Orthofix Medical Inc. (OFIX) Q1 2013 Earnings Report, Transcript and Summary

Good afternoon, ladies and gentlemen, and welcome to the Orthofix International Sponsored 2013 First 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, Director of Investor Relations, Mark Quick. Sir, the floor is yours.

Thanks, Operator, and good afternoon, everyone. I’d like to welcome you to the Orthofix first quarter 2013 earnings call. Joining me on the call today is our President and Chief Executive Officer, Brad Mason; Chief Financial Officer, Emily Buxton; Senior Vice President of Business Development and President of Biologics, Mike Finegan; and President of Spine, Brian McCollum. I’ll start with our Safe Harbor statements and then pass it over to Brad. During this call, we’ll be making forward-looking statements that involve risks and uncertainties. All statements other than 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 place undue reliance on such forward-looking statements, as there is 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, May 8, 2013. We do not undertake any obligation to revise or update such forward-looking statements. Some factors that could cause actual results to be materially different from the forward-looking statements made by us on the call include the risks disclosed under the heading Risk Factors in our 2012 Form 10-K and subsequent 10-Qs filed with the SEC. If you need copies, please contact my office at Orthofix in Lewisville, Texas. In addition, note that 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 impact of these items as a supplement to financial performance measures determined in accordance with GAAP. Please refer to today’s press release announcing our first quarter 2013 results, available on our website, for a reconciliation of these non-GAAP performance measures to our GAAP financial results. At this point I’ll turn the call over to Brad.

Thanks, Mark, and good afternoon, everyone. Welcome to the Orthofix first quarter 2013 earnings call. I want to start off by thanking the board and the Orthofix employees for their support and warm welcome they’ve given me over the past two months. I’m very excited to be back at Orthofix and feel like I’m home. On today’s call, I will start by providing some of my initial thoughts on the current state of the company, and then give an overview of the first quarter results. I will then hand it over to Emily for a detailed review of our sales and financial performance, along with our outlook for the second quarter. Finally, I’ll speak at a high level about my plans for the future of Orthofix and discuss our newly authorized stock repurchase plan. We appreciate everybody bearing with us during this time of transition at Orthofix. While my review and analysis of the company is well underway, it is not yet complete. So I have not yet made any conclusions about our current strategy. That said, we do intend to host a subsequent conference call in June to comprehensively outline what we believe is ahead for Orthofix. With that, let me give you my initial thoughts after rejoining Orthofix. In my first eight weeks on the job, I’ve had a chance to dig deeply into almost every aspect of the business. When I analyze the business, I start with the customers and the salespeople. I find their assessment of how we perform as a company to be the most valuable in determining our strengths, weaknesses, and opportunities. For me, the customer is and must always be our main focus, and we’re looking to further support that here at Orthofix. The feedback I have received from the field has generally…

Thank you, Brad. I’ll start with providing details into our sales and earnings results, and then discuss the performance of other financial measures. Finally, I’ll provide some of our expectations for the second quarter 2013. As Brad motioned, net sales in the quarter were $100.3 million, down 13% on a constant-currency basis. Foreign currency exchange rates negatively impacted net sales by approximately $700,000, or 0.6%, when compared against prior year. Excluding the impact from foreign exchange translation and the two fewer selling days, net sales would have been down approximately 10%. Now we’ll talk about each business in more detail. Starting with Spine, total sales were $66.3 million, down 12% versus the prior year. This decrease was primarily due to Spine Stimulation sales, which declined by $7.2 million to $32 million. Let me discuss the three specific reasons for the shortfall. First, about a third of the decrease was due to sales rep turnover in 2012, as previously discussed. You may recall we had mentioned it takes up to 12 months for new reps to establish themselves in their territory. Second, roughly another third of the shortfall was due to higher-than-historical mix of wholesale revenue in prior year. Third, fewer selling days and other miscellaneous issues made up the balance of the revenue shortfall. Let me provide a little more color around the impact of wholesale orders. In an effort to find new ways to expand Stimulation sales to new prescribers in 2012 and convert competitive business, the company increased the mix of its Stimulation wholesale business with large orders in particular markets. This strategy has paid off in capturing new customers and converting competitive business in some instances. We are also seeing some anticipated cannibalization of third-party billing sales from the distributors that purchased last year, which became noticeable…

