Q2 2019 Earnings Call
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Ladies and gentlemen, and welcome to the Orthofix second quarter 2019 earnings results Conference call.
At this time all participants are in listen only mode. Later, we will conduct a question and answer session and instructions will follow at that time.
If anyone should require assistance during the conference. Please press Star then zero on your Touchtone telephone.
As a reminder, this conference call is being recorded I would now like to turn the call over to your host Mr., Marc quick senior director of business development and Investor Relations. Sir. Please go ahead.
Thank you operator, and good afternoon, everyone welcome to the World six second quarter 2019 earnings call. Joining me on the call today are President and Chief Executive Officer, Brad Mason, Chief Financial Officer, Doug Rice.
I'll start with our Safe Harbor statements and then pass over to Brad.
During this call well 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 any statements about our plans beliefs strategies expectations goals or objectives.
And answers are cautioned not to place undue reliance on such forward looking statements. There's no assurance that the matters contained in such statements will occur.
The forward looking statements, we make on todays call are based on our beliefs and expectations as of today August five 2019, 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 Form 10-K for the year ended December 31, 2018, as well as additional FCC filings, we make in the future.
If you need copies of these documents please contact my office at Orthofix in Lewisville, Texas.
In addition on today's call, we'll refer to various non-GAAP financial measures, we believe that in order to properly understand our short term and long term financial trends investors may wish to review these matters as a supplement to financial measures determined in accordance with us GAAP.
Please refer to today's press release announcing our second quarter 2019 results for a reconciliation of these non-GAAP financial measures to our GAAP financial results at this point I will turn the call over to Brad.
Thanks, Mark and good afternoon, everyone.
As you may have already seen in our press release, a short time ago I'm very pleased to announce that John for Bostick will be joining orthofix effective immediately to become the president and CEO of Orthofix.
On November Onest of this year.
Between now and then John has agreed to take on the vacant role of President of global spine.
A seasoned executive with more than 30 years experience in the medical device and biotech industries. John served in several leadership positions at Biomet, Inc.
Including worldwide President of Biomet biologics.
Worldwide group President of Orthopedics.
And president of Us orthopedics.
Prior to joining biomed he held various general management positions within Medtronic, Inc., including worldwide Division President of spine.
Worldwide, Vice President and general manager of Biologics further spine and biologics business.
Additionally, John spent 13 years with the P. Orthopedics, a Johnson <unk> Johnson company, where he served in numerous roles of increasing responsibility.
Including the vice President of marketing and product development, and as vice President of spinal operations.
John its expertise and proven track record are perfectly aligned with our business composition and make him an exceptional choice to lead the company as president and CEO .
With the recent leadership change in our spine business I am pleased that John has agreed to serve as the president of global spine on interim basis.
This will give them time to focus on our needs and opportunities in that business before he takes on the broader CEO role, which should help assure a seamless leadership transition for the benefit of all orthopedics stakeholders.
Moving on to the quarter results.
As usual I'll start by giving you a summary of our second quarter 2019 sales performance after which Doug will discuss the financial results in more depth.
I will then follow up with our outlook for the remainder of 2019 before taking questions.
For the second quarter, we reported net sales of $115.9 million, representing a year over year in year over year increase of 3.9%.
Were 5.0% in constant currency.
These results were generally in line with our expectations other than in our biologics portfolio, which exceeded our plan for the second consecutive quarter.
With these results and the cadence of the Mpsix C cervical disc rollout in the us, but I will discuss in a moment, we feel confident about the sequential quarterly sales acceleration that we expect in the back half of the year, which is reflected in our full year guidance.
Orthofix spine, which includes our bone growth therapies, spinal implants, and biologics product lines.
Generated $90.1 million of sales in the second quarter, which represents a 3.8% increase in reported sales over prior year or 4% in constant currency.
Beginning with the bone growth therapies product line net sales increased 3.9% in the second quarter versus prior year. This met our expectations for the period and we continue to expect this business to grow in the 3% to 4% range for the full year.
