RTI Surgical's (RTIX) CEO Brian Hutchison on Q2 2016 Results - Earnings Call Transcript

| About: RTI Surgical, (RTIX)
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RTI Surgical, Inc. (NASDAQ:RTIX) Q2 2016 Earnings Conference Call July 27, 2016 8:30 AM ET

Executives

Wendy Crites Wacker - VP, Global Communications

Brian Hutchison - President and CEO

Rob Jordheim - EVP and CFO

Caroline Hartill - Chief Scientific Officer

Analysts

Matt Hewitt - Craig-Hallum Capital

Jayson Bedford - Raymond James

Chris Cooley - Stephens

Operator

Good day ladies and gentlemen, and welcome to the RTIX Second Quarter 2016 Earnings Conference Call. At this time, all participants are in a listen-only mode. Later we will conduct a question-and-answer session, and instructions will be given at that time. [Operator Instructions] As a reminder, this conference call is being recorded.

I would now like to turn the conference over to our host for today, Wendy Crites Wacker, Vice President of Global Communications. You may begin.

Wendy Crites Wacker

Good morning everyone, and thank you for joining RTI Surgical for our second 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. During the call we will also present certain financial information on a non-GAAP basis. Management believes that non-GAAP financial measures taken in conjunction with US GAAP financial measures provide useful information for both management and investors by excluding certain non-cash and other expenses that are not indicative of our core operating results.

Management uses non-GAAP measures to compare our performance relative to forecast of strategic plans to benchmark our performance externally against competitors, and for certain compensation decisions. Reconciliations between US GAAP and non-GAAP results are presented in tables accompanying our earnings release which can be found in the Investor Relations section of our Web site.

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

Brian Hutchison

Good morning everyone, thank you for joining us. I will start with a few key takeaways for the quarter. First, as detailed in the press release issued this morning, we reported second quarter revenue of $67.6 million, a 6% decrease compared to second quarter 2015, but exceeding company guidance of $66 million to $67 million.

We also recorded second quarter net loss for our fully diluted common share of $0.05. On an adjusted basis, excluding other charges, we reported net loss per fully diluted common share with $0.00. Second, we saw continued strong performance from our direct business with growth of 16% compared to second quarter last year. This growth was offset by larger-than-expected declines in our commercial business due to lower orders associated with the consolidation among some of our commercial distributors.

Additionally, reduced outlook for our commercial business for the remainder of the year required a slowdown in manufacturing production resulting in lower-than-expected gross margin which negatively impacted our EPS for the quarter, but positively impacted our cash flow. Finally, we announced in our press release that management and the Board of Directors are launching a comprehensive strategic review of our business lines and operations. I'll talk more about this later in the call.

At this point, I'll review the performance for each of our lines of business within the global direct business. Second quarter direct U.S. spine revenue increased 25% compared to second quarter 2015. Our direct spine business continues to show excellent growth in revenue, distributors, and surgeon users. In the past year, our direct spine team increased its distribution relationships by 36% since second quarter 2015. Additionally, surgeon users increased 33% in Q2 compared to Q2 2015.

During the second quarter, the spine direct team has record revenue of map3 Allograft and nanOss Advanced Bone Graft Substitutes, and achieved double-digit increase in hardware revenue compared to second quarter 2015.

Our U.S. direct sports and orthopedic business decreased 2% compared to second quarter 2015. Our customer base remains stable and pricing remains steady, but we've seen revenue pressure from a continued move to autograft within each count [ph].

Growth in cartilage and map3 Allografts helped offset the general move to autograft. The distribution team continues to focus on recent contract wins and improve distribution coverage as a way to bring on more new customers. Our sports and orthopedics team is gaining momentum with map3 Allograft with revenue more than tripling in Q2 2016 compared to Q2 2015. Surgeons are excited about the clinical results they are seeing, driving higher utilization and customer acquisition.

Second quarter surgical specialties revenue for the U.S. direct business increased 17% compared to second quarter 2015. Four new experienced direct representatives were added in the quarter in areas strategically selected based on favorable contract access. Expansion will continue in areas where favorable access as we work towards growing our customer base. Surgeons have told us they are pleased with both the quality of our implants and the early results they are seeing.