Thank you, Emily. As I said when I started in this position eight weeks ago, I wanted to take 90 days to assess the business and compose a strategy for the future, so I’ve not yet reached any final conclusions regarding any potential changes to our current strategy, and I’m not able to update full-year guidance just yet. As we mentioned earlier, we will have another call in June to update you on these decisions and our future plans. At that time, we will talk in greater detail about our strategy to drive shareholder value, and we’ll describe our growth and operational initiatives as well as our capital deployment strategies. We will also be providing further details around the 2013 guidance. In closing, I want to note that my first few weeks have been extremely productive, as I’ve had a chance to sit down and speak with a number of our surgeons, distributors, sales reps, employees, partners, and shareholders. I see a tremendous amount of value in our business, within our people, technologies, partnerships, and market positions. My expectation is to realize that value by executing on a sound strategy. As a first step, underscoring the board’s confidence in our growth opportunities and our commitment to enhancing shareholder value, we also announced today that the board has approved a share repurchase program of up to $50 million. The board and I believe that this is an appropriate use of our cash and will enhance shareholder value. Given Orthofix’s financial position and flexibility, we’re confident that this buyback will not hinder or disrupt other capital deployment strategies. We intend to be very prudent and opportunistic with all growth investments, always focusing on shareholder return. We will discuss this in more detail on our upcoming call. In summary, I’m very excited to be here and believe that we have an opportunity to create significant value for our customers and shareholders. I look forward to talking to you again in June and describing our strategy to accelerate our business in more detail. With that, Operator, we’re ready to take questions.

Thank you very much. (Operator Instructions). Okay, we’ll take our first question from Imron Zafar with Jefferies. Your line is live. Imron Zafar – Jefferies: Hi. Good afternoon. Thanks for taking my question. First, I wanted to ask about this share buyback program. I was a little bit confused by that strategically, just given that the prior focus on the better balance sheet had been toward accelerating the top line. I realize that they’re all necessarily mutually exclusive, but does that signal less M&A in terms of the longer-term strategy, or how should we think about that relative to what you’ve outlined in the past?

Hey, Imron, this is Brad. It’s a good question and one we kind of anticipated. The board and I believe that our shares are undervalued where they are. We have a strong belief in the future of the company and growing the business, so we think it’s just a very good investment for us to make at this time. Additionally, it’s not going to adversely affect any of our M&A acquisitions – or M&A activities, I should say. We still have plenty of room to do the things that we want to do to grow the business, and plan to do that. Imron Zafar – Jefferies: Okay. And then in terms of your cost structure, given the lower revenue growth, what’s the strategy there now and directionally in terms of your operating expenses? Should we expect that to be toned down commensurate with the lower sales growth, or how should we think about that?

Well, we’re going to – one of the things that we’re going to work on in our strategy that we’re developing is how we’re going to spend our money to increase our growth. So as we continue to decide what that strategy’s going to look like and put that plan together, we’ll figure out what those things are going to look like going forward. So when we get into June and have a chance to talk about it, then we should have a lot more specifics for you at that time. Imron Zafar – Jefferies: Okay. And then in the orthopedics business, obviously, Brazil remains challenging, and last quarter you had attributed that mostly to regulatory delays, and on today’s call you talked about a big contract loss. I just wonder what level of revenues we should be looking at going forward for the rest of the year and beyond. If you can quantify that, the contract loss impact versus the regulatory delays in Brazil?

I don’t think we’re ready to do that today. We do think that the – since the regulatory issues are now behind them in Brazil, they are going to be catching up, and we do expect to see improvement as the year goes along, but I don’t have the specific numbers. I think we should see improvement in Q3 and Q4. Imron Zafar – Jefferies: Okay. So we’re looking for improvement in both Spine-Stim, with the sales force ramping up in Orthopedics in the back half, that’s fair to say?

That’s fair to say, absolutely. Imron Zafar – Jefferies: Okay. And then last question, I noticed that MTF got an FDA warning letter relatively recently. I just wonder if that puts at risk your launch timelines for the next-gen Trinity Evolution. Thanks.

Yeah, Imron, Mike Finegan here. The warning letter which they received, which was the result of just a routine inspection, it has no impact on our business in any way, shape, or form. So it won’t impact the launch. It won’t impact operations in any way. Imron Zafar – Jefferies: Okay, great. Thank you very much.