Its spinal implants, which includes both spine fixation and most motion preservation products, we reported a net sales decrease of 2.7% or 2.0% at constant currency compared to prior year.
These reported results were driven by a 6.7% decrease in spine fixation products.
Primarily due to the abnormally high ASP pressure offset by a 33.5% increase from our motion preservation products.
As I mentioned on our last call in selective strategic major markets. We are upgrading our U.S spine implants legacy Salesforce with new high potential sales partners that are attracted to our unique portfolio of motion preservation fixation and biologics products.
These new sales partners are coming up to speed nicely and we expect the pace of sales in our spine fixation product line to improve in the third and fourth quarters as a new as these new distributors continued to gain traction.
We also expect a higher than usual ASP pressure that we saw in the period to return to more normal levels in the upcoming quarters.
US sales of our EMS six cervical disc are going very well.
Our training program. This program is continuing to ramp up and we have trade over 50 service today.
It's important to note that there can be a lag between when a surgeon is trade and when they start performing cases due to case timing and hospital approvals.
By year end, we expect to have over a 150 surgeons trained.
To provide a little more visibility on our progress to date.
17 surgeons have implanted over $550000 in U.S.M. sixsix cervical disc to date.
This is ahead of our launch plan that gives us confidence that we will achieve or exceed our $3 million to $4 million full year revenue target.
Although the majority of that will come in in Q4.
Overall, we expect a spinal implants will grow high single to low double digits for the full year.
Our biologics product line had another outstanding quarter reporting sales increase of 14.2% compared to prior year.
This performance continues to be driven by the contribution from new distribution added in the last year and the return to solid results in each of the three U.S sales regions.
Also we are pleased to report that based on recent Smarttrack data. We believe that we have now achieved the number one position in the cellular allograft market with over $100 million of sales to hospitals in the last 12 months.
Based on our first half performance, we now expect our full year sales growth expectations to be in high single digits for this business.
Lastly, in our Orthofix extremities business reported net sales for the second quarter were $25.8 million, an increase of 4.0% or 8.5% in constant currency over the prior year.
Given the quarter variability in this business, we believe the best way to assess its performance is to look at the constant currency trailing 12 months year over year growth.
On this basis.
Orthofix extremities business grew 3.7% in constant currency.
On a reported basis, given the currency headwinds of $3.5 million to $4 million for the year. Our current expectations for this business are for growth to be flat or low single digits for the full year.
In summary, second quarter sales were generally in line with our expectations in most areas with the exception of biologics.
Which outperformed against our plan for the second consecutive quarter.
Additionally, the launch of the Unsexy cervical disc in the US is going very well and gives us confidence in our expectations for the remainder of the year.
Doug will now take you through the key financial metrics in the quarter Doug.
Thanks, Brad and good afternoon, everyone I'll start by providing some additional details into our net sales and earnings results and then discuss some of our other financial measures as Brad noted total net sales in the quarter were $115.9 million up 3.9% on a reported basis and 5% on a constant currency basis, when compared to the second quarter of 2018.
Extremities experienced the majority of the $1.3 million a currency headwind during the quarter, while we saw outperformance from biologics and modestly weaker than expected spine implant performance.
Gross margin in the second quarter was 77.7% compared to 79.5% in the prior year period.
Gross margin was impacted by higher than normal noncash charges related to the build up of spinal implant inventory to support sales growth from our new sales partners in key geographies.
However for the full year 2019, we continue to expect gross margins to be between 78 and 79% of net sales.
Sales and marketing expenses were 49.1% of net sales in the second quarter of 2019 and increase support over 46.2% in the second quarter of 2018.
As with Q1 of this year the increase was primarily due to the investments in our extensive training and education programs to support them Sixsix us commercial launch.
The continued outperformance in biologics has also increased our commission expenses.
With expected outperformance and biologics continuing into the back half of the year, We now project sales and marketing expense in 2019 to be approximately 47% of revenues for the full year.
