Orthofix Medical Inc. (OFIX) Q1 2014 Earnings Report, Transcript and Summary

Good afternoon, ladies and gentlemen, and welcome to the Orthofix International 2014 First Quarter Earnings Conference Call. [Operator Instructions] Now I'd like to turn the floor over to your host, Mark Quick with Investor Relations. Sir, the floor is yours.

Thanks, operator, and good afternoon, everyone. I'd like to welcome you to the Orthofix First Quarter 2014 Earnings Call. Joining me on the call today is our President and Chief Executive Officer, Brad Mason; Interim Chief Financial Officer, David Zigler; and Chief Financial Officer effective this Friday, Mark Heggestad. I'll start with our Safe Harbor statement 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 7, 2014. 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 2013 Form 10-K/A, as well as additional SEC filings we make in the future. 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 these matters as a supplement to financial performance measures determined in accordance with GAAP. Please refer to today's press release announcing our first quarter 2014 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. Since it's only been a few weeks since we last spoke to you, we'll keep the narrative relatively short today. On today's call, David will provide information on our financial performance during the quarter. I will then follow-up with my takeaways and highlights of our progress in rebuilding our foundation for long-term profitable growth. I will also introduce Mark Heggestad, to say a few words. Now I'll turn the call over to David to provide the financial details during the period, David?

Thanks, Brad. Consolidated net sales were $101 million to the first quarter of 2014, decreasing 2% from net sales of $103 million in the first quarter of 2013. This was produced from our 4 strategic business units, or SBUs, that I will now cover. Let's start with BioStim. Sales increased 0.5% to $38.4 million in the first quarter of 2014 compared to $38.2 million for the same period in the prior year. The increase in BioStim revenue was driven by a stable performance in spine stimulation and a lower yet improving performance in Physio-Stim as we continue to transition the sales force. The net margin for BioStim in the first quarter of 2014 was $14.2 million or 37% of sales as compared to $16.9 million or 44% of sales in the prior quarter last year. This decrease was primarily due to higher commission expenses related to improved performance by our sales force, as well as the conversion of some reps to distributors as part of our stabilization and growth strategy. Net sales in our Biologics SBU decreased $400,000 or 2.7% to $13 million in the current quarter from $13.4 million in the same period last year. This decrease was due to a reduction in our marketing service fee rate with the Musculoskeletal Transplant Foundation to 65% from 70% on April 1, 2013, for Trinity Evolution and Trinity Elite sales. When normalized with this change, sales in Biologics grew 4% year-over-year in Q1. The net margin in the first quarter of this year, was $6.7 million or 51% compared to $6.0 million or 45% in the first quarter of 2013. Net sales in our Extremity Fixation SBU increased $900,000 to $27.1 million or 3.4% in the first quarter of 2014 compared to $26.2 million for the same period last year. The…

Thanks, David. Overall, I am pleased with the financial performance in the first quarter which was better than our expectations. We believe it confirms that our business has stabilized and gives us further confidence that our initiatives to improve and grow our business are appropriate and effective. As a reminder, the sales for the first quarter of each year for Orthofix are historically lower sequentially than the previous year ending quarter, which is normal seasonality. However, this year, that percentage drop was only about half of our traditional average. I will now give you a short overview of each strategic business unit's Q1 performance. Starting with BioStim, sales exceeded our expectations during the quarter driven by our new leadership team and field focus. With almost entirely new sales management in place and a reenergized sales force, we are seeing progress across much of the U.S, particularly in spine. Physio-Stim continues to be a drag on top-line growth, as we invest in our sales force and transition the product from Extremity Fixation to the BioStim team. We expect this investment to lead the stabilization and growth in our Physio-Stim business in late 2014 and beyond. Long term, Physio-Stim should be a growth driver for us. Our Biologics SBU, while down in sales overall year-over-year, was up 4% when normalized for the marketing service fee adjustment made last year with MTF for Trinity. Trinity Elite continues to exceed our expectations and is ahead of plan in account conversions from Trinity Evolution. In addition to Elite conversions, our focus for this year as we stated on the last call, is to continue to find additional distribution for covering spine procedures, as well as opening up and improving channels in the orthopedic markets. Additionally, our net margin in this business for the period was…