Thank you very much. We’ll take our next question from Michael Matson with Mizuho Securities. Your line is live. Mike Matson – Mizuho Securities: I guess my first question is just on your guidance for the second quarter. You’re at about $100 million for the first quarter. I think you’re guiding to $104 million to $107 million, so that’s a pretty big sequential increase, so just wondering why it’s not going to be more like in the $100 million-$101 million range – or $102 million range.

Yeah, Mike. I think what we saw in Q1 was the drop that we think that’s the bottom. And particularly relating to the Spine Stimulation, we expect that to come back up. So we’re reasonably optimistic about the rise, and we think that’ll continue to happen, particularly as we get toward the end of the year. Mike Matson – Mizuho Securities: And what gives you the confidence that the Spine-Stim’s going to bounce back that quickly? Because I thought that you just – not you, but I think it was Emily, someone said that it was – it takes 12 months for the reps to ramp. So where are you at in terms of your rep hiring, and how seasoned are these new reps? Where they are at on average in their tenure, and so forth?

Hey, Michael, it’s Brian. Yeah, we talked about turnover last year right in the middle of the summer, right at the end of Q2, related to the implementation of our corporate integrity agreement. We’ve definitely filled all those positions now, so we’re right around that six- to nine-month timeframe. What we found is we were able to go into those markets and find people who had relationships in those markets, so pretty seasoned distributors who had contacts in those markets. So that’s what gives us confidence that Q2 will look to be sequentially up from Q1. The other thing, too, is we’ve got various things that are annualizing that will happen now – between now as we move throughout the end of the year, and so those things are always going to be in our favor as we remove some of those and annualize some of those unusual things from the prior year. Mike Matson – Mizuho Securities: Okay. Let’s see. Just, in Spine-Stim, I understand the sales turnover issue, but one thing I’m wondering about is just putting the sales – if you just look at the salespeople that are still there, where they haven’t left, are they still able to grow the business? Because I’m just worried that this business has been restrained by the DOJ settlement to the point that whatever approaches they were using to sell these products before, they can’t do that anymore, and now it’s a much harder sell. Is that an inaccurate way of looking at it?

Well, I wouldn’t necessarily say it’s a much harder sell. There’s a lot more paperwork. There’s a lot more things that have to be done. I would say that the market conditions, fusions being delayed, denied, pushed back, have had some impact. I would say in markets where we have very senior, tenured reps who understand how to drive the business and understand the benefits of stimulation and can sell those benefits, have been able to grow their business even through these times. So it’s not that it’s becoming a harder sale; it’s just becoming a more involved sale, if you will. We all know insurance payers get into delay, deny, and discount; that’s their motto. And so in core businesses, same-store sales are actually improving. It’s these markets where we’ve had turnover, number of selling days, et cetera, that are really impacting our business right now. Mike Matson – Mizuho Securities: Okay. And then just – I know you’re not giving – or updating your annual guidance, but just with regard to the operating cost structure, given you’ve had a pretty big step-down in your revenue run rate here, I know there’s a desire to try to invest to drive improved top-line growth. But I guess just, this quarter it seemed like the – year-over-year, those expenses were kind of flattish – I guess, on a dollar basis, obviously not a percent of sales. But is that – in other words, are you going to do any cuts to kind of reflect this big step-down in revenue that we’ve seen?

Mike, it’s Brad. Again, we’re in the process of working through our strategy, and so I don’t want to comment on that because I really couldn’t tell you at this point what that strategy’s going to look like and where it’s going to make sense. But, as I said, we’ll look at three things. We will look at internal process improvements, in that bucket. We’ll also look at some growth initiatives, as well as our capital deployment strategy. So we’ll know more in June, and we’ll be able to update you then pretty specifically. Mike Matson – Mizuho Securities: Okay. And then, finally, just on the buyback, so it sounds like that’s going to potentially start in early May. Is that correct? And then do you have any intention of doing an ASR, accelerated share repurchase program?

Hi, this is Emily. Our share repurchase program will begin on Friday, May 10, and we will be doing this through an open market. Mike Matson – Mizuho Securities: Okay. All right, that’s all I have. Thank you.

Thanks, Mike.

Thank you. We’ll take our next question from Charles Croson with Sidoti & Company. Your line is live. Charles Croson – Sidoti & Company: Hi, guys. Thanks for taking the questions here. Can you hear me okay?

Sure can, Charles. Charles Croson – Sidoti & Company: Okay. Wanted to get a little bit more into the Stim side; Emily, I think you were talking about the wholesalers. I kind of missed a little bit of that. Can you just – can you add a little bit more color with that one? Because it was down a pretty significant amount after a few quarters here, with the exception of Q4 last year that seemed to be doing fairly well, so I’m just trying to get a little bit more idea behind that. Thanks.