GAAP DNA expenses were 18.9% of net sales in the second quarter of 2019, which were down from 19.7% in the prior year period. This decrease was due primarily to lower compensation expenses related to the realignment of global spine last year, partially offset by increased executive succession charges. We expect that these continued decreases in DNA will offset our increased sales and marketing investments during 2019.
In line with our expectations R&D expenses for the second quarter were 7.8% of net sales up from 7% in the prior year period due to increased clinical research in bone growth therapies and motion preservation as well as cost specific to comply with the recent medical device regulations in the European Union.
R&D spending will increase modestly in the second half of the year and for the full year 2019, we continue to expect R&D expenses to be at approximately 8% of revenues.
Adjusted EBITDA decreased to $17.3 million or 14.9% of revenue down from $22 million or 19.7% of revenue in the second quarter of 2018.
This decrease was primarily driven by costs related to the investment in the IBM Sixsix commercial launch that are reflected in sales and marketing as well as the gross margin decrease that I mentioned.
We expect adjusted EBITDA for the year to be $86 million to $89 million, implying margins of over 20% in the second half of the year with significantly higher flow through in Q4.
Now turning to tax we had GAAP income tax expense for the quarter of $1.2 million or 181% of income before income taxes as compared to income tax expense of $1.1 million or 53.8% of income before income taxes in the same period of 2018.
While this year over year quarter tax provision was flat the increase in the effective tax rate was driven by increases in certain nondeductible acquisition related and other financial expenses.
For the second quarter 2019, we reported a GAAP loss of three cents per diluted share as compared to net income of five cents per share for the second quarter of 2018.
After adjusting for certain items and when normalizing for tax using a non-GAAP long term effective tax rate adjusted EPS for the second quarter 2019 was 28 cents compared to 42 cents in the second quarter of 2018.
The majority of this decrease was due to the investments in motion preservation.
Moving on to the balance sheet highlights.
Day sales outstanding or Dsos were 63 days at the end of the second quarter 2019 up modestly from 61 days at the end of the second quarter 2018, and down sequentially from 66 days at the end of the first quarter 2019 as noted on the last call. This year over year increase was due to the timing of collections from bone growth therapy payers as well as stocking distributors in our owed us extremities business.
Our inventory turns at the end of the second quarter 2019 improved modestly to 1.3 times versus 1.2 times in the second quarter 2018, due primarily to our inventory management initiatives.
Cash cash equivalents and restricted cash at the end of the second quarter totaled $52.1 million compared to $45.7 million at the end of the second quarter and 2018.
Cash flow from operations for the quarter was $9.4 million down from $16.6 million in the second quarter 2018, due primarily to increases in accounts receivable inventory and other working capital investments that support our topline growth.
Capital expenditures were up in the quarter to $5.4 million from $3.2 million in the prior year due primarily to investments in our global infrastructure and manufacturing capacity expansion for the M. Six c. artificial cervical disc.
Based on recent enhancements to our manufacturing outsourcing strategies, we now expect 2019 capital expenditures of $22 million to $24 million a decrease from our prior guidance of $24 million to $26 million.
Free cash flow, which we calculate by taking cash flow from operations and subtracting capex was $4 million during the quarter compared to $13.4 million in the prior year.
Consistent with prior years, we expect our free cash flow to improve as our sales ramp for the remainder of the year with that I will now turn it back to Brad.
Thanks, Doug.
Regarding guidance for full year 2019, our outlook remains unchanged. The company continues to expect to report net sales in the range of $472 million to $477 million, including a 4 million dollar currency headwind, representing a reported year over year increase of 4.2% to 5.3% or approximately 5% to 6% in constant currency.
We also continue to expect to reported sales cadence for the year to be heavily weighted toward the last half of the year with mid single digit growth for Q3 and high single digit growth in the fourth quarter.
As I mentioned on our last earnings call. This sales cadence is being driven by a number of factors including.
The ramp up of sales in the last third of the year of the M. Sixsix desk in the U.S.
The ongoing conversion of the U.S spine implants legacy Salesforce in selective major markets.
As our new high potential sales partners that are now attracted to our motion preservation fixation and biologics portfolio continue to ramp up sales.
