Orthofix Medical Inc. (OFIX) Q4 2012 Earnings Report, Transcript and Summary

Good afternoon, ladies and gentlemen. And welcome to the Orthofix International-sponsored 2012 Fourth Quarter Earnings Conference Call. At this time, all participants have been placed on a listen-only mode. And the floor will be opened for your questions and comments following the presentation. Now I’d like to turn the floor over to your host Senior VP and General Counsel Mr. Jeff Schumm. Sir the floor is yours.

Thanks operator and good afternoon everyone. I’d like to welcome you to the Orthofix fourth quarter 2012 earnings call. Joining on the call today is our President and Chief Executive Officer, Rob Vaters and interim Chief Financial Officer, Emily Buxton. I’ll start with the safe harbor statements and then pass it over to Bob. During this call, we will be making forward-looking statements that involve risks and uncertainties, all statements other than statements those of historical fact are forward-looking statements, including any earnings guidance we provide, and any statements about our plans, beliefs, strategies, expectations, goals or objectives. Investors are cautioned not to play undue reliance on such forward-looking statements as there’s no assurance that the matters contained in such statements will occur. The forward-looking statements we make on today’s call are based on our beliefs and expectations as of today February 21, 2012. .: On today’s call we will refer to certain non-GAAP financial measures in which we exclude certain items from our GAAP financial results. We believe that in order to properly understand our short-term and long-term financial trends investors may wish to consider the impacts of these items as a supplement to financial performance measures to determine in accordance for GAAP. Please refer today’s press release announcing our fourth quarter 2012 results available on our website for reconciliation of this non-GAAP performance measures to our GAAP financial results. At this point I’ll turn the call over to Bob.

Thanks Jeff and good afternoon everyone. Thanks for joining us today for our fourth quarter 2012 earnings call. I’ll start by going over our overall performance in the quarter and full year part of which we pre-announced in January. I’ll then turn it over to Emily for further financial details. The fourth quarter performance was highlighted by record profitability driven by strong margins of 83% and strong adjusted operating margins of 22%. The bottom line or adjusted net income from continuing operations grew 40% in the quarter. In addition, we removed a multiyear overhang on the company by finalizing both our Blackstone Medical, Inc. and our Bone Growth Stimulation legal matters, including making final payments to the U.S. government. Even after making these payments, we continued to have strong cash position, zero net debt and obviously ample borrowing capacities supported by solid earnings. We also won a major arbitration award against an insurance carrier providing product liability claims associated with the Sports Medicine Business that we divested last year. This win will provide us $13 million in expense reimbursement and up to $15 million in additional insurance coverage. We expect to receive the reimbursement sometime during 2013. Revenues were in line with our prerelease made in January; while it was not satisfied with the overall top line growth this quarter do a number of challenges, which I will discuss. I am encouraged by strong growth in our U.S. Spine Repair Implants and Regenerative Biologics business. In addition, we have also once again proven our ability to navigate through a challenging environment to consistently achieve operating margin expansion and strong earnings growth. So let me start by discussing our sales results for the quarter. Net sales were $112 million in the quarter, 2012 down 8% on a constant currency basis. As…

Thanks Bob. Going through the income statement for the quarter, Bob covered revenues and gross margin with the operating expenses and move onto the balance sheet. Finally, I will provide full year 2013 revenue and earnings guidance. SG&A expenses were $62.8 million for the quarter, which were down slightly when compared to the prior year, but remains roughly steady on a percentage of sales basis at 56.1%. R&D expenses in the quarter were $5.4 million or 4.8% of sales, up 60% basis points from last year’s 4.2%. As Bob mentioned, during the quarter, we launched the TrueLok Hexapod System and FORZA Spinal Spacer System; two new products that are the result of our commitment to productive R&D. Operating income from continuing operations when adjusting for $283,000 charge for a prejudgement interest related to certain settlements with the U.S. government was $24.8 million or 22.1% net sales compared to 21.3% in the prior year. This 80 basis point improvement was driven primarily by the increase in gross margin as Bob previously discussed. Total stock-based compensation from continuing operations in the fourth quarter was $1.2 million and was flat with the fourth quarter at the prior year. Net interest expense in the quarter was approximately $600,000 compared to $2.6 million in the prior year, as a result of lower debt outstanding and lower interest rates. Our effective tax rate during the quarter was 36.8% when adjusting for a settle tax assessment and a foreign jurisdiction, the tax rate was 32.9%. Our effective tax rate for the full year was 34.8%. Now moving on to net earnings from continuing operations; in the fourth quarter 2012, we reported net income from continuing operations of $14.6 million, or $0.74 per share. Adjusting for the charges related to the prejudgement interest of certain settlement with the…

