the company, is just what the real operating leverage is here. Is it a mixed shift that’s driving maybe lack of operating leverage? What is it, why doesn’t the bottom line move up when you raise top line guidance?
John Bakewell
Firs let’s talk about Q1. We just grew the top line at 19% constant currency and delivered a 43% increase on the operating income line, so that was 170 basis points of leverage. That we think is pretty darn good shooting.
Gary Henley
I’m not sure, when you say the bottom lines gone down and we see it a little differently.
John Bakewell
Yes, as we move out through the rest of the year, again at the operating income line, we’re maintaining the same outlook we had from the very beginning. There’s about $0.05 of pressure as a result of non-operating reductions to interest income as a result of rate declines, but operationally nothings changed in our view there at all.
The leverage that we saw in Q1 really wasn’t planned. We did not model a lot of leverage into Q1 mainly because all of that acquisition activity that took place in ’07 really doesn’t begin to annualize until Q2, so we were still struggling to get out from underneath the tough leverage comps that you get with acquisitions.
I think we’re in pretty good shape to deliver some very good operational leverages as we move through the rest of the year.
Gary Henley
And we’re very focused on growing that bottom line faster than the top line and I thought that this quarter was a good example of that.
Mark Mullikin - Piper Jaffrey
How does the M&A pipeline look, any expectations? Some of the questions I had in the last couple of months were around why the stock price was weak when the fundamentals seem to be very strong at the company end. One thought was that you did the INBONE acquisition that was $0.03 dilutive, maybe that makes people recalibrate the impact of M&A on your financials. Can you just comment a little bit around what you’re looking at? You’ve got a lot of cash sitting on the balance sheet to go out and do deals, what should we expect?
Gary Henley
I think what we’re looking at are deals that make sense to us, both from a strategic perspective, as well as a financial perspective; we look at them both near term. We’d love to have accretive deals quickly, we’re looking for those, but we also have to look at the long-term strategy, we’re managing this business for the long haul and when we find things that are very strategic that as we look out over two or three years they fit perfect in our vision and growth strategy, we’ll continue to pursue those.
We’ve got a lot of things on our radar screen. We’re working hard in that business development arena and we’ll continue to do that, but I think you can expect to see us be opportunistic, I think that’s the best word I can give you.
Operator
Your next question comes from Taylor Harris - JP Morgan.
Taylor Harris - JP Morgan
Gary, I want to follow up on a point you made at the closing remarks there on the large joint market and the momentum you’re seeing. It was perhaps most evident internationally, so I’d like for you to talk about what is happening internationally that’s giving you that momentum.
Then domestically it was an interesting quarter for the bigger hip and knee players. You, I think probably when all is said and done, outperformed the big guys so, I’m just curious, did any general market trends that you saw in the first quarter and are you in a position now where just given some of the changes in the landscape with the DOJ, etc., where you’re seeing opportunities that perhaps you didn’t in the past?
Gary Henley
We’ve gotten our act together in Europe. Paul’s done a super job over there. The team is really getting streamlined and focused in the large joint area, so we’re getting good growth there. The Japanese market has continued to be very strong for us, as well as Asia. We’ve got a great business in Korea, Karen’s done a super job in Latin America and South America, and so we’re experiencing very nice growth.
We’ve got great products, as I said all along, so we’re just being more effective taking them to the marketplace internationally and here in the US, a lot of the same story: we’re benefitting from this focused effort on the distribution side.
We’ve been talking a lot about the foot and ankle and how that focus has helped, but the added benefit is on the large joint side as well. When these and gals are not distracted and the sales force aren’t distracted by selling extremities and biologics, they’re focused, focused, focused, on hip and knees, that coupled with outstanding products: the statured product on the knee, BIOFOAM, the patch system, the A-class metal BSH that we’ve got.
We’ve got great products. As evidenced we’ve been selling modular necks for 20 years and very successfully. It seems to be that a couple of our competitors have said, “Hey that’s a pretty good idea, we actually think that will help us”: anybody that doubted the veracity of modular necks, now they see that some of the big guys are going “Hey this is a great idea” now that our products are off patent. We’re very bullish about our large joint business.
As far as the DOJ, I can’t really comment one way or the other. All I know is that when our products are evaluated on their performance, their features and benefits and outcomes we give patients, we do very well.
