Orthofix Medical Inc. (OFIX) Q1 2008 Earnings Report, Transcript and Summary

Good morning. My name is Jason and I will be your conference operator today. At this time, I would like to welcome everyone to the Orthofix First Quarter 2008 Earnings Results Conference Call. All lines have been placed on mute to prevent any background noise. After the speakers’ remarks, there will be a question-and-answer period. (Operator Instructions). As a reminder, this conference is being recorded today, Thursday, May 1st, 2008. Thank you. I would now like to turn the call over to, Mr. Dan Yarbrough, Vice President of Investor Relations of Orthofix. Mr. Yarbrough, you may begin your conference.

Good morning, thank you all for joining us to discuss the Orthofix International’s financial results for the first quarter of 2008. During this call, we will be making forward-looking statements within the meaning of Section 27A of the Securities Act of 1933 and 21E of the Securities Exchange Act of 1934, which involve risks and uncertainties. All statements other than statements of historical fact are forward-looking statements, including any earnings guidance we provide and any statements about our plans, beliefs, strategies, intentions, expectations, objectives, goals or prospects. Factors that could cause actual results to differ materially from the forward-looking statements made by us on this call include the risks disclosed under the heading Risk Factors in our 2007 Form 10-K and subsequent Form 10-Q filed with the SEC. Joining me on today’s call will be Orthofix’s CEO, Alan Milinazzo and our CFO, Tom Hein. And with that, I will turn the call over to Alan.

Thanks, Dan, and good morning everyone. Thanks for joining us for the call. As you have seen from our press release this morning, Orthofix started 2008 on a very positive note reporting strong first-quarter revenue and earnings. Before I go on, I would like to take this opportunity to acknowledge and thank all of our employees and business partners associated with each of our business units around the world, for their steadfast dedication and outstanding performance particularly during the first quarter of 2008. Despite some potentially disruptive events, this team remained focused and delivered strong financial results for the full quarter. Our total revenue of 128 million represented growth of 9% year-over-year. This revenue growth was once again very balanced across our primary business units continuing the trend we demonstrated throughout 2007. We believe these growth rates reflect the positive impact of a number of strategic activities that have taken place over the past several quarters. These include product launches, distribution enhancements and key management initiatives focused on driving our top line across all segments of our business. We were especially pleased to see our spine stimulation revenue up 13% year-over-year, which we believe is in excess of the overall market growth rate and continues the growth trend we achieved during the second half of 2007. And during the first quarter, we continue to see increases in the total number of prescriptions written for our market-leading spine stimulators as well as in the average number of prescriptions per physician. We believe these are both very important indicators of the increasing demand for our spine stimulation products and provide an additional avenue to cross our spine implant and biologic products in the future. Meanwhile revenue from our spine implant devices and biologics grew 10%. During the first quarter we took the…

(Operator Instructions). Your first question comes from Michael Matson with Wachovia Capital.

Hi, thanks for taking my question. I guess with regards -- you had a really good spine stimulation number in the quarter and I realize you had a little bit of an easier comp given the reimbursement issued last year but we notice that one of your competitors Biomet, they have been loosing share historically but it looked like they had some better results there, have you noticed any change in that kind of environment there?

Not really Michael, I mean our group continues to focus on that business and I had say we are taking share really from Biomet, we are taking share from other players. It isn’t specifically coming in at any one specific competitor’s expense now.

Okay. And, I understand your decision on orthopedics business but you did sell the Pain Care business. Are there still other things that you’re looking at selling, I mean, it look -- sounds like you have signed a new contract for the vascular business, so I guess that I wouldn’t interpret that as a sign you are not planning to sell that any time soon?

No, I think Michael we have talked in past that first thing if you think the business is healthy and we found some good things on the vascular business to improve the health profitability -- the health of that business. This was an important part of that. It’s in that contract which has been in place for a number of years refresh. So we are at this point in time we are comfortable with the next three years with that business. It does not mean we won’t continue to be opportunistic in things that arise for us on a product portfolio standpoint that aren’t long-term going to be part of our growth plan. We would certainly -- we certainly would look at those things. But we don’t have any specific plans right now for any other divestitures.