Thanks, Emily. Let me just say a few things before we go to Q&A. 2012 was a great year of accomplishment, the divestiture of the sports medicine business was an outstanding success that left us with the higher margin company with a very strong cash position and financing capacity. We exceeded our adjusted operating margin goal of 20%, this was an objective we established a couple of years ago and as we stand today, we are one of the most profitable companies of our size in the industry. This has led to record earnings results for Orthofix. Finally, the company removed its biggest overhang as our three major U.S. government investigation to finalize it. With the payment of these settlements significant risk has been mitigated. We now have one of the most robust compliance programs in the industry, which further differentiates Orthofix as a trusted partner for hospitals and healthcare providers. Given this strong foundation, along with the investments and new product introductions, and distribution upgrades being made in 2013, I am excited about our long-term growth opportunities. With that operator, I would now like to open up the line for questions.

Thank you very much. Ladies and gentlemen, the floor is now open for questions. (Operator Instructions) And we’ll take our first question from Dave Turkaly with JMP Securities. Your line is live. David Turkaly – JMP Securities: Thanks. You mentioned some of the distributors, I think for the metal side in the quarter, could you remind us what is your footprint today in the U.S. territory for that business? And where do you think that’s going over the next couple quarters?

Hey, David, it’s Bob. I don’t want to give specific, but I would say at this point, it’s improving. But we have a tremendous appetite to grow there and we have a lot of light territory of where we don’t have footprint. A big initiative for 2013 is to increase that and use our additional financing capacity and cash to acquire and do the deals with distributors which we did actually during the fourth quarter. David Turkaly – JMP Securities: I missed on that, you may have said in the call I don’t know, your financing capacity how would you define that, what do you have available if you are to do something today?

Well, I mean that question can be look at lot of ways. We have a net cash position over $30 million. We have trailing 12 months of adjusted EIBTDA of $112 million and as Emily mentioned we have zero net debt, so you can spend and of course we have stock, so you can triple that in a lot of different ways, but I think we have certainly more capacity than we’ve had in many years and what resolution government settlements we’ve had be a substantial dry powder. David Turkaly – JMP Securities: Thanks a lot.

Thank you very much. We'll take our next question from Imran Jaffer with Jefferies. Your line is live. Imran Jaffer – Jefferies & Co.: Hi, good afternoon thanks for taking my question. I know you haven’t historically given revenue guidance by segment, but given all the company specific and I guess end market considerations, can you just talk about what is baked into your guidance in terms of recovery in Physio-Stim the Brazil situation and maybe more broadly pricing and volume trends in ortho and spine broadly? Thanks.

We're very cautious about Brazil and don't have a lot of recovery until the end of the year, so there's not a significant amount there particularly as these registrations pave our way through. We have recovery in Spine Stim, in Physio-Stim we don’t have a robust forecast, because we are trailing a new rep program as I mentioned. But overall we are continuing to look for a good year, strong year in the Spinal Implant business, particularly in the U.S. So I think all those things are driving our forecast for the year, which we’ve given the 1% to 3% growth in the strong profitability continued. Imran Jaffer – Jefferies & Co.: Okay. And then in terms of the non-coverage in France, is that purely austerity driven, or is there any other clinical data basis for that, then as a risk of other healthcare economies doing same?

Hi, this is Emily. In France, we really believe this is purely driven by the French government. Our clinical data looks very good and we provide studies to them every two years. So we believe this is purely an economic situation there. Imran Jaffer – Jefferies & Co.: Okay. And then lastly, [now] you’ve reached your objective of that 20% adjusted EBIT margin, can you talk about what your objectives are over the next couple of years on that metric?

Sure. Certainly it is going to be difficult to repeat what we’ve done over the last couple of years, particularly with things like on the operating margin level device tax I think we don’t have this. So I think in our guidance we feel like we are good at the 80% gross margin and 20% operating margin. But if we can grow the top line keeping those margins would be very satisfied. Imran Jaffer – Jefferies & Co.: Okay. Thank you very much.

Thank you very much. We will take our next question from Spencer Nam with Janney Capital. Your line is live. Spencer Nam – Janney Capital Markets: Thanks for taking my questions. Maybe you will start off with the both, Bob you concluded your remark by indicating that this core potential that is very promising. You guys have launched some new products that could be very interesting as well. But having said that, you’re guiding 1% to 3%, which is certainly more in line with last couple of years if you will, maybe on the software side even. Just curious kind of how you guys aside from potentially acquiring somebody, how you’re seeing growth coming to the top line here?