Taylor Harris - JP Morgan
John, on guidance, you lifted the overall sales range by $25 million, I believe. You’re saying INBONE is $4 of that. Upside in the quarter was maybe $6 or $7 and I wouldn’t think that FX is the remaining close to $15 million, or is it? If not, are there particular areas within the business that organically you’re expecting better things from?
John Bakewell
Yes, very close to that $15 million is the expected currency differential, Yes. We’re a little bit early in the year to be making major changes right now to, the underlying, and constant currency growth assumptions. What we’ve chosen to do is exactly what you just laid out. We’ve increased guidance for the Q1 over performance, for the roughly $4 million of incremental sales related to the INBONE acquisition and the rest of it are changed in FX.
Taylor Harris - JP Morgan
On the INBONE deal you mentioned $4 million this year, $10 to $12 next year, which is a nice ramp. What do you need to do to make sure you get to that $10 to $12 million? Is that a training issue, or help us understand that.
Gary Henley
Well there are a couple components to it, one is just the sets, when we acquired them they had I think four complete sets of instruments. So, we’ve got to get the inventory and the instrument sets built and into the field. We’ve got to continue to train our sales reps, which we’re doing, and then we have to train the physicians.
I think we’ve got really good programs. We’ve worked hard in the diligence phase of this acquisition to lay these things out. As I said earlier, we hit the ground running: we were literally training surgeons and sales reps the day after the acquisition.
I feel good about those numbers. I think they’re very achievable, but who knows it could even be better, but that’s how we see it today.
Operator
Your next question comes from Philip Legendy - Thomas Weisel Partners.
Philip Legendy from Thomas Weisel Partners
I wanted to ask you to comment on the impact of price in the quarter, on what you’re seeing there, mainly in the large joints?
John Bakewell
It’s been relatively small, roughly the 1% to 2% across, if you aggregate it, hips and knees together, that’s approximately what we’re seeing.
Philip Legendy from Thomas Weisel Partners
Is that fairly consistent across geographies, US an international?
John Bakewell
What I just said applies to the US market.
Gary Henley
The European market has been pretty stable. We are having a decrease in Japan, actually starting, I think it’s May 1, a legislative decrease of 6% to 7% between hips and knees, so that’d be a little headwind for us, but other than that I’d say pricings remain about stable for us.
Philip Legendy from Thomas Weisel Partners
Some of your larger competitors have commented on a slow down in procedure volumes that they think they’re seeing this quarter. I was just wondering if you have any comment related to that view.
Gary Henley
I’m not sure we have seen a slow down: hopefully we don’t but at this point I would say we haven’t.
Philip Legendy from Thomas Weisel Partners
You launched the knee with BIOFOAM in the quarter, I was just wondering if you have any early feedback on how that’s going.
Gary Henley
It’s done very well, we’ve gotten great acceptance by our clinicians, and they’ve reported outstanding results in their patients. This is a product that’s designed to get better cement with fixation than what’s available through course coated tibia bases. Early indications are it’s doing what we expected it to do. We’re very excited about BIOFOAM: this is a proprietary product that you’ll hear a lot more about as we go forward, because it will find its way onto many different implants. Our next logical step would be to put in on an acetabular cup.
You’ll hear a lot more about BIOFOAM as we go forward. We’re very pleased with what we’re seeing so far.
Philip Legendy from Thomas Weisel Partners
Is that a product that’s priced at a premium today?
Gary Henley
It is a slight premium. I think new technology premiums are probably harder and harder to get these days: we try and we’re successful to some extent.
Operator
Your next question comes from Raj Denhoy - Bear Stearns.
Raj Denhoy - Bear Stearns
Did you say that $6.2 growth in the quarter was from acquisitions?
Gary Henley
Yes.
Raj Denhoy - Bear Stearns
And there was, I take it, no in bone in that number?
Gary Henley
That’s correct.
Raj Denhoy - Bear Stearns
It seems it’s a small number, but in the last couple quarters I think acquisitions were maybe 4 or 5 percentage points of the company’s business. It seems like those acquired businesses are accelerating a bit here. Is there anything to read into that, or are you really starting to finally get traction with those, are they getting integrated properly here?
On the extremities business, I think even when you look outside of your acquisitions. I think you said the US business was still 23% outside of acquisitions. I’m curious if maybe you could give us some broader thoughts around extremities here and what’s really driving this market, how long it’s going to run here at these kinds of growth rates?
