RTI Surgical's (RTIX) CEO Brian Hutchison on Q1 2016 Results - Earnings Call Transcript

| About: RTI Surgical, (RTIX)
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RTI Surgical, Inc. (NASDAQ:RTIX) Q1 2016 Earnings Conference Call April 28, 2016 8:30 AM ET

Executives

Wendy Crites Wacker - VP, Global Communications

Brian Hutchison - President & CEO

Robert Jordheim - EVP & CFO

Analysts

Matt Hewitt - Craig-Hallum Capital Group

Operator

Welcome to the RTIX First Quarter 2016 Earnings Conference Call. [Operator Instructions]. I would now like to the turn call over to your host for today's conference, Ms. Wendy Crites Wacker, Vice President, Global Communications. Ma'am, you may begin.

Wendy Crites Wacker

Good morning and thank you for joining RTI Surgical for our first quarter 2016 conference call. Today we will hear from Brian Hutchison, President and Chief Executive Officer; and Rob Jordheim, Executive Vice President and Chief Financial Officer. Before we start, let me make the following disclosure about forward-looking statements. The earnings and other matters we will be discussing on this conference call will involve statements that are forward-looking. These statements are based on our management's current expectations, but they are subject to various risks and uncertainties associated with our lines of business and with the economic environment in general.

Our actual results may vary from any statements concerning our expectations about future events that are made during the course of this meeting and we make no guarantees as to the accuracy of these statements. Accordingly, we urge you to consider all information about the Company and not to place undue reliance on these forward-looking statements.

Now, I'll turn the call over to Brian Hutchison.

Brian Hutchison

Good morning, everyone. Thank you for joining us. First, I will give an overview of our performance this quarter and then Rob will discuss our financial results. As a reminder before we get started, we announced a new revenue reporting structure in our fourth quarter and year-end 2015 conference call. We're now reporting our direct revenues and commercial revenues separately. In our direct business, we'll be breaking out revenue into five categories; spine, sports and orthopedics, surgical specialties, cardiothoracic and international. As detailed in the press release issued this morning, we reported first quarter revenues of $67.4 million, relatively flat compared to the first quarter of 2015 and exceeding Company guidance of $65 million to $66 million.

We also reported first quarter net income per fully diluted common share of $0.03 meeting our guidance. At this point, I will review the performance of each of our business lines within the global direct business. First quarter U.S. spine revenue increased 17% compared to first quarter of 2015. Our direct spine business continues to show excellent growth. Our direct spine team has added to our sales force strategically and steadily over the past year with a 27% increase in distributor relationships since first quarter 2015. Additionally, surgeon users have increased 31% in Q1 2016 compared to Q1 2015. Our direct spine team has seen steady growth over the last year in hardware and high double-digit growth in biologics over the same period. With the addition of new products and line extensions planned for the rest of this year, we expect this trend will continue.

To date in 2016, our team has introduced three new spine products. The Unison-C Anterior Cervical Fixation System which is a standalone device for interbody market; Deformity Instrumentation for the Streamline TL Spinal Fixation System which is an expansion of our existing system that provides surgeons with the instruments necessary in challenging adult deformity cases; and finally, the Release Laminoplasty Fixation System which is a system that allows for central spinal cord decompression from C3 to T3 in laminoplasty procedures. All three of these are important additions to run on our spine portfolio and meet the needs of our surgeon customers. These introductions are in limited phase to key surgeons initially with the expansion to full market planned for later this year. In addition to these introductions, we have a robust pipeline of development projects yet to come this year and beyond for our spine team.

Our U.S. direct sports and orthopedics business decreased 4% compared to first quarter 2015. [Indiscernible] in bone graft substitutes including our map3 cellular allogeneic bone graft offset lower revenues in implants for ligament reconstruction. The team saw an increase in surgeon customers for our map3 allograft in both foot and ankle and trauma specialties. Surgeons have told us they are excited with the results they are seeing even from their most challenging patients and are becoming repeat users. New experimenting in trauma surgeons are being added monthly and we expect this segment of our map3 allograft business to perform well.

As mentioned last quarter, the ligament reconstruction business is seeing ongoing increase of the use of autograft in some regions due to the perception that autograft is a lower cost option. Although we've not seen any significant customer losses due to the competitive activity and we have added new accounts through conversions, this positive activity has not yet been enough to offset the ongoing drag of increased autograft utilization. We have recently been awarded primary supplier status with two major surgical center purchasing groups which provides a promising path forward for our sports medicine business. The sales management team is actively engaged with these groups to drive new business and we look forward to realizing the benefits of these contracts in coming quarters.