Sure, thank you for the question Spencer. Just to be clear, this is a guidance that has no inorganic activity. So it’s an organic activity. Although we do have for the first time in many years a pipeline is coming out with several products this year. We are seeing cautious particularly with the European and Brazilian markets performance competitively. And not having complete certainty to when that turnaround happens when the registrations gets cleared up. And in case of the things like France when the reimbursement issue gets cleared up. So we were cautious and that’s all baked into those things. In addition the one thing that we haven’t baked in with certainty is the launch of Trinity Elite, which we’re expecting in the second half of the year as opposed to beginning of the year. So all those things together lead us to forecast we get in. Obviously, to the extent we do anything in organically with this acquisitions or products that would increase those numbers. Spencer Nam – Janney Capital Markets: Thanks for the color there. Emily, on the free cash flow side, I think you guys have not really talked about free cash flow in the past due to some of these outstanding issues, but now that's cleared up can we make any sort of a wealth estimate on what the free cash flow would be this year?

You are absolutely right, we have not provided that metrics, because there is lot of noise that’s been in there in the past several years. As the noise has cleared up, we will start looking at that metric and provide it in the coming quarters. Spencer Nam – Janney Capital Markets: Okay, that's helpful. And then maybe going back to the Trinity Elite launch, besides the fiscal difference if you will between the Elite and Evolution are there any Bob I know you mentioned in your remarks that it’s a successful launch, successful trial if you will with physicians and so forth. Are there any specifics in the clinical differences that you are seeing would be lead, I know that you guys have a full trial on this (inaudible) comparing with Evolution, but I was curious if you have some specific thoughts at this point suggesting why Elite will be superior is superior and if so and what way?

Thanks for the question. Mike Finegan our President of Biologics is also joined us on the call today, I'm going to let Mike comment on that. Mike?

Yeah, obviously we've done very well on the Trinity Evolution as kind of the one the lease cell based tissue form out there. And launching that and having been successful about through the past really several many quarters and couple of year’s feedback that we've gotten from physicians has been – has offered a suggestions in terms of ways to improve that, specifically around the graph containment or handling characteristics or scaffolding characteristics of Trinity Evolution. And so those are some of the improvements that we made in Trinity Elite. We have shown it to around 25 preliminary surgeons in the country and private channels have gotten very specific feedback. We had our first two cases this week. All the feedback has been tremendously positive with regard to the improvements made, with regards to the scaffolding, with regards to the handling characteristics. And we think the applicability based on that feedback is going to give us lot more penetration capability, a variety of different spinal and orthopedic procedures. So we’re very confident that we’ve made substantial improvements. We’re very confident that the market is robust and we think we’ll be very successful. Spencer Nam – Janney Capital Markets: Thank you.

Thank you very much. We’ll take our next question from Matt Miksic with Piper Jaffray. Your line is open. Sachin Kulkarni – Piper Jaffray: Hi, this is Sach Kulkarni on the line for Matt. We have three calls going on simultaneously here to night. So I apologize on Matt behalf and I do have a couple of questions.

Okay, welcome. Sachin Kulkarni – Piper Jaffray: You hear me okay?

Yeah, we hear you, fine. Sachin Kulkarni – Piper Jaffray: Right, on the biologic side, there seems to be an opportunity to pickup share after the warning letter and lawsuits effort infuse. Do you think that cycle is pretty much completed or do you see further acceleration away from infuse?

Yeah, I’ll take that. I think discontinued opportunity has evidenced by Medtronic’s recent commentary on infuse. So I think that is going to continue to be opportunity for all those in the market and certainly for us. Sachin Kulkarni – Piper Jaffray: All right, at what point are you taking share from infuse and are you pricing product somewhere between bone graft in infuse or somewhere between a synthetic in infuse?

I think in terms of product positioning that's a broader question in terms of taking share, I can only comment on by telling you that we continue to grow quarter-in and quarter-out that we have grown for the past many, many quarters and we expect to continue to grow. So we think there is ample opportunity in a very, very big market to continue to take share from all other players. Sachin Kulkarni – Piper Jaffray: All right. Thank you so much.

Thank you very much. We'll take our next question from Mike Matson with Mizuho Securities. Your line is live. Michael Matson – Mizuho Securities: Thanks. I know Emily commented about kind of the first quarter revenue probably being down sequentially from the fourth quarter. And I know you don't give quarterly guidance, but just thinking through kind of the sequencing for the remainder of the year, I’m modelling kind of a little bit of improvement revenue growth just quarter-by-quarter as the year goes by, and I know the comps certainly get easier in the second half, does that sound reasonable?