John Bakewell
The organic growth, Raj we have seen the acquisition related growth step up just a little bit over the last couple of quarters. It was running about 5%.
Gary Henley
The reason for that is we’re finally getting all the products into the marketplace: for example, the R&R that we’ve acquired, it’s taken us a long time to get those sets manufactured and into the field. The same way with a couple of the other acquisitions, the vendors that were supplying those were very small vendors, by a small company and it took them a long time to ramp up. That’s part of it and getting it into the field with sets and instruments and some training that has to come along with it.
I think you’ll continue to see some of that acceleration in growth rate of those acquired products for some time to come.
Raj Denhoy - Bear Stearns
Broader thoughts around extremities, because I think it’s a market that’s somewhat surprising in that it’s growing quite a bit faster maybe than.
Gary Henley
Well I think some of it is we’re taking market share. That’s a component of it, I don’t know how much, but I’m sure that that’s the case. The other thing is that we’re bringing solutions that maybe didn’t exist before, or at least weren’t widely known to surgeons. It’s a growing market, no question about it with the effects of obesity and diabetes in this country and around the world; those have a major influence on the foot and ankle market growth.
We anticipate the market to continue to grow. It’s a little bit newer market than maybe hips and knees and some of those things. We can take our innovative solutions, some of the products that we brought from other subspecialties to foot and ankle and bring solutions to surgeons that heretofore they didn’t have.
Raj Denhoy - Bear Stearns
You mentioned you weren’t maybe taking too much share, so would you peg the underlying growth rate to this market at north of 20% here?
Gary Henley
Yes, I think that’s probably a good estimate. Its funny there’s not a lot of analysts that write and publish reports on foot and ankles so far, so it’s hard to get some really good benchmarks on growth rates.
Raj Denhoy - Bear Stearns
A couple of the INBONE, there are some other ankles on the market, I believe some of them are still in PMA trials. When do you expect those other, those newer generation products that are being trialed right now to get to the market?
Gary Henley
That’s hard to say, I have no idea. I don’t have any visibility to where they are in their processes. All I know is this is a proven product today. They’ve had great success. The clinical success that this product provides is outstanding. I think this product has a long life irrespective of whatever competition comes in.
Raj Denhoy - Bear Stearns
With the acquisition of Life Sale by KCI, are you expecting any changes to your supply of GRAFTJACKET here going forward?
Gary Henley
No, this should have no impact on our supply what so ever. This is an acquisition of one company by another and we have contractual obligations and we’re a good partner: we provide a lot of sales growth and operating income for that new company, so I suspect they’re quite happy with us.
Operator
Your next question comes from Bill Plovanic - Canaccord Adams.
Bill Plovanic - Canaccord Adams
John, alternative bearing as a percent of the US hip business in the quarter?
John Bakewell
It’s running about 75%.
Bill Plovanic - Canaccord Adams
We’ve heard some of the other players talk about less selling days in the quarter and the impact of Easter, what do you think about all of that?
John Bakewell
We may all have slightly different ways of calculation sales days, but at least in the US we come up with the same number of sales days as we had last year. We book sales on Good Friday. Good Friday is a surgery day, so we didn’t count that as a vacation day in our calculations.
Bill Plovanic - Canaccord Adams
In terms of earnings per share, $8.9 million the adjusted net on $43.4 million shares gives me $0.21.
John Bakewell
I’d have to look and see how you’re doing your math, but there has to be an add back for the interest, because you use what’s known as the F-converted method.
Bill Plovanic - Canaccord Adams
Do you provide that in any of the documents you provided? I didn’t see it out there.
John Bakewell
It should be in the back of our press release.
Operator
Your next question comes from Steven Lichtman - Banc of America Securities.
Steven Lichtman - Banc Of America Securities
First a clarification, in terms of the RTI distribution products is that in extremities or is it in biologics?
Gary Henley
It’s biologics.
Steven Lichtman - Banc Of America Securities
Can you talk a little bit about your outlook for biologics? You have that product as well as GRAPHJACKET. What should be thinking as you think about the growth of that business over the next 12 to 24 months?