Okay. And then just on Trinity, I heard your commentary and its good news that you are getting more supplies. Is there any way that you can quantify that, I mean, I realize you probably don’t give us dollar amounts, but is it a doubling capacity?

It’s definitely a lot more -- and it’s quantified by saying a lot more, but we continue to be pleased with the ramp of inventory. But we have -- and we have been building some of our biologic capabilities with that distribution expansion as well. So we are still carefully but more aggressively than before growing out based upon the fact that our inventory position has improved. So we have a lot more inventory on our shelves than we had before. But we are still working through some mix issues there and it’s important that we get the mix on our shelves right. So I could say it’s improving nicely every quarter, Michael, but I can’t quantify it for you.

And the mix issue you are talking about that’s referring to the sizes of the packages that you are getting?

Exactly. And as you know, certainly by procedure, it’s important to have the right size with the procedure otherwise you have a lot of waste in material.

Okay. And then, just one financial related question. I noted that you had written down some intangibles in the fourth quarter and so I guess I thought that may be your tangible amortization would actually go down this year and it actually went up. So it sounds like you increased the life -- sorry, reduced the life of some of those intangibles, can you explain why you did that?

Yeah, Mike, this is Tom. We did on the distribution channel at Blackstone. We reduced the life of the intangible there and increased the annual amortization.

Okay. Is there a reason you did that or just being more conservative or --?

A combination of being more conservative and the fact that we are seeing some churn in that distribution group.

Okay. All right. That’s all I’ve got. Thanks.

Thanks, Mike.

Your next question comes from Jason Wittes with Leerink Swann.

I guess, first question is could you give us a running tally of how many distributors you have for Blackstone? And I guess your total supplying sales force with the running tally numbers at this point?

I think the -- hi, Jason, how are you it’s Alan.

Hi.

I think we have -- in our K, we have mentioned that we have 45 distributors. That’s still roughly a good number on the Blackstone in the U.S., yes, for Blackstone. We haven’t given out the specific number or feet on the street. Part of that is that we don’t always have visibilities if those distributors may add or delete sales representatives.

Right. I guess if you could kind of give us an idea of how you think this year looks in terms of those distributors. Should we expect that number to increase? Should we -- what percentage should we expect turned over things like that? What kind of color could you provide to give us an accurate idea of what the distribution is going look like this year with spine?

Yes, I would say from our stand point -- I don’t know if that number would change significantly. The number that we are obviously focused on right now is the direct rep group. Although I think I have mentioned in prior discussions. At times we may target some one for a direct representative position coming out of the distributor for example we don’t want to start their own distribution group. But we have also opened up our thoughts to enabling some of those reps who want their own distributorship come over for us. So the number I would focus on for the year I think would be that 40 to 45 number for Blackstone, remaining relatively constant with the addition of the 15 to 20 territories. I wouldn’t say for much from kind of a normal turn standpoint. We turned about 25% of that network last year. We don’t expect that to be anywhere close to what we have returned this year. We have talked in the past that going forward, we have got a terrific new sales management team we are implementing systems in terms of quarter management, territory management. And so this is all going to be performance based. So we really believe that that will create some turn over just based on performance. But from our standpoint, we view that as somewhat normal and manageable within the guidance that we have obliviously provided already.

So I guess from that comment we should assume that most of the -- sort of changing around the Blackstone distributors has happened at this point. I mean it sounds like there’s still a few left but the majority has already taken place and now its expansion?

Yes, there will still be some -- again I think there will return that would be what I would call normal and within the range of our expectations. We also want to be opportunistic, so when we find ourselves in situation, where we can bring on someone in a marketplace and can create an opportunity not by supplanting someone but maybe by going alongside of someone. So we may end up increasing that number by just -- further penetrating a specific market and New England comes to mind, where we had one distributor in New England and now we have two.