First quarter surgical specialties revenue for the U.S. direct business increased 56% compared to first quarter of 2015. Our direct surgical specialties business continues to see solid growth as we penetrate the market with our competitive biologic portfolio. In particular, our Cortiva Allograft Dermis is showing strong growth trends and we continue to strategically add experienced distribution to that space. First quarter revenue for our U.S. direct cardiothoracic business increased 29% compared to first quarter of 2015. This team has now achieved seven consecutive quarters of record revenue. The increase in direct cardiothoracic business is due to continued sales expansion and growth from our Tritium SCP System and the Tutopatch ECM extracellular matrix implant.

Revenues from our Tritium System grew almost 60% in Q1 compared to Q1 of 2015. While we achieved more than 250% growth year-over-year for our Tutopatch ECM extracellular matrix implant, a collagens matrix derived from bovine pericardium for pericardio repair and soft tissue reconstruction. First quarter revenue for our direct international business increased 18% compared to first quarter of 2015 or 20% on a constant currency basis compared to the same period last year. The increase is due to year-over-year growth in all three international regions of EMEA, Asia Pacific and Latin America. New leadership and a restructured sales organization in EMEA continue to gain traction. Additional restructuring is expected to optimize the Asia-Pacific and Latin American regions in the upcoming quarters which is expected to further enhance growth.

At this point, I'll turn it over to Rob for additional detail on the financials.

Robert Jordheim

Thank you, Brian. Worldwide revenue of $67.4 million for the first quarter of 2016 decreased 1% as compared to the first quarter of 2015. Revenue comparisons between the first quarter of 2016 and the first quarter of 2015 are impacted by the recognition of $1.5 million in non-recurring accelerated deferred revenue in the first quarter of 2015 due to loss of exclusivity by our commercial distributor in the post mastectomy breast reconstruction market. Excluding the impact of the accelerated deferred revenue, worldwide revenue increased 1% compared to the first quarter of 2015 on an adjusted basis.

Direct revenue of $38.7 million for the first quarter of 2016 increased 11% compared to the first quarter of 2015 due to double-digit growth in the spine, surgical specialties, cardiothoracic and international business lines partially offset by a slight decline in sports. Global commercial revenue of $25.3 million for the first quarter of 2016 decreased 12% compared to the first quarter of 2015 due to higher orders in the first quarter of 2015 related to consolidation of some of our commercial distributors.

Domestic revenue of $61.2 million for the first quarter of 2016 declined 2% compared to the first quarter of 2015 due to lower orders in the global commercial business and the $1.5 million in accelerated deferred revenue in the first quarter of 2015, partially offset by strong growth in the domestic direct business. International revenue of $6.2 million which includes direct and commercial exports and distribution from our German and Dutch facilities, for the first quarter of 2016 increased 15% compared to the first quarter of 2015.

On a constant currency basis, international revenue for the first quarter of 2016 increased 18% compared to the first quarter of 2015. Net income applicable to common shares for the first quarter of 2016 was $1.5 million or $0.03 per fully diluted common share based on 58.2 million fully diluted shares outstanding compared to net income applicable to common shares of $2.9 million or $0.05 per fully diluted common share based on 57.9 million fully diluted shares outstanding for the first quarter of 2015.

Included in net income applicable to common shares for the first quarter of 2016 is $308,000 of pretax expense associated with our ongoing proxy contest. Included in net income applicable to common shares for the first quarter of 2015 is $1.5 million of pretax income associated with the previously mentioned non-recurring accelerated deferred revenue. Excluding the $308,000 of pretax expense in the first quarter of 2016 and the $1.5 million of pretax income in the first quarter of 2015, adjusted net income applicable to common shares for the first quarter of 2016 was $1.7 million or $0.03 per fully diluted common share based on 58.2 million fully diluted shares outstanding compared to adjusted net income applicable to common shares of $2 million or $0.03 per fully diluted common share based on 57.9 million fully diluted shares outstanding.