Gary Henley
I’m not sure what we have in our guidance, if we’ve modeled anything, but we’re very happy with the growth rates in our biologics. We get a lot of poultry in the lower extremity foot and ankle area; a lot of our biologics are used there for GRAPHJACKET and foot ulcers, tendon repairs, joint resurfacing, all kinds of applications for that. We’ve got the CANCELLO-PURE which we’re very pleased with from RTI and we’ve got all of our PBNs with our matrix, we’ve got our PRO-DENSE product that’s been really well accepted out there.
I’m pleased with where we’re going. I think biologics benefits from this focused effort that we’re doing and I think we’ll continue to see nice growth.
John Bakewell
Yes, Steve if you go back to our December modeling call, we put out there low to mid teens growth for the biologics business. Overall I think that outlook would remain current today too.
Steven Lichtman - Banc Of America Securities
I know the smallest line, but just as a part of clarification on the other line, it’s running at $2.5, $3 million last year and it came in at a little under $5,s o what’s on that line again, on the other line?
John Bakewell
Well internationally there are a few things going on there. You have a very small line of spinal products that are sold in a couple of European countries, in Italy and France. Then we are also the distributor of Microware surgical instruments in a couple of European countries; one of those is the UK and the other one is Germany, German-speaking countries I believe.
Steven Lichtman - Banc Of America Securities
Relative to the Toulon closing, can you remind us when exactly it was officially closed and in terms of the pace of benefits of that into the P&L is it pretty evenly distributed through out the year, or more so later?
John Bakewell
Operations ceased to occur in December and that’s really when the run rate from it, with respect to administrative expenses also completely ended. It’s a pretty steady, we might benefit a little bit more towards the end of the year, but for the most part it’s a constant number; we bumped it back in 2008.
If you get into 2009, as we’ve covered before, that’s when the cost of sales synergies kick in and we should get probably another120 or so basis points of improvement just from cost of sales synergies.
Steven Lichtman - Banc Of America Securities
What’s your anticipation on the SG&A benefit this year? I don’t know if you can exclude a FAS 123 expended, the year-over-year benefit you’re expecting from the Toulon plane closing?
John Bakewell
It’s unchanged from what we put out there earlier; it’s in that range of 60 basis points or so.
Steven Lichtman - Banc of America Securities
And that’s on top of, for the top margin you’re expecting that 100 to 150 basis points from the sale?
John Bakewell
Yes, when you add them together you can probably expect on a full-year basis we’re going to see somewhere between about 160 to 210 basis points of leverage.
Steven Lichtman - Banc Of America Securities
That’s before the dilution from?
John Bakewell
Yes, that’s before the dilution from ENDBONES, so the ENDBONE dilution will go against that slightly, yes.
Steven Lichtman - Banc Of America Securities
Looking at the balance sheet you saw a pretty big uptick in inventories and somewhat less so in receivables, but inventories, can you talk to us a little bit about, inventory dates were really high here. Where do we think that this can be leveraged down to over a period of time?
John Bakewell
Inventory did grow. Of course the sales grew as well. We had 23% top-line growth, inventory grew a little bit more than that, and that was a conscious effort. We’re putting a lot through our raw materials and whip right now in anticipation of building sets and getting basically some of these new products and these acquisitions launched more deeply. It’s really supporting all the acquisitions and the new products sale activities that are going on inside the business.
As we move into the second half of the year you’ll start to see our DOH number settle out. But, right now we’re in a pretty heavy investment mode to support the rollout of all these new products.
Steven Lichtman - Banc Of America Securities
What was the operating cash flow in the quarter and/or free-cash flow, whatever number you have?
John Bakewell
Free-cash flow as a +$2.9 million and operating cash flow was about $12.8 million.
Operator
Your next question comes from Jeff Johnson from Robert Baird.
Jeff Johnson - Robert W. Baird & Co.
John, can you remind me on the R&D tax credit, I may have missed it. If that is reinstated is that reinstatement already included in your guidance, just not in the Q2 guidance, or it’s not in the ’08 guidance at all?
John Bakewell
It’s included in the full year 2008 guidance. We assume at some point between now and the end of the year congress will reinstate it and they will reinstate it retroactive for the full year. That’s not how we’re allowed to account for it. We have to report our quarters up presuming that, if it hasn’t been reinstated, we have to report it without that benefit. Whenever it is reinstated there would be a catch up.
Jeff Johnson - Robert W. Baird & Co.
When that catch up is booked it still should keep you in that $87 to $91 range where you are for the year on an EPS.
John Bakewell
That’s correct.
Jeff Johnson - Robert W. Baird & Co.