Thank you, Brad, and hello to those of you listening in our first quarter conference call. As Brad noted, I'll be joining Orthofix as CFO upon filing of the first quarter 10-Q, expected later this week. First off, I'd like to provide you with a brief background about me. I have a 25-year career in accounting and finance-related functions, started my career as an auditor with KPMG and since then have spent the last 20-plus years in the medical device industry, specifically 18 years with increasing responsibility at the Medtronic, and most recently, the last 5 years as CFO of American Medical Systems, a $0.5 billion in revenue medical device company specializing in devices used to address public health problems. I left American Medical Systems shortly after we sold it to Endo Pharmaceuticals. As many of you know, Orthofix has dealt with a number of significant issues over the past couple of years which have caused the distraction in the management's time and focus. As Brad just mentioned, there have been significant changes in the leadership of Orthofix over the past 12 months. During my interview process with Orthofix I had the opportunity to interact with a number of individuals, including several members of the senior management team, Brad, members of the Board and our newly appointed Chairman, Ron Matricaria. I came away from this process believing that the distractions are for the most part behind the company. Do it all, the fundamentals of the business have remained strong. Orthofix has a solid reputation in the market as a company with innovative products and high-quality service. Orthofix continues to be highly respected by its customers and appears to have a strong pipeline of future products. Even more important throughout my entire interview process, and it was an extensive process, I was impressed with the caliber of the very capable and energetic leadership team, and I am delighted to be joining them. By combining the talent and energy of the redefined management team and Board that we currently have in place, with the ability to apply our collective focus on the business, I believe there is a huge opportunity to surpass our customers and patient's expectations and optimize our shareholder value for far beyond where it is today. With that said, I look forward to beginning my role at Orthofix and to personally meeting with each of you. I'll now turn the call over -- back over to Brad.

Thanks, Mark, and welcome to Texas and the Orthofix team. I'm going to conclude my remarks today by comparing our first quarter performance with the priorities we set for ourselves last year and we made a commitment to stabilize our business and change our trajectory, this starts with people. The recent additions of Ron, Jim and Mark, as well as many other talented professionals who joined our team the last 12 months, shows our commitment to fundamentally reposition Orthofix for future success. We've also made a commitment to achieving and maintaining the highest standards of compliance and internal controls and fostering a culture of integrity and performance that will be essential in driving shareholder value. In the past, I've alluded to the need for infrastructure changes at Orthofix. We are ramping up our enterprise improvement initiatives this year and expect this will continue to have both a dollar and distraction cost the next 18 to 24 months. These initiatives will be widespread and include implementation of a new enterprise resource planning system worldwide. This work is not optional if we are to realize our vision of delivering exceptional value to our stakeholders. When complete, it will allow us to act on many strategic opportunities that are not possible for us today. Next, we made a commitment to profitable growth in all of our businesses. While we've made a lot of progress towards stabilizing our top line and our adjusted operating income for the first quarter was significantly improved over our recent trend, we expect to see some operating income percentage variation for the next several quarters as we continue to work on our SBU strategies and enterprise improvement initiatives. Long term however, our expectation is to continue to improve our operating income percentage and leverage our growth. Lastly, we are committed to maintaining a strong balance sheet and cash flow. The cash flow generation was lower than historical quarterly performance we had a few things working against us, as David pointed out. Also as David mentioned, our total cash position increased roughly $14 million in April. We are also committed to being a good steward of our shareholder's capital, focusing on prudent investments that are within our current capability to succeed. Regarding guidance, our first quarter performance was at the upper end of our expectations and gives us further confidence that as mentioned on our last call, we expect modest top line growth and an improving bottom line in 2014. As we get another quarter or 2 behind us, we expect to give you better clarity for the full year. With that operator, let's open up the lines to questions.

[Operator Instructions] We'll take our first question from Matt Miksic with Piper Jaffray.

So one on the core BioStim business. In terms of distribution, I guess I'd love to get a sense as to whether that's going to be an area that you continue to buildout? And at what point do you have what you need there? Can you talk a little bit about your plans both in terms of growth and, maybe, productivity? And then I have one follow-up.

Sure. I would say for us, you got to look at it in 2 ways, Matt. This is Brad. We have to separate it between spine and Physio-Stim. So on the spine side, I would say our sales force is very stable. We cover the vast majority of the geography out there now. We will be expanding -- continually expanding to get more time from our sales reps if not more feet on the street. But in any case, we are very solid and our Spine Fixation business -- or excuse me, BioStim business on the spine side. And we expect that to continue to ramp up our growth as we go forward for a couple of reasons. One is our the sales management and the focus that we have there now. And additionally, the leadership the division overall. BioStim is a little bit different. As you know, we talked about before we're breaking the Physio-Stim distribution out from underneath what used to be our orthopedics division and it's going under BioStim. So there was a combined sales force before that we're working our way through right now to see whether they're going to be on Physio, on the orthopedic products, on Biologics and we're working our way through that. That's going to take some more time, and that's why we had a little bit of a drag in that business. But we expect that, that will ramp up as the year goes through and we get better focus on the Physio-Stim products and that should continue to improve in 2015 and beyond.