And lastly currency headwinds weighted toward the first half of the year.
Primarily due to the sales ramp we expect our adjusted EBITDA to be heavily weighted toward the end of the year as well, but continue to believe that for the full year 2019, adjusted EBITDA, including spinal kinetics, we will be in the range of $86 million to $89 million and adjusted earnings per share will be $1.75 to $1.82 using a non-GAAP long term tax rate of 27%.
With that operator, we're now ready to open up the lines for questions.
Ladies and gentlemen, and Kevin.
And at this time. Please press Star then the number one on your telephone keypad.
If your question has been answered any wish to remove yourself from the queue.
Chris.
Again press Star one to ask a question.
Our first question comes from the line of Craig from Cantor Fitzgerald.
Good afternoon, guys. Thanks for taking the questions.
Hey, Greg how are you today good bye.
Thanks, Greg.
Well, let me start with John as the new CEO , So obviously years of experience in ortho and spine.
Brad you had a very or you had a specific strategy for the business and what you saw going forward. So when looking at candidates for the new CEO role, how how important was that to find someone that can then that shared your vision for the future of the company.
And then maybe.
Maybe just some other thoughts on why John is the right person.
To succeed you.
Sure I think Craig it was actually very important I think what John shared with the board and myself in terms of the vision is to continue to accelerate our top line growth through organic and inorganic opportunities and that is where we have been what we've been talking about for the last.
Probably four or five quarters, and what we've been delivering on now and art will be delivering on even more in the back half of the year. So John is very much in in step with that strategy and I think you bring some things to the table. They certainly bring some things on the table that I did not have terms of his experiences in spine and biologics and other places in our industry and with the people. He knows the company knows that are out there the distribution and those sorts of things I think he will be an incredible asset to the company and as I said in my prepared remarks is his experiences.
It's right at a central casting in terms of.
Our business and how those aligned so so that's that's number one.
Second part of your question I'm, sorry, Craig I lost track of it no. It was just any other thoughts on why is the right person to succeed you, but I think you you pretty much answered it Brad.
Yes, no I couldn't be happier that I mean.
This is I think having John come in and be willing to take on the spine role for a period of time I think it's a very elegant.
Solution to the situation we're in today with my retirement pending and.
And and the recent loss of one of our leaders in spine. So I think it's.
Set up perfectly for success and I think it will be a very very smooth transition.
Great. Thanks, that's helpful.
And then I wanted to talk about the the spinal implants business.
Obviously, you're seeing some disruption there but.
On a sequential basis it looks like the the loss was a little bit.
Better than what you saw in Q1.
I know you do have some.
Non organic revenue from spinal kinetics. So I just wanted to see if you could call that out and then.
When you think about the improvement that you expect in Q3 and Q4, maybe just.
Are there anecdotal or is there anecdotal feedback that you can provide on what gives you. The confidence are you are you seeing it in the later part of Q2, what gives you the confidence that that spinal or that the disruption.
That you saw or are seeing is going to rebound in the second half.
So in answer to your first question I don't have the numbers off the top of my head I guess some guys in the room, we can figure that out for me given and get it to you or we can give it to you on a on a follow up call exactly but.
In terms of the confidence.
You know obviously the growth in the second half of the year is for for spine implants, which includes motion preservation and fixation is going to be driven by M. Six and I think that adoption of the M. six is what will get us to the high single digit low single digits for the low double digits for the full year in.
And.
Our spine implant business.
But the pull through of the M. six we expect to have a positive impact. We also expect now to have some of these larger distributors, who we signed up.
60, 90 days ago to start to begin to have an impact as well and that should ramp as we get towards the end of the year. So we feel very good about it.
Okay.
From where we are starting and.
I think.
If I step back and look at it the primary driver is going to be the ampsix and the pull through from that in addition to those distributors. So at this point I think we are in good shape.
Got it and if I can squeeze one more in.
Doug maybe on EBITDA.
I appreciate it.
I appreciate brad's comments on in the script about the more revenue in the second half obviously leads more EBITDA, but if you.