The Company's first quarter adjusted earnings before interest taxes, depreciation and amortization or adjusted EBITDA was $9.1 million or 14% of revenues for the first quarter of 2016. This compares to $10.7 million or 16% of revenues for the first quarter of 2015. Gross margin for the first quarter of 2016 was 53.5% compared to 54.4% for the first quarter of 2015. Excluding the $1.5 million accelerated deferred revenue recognition in the first quarter of 2015 with no associated cost to sales, gross margin increased 10 basis points compared to the first quarter of 2015.

During the quarter, marketing, general and administrative expenses totaled $27.6 million, an increase of $297,000 or 1% compared to the first quarter of 2015. The increase was primarily due to higher variable compensation and distributor commissions. Research and development expenses totaled $4.2 million, an increase of $581,000 or 16% higher than the first quarter of 2015. The increase was primarily due to higher research study related expenses.

Operating margin for the first quarter of 2016 was 6% compared to 9% for the first quarter of 2015. Excluding the $1.5 million accelerated deferred revenue in the first quarter of 2015 with no associated cost to sales or selling expense and the $308,000 of contested proxy expenses in the first quarter of 2016, operating margin in the first quarter of 2016 is comparable to the operating margin for the first quarter of 2015. Our tax rate for the first quarter of 2016 was 35% compared to 36% in the first quarter of 2015.

Our comparative income tax rate was positively impacted due to recognizing a portion of the 2015 research tax credit in the first quarter of 2016 with no comparable credit being recognized in the first quarter of 2015. Turning to the balance sheet. Our cash position at the end of the first quarter was $11.7 million compared to $12.6 million at the end of 2015. The decrease was primarily due to increased payments to vendors, principal payments on long term debt obligation and payment of a technology in-license fee in the first quarter of 2016.

For 2016, we anticipate being cash flow positive from operations. We're confident that with current cash balances and available debt, we have adequate liquidity to support our future operations and meet our financing obligations. Working capital at the end of the first quarter of 2016 totaled $132.8 million, an increase of $880,000 compared to working capital at the end of December 31, 2015. During the first quarter, the Company made a quarterly principal payment of $1.1 million on the $60 million term loan. At the end of the first quarter, we had $77.9 million of debt and approximately $6.6 million available under our revolving credit facilities.

With that, I will turn the call back over to Brian.

Brian Hutchison

Thanks, Rob. As many of you recall, we embarked on a strategic plan almost five years ago to invest in our direct business as well as diversify and broaden our implant portfolios in spine and orthopedics. We knew that we needed to establish a direct spine channel for our map3 allograft and we knew that we needed to broaden our portfolio to include metals and synthetics to prepare for long term growth in changing healthcare markets. While it's a vital and necessary part of our strategy, the commercial business specifically for the tissue based implants is historically very lumpy as many of you know.

As we stated in our last quarter call, this year the strong growth in our direct business overall is being offset by declines in our commercial revenue. We believe this illustrates the need for us to continue on our long term strategic plan to grow our higher gross margin direct business faster than market and thus as a percentage of our revenue over time. We'll work to maximize each of the commercial relationships that we have while at the same time grow our direct business to increase profitability and improve predictability in our business. Since we started our first direct sales force in 2005 through today, we have proven successful in achieving above market growth at 28% compounded annual growth rate in our overall direct business.

Additionally, during the same time frame, we've seen revenue from our commercial business ebb and flow from year-to-year, but trending to growth long term. In fact from 2005 through today, our commercial business has achieved compound average annual growth rate of 7%. If we look at the business drivers that we laid out year-to-date; base biologics, hardware and focus products; we see base biologics declined by 11% overall primarily due to declines in commercial biologics particularly in spine and BGS GO and in other revenue due to the $1.5 million acceleration of deferred revenue in first quarter of 2015.

In the key growth area of hardware, revenue grew 8% due to solid growth in our direct spine and cardiothoracic businesses, partially offset by moderate growth in our commercial trauma business. Our focused products of map3 allograft, nanOss advanced bone graft substitutes and U.S. direct surgical specialties portfolio grew 48% with balanced growth in all three product areas once again. As we've said, we do not expect our pathway to be linear, but we remain confident we can be successful in reaching our long term goals. We'll be diligent in our plan to grow revenues faster than market with gross margins approaching 60% and operating margins approaching 20% of total revenue.