Hey, Charles, this is Brian. Coming out of 2011, we had lost some market share as it relates to going through the investigation and turnover, et cetera. And so we deployed a strategy to get access to more prescribing surgeons and to convert some competitive accounts. Well, in 2012, we were selling to re-billers – or wholesalers, we’re calling them today – in order for them to reach surgeons that we were not able to reach in the past and also to actually convert some competitive business. So what you saw on the prior year was you actually saw those wholesales sales coming through in the quarter, which primarily happened in the first three quarters. We didn’t have any of those in the fourth quarter. And what you’re seeing as a result, in 2013, is that some of those units are actually cannibalizing some of the third-party business we would have typically gotten. And so that was a little bit of an unintended consequence, but we knew it was a possibility. So as we left 2011, when the market share was down, we put in a strategy to recover that, and I think as we play throughout the next two quarters, we’ll be able to assess by the end of this year whether that strategy worked or not by the amount of market share we were able to regain over the last two years. Unfortunately, those comps in each of these periods as we go through last year into this year are a headwind, but by the time we get to the fourth quarter, in which we went back to our historical levels of wholesale versus retail mix, you’ll be able to see the benefits of that. Charles Croson – Sidoti & Company: Okay. All right, that’s helpful. Thanks, Brian. And then, Trinity – I think you guys started breaking this out now – it grew about 7%. That’s definitely lower than what it had been in the past. I was wondering if some part of that is just due to surgeons waiting for Evolution. Is that part of it, or is it just the tough comps?

Yeah. Hey, Charles, Mike Finegan here. The answer to the question is we’ve grown that business, really, for three years in a row at mid-20% growth rates. So certainly the comps are difficult. I wouldn’t say that people have withheld purchases to wait for Trinity Elite. But having grown the business 7% in the first quarter, I feel we’re in a terrific position to continue to build upon the business, and as we launch Elite, I think good things are going to happen. So we feel really good about where we are. We feel terrific about Elite. We’ve had great feedback on it. And I think we’re perfectly positioned. Charles Croson – Sidoti & Company: Okay, that’s helpful, and then just had a couple more here real quick. On Europe, on the Orthopedics side, it seems like that continues to be troubled. How does this get fixed? I know some of that you might not be able to just because of government changes in reimbursement policies, but I’m just trying to figure out how you’re repositioning yourself there, particularly in Europe. And in Brazil it sounds like that’s getting fixed, but in the more troubled European markets, I’d love to hear something you guys are doing there.

Sure, Charles. I think the key there is the new product strategy. We’ve got several new products that have just come into the market there. We’ve got the TRUE/LOK hex coming on and Galaxy, and so we’re pretty confident that we can keep moving that business forward, and we’re going to continue to focus on product development over there. Obviously, as I think most people know, we have a great reputation in Europe. The Orthofix name is powerful over there, and we’re going to leverage that. Charles Croson – Sidoti & Company: Okay. That’s helpful. And then just last one here – I wanted to see if you guys could comment on the investigation now into PODs and how that might impact you guys.

Yeah, I’ll let Brian talk about it because he’s a little bit closer to it than I am.

Hey, it’s Brian. Look, obviously, the alert that came out from the OIG is probably one of the more pointed ones that we’ve seen, especially in my lifetime. We made a decision two or three years ago to stay away from PODs and actually walk away from business, so we feel very comfortable in our decision two or three years ago. We will continue to watch it to see if anything comes out of this. Our position is that it probably has not necessarily given us a windfall of opportunity, but it’s probably leveled the playing field a little bit, so we’ll probably have a better opportunity to go in and win some of those accounts we might have historically just had to walk away from. So that’s really what we think can happen to us over the next – in 2013, if you will. It will be interesting to see how people change, based upon that alert, though. So it’s really too early to know if there’s upside. I think it does level the field a little bit, and we’ll just continue to watch it. Charles Croson – Sidoti & Company: Okay. All right, thanks, guys. I really appreciate the questions there, and I’ll hop back in the queue.

You bet. You bet, Charles.

Thank you very much. We’ll take our next question from Spencer Nam with Janney Capital. Your line is live. Spencer Nam – Janney Capital: Hey, guys. Thanks for taking my questions. Can you guys hear me okay?