And then given the consolidation is going on here or proposed anyway in '15 and beyond, I wonder whether that has on the Stim side, triggered any opportunities for you? Or is it too early to say? Or I wanted to get a sense of how that maybe changes the dynamic in terms of either reps or with competition or share in the Stim side again?

That's a good question. There certainly are areas where we will have some synergies where we have as an example, we may have distributors who are very, very solid spine distributors that we -- where we may be weak in the Physio-Stim and they may be able to provide leadership for reps in the particular territory in Physio-Stim, so there will be some crossover. But the customers are a little bit different. And the process for selling the product is a little bit different as well. Well I think it's going to be more about the leadership of the sales reps and distributors where we might get the synergies as opposed to with the customers themselves.

And the Biomet, Zimmer deal there, does that change the environment for you at all? Or have you noticed anything coming out of that the back of that announcement?

Haven't noticed anything yet, but we'll see how that plays out over time.

Great. And then just on the spine side, I understand maybe the changes there or the steps you need to take to drive some forward momentum there a little bit different, obviously, than on the Stim side. But if you could maybe give us a sense of what the next couple of catalysts are going to be, whether it's internal actions or distribution changes or new products that could start driving that business both in terms of the top line and margins?

Sure, Matt. One of the things that you can already see in Q1 is that I outlined our strategies for that business, is cutting our sales and marketing expenses, discount controlling, product development productivity and reducing depreciation and inventories and new products in this year. In Q1 we can already see the effect of some of those things. Sales and marketing costs, we've cut pretty dramatically. We're starting to get a better handle on our discounting control and our ASPs. And although I think they were probably down a little bit in the first quarter, I expect those to bottom out and hopefully go the other way -- I expect them to go the other way over time. And then in terms of product development productivity, we've got some really good things coming out this year. We have the Centurion posterior cervical system, I've talked about that before. That's a pretty unique product. It's not just a standard posterior cervical system. It's got a couple of unique features to it that took a long time to develop and we think will be very, very well received in the market. We also recently, in the last couple of weeks, released our Lone Star standalone cervical device. And then finally in -- later in the year, in beginning towards the beginning of Q3, we're going to do a limited market release of our Sky Hawk collateral system, and we're very excited about that system. And I talked about that towards having a very, very unique retractor, which is the key part of that system. So it's going to be a combination of all those things. And then working closer with our distributors is another aspect that I haven't mentioned. But with our new sales leadership, they're really starting to partner with our distributors in much more effective way, and we expect that to drive the business as well.

[Operator Instructions] And we'll take our next question from Dave Turkaly with JMP Securities.

I guess, that you've been looking at a different businesses strategically again. I'm just curious for some additional color as you look across the floor in your SBUs. I mean, longer term, again, as these things get rightsized, is BioStim kind of the defining asset that you think Orthofix will have? Do you think that we'll return to a time where that is the, let's say, primary driver of growth ahead? And then as also as you look across these 4 units, do you think you need more scale in any of them to compete effectively? Or do you think with the size that you are today in those businesses, you are okay?

Good question. So I'm a huge fan of the BioStim business, I always have been. I like just like the business model. I like how effective that product is. In the cases where it's utilized for the patients at risk of non-unions and non-unions for long bone. So I'm a big fan of that. I'm a big fan of the numbers of that business, obviously. We lost some ground in the last couple of years, and I think there's -- my expectation is that we're going to make up that ground and continue to grow that business. So there's no question it is a leading business for us. Now, that said, I don't view any one of these business as dispensable or disposable in any way, shape or form. We want to grow all of these businesses and we expect to grow all these businesses. As you think about Orthofix, we really are a bone fusion company, that's what we do. And every one of these businesses is about bone fusion. So when I look at each one of these, they're all important to me and they all deserve the attention. That's one of the reasons that I split them apart is so that we could get that focus and they could get the attention and get the investment frankly that they need. And which we've talked about in the past a little bit. So in answering the second part to your question, about scale, I could always use more scale in each of our divisions. But BioStim certainly with our 50% spine market has plenty of scale. We have the technology, we have the capability, we have the billing capability, that business we're in great shape. Biologics, we have the technology, we're a little bit biased, that we think…

We'll take our next question from -- a follow-up from Matt Miksic with Piper Jaffray.

