Exactech's CEO Discusses Q2 2012 Results - Earnings Call Transcript

Aug. 1.12 | About: Exactech, Inc. (EXAC)

Exactech, Inc. (NASDAQ:EXAC)

Q2 2012 Earnings Call

August 1, 2012 10:00 am ET

Executives

Bill Petty - CEO

Jody Phillips - CFO

David Petty - President

Analysts

Bill Plovanic - Canaccord

Jeff Johnson - Robert W. Baird

Jim Sidoti - Sidoti & Company

Operator

Good morning, ladies and gentlemen, thank you for standing by. Welcome to the Exactech Inc. Second Quarter 2012 Results Conference Call. During today's presentation, all parties will be in a listen-only mode. Following the presentation, the conference will be opened for questions. (Operator Instructions)

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

Bill Petty

Thank you, Vince, and good morning and welcome to Exactech 2012 second quarter conference call. As we specifically do, I will make the opening comments, and Jody Phillips will give some more details about the financial report. And then Jody, and David Petty and I will participate in the question-and-answer session.

Before we begin, the disclaimer. The release contains various forward-looking statements within the meaning of Section 27A and 21E of the Securities Act of 1933 and 1934 respectively. They represent the company's expectations or beliefs concerning future events of the company's performance. These forward-looking statements are 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, compliance cost, the effects of government regulations, and other potential effects. Results actually achieved may differ materially from expected results included in these statements.

Now, to go into my comments about our second quarter. First of all the highlights top-line revenue for Q2 2012 was $55.2 million compared to $51.7 million in the second quarter of 2011, this is a 7% increase.

Net income was up 11% to $3 million or $0.23 per diluted share compared to $2.7 million or $0.21 in Q2 of 2011.

For the Q1 segment performance knee implant revenue was up 1% to $21 million. Extremity implant revenue up 24% to $12 million. Hip implant up 22% to $10.3 million. Biologic and spine revenue decreased down slightly 1% to $5.9 million. And our other products revenue, and just as a reminder that's instrument sales to distributors and also our cement product that was down 14% to $6 million.

If we look at our U.S. versus outside the U.S. for Q1, our U.S. sales increased 8% to $35.2 million compared to $32.6 million in 2011. And the international sales were up 5% to $19.9 million, primarily due to strength in Asian and Latin America markets. Though we experienced weakness in some European markets, other sales were going well. International sales represented 36% of total sales for the second quarter.

Our six month highlights, for the first six months of 2012 the revenue was $113.8 million, which is an increase of 8% over $105.1 million for the first six months of 2011.

Net income for the first six months of 2012 were $6.3 million or $0.48 per diluted share compared to $5.7 million or $0.43 per share for the first six months of 2011. This is an increase of 11% in net income for the first six months in 2012.

The segment performance for six months again knee implant revenue was up 1% and that rose to $42.5 million, extremity implant up 31% to $25 million, hip up 29% to $21.2 million, biologic and spine down 7% to $12.1 million, and other products down 10% to $13.1 million.

For the first six months the U.S. sales rose 7% to $72 million compared to $67.6 million in 2011. International sales increased 12% to $41.8 million from $47.5 million in 2011 and represented 37% of the total for the first six months.

Though we're never completely satisfied with our results or our progress, we are pleased with our performance so far for 2012. We have led with hip and extremity revenues and our largest segment knee has held its own. The biologic and spine segment was near flat in Q2 suggesting stabilization there. We continued to see a somewhat unsettled market and not unlike the general worldwide economy. We at Exactech, so I believe, we can continue to maintain some share going forward despite the general uncertainty. Jody?

Jody Phillips

Good morning everyone and thanks for joining us for the second quarter conference call. We feel the second quarter sales and earnings results were largely within the balance of our expectations albeit there were a few moving parts that I'll touch on in my comment.

In order to review our second quarter operating performance, I'll review the major elements of the income statements and then make a few comments related to the balance sheet.

Our gross margin percentage expansion during the quarter from 68% to 68.8% was consistent with our expectations and as we look to the balance of 2012 we continue to expect probably a 50 basis point increase in gross margin percentage on a quarter-over-quarter basis, as we expect internal manufacturing cost reductions to continue to offset modest pricing pressure.