Yeah, this is Bob, I think that's reasonable. Michael Matson – Mizuho Securities: Okay. I apologize if I missed this, but did you give – did you quantify the U.S. growth of Spinal Implants and Biologics?

No, we do not. Michael Matson – Mizuho Securities: Can you do that?

No. Michael Matson – Mizuho Securities: All right, I thought I try. And then I remember talking in the past and I think with regard to your margins you mentioned you're looking at doing some evaluating anyway vertical integration of your Spinal Implant manufacturing, I think it was, is that something that you are still looking that and is that something, is that an area for potential gross margin improvement?

We continue to look at it, and I think it will continue to show some improvement, but it's going to be opportunistically like, for example, in areas like Brazil we're looking at the local manufacturing how that can improve our margins. But I don’t look at in a grand way, but certainly we are continuing to look at opportunistically. And just back to your prior question, I didn’t want to be able to see that, we’re clearly doing very well in our U.S. Spinal Implant markets and we finished the year in a sort of double-digit growth pattern so. Michael Matson – Mizuho Securities: Okay. And then, just wondering if you could give an update on where things stand with your acquisition strategy. I know on the past, it sounds like you are getting close to doing something or multiple things, and I’m just wondering, I guess I’m a little surprise that we haven’t seen anything yet. So I know you can’t say specifically what you are looking at or give timelines, but just wondering if there is still a lot of activity there, and just thoughts around dilution accretion from potential deals?

Yeah, Matt, our activity has definitely increased, I’m spending more time on it, our business development team is spending more time on it. We haven’t closed a major transaction, [we’ve booked] that and made some progress on small product oriented activity, and we’ll continue to do it. Again, I can’t speculate. Also, on the dilution and accretion, I would say that it’s a factor, but it’s not the only factor. And to the extent, we complete something we’ll announce it as soon as we can. Michael Matson – Mizuho Securities: All right. But I mean just in – is there a kind of a level of dilution you’re willing to tolerate, or it just really depends on the nature of the deal itself?

It would depend on the nature of the deal itself. But as you know, we will, Mike, dilution is something that I would factor in quickly, not necessarily in immediate, but I would always look to a transaction that would give us a pact of accretion. Michael Matson – Mizuho Securities: All right. That’s all I have. Thanks a lot.

We have time for one more question. We’ll take that from Charles Corson with Sidoti & Company. Your line is live. Charles Croson – Sidoti & Company, LLC: Hey, guys thanks for taking the questions. Most of my – in fact, have been answered. So I guess it was kind of give a basic, Emily, are you guys expecting for S&M expenses going forward. Should we kind of look at this level or should those kind of pair down for those we go out into 2013?

We’re not providing specific in the guidance. I think what’s key to remember is our gross margins are going to be 80% and the LI margins are going to be around 20%. And you’re going to see some increased investments in R&D like we spoke about. And as I also mentioned, the medical device tax will be in the G&A line. Charles Croson – Sidoti & Company, LLC: I see, okay, thanks. Thanks for that. And in terms of that device tax, I’m looking at around $7 million or so. Is that a bottom line with what you guys are looking for?

No, we’re excluding our stimulation products from the medical device tax. So in our guidance, we have about $2 million or $3 million in medical device tax. Charles Croson – Sidoti & Company, LLC: Okay, okay that’s helpful, thanks. And then just one more and I think others have already harped on this. But I’ll ask you to maybe a little bit different way. Given guidance has kind of come down here couple of times in the past two quarters, what’s the confidence that you think you can meet this level going forward, particularly in the base of pots and payer pushback. I know you highlighted on that the macro issues. But I’m just trying to dive a little bit deeper on some of the industry specific item that are affecting everybody as well.

This is Bob. Obviously, the guidance is based on how we look today and what we see. There is sort of pros and cons right, so what could provide upside is very successful Trinity Elite launch in the second half of the year. What gives us some pause is the registrations and activity in Brazil and the continued economic situation in Europe. I'm also confident that we can grow our stimulation as we get into the year. So all of those things together at this particular juncture give us the conclusion of our 1% to 3% growth, and of course, our continued profitability growth on a normalized basis is higher than that, so those are all the fact as we know today that went into the guidance. Charles Croson – Sidoti & Company, LLC: Okay. All right, that’s very helpful. Thanks, Bob. Thanks guys.

Okay, I think that's about all. I thank everybody for joining us today. I'm glad that the fourth quarter now comes to close. And we have very excited about the activity that we have and I look forward to see you or hear you on the next call. Have a good evening.

Thank you very much. Ladies and gentlemen, this concludes today’s presentation. You may disconnect your lines, and have a wonderful day. Thank you for your participation.