Any early evidence on the BIOFOAM side that not just mixed benefits are going there, but any volume pick-ups? Or said another way, any early evidence of shared gains or taking any competitive surgeons with the BIOFOAM product?
Gary Henley
Yes, I think we have seen that. Again, it’s a limited launch, but we have seen some conversion and the doctors have used it clinically and spoken to other physicians and said, “Hey this is really something”; I think we’ll see more of that once we can append this whole launch.
Jeff Johnson - Robert W. Baird & Co.
Using the simple analogy you just used on walking through operating margin expansion in ’08, I would assume it still holds in ’09 then, the 120 basis points of cost of goods plus the 100 to 150 basis points in core operating margin? So 220, 270 is not out of the range for operating margin expansion in ’09?
John Bakewell
That’s not outside the range of possibility. We’re expecting a pretty good leverage standpoint in ’09 because of the manufacturing synergies on top of our base 100 to 150 basis point expansion.
Jeff Johnson - Robert W. Baird & Co.
The accretion from INBONE probably kicks in a little bit at that point as well?
John Bakewell
It does.
Jeff Johnson - Robert W. Baird & Co.
John, conceptually is there any reason not to expect currency this year, the benefit of currency to flow through to your bottom line to maybe a slightly greater extent than it has in the past given the closure of Toulon and some of your cost structures, our of Euro based area’s? I’m just a little surprised that the $0.05 dilution on the interest income line, or the $0.05 negative impact from lower interest rates on your cash balances isn’t offset a little bit more by the higher currency and you lack of cost structure now in Euro.
John Bakewell
We try to do as good a job as we can of balancing the reported profitability over there so that we maintain a natural hedge. Yes, you are going to get some profitability with Toulon closing, but I really don’t think we’re going to see that in a profitability that makes us subject to a whole lot of currency exposure until ’09.
Another way to think of it is a lot of the inventory that was manufactured in ’08 will not improve cost of sales until 2009.
Operator
Your last question comes from Bob Hopkins - Lehman Brothers.
Robert Hopkins - Lehman Brothers
It was unfortunate you had this little interest rate issue that affects non-operating results and then drags down EPS. I apologize if you went through this before, but John, could you just run me through how that math works in terms of the assumed interest rates that you’re getting on your cash and your investments and just how that math works to that -$0.03 to -$0.05 relative to the previous guidance?
John Bakewell
We entered the year with a planning rate assumption for interest income on a tax equivalent basis of about 4.75% and that was actually achievable and pretty conservative until the feds started cutting rates. They’ve been taking rates down by, what 225 basis points now just over the last few months and consequently short-term investment yields are stair stepping their way down as well. There’s not a whole lot we can do about that.
We want to be very careful and be sure that we are focused on safety and quality so we didn’t get something somewhat that’s being liquid, or even worse, having to be written down because of some of the auction rate issues and that.
Basically, it was just reflective of what’s going on with rates out there since the beginning of the year.
Robert Hopkins - Lehman Brothers
So what exact interest rate are you assuming in this new guidance?
John Bakewell
On a taxable basis about 2.75, that’s coming for the remainder of the year.
Gary Henley
Thank you everybody for joining us today. As you can imagine, we, myself, and the team here at Wright are very pleased with the results of Q1 and the progress we continue to make. I think the excitement at Wright Medical is palpable as you walk through the halls here. I’m sitting here today looking across the road at our new facility, so that’s a physical embodiment of the changes and the growth that we’re experiencing here. Stay tuned, we clearly are a company on the move.
Thanks for joining us; we’ll talk to you on our next call, thanks.
Operator
Ladies and gentlemen, as explained at the beginning, this conference call may have included some forward-looking statements as defined in the Federal Security Laws. We refer you to our earlier explanation for the more detailed description of forward-looking statements.
We again caution you that actual results might differ materially from those described in the forward-looking statements. We also direct your attention to the risks and uncertainties discussed in the SEC filings, including our 10-K for 2007 and our subsequent 10-Qs during 2008. These factors could cause our actual results to materially differ from those described in the forward-looking statements.
In addition, you should not view a forward-looking statement as a representation by us that describes the results that will be achieved. Again, we again caution you not to place undue reliance on any forward-looking statements. Finally, all forward-looking statements are made as of today’s date and nor do we assume any obligation to update any such statement after this day.
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