From a sales and marketing expense perspective the 4% increase was lower than sales growth, primarily due to lower bad debt expense, as a result of large Spanish government payments received during the second quarter. We expect sales and marketing expense growth to be in line with sales growth for the balance of 2012.

The second quarter 2012 G&A expenses decreased to 19% as compliance spending continued at roughly half of what it was in the previous year. Going forward, we expect G&A spending to roughly flat with the second half of 2011 as the comparative compliance spending from last year began to decrease.

R&D expenditures in the second quarter increased 51% primarily due to a relatively low comparative from the second quarter of last year. On a sequential basis compared to the first quarter of 2012, R&D expenses were relatively flat, and we expect R&D expenses to be relatively constant at 7.5% of sales for the balance of this year, which will represent approximately a 15% increase as compared to the second half of 2011.

Depreciation and amortization expenses increased 7% for the quarter and this is what we expect it to continue for the balance of the year as well.

As a result of these individual expense items and the gross margin performance, the 2Q total operating expenses increased 4% and as a percentage of sales total operating expenses decreased to 59% as compared to 61% in the second quarter of last year. We expect similar increases and similar percentage of sales reductions for the balance of 2012 as well.

Due to the sales and sales growth and the OpEx activities our operating margin increased 38% to 9.6% of sales versus 7.5% of sales in the second quarter of 2011 so we are beginning to deliver some of the leverage that we've been speaking about.

Below the operating profit line, we experienced a 40K, $40,000 currency exchange loss as compared to $388,000 gain in the second quarter of last year; obviously this was due to the strengthening of the Dollar versus the Euro.

As Dr. Petty referenced in the release, our second quarter effective tax rate of 38% was impacted by the determination during the quarter that an additional amount of our 2010 DOJ settlement was nondeductible. Basically, prior to IRS discussions with the DOJ that occurred during the second quarter, we estimated that $600,000 of the settlement was nondeductible, and during the quarter the IRS determined that $1.3 million of the settlement was nondeductible and this resulted in a $280,000 tax charge, which was basically two pennies per share.

As a result of these activities our net income of $3 million reflected an increase of 11% and was consistent with our expectations despite the FAS adjustments.

From a balance sheet perspective we were pleased to receive the large payment I referenced earlier from the Spanish government, this largely covered all receivables prior to 2012, which totaled over US$11 million. As a result we experienced $9.8 million reduction in AR as compared to the end of the first quarter.

Our inventory increased $4.5 million during the quarter and we expect that this will be the largest quarterly increase in 2012, as we expect either flat or slightly modest increases to the balance of the year.

During the quarter we reduced our total debt by $4.8 million to a total of $43.5 million and we're currently projecting either consistent or possibly slightly lower debt levels through the balance of 2012.

One last comment, before I reference our guidance update, obviously the currency is a factor in our reported growth. On a constant currency basis, our total growth for the quarter was 9% versus the reported 7% and on a year-to-date basis our worldwide growth was also 9% versus the year-to-date reported 8%.

From a guidance perspective, we narrowed our full year 2012 guidance to revenues of $218 million to $223 million, and diluted EPS of $0.91 to $0.95. This narrowing reflects a combination of the in line performance for 2Q, the impact of current exchange rates versus our initial projection, and the strength of our U.S. business. Our third quarter revenue guidance of $49 million to $51 million and EPS guidance of diluted EPS of $0.17 to $0.19 represents a sequentially lower revenues due to our presence in Europe and the impact of currency rates. Those were all the comments at this time.

Vince that concludes our opening remarks. So we can open up for the Q&A.

Question-and-Answer Session

Operator

Thank you sir. (Operator Instructions) Our first question is from the line of Bill Plovanic, Canaccord. Please go ahead.

Bill Plovanic - Canaccord

Great, thanks. Good morning. Can you hear me okay?

Bill Petty

Yeas, Bill, loud and clear.

Bill Plovanic - Canaccord

Thank you. Thank you. So, just Jody what was the dollar impact from FX in the quarter?

Jody Phillips

It would have been roughly 1 million USD.

Bill Petty

You're right.

Jody Phillips

I thought you're referencing the top-line, right?

Bill Plovanic - Canaccord

Correct. And then, what do you think that costs you in terms of the bottom line concerning your manufacturing is U.S. based?