Right. Can I -- I guess, just to push you one step further on this, when you say normal turnover what is that 5 to 10% or what should we be thinking about for normal turnover?

Well that’s true actually.

Yes. I mean you would think as you go forward, it would certainly be under 10% just based upon the fact of the business (inaudible) and if you are running a direct organization, it should be roughly the same.

Right.

From my standpoint, I continue to believe that the past four, five months has been really a remarkable transformation for the sales management group at Blackstone. We have brought on really some very high quality folks. We have talked about that in Q4. And I think now we have got a terrific distributor base, and we are going to manage them on a really kind of a normal course of business that’s based on performance. So I would expect it to be below 10%.

Okay. Just to move on, but related. So how is it going with the 15 to 20 territories you are looking to fill? Can you give us any kind of indication of how close you are to filling of your unit percentage of physician designated will fill at this point or at least a time line to think about in terms of filling it?

Well we commented that we have got 15 direct reps. Our target was 15 to 20 for year Jason, and we commented that we have got 15 as of this morning. And again we have had some very good success as we talked about. We wanted the sale management team on board first and this group being is hired is what the sales management team that will take us going forward. So we feel very good about the quality of the folks that are out there and interested in our opportunity and recall that we really have a very unique situation in that we have this stimulation opportunity. So that opportunity to bring reps on who can participate on the stimulation side is also very attractive.

Okay. Now for the fixation business, now that you are keeping it -- I guess what kind of investments are going to be required to get it to where you had like it to be. I guess that’s already in guidance, but I assume there is still going to be some investment there. And I guess -- can you just explain a little further the nature of the investment, is that to increase the profitability and increase distribution or how should we be thinking about that?

Yeah, I think -- there are probably two things to think about with regard to the orthopedic business. Really, we now look at it from a geographic standpoint, so really look at what are the geographies that we are currently participating in and where can we get the maximum return on our investment. And so that’s the first thing that we are looking at very carefully. The second is, what does the product portfolio, need to look like within those geographies. Where can we compete effectively and where do we get the highest margins of those products. So that process is underway right now. We have promoted one of our kind of best and brightest from our European group, gentleman named Luigi Ferrari, who has been with the group for about 40 years. All of our fixation business grew up with the fixation business, and so each really meeting those geographic and product efforts in combination with our U.S. groups. So from our standpoint, it’s going to the combination of focusing on the right geographies where we can maximize the return on the investment as well as on the product line that give us the highest return. We have done a little bit of this already, Jason, we have tried to focus down -- since I have been here, we are trying to focus down on fewer products for our R&D resources into products we think can be very successful. So it’s really continuing that process. In the U.S. certainly we think that the expansion of our Physio-Stim share is -- we have got a great product. Share position is still relatively low, so although it’s increasing, so we think that’s the key part of that and then selected -- in a selective hardware portfolio on biological products in the U.S. to drive revenues.

Okay, great. Thanks a lot.

Thanks, Jason.

Your next question comes from Steve Lichtman with Bank of America Securities.

Good. Thank you. Good morning. On the sports medicine business, looks like an underlying acceleration here of that 14% extra pain business from last year. Is it -- is that the case of the ongoing products, actually sell a little bit in the acceleration or is it that the pain products were just weighing down growth last year. And if there was acceleration what would be the reason for that?

Yeah, now, I think -- I think Steve its an acceleration. I mean this is a business that really in the past six quarters in particular and through a combination of things, one is there is the new product introductions in focus. So there are a couple of key drivers here for the group and cold therapy and functional knee bracings. And then the second really is the enhancement that they have made to their distributions systems. So the group there has complemented their existing distribution systems in markets where they have work fully penetrated with these one-man distributorships, which come in and really focus exclusively on the direct portfolio. I think the combination of that product introduction in focus as well as the distribution enhancements are just given as the outstanding, very strong mid-teens growth in those two segments. So that’s because backing out of the Pain Care entirely, just those two segments.