Our Cortiva Allograft Dermis was part of a retrospective study recently published in Plastic and Reconstructive Surgery's global online journal.

The peer-reviewed multi-center study conducted at Emory University in Atlanta Northside Hospital was an independent five-year review of two acellular dermal matrices in breast reconstruction: Cortiva Allograft Dermis and AlloDerm RTM. While Cortiva Allograft Dermis had a more challenging patient cohort, statistically higher BMIs and patient age, this series has shown that Cortiva Allograft Dermis has an equivalent complication frequency to AlloDerm RTM.

Second quarter revenue for our U.S. direct cardiothoracic business increased 31% compared to second quarter 2015. This team has now achieved eight consecutive quarters of record revenue.

Revenues from our Tritium SCP System grew 75% in the second quarter 2016 compared to the second quarter 2015. Strategic expansion of the sales force continues to drive growth, and increase in focus on Tritium and Tutopatch ECM is driving higher ASPs per procedure.

Second quarter revenue for our direct international business increased 27% compared to second quarter 2015, or 25% on a constant currency basis compared to the same period last year. International growth year-over-year was seen in all three international regions of Asia Pacific, EMEA, and Latin America. New distributors across Asia Pacific as well as continued market execution in the EMEA and Latin America markets fueled the growth.

To ramp up the direct portion of our business, our focus products, the map3 Allograft, nanOss Advanced Bone Graft Substitutes, and U.S. direct surgical specialties portfolio grew 54% with strong growth from map3 Allograft and nanOss product helped moderate growth in the U.S. or in the surgical specialties area.

With regard to our map3 Allograft, we announced earlier this year that the journal of tissue engineering recently published a peer-reviewed, preclinical study comparing multi-potent adult progenitor cells to mesenchymal stem cells. The preclinical study gives similar materials to the proprietary patented MAPC technology used in RTI's map3 Allograft. The study is the first peer-reviewed, published preclinical study comparing MAPCs to MSCs in bone healing.

Results demonstrated that MAPCs exhibited a more robust angiogenic protein release profile compared to MSCs in vitro. In addition, MAPCs demonstrated enhanced revascularization and bone formation in vivo in orthotopic defect model when compared to MSCs when placed on a DBM scaffold.

At this point, I will turn it over to Rob to provide additional details on the financials.

Rob Jordheim

Thank you, Brian. Worldwide revenue of $67.6 million for the second quarter of 2016 decreased 6% as compared to the second quarter of 2015. Direct revenue of $39.6 million for the second quarter of 2016 increased 16% compared to the second 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 $24.8 million for the second quarter of 2016 decreased 27% compared to the second quarter of 2015 due to lower orders from certain commercial distributors primarily in the spine, trauma, and dental markets.

Domestic revenue of $61 million for the second quarter of 2016 decreased 8% compared to the second quarter of 2015 due to lower orders in the global commercial business primarily in the spine, trauma and dental markets, partially offset by strong growth in the domestic direct business.

International revenue of $6.6 million which includes direct and commercial exports and distribution from our German and Dutch facilities, for the second quarter of 2016 increased 18% compared to the second quarter of 2015.

On a constant currency basis, international revenue for the second quarter of 2016 increased 16% compared to the second quarter of 2015. Net loss applicable to common shares for the second quarter of 2016 was $3.2 million or $0.05 per fully diluted common share based on 58.2 million fully diluted shares outstanding. This compares to net income applicable to common shares of $2.7 million or $0.05 per fully diluted common share based on 58.8 million fully diluted shares outstanding for the second quarter of 2015.

Included in net income applicable to common shares for the second quarter of 2016 is $4.2 million of pretax expense associated with our proxy contest, restructuring charges and severance charges.

Excluding these charges, adjusted net loss applicable to common shares for the second quarter of 2016 was $209,000 or $0.00 per fully diluted common share based on 58.2 million fully diluted shares outstanding.

The company's second quarter adjusted earnings before interest taxes, depreciation and amortization or adjusted EBITDA was $6.4 million or 10% of revenues for the second quarter of 2016. This compares to $10.8 million or 15% of revenues for the second quarter of 2015.

Gross margin for the second quarter of 2016 was 50% compared to 52% for the second quarter of 2015. The lower gross margin in the second quarter of 2015 was primarily due to lower production output driven by a reduced outlook for the global commercial business.