We can, Spencer. Thank you. Spencer Nam – Janney Capital: Great. I just have a few questions here, start with guidance. The second quarter guidance, the revenue side, can you guys provide any more color on which part of your business would contribute more to the upside for the second quarter, or is that – so – and if you cannot provide that, I guess this kind of goes back to the previous question that was asked, which is kind of, like, how did you come up with this numbers? Was it bottoms-up at this point, or was it just looking at the overall trend and trying to triangulate the numbers?

No, this was a bottom-up reforecast, Spencer, that we did by business unit throughout the organization, so that we have a little more confidence around that number, then, because of that process. Spencer Nam – Janney Capital: And then if that’s the case, like, where are you – is it the recovery from the Spine Stimulation that’s going to drive the most of the growth, or how should I think about that?

I think that’s – since it was the biggest percentage of loss, it’ll probably drive the biggest percentage forward, but all the businesses, we expect, to do well as we move forward within the guidelines that we gave you. Spencer Nam – Janney Capital: Okay, that’s helpful. And then the – when Emily was going through the details on the Spine Stimulation weakness, the third of the reasons for the weakness was fewer selling days plus miscellaneous. I felt like that was a bit of a – large enough chunk to not have the miscellaneous part explained a little more clearly. What would constitute miscellaneous weaknesses?

Yeah, this is Brian. The impact on Stimulation are, one, number of selling days, but two, the phenomenon of wholesale versus cannibalized retail business: that was also a pretty large part of that as well. So those two things are the primary drivers, as well as the turnover from the implementation of the corporate integrity agreement last June. So those are the three main buckets. You’ve got the number of selling days; you’ve got the turnover impact of territories being turned over and not being fully ramped, along with the wholesale versus retail cannibalization and sales from prior year. Those are the three primary buckets, almost equally contributing, to be honest. Spencer Nam – Janney Capital: Okay. No, that’s helpful. A couple more questions – for this June call where, Brad, you will provide more clarity and the forward-looking view on the company, it seems like everything is on the table, including growth-driven acquisitions, potentially cost reductions. Is that how I should think about it, that you guys are considering every possible venue to address the issues here, or there are some things that may not be as important or you guys not really focusing on at this point?

I think you’re right. We’re going to look at all options. And I’m not particularly as concerned about a recovery. From where we were in Q1, a lot of things are going to happen; if we did nothing, we would recover because of the dynamics in the field. I’m much more interested in long-term stable growth, and we will be opportunistic with our capital strategies as well. And so everything is on the table at this point, and we’re at an inflection point that allows us options that we just simply haven’t had in the past quarters, and that’s why I’m here, because these are some things that I can help with a lot. So I’m very, very excited about the future and the process of going through this, putting the strategy together. Spencer Nam – Janney Capital: Great. And the final question kind of related to that is, when you arrived, I guess, about eight weeks ago now, Brad, how would you describe – I know you described sort of like the things that you have to go through, but in terms of – how do you describe the situation at the company? Do you feel like it was one of those things where you guys sort of – there was the confluence of negative events that kind of put you guys into the position where you’re at today, or are there some issue that you guys really have to address to fix things, if you will? Could you maybe, in a qualitative way, explain sort of the situation that you felt that you were involved in?

Sure, absolutely. I think the company strategy the last several years was to focus on operating margins, and they did a great job of doing that. But in that process, I think we probably overshot a little bit, and as you put that much focus on operating margins, you do put some of your growth investment at risk. And so I don’t think this is – there’s nothing broken here. We’re just going to course-correct, and now we have the financial wherewithal to do that. So I didn’t come into anything that’s broken. I didn’t come into anything that needs turning around or anything along those lines. It’s all, from here, we’re at an inflection point where we have a lot of options, and we’re going to look at those options and pick the best ones that create the most shareholder value. Spencer Nam – Janney Capital: Great. Thanks, guys, appreciate it.

All right, you bet. Take care, Spencer. I think we have time for one more call.

Okay, I’m showing no further questions in queue.

All right, well, thank you, Operator. I’d like to thank each of you for listening to the call today. As you heard, I’m excited to be back at Orthofix, and look forward to working with the team to drive growth and shareholder value. I’m confident that, given some time, you will see very positive results from our efforts. I hope you’ll join us on the call in June when we’ll be able to speak in more detail about our strategy in future. Thanks again for joining us. So long.

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.