Great. And then on the Covidien adjustment there, that is just a one quarter inventory adjustment?

It appears to be Steve, based on the forecast that we have gotten from them but it is -- it appears to be about $2 million adjustment of inventory in the quarter.

On the ortho business, obviously heading into the year you have built in some assumption of some suppressed growth, as you would potentially sell the business. How should we think looking forward after this is going to shake out of, if this is the underlying growth of the business, is that 10% or give us a broad range if you could or is that something greater?

Yeah I mean, I don’t -- I think, we returned an 8% after 17% year last year. And so I would tell you, I wouldn’t expect us to do 10% this year. I mean our forecast that we put out of beginning of the year I have to stand by that. We’ve gone through this process quickly and efficiently, we’ve had tremendous employee retention and focus to deliver that kind of result we saw in the quarter. But as we begin to modify that strategy, I would -- I had be low as to get in front of what we’ve already put out there on a formal basis.

Okay on the half margins of that business, can you give us a sense broadly of where that is versus corporate and where you think you can get additive in the ortho business.

Yeah, I think we’ve mentioned in the past Steve, its well below what our corporate average is but we do believe with some effort and that focus on the key product areas like long bone stimulation. Some of the other products that we’ve got in -- our metal products, which have higher margins, we think we can get it up. I’m not sure we can get it to exactly our corporate target but we believe that over time, it can have an operating contribution that is in line in the range of what our target is for the company.

Okay. And then two last questions here. One is about what percentage of the manufacturing is OUS. So it’s getting impacted by effects and then Tom should we be thinking about a lower interest expense in 2Q as a result of LIBOR going down in the first quarter?

Yeah. About 30% of our revenues more or less are produced offshore and with regard to interest rates for the second quarter, yes. We are at a current rate of 4.64% for the second quarter. We would refer on top of that a little bit of debt placement amortization you should figure about a 5% interest rate on the second quarter, which is a reduction. And depending upon lumens in LIBOR that could continue through the balance of the year.

Sure. Okay great, thanks guys.

Thanks Steve.

Your next question comes from Dave Turkaly with SIG.

Good morning guys.

Hi, Dave.

You guys have something about negative impacts from the second quarter from Covidien?

Yes.

Revenues can you talk about that again? Could you add some color?

Yeah. No problem. So we have a 14-year long relationship with Covidien. They are our distribution partner in the United States, which is a significant portion of the revenues for that business. So we just renewed our agreement with them. As part of this contract or renewal, they are going to adjusting the inventory levels from what they currently are, down, and that’s really based upon end-user demand. So if you think about the business of end-user demand is changing in that segment of the market. So they are reducing their inventories. However we were able to get a price increase for the products which, is helping us. We also moved on manufacturing a year-ago from UK to Mexicali, which has improved our profitability on the products. So what we might want to do is, you know from our standpoint, just continue to monitor that for the remainder of the year. But our expectations in Q2 is about a $2 million hit for us on the top line, could be between 2 and $0.03 in earnings for us.

But that is based into our guidance?

It’s in our guidance. That’s right.

Okay, thank you.

Thank you.

Your next question comes from Steve Ogilvie with ThinkPanmure.

Hey guys, two questions. First on the new spine guys that you are bringing on, are they selling Stim at all and if not could you may be talk about their relationship with the Stim sales force? And then the second question is you know as you look across your global businesses in terms of manufacturing is there anything that can be consolidated there, you guys are obviously consolidating some of your administrative offices and are there efficiencies to be gained in manufacturing perhaps?