During the quarter, marketing, general and administrative expenses totaled $28.4 million, an increase of $1 million or 4% compared to the second quarter of 2015. The increase was primarily due to higher variable compensation and distributor commission expenses on direct revenue distributions. Research and development expenses totaled $4.1 million, which is comparable to the second quarter of 2015.

Operating loss for the second quarter of 2016 was $2.7 million compared to operating income of $5.7 million for the second quarter of 2015. Excluding the $4.2 million of proxy contest expense, restructuring charges and severance charges, operating income in the second quarter of 2016 was $1.5 million or 2% of revenue.

Our tax rate for the second quarter of 2016 was 27% benefit compared to 35% provision in the second quarter of 2015. Our comparative income tax benefit rate was lower due to the recording of restructuring charges with no realized tax benefit.

Turning to the balance sheet; our cash position at the end of the second quarter was $12.8 million, an increase of $1 million from the first quarter of 2016. During the second quarter of 2016 the company increased its maximum revolving credit amount from $30 million to $45 million. For 2016, we anticipate being cash flow positive from operations. We're confident that with current cash balance and available debt, we have adequate liquidity to support our future operations and meet our financing obligations.

Working capital at the end of the second quarter of 2016 totaled $128 million, a decrease of $3.1 million compared to this working capital at the end of 2015. During the second quarter, the Company made a quarterly principal payment of $1.1 million on the $60 million term loan. At the end of the second quarter, we had $77.2 million of debt and approximately $21.2 million available under our revolving credit facilities.

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

Brian Hutchison

Thanks, Rob. This past May at our Annual Shareholders meeting, our shareholders elected a significantly refreshed Board of Directors. During the weeks leading up to that meeting, we had an opportunity to talk to many of our shareholders about the strategic direction of the company and we value the insights and feedback we received.

At this time, the Management and the Board of Directors of RTI are launching a comprehensive strategic review of the company's business lines and operations to identify additional opportunities to increase shareholder value. We intend to engage the management consulting firm to assist with this review. Over many years we have pursued an aggressive and transformational strategy to grow the company and improve profitability. We've made extensive investments in our high-margin direct businesses, and broadened the implant portfolio to include metals and synthetics, while controlling our operating costs.

The results of this strategy have been encouraging, but we remain focused on exploring new opportunities to grow our company and enhance performance. The strategic review on which we are embarking is a logical next step to look for additional ways to adapt to our changing industry and healthcare paradigm so that we can generate increased value for stockholders. No timetable has been set for the completion of the review and there is no assurance that any specific actions will result from this review. We will give updates as information becomes available.

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

Question-and-Answer Session

Operator

Thank you. [Operator Instructions] And our first question comes from Matt Hewitt from Craig-Hallum Capital. Your line is now open.

Matt Hewitt

Good morning, just a few questions for me.

Brian Hutchison

Good morning.

Rob Jordheim

Good morning.

Matt Hewitt

First one, regarding the commercial business, is it one partner that you're having some issues with or is it a couple of them?

Rob Jordheim

Matt, this is Rob. It's primarily one partner. It's our commercial distributor in the trauma and dental businesses. With the major acquisitions made last year by this particular commercial partner, the 2015 inventory balance, they ordered a lot of product from us in an anticipation of sell-through opportunities or cross-selling opportunities. Those cross-selling opportunities have been slower than expected to materialize. So net-net in 2015, the orders were higher than they probably should have been, and we're feeling the impact of that in 2016.

Matt Hewitt

So I guess a follow-up to that would be how long you anticipate it will take to utilize that excess inventory? I mean, is this going to linger into 2017 as you look at it today, or do you think that we'd get through this year and then they'll return to a more normal ordering pattern?

Rob Jordheim

I think it's going to be the latter. We've been told that these cross-selling opportunities are expected to materialize late '16 and early '17. So I think we're at a steady rate now and we should expect to grow off that next year.

Brian Hutchison

Matt, this is Brian. The primary reason we changed our forecast was we've been given updates from them twice in the past several months, and the last update come in June. And it indicates just what Rob just said, that they expect that it will be over this year, but as we said, we'll keep giving you updates. We don't have visibility to their inventory, we just -- we have to listen to what their people tell us about what to have, and the pace at which it's moving.