Jody Phillips

Yeah, it's little difficult to get your hands around those numbers. I think we're probably looking at something in the neighborhood of 2 pennies a quarter with the exchange rates where they're now versus where they were last year.

Bill Plovanic - Canaccord

Okay. And then, for the tax rate the DOJ, was that a one-time deal and we'll go back down to that kind of 34% rate going forward?

Jody Phillips

It's a good question. We certainly think we're done with the DOJ deductibility issue. We are currently under an IRS audit and that process continues and we're not aware of anything else at this time. But I think thinking right now in terms of the 34% effective rate for the balance of the year is probably accurate.

Bill Plovanic - Canaccord

Okay. And then, your shoulder growth slowed a bit, yeah it was down sequentially, what are the dynamics around that?

David Petty

Hi Bill, it's David. Well I guess when we're growing like we've been in the 30s and high 20s that's hard to sustain, as that base gets bigger. We've launched number of line extension in new products, and simultaneous to that, we're also dealing with a little bit of pricing pressure. So, we feel pretty good about the shoulder business going forward. We've done a full launch of our posterior augmented glenoids and a reverse base plates in the second quarter and we're going to do a limited release. But we're in the process of doing a full release I'm sorry on our cage glenoid product. So with those new products even though they're not substantially new systems they offer new capabilities that we haven't had before which is opening doors to more prospective customers and I guess there is a long way of saying we feel confident in our ability to continue to grow the shoulder business.

Bill Plovanic - Canaccord

Right if I look at this David I'm trying to figure out if we had a kind of down Q1 to Q2 quarter I think the last time we saw that was '09. And right is that an international impact I'm just trying to get a hand on around why it would be down sequentially I understand a decelerating growth rate?

David Petty

Yeah, I'll have to dig into the details there but I do know that our European shoulder business is under a little bit of pressure.

Bill Plovanic - Canaccord

Okay and then.

David Petty

And I know we're under surprising pressure in the U.S. Pretty much a $1 million of that, companywide across all products a $1 million of that sequential drop was due to currency so that's a factor that's a little bit less prevalent on shoulders than it is on hip because of the concentration of U.S. business being NV but I mean it was also a good factor on shoulders.

Bill Plovanic - Canaccord

Okay and then two more questions I'll jump out. Just the hip has done really well I mean this company was founded on hip but it's nice to see it's reaccelerating growth here is that just purely the product line extensions and what have you?

Bill Petty

Bill I guess the sales people would say they're doing a good job too. But obviously the -- getting the line extensions under the whole innovation umbrella notably the elements down which has been really important driver for us over the last five or six quarters, as well as InteGrip porous acetabular system, which I think you saw back in February is important to helping us access new customers. So we're currently starting another line extension with element to offer a shorter knack, which will give us a real and meaningful competitive advantage to the other prevailed style stems that are on the market in the U.S.

Bill Plovanic - Canaccord

And then.

Bill Petty

And then by the way also don't forget Japan. Japan is a big part of that growth too. So we're growing nicely in the U.S. and then Japan is just icing on the cake.

Bill Plovanic - Canaccord

Okay and then as I promise the last question just on knee, I'm sorry U.S. growth is the U.S. growth I mean we've seen an acceleration over the past couple of quarters. Obviously, this is for the comps get easy there but, it’s just the US knee business is coming back and I know you don’t breakout US over US but if you parse through the numbers is that what we are starting to see, is that a fair kind of assumption?

Bill Petty

It is fair to say that we are starting to see an improvement in the US knee business and of course we think that the fundamental things that we are doing both in sales and marketing will continue to accelerate our knee growth. Having said all of that, there is pricing pressure and so we are dealing with that. But I would point out we are not, as we have already discussed we are not, and this keeps out of the US competition as the whole picture, we are not reporting constant currency and our actual knee growth is 4% on currency.

Operator

Our next question is from the line of Jeff Johnson from Robert W. Baird. Please go ahead.

Jeff Johnson - Robert W. Baird

David, I wonder if I could maybe just follow up with you just on the hips comments there. Would you provide the US growth rate for hips or any of the other product lines? I am sure shoulders were up nicely in that 20%, 30% range in the US but for knees or hips would be helpful?