Yes, first and foremost on the cross-selling side. We still view that as an important opportunity for us although both groups have different activities in the field, same customer base but different activities in the field. So in some case we are already optimizing the cross-selling activities. I think we are doing about $1 million Stim revenue right now and due to the cross-selling activities with Blackstone. We do think that is something that we can improve upon although groups are performing at a good rate right now. So we want to do that in an appropriate way. So I would look for some of those reps to continue to cross-sell not all at this point in time. But we will continue to evolve that strategy. Relative to manufacturing we have been looking at that. We have taken steps as I mentioned and we have moved out of certain expensive offshore locations. We are manufacturing in the UK, we have moved some manufacturing to Mexicali. We have moved out of Seychelles Islands for some of our products. We haven’t really looked extensively at our European manufacturing options. And so that is one of the things as I mentioned as we look at our orthopedic business we broaden -- presence for the fixation business outside the U.S. that will one of the agenda items.

Okay, thanks

Okay thanks Steve.

Your next question comes from Peter Bye with Jefferies and Company.

Hi, good morning this is actually Josh filling in for Peter.

Hi, Josh.

Was there any distributed turnover in the quarter and can you comment on the performance by new distributors that you have signed on in the last few quarters and anymore turnover anticipated in the year?

Yeah, we had some normal distributor turnover as I mentioned in the prior calls and just a little bit earlier. We do expect that we will have kind of a normal distributor turn more performance based which has been -- which is what you would see normally. But from our standpoint we managed it within the expectations that we had already provided expect going forward we will continue to be able to manage that within the full year guidance that we have given.

And any comments on how those new distributors in the fourth quarter sort of started with their launch of some of our products?

Too early. We really forecasted most of the impact that we will see will be in the back half of the year. So we are expecting that those folks that we are bringing on both direct as well as the new distributors, the replacing -- the replacement distributors, will really start to kick-in in the back half of the year. But positive enough that despite some of the turnover that we had, no turnover we were able to exceed our numbers that we had forecasted.

Great. And then turning to the (inaudible) front mow that you have decided not to divest off the fixation business, now, what are your strategic plans in terms of exploring acquisitions to sort of further solidify your spine business?

Yes, It’s a good question. From our standpoint we really feel like we are focused more organically this year although we continue to be very active and looking at tuck-in acquisitions. A good example of that would have been what we did last year with our acquisition of our interspinous product. the InSWing product that we just actually put into limited market release this past quarter in Europe. So those sort of acquisitions or license activities, we are still very active in. So, nothing material for I would say at least on the books, but from our standpoint we continue to be very active with tuck-ins that can be complementary to the distribution system that we are building right now.

Great. And it looks like the Blackstone grew 8% for this quarter as well as last quarter. Have you sort of forecasted this growth trajectory in back half of the year with the preliminary distributors coming on board, your expansion of the sales force and also they are proving in the Trinity supply?

Yes, again, we have got a full year projection of 133 to $136 million for the year, so we obviously expect improvement in Q3 and Q4 based upon the effectiveness of those investments. And we started off our guidance call earlier in the year talking about, that we are going to see a slow ramp of that growth and so if we look at mid-single digits for Q1 and expanding throughout the course of the year, but the major inflection point really would be Q3 and Q4 for that business.

And I want to back a correction point here Josh. The growth of the Blackstone business worldwide was 10% during the quarter, the NAV growth was 8%. But the product growth -- the worldwide growth of the product was domestically and internationally was 10%.

All right. Great, thanks a lot.

Thanks, Josh.

Your next question comes from John Putnam with Dawson James Securities.

Spine stimulation business, what market share position would you be ending things?

Hey, John. We are estimating about 55% at this point.

You mean that spine stimulator is about 55%?

No, our share of this spine stimulation market is about 55%.

Okay, but if you excluded that in the overall spine business, what would your market position be, I guess?

Oh I see, if we were to take that out and just compare ourselves to the spinal implant companies?

Correct.

Apples-for-Apples. It’s hard, you had almost have to go product-by-product John because we don’t -- we define the market differently than others define the market with biologics, I mean we are a 100% of the Stim cell market. So it will hardly give you that, because everybody does really look at it, you have to break it down by product almost.

Okay. And in the sports medicine business, are you guys gaining market share? What you kind of see with the market dynamics there?