Matt Hewitt

Okay, all right. Thank you. And then regarding the strategic review, what options are on the table, what is off the table? I mean, is there something where you'd consider divesting products or product lines, or maybe acquiring new products or product lines? I'm just trying to get a sense for the scope of this review.

Brian Hutchison

Matt, this is Brian. We're really early. We're really early in the beginning of this. We're just launching this now. So the answer to your question is "Nothing is off the table." So all lines of business, all segments will be reviewed, everything will get a top-to-bottom review and it will be in combination with management, Board, and the outside management consultant once they are selected.

Matt Hewitt

All right, and then one last one for me and then I'll hop off. You had set out some, I wouldn't even call them aggressive goals, but you had set out some nice targets for double-digit revenue growth, 60% gross margins, 20% operating margins. Given the current situation, are those still on the table, or how should we be thinking about those targets given the current state?

Brian Hutchison

Well, the new Board -- and this would be our normal time to revisit our strategic plan anyway as the management team with [indiscernible] to be engaging with them, as well as this outside group. So I would suggest that we will revisit those objectives as well. Although I can tell you that the Board still believes that it needs to provide a company that returns value to shareholders, and the way we had aligned it before was -- were a good set of goals, but I'm going to say that we have to re-look at everything, including those.

Matt Hewitt

Okay, great. Thank you.

Operator

Thank you. And our next question comes from Jayson Bedford from Raymond James. Your line is now open.

Jayson Bedford

Hi, good morning, and thanks for taking the questions, just a few. And I apologize if I missed this, but did you guys give third quarter guidance?

Rob Jordheim

Yes, we did. If you look at our earnings release that went out this morning you'll see the guidance in there for the full year.

Brian Hutchison

For full year, we didn't give the quarter.

Rob Jordheim

Yes, we did not give -- we've suspended giving quarterly guidance primarily due to the fact of the variability of the commercial business, but we did give full year guidance. The full year guidance revenue for 2016 is now $274 million to $280 million.

Jayson Bedford

Yes, okay, I got that, Rob, that's fine. I just thought I had missed third quarter, okay. In terms of the gross margin, I understand the explanation, was price a factor at all? Have you seen any erosion in end user pricing?

Rob Jordheim

No, we really haven't seen much erosion. What we've suffered from in the second quarter here is we basically lost a point of margin due to unfavorable mix. The direct business actually -- or the commercial business actually came a little -- came in a little bit stronger than we expected in the second quarter. And obviously, the commercial business carries much lower gross margins than the direct business. And then we lost roughly two points of margin due to the manufacturing variances as we stated in the earnings release that due to the commercial outlook, we have slowed manufacturing in three of our plants because of that.

Jayson Bedford

Okay. And what does gross margin look like for the whole year then?

Rob Jordheim

I would we're going to be somewhere in that -- somewhere between the low to mid 50s.

Jayson Bedford

Okay. Okay. And then in terms of focus products, can you just give us some idea how big are they in terms of percentage of the overall revenue pie?

Brian Hutchison

Focus products, they run roughly about 10% of our total revenue.

Jayson Bedford

Okay. And then the strategic review, you are hiring consultants, correct? Not an investment bank. Just I wasn't clear there.

Rob Jordheim

Yes, sure, correct, it's a management consulting firm, not an investment bank.

Jayson Bedford

And then finally, you've mentioned that I think in the last couple of quarters within the sports business, the move to autograft, what kind of stops that trend?

Brian Hutchison

Well, this is the cycle I have seen a number of times while I have been here, and what generally stops this is surgeon see results they don't like, especially in revision and they want to start to use allograft for more and more cases that they -- in other words they want to be surgeon preference and individual patient-by-patient call. What's different about it this time is with the changes in healthcare economics, the change is in that lot of the surgeon now being employees of hospitals, they are less inclined to push back on what administration wants, so it's taking longer.

I still believe that the outcome will be similar in that the surgeons will ultimately decide what's best for each patient, which is ultimately I think what all of us would want. So that's where we're going to have keep working at this until we see a change in it. And what we are going to be doing in the meantime is adding representatives and adding new accounts.

Jayson Bedford

All right, thanks. I'll get back.