The implied percentage of sales is still significantly higher so I was just hoping maybe a little bit color a little bit of color on what steps up.
From a EBITDA margin perspective in the second half and how you meet your guidance. Thanks.
No. It's a fair question.
I think we'd expect contribution really from.
From all components of RPL, you'd expect gross margin to normalize I think Q2 was an outlier.
For the reasons I mentioned in my script.
I think you'll see commissions and sales and marketing costs start to normalize.
In the back half of the year and improve as our sales ramp as we incurred a lot of cost as you know around the launch of our six in the United States.
Ahead of the sales so as the sales start to ramp in the fourth quarter I think.
You will start to see our flow through normalized but those are probably the two biggest drivers.
Great. Thanks for taking the questions guys.
Okay, you bet, Greg Thank you.
Our next question comes from the line of Ryan Zimmerman from BP.
Great. Thank you.
Just one follow up on Greg's question.
Brad based on the revenue achieved thus far with them.
I'm wondering if you could just speak to the surgeon base already implanted.
Certainly suggest.
Very high number and so.
As we think about it kind of rolling into Q3, and then the Q4 I mean.
Is this early leg how should we think of these as the early adopters and then maybe some of that revenue per search and maybe moderate a little bit out maybe you can help us understand kind of lose implant in today versus.
Oh, you expect plan during Q3 and into Q4.
Then Ivan.
A question as well.
Sure.
Good question Ryan so.
I think what you're seeing is is.
Actually maybe even a little bit.
Less than what we expect for search and believe it or not I think that.
The surgeons that we went to first sort of surgeons that were part of the I'd and we restricted our activities to those surgeons to make sure that they were taking care of their needs were taken care of.
For their participation in this study and and they had already been trained to so.
The retraining was less significant than with surgeons, who had not used pmsix in the past.
That said in recent weeks, we opened up that that funnel a bit and are now going to.
Additional surgeons around the country, we have instrument sets available we have implants available we have six people dedicated full time to training, we're adding three more so we think that the ramp will be will be very good.
We.
There is a delay between when a surgeon.
Decides to use the mpsix and gets trained and win and typically when they do their first cases or what as their or their cases ramp up some can be just.
Cases that were already set in and they've already made decision.
On the implant some can be the hospital registration or approval those sorts of things. So as we go through the year. We've I said, we expect to have over 150 surgeons trained by year end certainly not all of those surgeons will then be up in.
Full swing.
But I would expect over 100 would be at that point so.
I think the case volume, we're seeing from the first 17 that have done.
Don cases is.
Probably less than what we'll see overall.
But.
It's just it's still very early in the process.
Okay Thats fair.
And then I just.
I might have missed this but.
Pricing pressure on the corner you called out is abnormally abnormally high I think you mentioned about 6.7 decrease in your core.
Spine fixation product relative to the 33.5% increase in motion preservation.
What.
Are you seeing on the pricing dynamic and why does that get better.
Through the rest of the year.
Yes, really really good question Ryan so.
Overall, the industry, if you listen to some of our competitors they had some.
I would say unusually high pricing pressure as well in the spine implant business.
We saw a bit of that so thats, probably let's say two thirds of of what what we called out say the other third is is just internally some of our recently launched recently, meaning in the last 18 months launched products are coming off of some of the premium pricing that we were able to get in the early days and so that that affected our ASP as well so with those ramping off a rolling off.
The.
Better ASP, we don't expect that to continue to happen as we as we go through the year. So hopefully the market in general will.
<unk> decreased the price the pricing pressure will decrease in the market in general that's certainly internally, we expect to see a decrease as well.
Okay and last one for me and I'll hop back in queue.
On the guidance.
You took a nice step up I think about 20 cents.
On strategic investments.
For the year, just can you give us little more color on what what that is.
Sure about $4 million from what it.
Formerly was previously.
Yes, I'll take it Ryan.
Yes. So if you look historically, it's not too far off of what we spent last year. We as we said all along we're going to remain.
Very active we have we have been active and.