Absolutely we are gaining market share. From our standpoint I think it’s a very focused organization, very stable organization and some new products that have been delivered and very effectively launched into the marketplace with these enhancements to the distributor system. And you have got a business that, you know, depending upon which research report you look at is, call it mid-single digit growth. And we are growing 10% to 14% depending upon how you look at it.

Anybody in particular you’re taking share from?

No. No, it’s somewhat of a fragmented market, I know, that we tend to take share from everybody and we are happy to take share from everybody, we don’t discriminate in that regard. So I would say we are pretty much taking share from everybody.

Thanks.

Thanks John.

(Operator Instructions). Your next question comes from James Sidoti [Sidoti & Company].

Hi Jim. Jim Sidoti - Sidoti & Company: Alan, if you look at the first quarter you have been on the top line by about 4 million. You beat your pro forma -- the top rank -- the top end of your pro forma guidance by about $0.12, but you haven’t taken your pro forma EPS guidance up for the year, are you being conservative or are you worried about this Covidien issue or you just want to grow another quarter?

I’d love to think we’re conservative Jim but you know -- you have nailed in when you got -- Covidien is going to be a negative impact for us. So from my standpoint, I would love to characterize it as being conservative. Also remember that you know through the course of the year, our stimulation business really we had a phenomenal back half of the year in 2006 -- excuse me, 2007. So we expect that that growth rate to continue to be above market but 13% was exceptional for that group. Jim Sidoti - Sidoti & Company: Right. But you knew that when you gave your initial guidance as well?

But little higher than -- actually we -- again we are 4 million above our target, our high-end of our range. So, one of the things that we are very impressed with is that across the board all of our businesses delivered above performance. Stimulation folks again delivered a terrific quarter above guidance. Jim Sidoti - Sidoti & Company: And Tom did you pay down any debt during the quarter?

We did. We paid down about 4.5 million during the quarter, part of that was related to proceeds from Pain sales -- Pain Care sale and you could see we are carrying about $45 million of cash at the end of the quarter. Given the slowdown in pace of corporate development activity will probably accelerate during the year some additional pay downs. And I’m going to use, Jim, if you don’t mind I will use this opportunity because we didn’t comment in the call, the script part of the call on the balance sheet. That so, may be I will just go ahead and make some comments there. If you look at our DSO, our DSO, were 82 days coming out of the first quarter. That’s in line compared against 84 days, end on the first quarter of last year and 78 days year end. So we are basically right in line. Inventory on an absolute basis was up 10.3 million. But the inventory turnings were also up to 1.8 times versus 1.5 times at year end and 1.6 times a year ago. So the turn’s rate of inventory is in line. The growth in inventory about half of that came out of Blackstone and we talked a little bit about continuing to stage inventory for future growth. And the other half was spread through our international subsidiaries, the majority of which was currency or the impact of a 13% increase in the year over since the dollar and on the balance sheet the impact of that on inventories in our international businesses. We already mentioned the reduction in debt. So, that’s kind of a quick picture of the balance sheet. Jim Sidoti - Sidoti & Company: How much of that do you think you will be able to pay off this year?

Not going to make a prediction on that. But you know you have a pretty good handle on the free cash flow we are generating. Jim Sidoti - Sidoti & Company: Okay, All right. Thank you.

Thanks Jim.

And there are no further questions. Are there any closing remarks?

Yes, thanks, operator. Few messages I had like to leave with you today are that we continue to generate solid, balanced revenue growth across each of our core operating units. Also we are on course with our plans to accelerate our spinal implant biologic revenue and earnings during the second half of the year as we begin to build a hybrid sales network that will involve our expansion into new geographic regions around the United States. I want to thank you very much for your calling in today, I look forward to updating you more on our progress during next quarter’s call. Thank you, operator.

Ladies and gentlemen, this concludes today’s Orthofix first quarter 2008 earnings results conference call. You may now disconnect.