David Petty

I don’t have the -- I mean do you have --

Jeff Johnson - Robert W. Baird

Break out?

Bill Petty

No, we don’t want to break that out I guess I am -- we can give some generalities I think David is already referring that the knee has been sequentially improving its not where we wanted to be but it is better than where it was in the second half of the year specifically to the US. The hip growth rates in the US are well above market and that shrinks specifically in the second quarter and the balance between US growth and growth in Asia that David referenced, obviously the extremities is a lot of that growth is in the US. So, really all of those areas are sequentially compared to the first quarter as well as the second half of last year in the US they are doing relatively better.

Jeff Johnson - Robert W. Baird

Good and yeah, it does and if the US hip market we think maybe this quarter is 2%, 2.5% then it sounds like you guys would be mid upper single digits on the US hip side is not an unfair characterization?

Bill Petty

That would be extremely conservative.

David Petty

Little bit better than that.

Jeff Johnson - Robert W. Baird

And then Jodie, I guess just following up on one of your comments on the FX impact, the EPS at a couple of pennies per quarter probably for the next few quarters, that would be the year-over-year impact I guess, since the last time you updated guidance, is it fair to say the year has gone from what they may be about $1.32 since last time you updated to today, so the incremental impact is $0.01 per quarter is the year over year impact is about $0.02 per quarter?

Jody Phillips

I think I don’t think -- I think in total it would be $0.02, so it’s probably $0.01 quarter, per quarter since our last update. (Inaudible) per quarter versus our original projections does, that makes sense.

Jeff Johnson - Robert W. Baird

Yeah, no that’s exactly I would think about it just wanted to check it. And Dr. Petty I would love to get your opinion just on the margin where hip issues in the industry obviously Exactech very little if any exposure there. But, if you look historically at what happened on metal on metal things like that you had maybe one or two products recalled but still the whole category was kind of abandoned as you started to see some of the longer term revision issues and some of the (inaudible) problems and things like that. Wondering kind of if you start to see some of that stuff come up in especially the dual taper modular hips, do you think there is risk to that kind of where it kind of gets thrown out along with metal on metal as far as just abandoned from a use standpoint or do you think it will be a product specific issue that will only get a couple of companies?

Bill Petty

Difficult question to answer because I haven’t seen the data. I will say the following. Exactech studied modular hips very extensively and we made a decision a number of years ago not to proceed with a primary hip stent with a modular neck because even now we could meet all the criteria we as a company did not feel comfortable with that kind of construct. So, I think they are just based on our own data we believe that it's a challenging kind of device. Now, maybe some of our competitors have done a better job in their designs, I just don’t know, so it’s difficult to answer.

One of the commonest uses of metal on metal issue, I am doubtful about that just because the numbers I don’t think are anywhere close to what the metal-metal reconstructions were. But I think your question was could that design or construct go by the wayside, I agree you just have to wait and see how significant it is and doesn’t impact all the designs about type or just one or two, and I just don’t have the data to know that, Jeff.

Jeff Johnson - Robert W. Baird

And then the last question, I missed the first part of the call. I don’t think you probably broke out spine versus biologics but we have been hearing some decent things and good things on some new spine products. So, just wondering if the spine part your spine biologics number did pick up this quarter and any insight you have on end market demand and sign at this point?

Bill Petty

Yeah, important for us is use Exactech as a reference for the spine market (inaudible) them all, but I will say that as we studied a year ago when we launched the pinnacle screw system, the peak inner body and (inaudible) systems which we did in the second half of last year and we also have some additional line extensions going on in the first half of this year that we expect it to be able to start to show growth in our spine and we're doing exactly that. It's on a small base but its meaningful growth and it's moving in the right direction and it puts us in a position to recruit the higher quality sales people as we fill up the bag.

Now all of that implies within that biologics business is down and it is down slightly. But we believe we have stabilized that business and prospectively we're taking the step to try to get back to grow in the biologics and we expect nothing but growth out of spine going forward.

Operator

(Operator Instructions) Our next question is from the line of Jim Sidoti, Sidoti & Company. Please go ahead.

Jim Sidoti - Sidoti & Company

Good morning. Can you hear me?

Bill Petty

Yes sir.

Jim Sidoti - Sidoti & Company

It's good, great. So is it fair to say that we set up procedure basis that you're starting to see little signs of recovering the U.S. market?