Operator

Thank you. And our next question comes from Chris Cooley from Stephens. Your line is now open.

Chris Cooley

Apologies, I had my phone on mute. Good morning and thanking for taking the questions. Just two for me; first, maybe just a follow-on to Jason's comments when we think about the sports business there, I know you've seen several cycles now Brian as you just mentioned that I think we are effectively there at the bottom in terms of that. So, we can start to see the pull through from that three and the cartilage products really starting to drive growth there versus this pressure that we've seen from the shift to autograft.

And then just quickly on the balance sheet, maybe switching over to Rob, and then just kind of looking to some apply here obviously this morning, but it does look like you continue to have this build obviously on the inventory side what you alluded to which has led to the slowdown in manufacturing, what do you think about from a cash flow perspective that that's impacting the business here in the back half for the year. So when we think about cash flow going forward or as you have guidance here for '17, but how that can potentially convert and be a positive in the out year? Thanks.

Rob Jordheim

Chris, this is Rob. I'll take the inventory question and then Brian will answer the sports question. On the inventory side, we did see a little bit of growth between the end of the year and where we are right now. But I will tell you inventory is a very large focus for us for the remainder of the year. If you look at our financial results for Q2, we did slow the plants, which obviously impacted the gross margin rather than build a bunch of inventory that was not going to be sold.

So again, we are focusing on inventory, and the main focus behind that is to improve our cash flow situation. That's another big goal for the company is to increase free cash flow. So what we are doing right now is in line with those goals. Hopefully that answers your question.

Chris Cooley

Okay, thanks.

Brian Hutchison

In regards to the sports question, Chris, this is Brian. We do believe that we've seen all of our accounts pretty much the effect of the allograft autograft situation situation. We don't know exactly how long that's going to take to turnaround. And thus, we are not waiting. We are going to go ahead and add people who can go into wide spaces, where we don't have business and trying to have [ph] new business, because we have tenants available. So we are going to go, attempt to secure new customers. And I just met with our top sales leader and top sales force individuals and they all believe there is more opportunity, so they are going to try to get more business.

Chris Cooley

And if I may just squeeze two other quickies here, and then I will get back in queue; just, Rob, with the credit in the quarter from the tax perspective, any thoughts on a full year or revised full year guide for the tax rate? And then last question I will get back in queue on map3, great to see the preclinical study, but help us think about what kind of is the cadence for, and what we should be expecting there for additional data or additional studies I should say on that offering as well as man hours, so we can kind of see that dossier continue to build? Thanks again.

Rob Jordheim

Yes, I guess -- Chris, this is Rob. From a tax perspective, we are looking at the full year effective tax rate on the non-GAAP basis to be roughly around that 36%, where we have been in the past. So there shouldn't be any major, major material changes there.

Brian Hutchison

Chris, we are going to let Carrie address the pacing [ph] on the map3 data.

Caroline Hartill

Good morning, Chris. So as you can see, we released this week some of the early data that we have developed, and then we are continuing now into clinical study. So there are cases being presented as we see over the last couple of weeks [indiscernible] posters at various meetings of spine meetings as well as [indiscernible] meetings; the most recent of them was last week in Toronto. So, those posted in abstracts are actually the foundation of manuscripts that have been submitted are under our currently under peer-review. So we will publish the outcome of the peer-review studies as soon as they are published.

Certainly, some of those posters are in the public domain. So they are available, but we would -- we have taken the approach that we are not necessarily going to make a significant announcement around an abstract. We would rather hold off until we have a standard peer-review journal to which to reference. And then beyond that, we are undergoing -- we are underway with our first prospected clinical study in the lumbar spine, and we will be beginning before the end of the year our first prospective surgical spine study.

Chris Cooley

Thank you.

Operator

Thank you. And this does conclude our question-and-answer session. I would now like to turn the call back over to Brian Hutchison, President and CEO, RTI Surgical, for any further remarks.

Brian Hutchison

Thank you, Sonia, and thank you everyone for joining us this morning. I'm sure we will talk to many of you on calls later this morning, and we will talk to you again in about 90 days. Take care.

Operator

Ladies and gentlemen, thank you for participating in today's conference. This concludes today's program. You may all disconnect. Everyone have a great day.

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