We're going to continue to look for opportunities that can really.
Generate accelerating growth in the in the areas that we play so it's just us being active and pretty similar to what we had historically last year.
Okay understood. Thank you for taking the question.
You're welcome thanks.
Our next question comes from the line of Jeffrey Cohen from Ladenburg Thalmann.
Hi, Brett Doug and Mark how are you Hey, Jeff Good Hi, Jeff.
Just fine so.
Sure. So first I want to kind of follow up on some of Ryan's questions as far as his training goes and can you talk about where the training is taking place and what's typical on.
Average number of cases in the case of physicians that have not been involved with the IDH.
I'd.
So.
The first part first first question first so the training is taking place in Lewisville and also in the field.
This is not kind of our training this is.
Training with models, we have developed a proprietary model for training that the physicians.
Are very excited about actually is one of the best training tools, a the comments back and one of the best training tools they've ever used and so we can do that out in the field and we are doing that out in the field, but we also have pretty large groups of surgeons come in at least monthly into lewisville as well that's our preference.
We can expose them to our other products as well, while they're here and those sorts of things.
But.
Typically they are going to be in some training sessions and then we're going to be with them in surgeries.
For a number of surgeries until they are they are launched and ready to go.
The.
Second part of the question was sorry.
Okay. No I think you answered my question I guess as a follow on to that is.
So backlog is your listing surgeons waiting for training guys. You're right you are catching up with as far as bringing in are going through their facilities at this point.
Absolutely. Yes. There is there is there is a lot of demand for the Ampsix desk.
Great and then secondly could you talk a little bit about the biologic segment I'm just trying to get an understanding it looks like you had a solid quarter, but is that coming from training is it coming from better distribution is coming from more products.
More diverse selling platform.
It's more volume of Trinity, that's what that's what driving it a little bit more volume in some of our other biologic remember our ancillary products are only.
We are well less than 10% of our total biologic sales so its really Trinity volume.
That we're seeing and.
We we.
The distribution we've added in the last year is kicking in and Thats the primary driver of that.
That increase.
Okay, but I guess bigger picture, you're still seeing shrink.
The higher end of biologics kind of from a macro standpoint.
Absolutely, yes, we are.
Got it okay that does it for me thanks for taking the questions. Okay. Thanks, Jeff.
Our last question comes from the line of Jim Sidoti from today.
Thank you.
Good afternoon can you hear me.
Yes, we can Jim how are you Hey, Jim.
All well promote good good couple of questions.
The decline in the spinal fixation I assume that was almost entirely to us is that correct.
The call out on.
I'm, sorry, say again on the spinal hardware.
Weve spinal hardware that result.
Yes, basically basically basically use there is a little bit of international but basically you asked yes.
And what you're saying is once you get to maybe.
The new distribution work that you think that those results improve in the back half of the year and into 2020.
Correct that's correct.
Okay and then the.
The 4.8 million charge for strategic investments I, just wanted to be clear is that for us.
Acquisitions completed or is that for acquisitions that you're looking at now.
Jim our strategic.
Spend of $4.8 million for the quarter.
It is roughly flat with what it was last year and that represents some.
Spending as we finish up the integration on spinal kinetics and it also reflects what spread mentioned a few minutes ago with regards to us continually looking for ways to grow the company and grow our topline.
Okay and.
At this point in the curve, how many cases, we think a surge in me.
Do with spinal kinetics.
Before you can go so.
So typically if they've used to this before it's probably three or four cases, if they have not used the desk and they were not part of the I'd is probably five to seven cases, something along those lines. After they've received the initial modeled training.
Okay and has that number changed in the last three months or has that been pretty consistent.
No thats consistent.
Okay.
Alright that was it from me thank you.
Alright, Thanks, Jim Thanks, Jim.
We have no further questions at this time I will now turn the call over back to Brad.
Thank you operator, and thank you everyone for calling in today.
We appreciate the time and look forward to talking to you again soon take care.
Ladies and gentlemen, thank you for joining US. This concludes today's conference call you may now disconnect.