Bill Petty

We are. We were talking before the call Jim and looking at that 8% domestic growth all-in. We've probably an average 2% price impact negative price impact. So I guess that would make units back of the envelope about a 10% growth for us. Now that's led dominantly by the very strong growth we have hit and hit the children.

Jim Sidoti - Sidoti & Company

Okay. Specific to knees are you seeing any signs of knees picking up?

Bill Petty

We are. We are.

Jim Sidoti - Sidoti & Company

Okay. And Jody I'm sorry I didn't get the number, what were the legal expenses in the quarter?

Jody Phillips

We didn't specifically break it out, but we stated it was roughly half of last year and we broke it out last year it was $1.4 million. So think of it in half of that neighborhood. Does that make sense?

Jim Sidoti - Sidoti & Company

Yeah, I think you know that.

Jody Phillips

Thank you.

Bill Petty

1 is a simple math, Jim.

Jim Sidoti - Sidoti & Company

And just then can you give us an update on what products you plan to launch in the back half of the year and how the cartilage repair program over in Taiwan in going?

Bill Petty

Well you know that logic system we're in full launch mode on our fib-tibial trade and our, what we call the PSE tibial inserts and more importantly the full logic CRME system is in full swing, and that will all continue through the second half of the year, and we're also launching the Logic RBK in Europe, and we will have what we call as CRC tibial inserts launching really in the first half of '13 but an under pilot launch in the second half of this year.

Jody mentioned some of the hip products. The most important one being the short neck version of the element then, which is, has -- our initial surgeries are underway. We also have before the FDA our Crown Cup large heads and liners, which pending clearance potential in the second half of the year and something that we believe will be an important contributor to our growth.

And I did mention already the shoulder launches of the posterior augmented glenoids augmented reverse baseplates and the Cage Glenoid. And spine, we mentioned the one that launched at the end of last year Gibralt that's your cervical system in the second phase of that, which in launch mode now the cervical plate version of that will be available in the fourth quarter. And then we get into next year before we launch additional things in spine and do you want to comment on the status of cartilage project?

David Petty

Sure. Jim, on the cartilage project we're in an IVE in Taiwan, which began just late first quarter, early second quarter, and we are on track with that IVE. I've also mentioned that prior to that we got a study in 10 patients, we're now collecting data on the three year follow-up of those patients and we do believe with positive results, which is what we're seeing so far because that data may be sufficient for approval and release in some market but may not be U.S., but in some other markets so that's where we are.

Bill Petty

Jim, I left out an important hip product or effective for full launch in Q4, which is the InteGrip cup with the acetabular augment. That's an important product and I think will give us the reason to go knock on some doors for the new customer.

Jim Sidoti - Sidoti & Company

All right. And any changes in your distribution during the quarter or you're relatively stable at this point?

Bill Petty

You know that's an interesting question outside the U.S. it's relatively stable and I use the term stable in Europe loosely and hope for meanings but yeah in terms of keeping the organizations intact and not making changes I'll say in the U.S. markets over the last four quarters we've made changes. We've made changes for us that have made improvements in the sales organization. We've been successful in interacting experienced folks from the industry and adding them to our sales teams and we feel like that is a larger part of our improvement in the U.S. market as are product launches and whatever we can make of any improvement of surgery volumes that may be happening out there.

Jim Sidoti - Sidoti & Company

Has the overall number changed or you need to just to improve the quality of the registered we've had?

Bill Petty

The overall number has changed. But I'd say that the impact is probably greater by the qualitative improvement. We can put people on the street and we do. We need to grow the sales force but the qualitative improvement I think can get us there faster but yeah, we have that since last we reported we were up to about 265.

Operator

(Operator Instructions) Gentlemen, I'm sure we've no further questions at this time. I'd like to turn the conference back over to you for any closing remarks.

Bill Petty

Thank you Vince, and thank you to everyone for joining us on the conference call and your interest and analysis of Exactech and we look forward to continuing to make progress at the Exactech. Thanks and have a great rest of the week. Bye, bye.

Operator

Thank you, sir. Ladies and gentlemen, this does conclude the Exactech Inc. second quarter 2012 results conference call. Thank you very much for your participation. You may now disconnect.

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