Turning to guidance, in our press release issued this morning, we outlined expectations for revenue and EPS for the second quarter and full-year 2016. For the second quarter 2016, we expect revenues in the range of $66 million to $67 million. This would result in a 7% decrease in revenues compared to Q2 last year at the midpoint of our guidance. The decrease is due to declines of approximately 30% in our commercial business and other revenue partially offset by growth in high teens in our direct business for the second quarter. We expect net income per fully diluted common share as adjusted for the second quarter of 2016 to be approximately $0.03 based on 58.3 million fully diluted shares outstanding. Based on the results from the first quarter, we're narrowing our guidance for full-year revenues.

We now expect full-year revenues will be in the range of $282 million to $290 million compared to prior guidance of $280 million to $290 million. This would result in an increase of 1% year-over-year at the midpoint of our guidance compared to 2015. As compared to 2015, we expect full-year direct revenue to range from 16% to 18% growth as compared to prior guidance of 12% to 15% growth. Full-year commercial and other revenue range from 13% to 16% decline as compared to prior guidance of 9% to 14% decline. As we stated last quarter, the primary reason for this decline in the commercial business is that we do not expect the benefits that we experienced in 2015 from the consolidation of some of our commercial customers to continue into 2016.

Full-year net income per fully diluted common share as adjusted is still expected to be in the range of $0.18 to $0.21 based on 58.8 million fully diluted common shares outstanding. As mentioned previously, we expect to invest an incremental $1.4 million or $0.02 per fully diluted common share to fund our bovine tendon program. The net income per fully diluted common share guidance for the second quarter and full year as adjusted excludes expenses that are expected to be incurred as a result of the proxy contest.

At this time, the expenses expected to be incurred as a result of the contested proxy are estimated to be between $2.5 million pretax or $0.03 per fully diluted common share based on 58.8 million shares outstanding. Of the estimate of $2.5 million, $308,000 was recognized in the first quarter of 2016. The remaining $2.2 million of pretax expense is expected to incurred in the second quarter of 2016. Due to the inherent unpredictability of a proxy contest, our actual expenses may differ materially from our current expectations. We hope to see some of you this quarter.

We will be presenting at the Deutsche Bank Securities Annual Healthcare Conference on May 5 in Boston and the UBS Global Healthcare Conference on May 23 in New York. Before opening the call to questions, I would like to remind everyone that the purpose of our call today is to discuss our first quarter results and our guidance. I would ask that you please confine your questions to these topics.

At this time, let's open it up for questions. Bridget?

Question-and-Answer Session

Operator

[Operator Instructions]. Our first question is from Matt Hewitt with Craig-Hallum Capital. Your line is open.

Matt Hewitt

Couple of questions regarding the guidance. I'm trying to get to the numbers for your Q2 guidance while also reflecting the improved guidance for the full year. Obviously you started off strong, is there some seasonality that I'm not capturing or thinking about for Q2? Obviously coming off a very strong quarter, is there something going on in Q2 or is it a distraction? I'm not sure why you would anticipate a decline sequentially like that.

Robert Jordheim

The decline is primarily coming from our commercial business. We expect the direct business to grow double digit and continue that way for the quarters two through to four. For the commercial business, the forecast and orders that have come in are lower than what we anticipated from primarily in the ortho fixation line. So when you look out for the full year, we're narrowing our full-year guidance because we feel pretty good about the direct business, but that is somewhat offset by weakness in the commercial business. I will say though that we do expect the commercial business to really bottom out in Q2 and then sequentially improve in quarters two through four.

Matt Hewitt

Okay. And then a question on the focus products, can you provide what percentage of your total revenues both of your products represent?

Brian Hutchison

The focus products for Q1, Matt, were close to 10%.

Matt Hewitt

Okay. And then, I guess one last one from me. As we think about the remainder of the year, I would expect just based upon the guidance ranges that your gross margins would expand sequentially over the course of the year and then a little bit of it in Q2 for operating margins, but then a nice bounce back in the back half. Am I my thinking about that right?

Robert Jordheim

Yes, I think what you're going to see is the gross margin sequentially improve Q2 through Q4 on the strength of the direct business.

Operator

I'm not showing any further questions. So I'll now turn the call back over to Brian Hutchison for closing remarks.

Brian Hutchison

Thank you very much everyone for joining us on this call this morning. We'll be speaking to many of you through today and through the next few weeks. Take care.

Operator

Ladies and gentlemen, this does conclude the program and you may all disconnect. Everyone have a great day.

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