But I wanted to just -- Brad, if you could, along the same lines of the previous question. Just we tend to think a lot of times in terms of the growth rates of the markets that we cover, whether it's hips, knee, spine or cardio and stem is a market that just we don't get an awful lot of exposure to, and it's a market that's obviously pretty important to Orthofix. And so maybe if you could just give us an update as to -- as we think about spine market growth, maybe if that's 2% to 3% currently if that's in fact where it is. Is Stim kind of tracking with that or are there opportunities for you to better than that market growth rate? Or just how you think about positioning yourself around that market? And where do you think the future of the market growth rate is over the next few years?

Sure. So a couple of things. Our view is that the market is contracted in the last 1.5 years, but the primary driver of that was kind of the self-inflicted to a degree. We had some issues with our distribution turnover in different things, where we lost some sales. We don't think that those were necessarily picked up by others if you think about this business and I've kind of said this before, if a sales rep isn't there when a bones, Stim, need to be applied it doesn't get applied. There's -- you have to have a sales rep to do that. So when we were transitioning sales forces and things like that, we lost some business and went backwards. So I think that it probably declined. Now I also think in the spine portion of our BioStim business, we're a driver of the growth, because we're roughly 50% market share. And I do believe we can grow that market. We can not only get back what we had, but I think we can grow beyond that. That business hasn't been supported the way it needs to be supported in my view. So with updated clinical data, sure they're class III devices and we have the PMA studies out there. But we need an updated data, we need support on the reimbursement side with clinical and cost-effectiveness studies. And armed with those things and a good go-to-market strategy, we can grow that business, no question. Physio-Stim is different. We've got 8 percent-ish market share there. That market is very underpenetrated, both are to a degree I think to Physio-Stim even more so. And we have more opportunity to gain market share than we do in the spine business. And that one we really have not done a good job in the past. Well I shouldn't say that. We weren't optimized for those particular products with our distribution. Distribution was terrific, depending on some of them sold Physio-Stim very well, some of them sold orthopedics well, some of them sold Biologics well. They weren't all focused on the right customer at the right time and the right call point. We have good opportunity there we think that all of this -- both of these markets can grow and we're one going to be the one -- the primary driver of that growth.

Okay. And then just along those same lines opportunities for expanding, for growing the market. We look a lot of technologies that are positions maybe in the right place, maybe in the wrong pace relative to some of the changes in health care. Particularly I'm thinking of desire among health care systems, payers, reduction of reoperates or readmission rates. And I think about Stim in that context, and I wonder whether you see or have seen any opportunity for docs and hospitals to favor more -- to be more favorable towards sort of a balanced spender's approach or making sure they're backing up their cases with whatever they can to prevent those downstream events, which are as you know, now kind of on the hospital. That'd be great to get your thoughts on that.

Yes. If -- Matt, if you need a job in our strategic marketing department, you're perfect because that's exactly how we look at it. We don't have that evidence now to make that case strongly enough. But we know anecdotally, that it's about the readmittance rates and the complication rates from additional surgeries and the cost of additional surgeries. This technology works so you're spot on. But we have to do our homework. We have to provide the data to show us that, that's exactly the case. And we strongly believe it is. That absolutely be one of our drivers, no question about it.

Next we'll take our next question from Kevin Bromby with Jefferies.

I'm stepping in for Raj today. Just kind of wanted to ask a question about net margins. I see you guys had a great quarter and pretty big improvement, particularly in spine. You guys clarified a bit of that with Matt's question earlier. But wanted to get a little guidance kind of moving forward. Do you guys expect this margin expansion to be sustainable? Do you expect it to continue? Can give any additional color around that?

We're not going to step out on any limbs right now until we get another quarter or so under our belt, Kevin. We just want to see things settle out from all the things that we've been doing over the last 6 or 9 months. So sorry about that.

Okay, I am showing no further questions in queue. I'd like to turn the floor back to Brad for any closing comments if they can make.

All right. Thanks for joining us on the call. I look forward to updating you on our progress during the second quarter this summer. And for those of you who I'll see next week, I look forward to that as well. Take care and have a great rest of the afternoon.

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.