Capstone Holding Corp (CAPS) 2003 Q2 法說會逐字稿

Good afternoon and welcome to OrthoLogic Corporation second quarter 2003 earnings conference call. At this time all participants have been placed on a listen-only mode and the floor will be open for questions and comments following the presentation. It is now my pleasure to turn the floor over to your host Larry Delaney of (inaudible) Group. Sir, the floor is yours.

Good day. And thanks for joining us to discuss second quarter and six month 2003 financial and operational results with management of OrthoLogic. OrthoLogic management will provide an overview of the results and then we'll open up the call to your questions. But first, this call contains forward-looking statements that are made pursuant to the safe harbor provisions of the Private Securities Litigation Report Act of 1995. These forward-looking statements involve risks and uncertainties that could cause actual results to differ materially. Factors that could cause or contribute to such differences can be found in the statement accompanying this morning's press release as well as the company's annual report on Form 10K for the fiscal year ended December 31, 2002 and other documents filed by the company with the SEC.

With that, I will turn the call over to Tom Trotter, OrthoLogic's President and CEO.

Thank you all for joining us today. With me this morning are Sherry Sturman, Senior Vice President and Chief Financial Officer; Dr. Jim Ryaby, Senior Vice President and Chief Technology Officer. I will begin with a brief review of the second quarter and first half results. Sherry will follow with additional financial information and Jim will conclude with an update on the Chrysalin program. I'll then provide updated guidance on the outlook for the remainder of the year before we open the call up for your questions.

Second quarter was a very successful one for OrthoLogic. Our bone growth stimulation business continued to post strong growth and we again achieved net income this quarter, as well as positive cash flow from operations, while we continued to invest significant resources in our Chrysalin othobiologics program. Taking a closer look at the sales results for the second quarter, our bone growth stimulation business continued to outperform the competition. Revenues for our bone growth stimulation business increased 23% over the same quarter, prior year, with the OL1000 and SpinaLogic posting strong double digit sales increases. Since this revenue growth rate, the bone growth stimulation business significantly exceeded the estimated market growth rate for the second quarter, we believe we are continuing to gain market share.

For the first six months of 2003, we posted a 21% growth in revenues from our bone-growth stimulation business as well as net income and positive cash flow from operations. In addition to the excellent financial performance we also achieved significant progress with our Chrysalin orthobiologic program during both the second quarter and the first half of 2003. Orthobiologics continued to generate considerable excitement in the orthopeudic community and OrthoLogic is beginning to appear on the industry's radar screen with our Chrysalin product platform. In a moment, Jim will provide more details.

I will now turn the call over to Sherry who will provide you with additional details regarding our financial results. Sherry?

Thank you, Tom. I am pleased to give a brief overview of the company's financial performance for the second quarter of 2003.

Starting with the statement of operations. Total revenues for the second quarter of 2003 were $11.4 million compared to $9.7 million in the comparable quarter of the prior year. The 2002 second quarter revenues include 467,000 of Hyalgan royalties with bone stimulation revenues of $9.2 million. The increase in bone stimulation revenues over the comparable quarter the prior year is 23%. Gross profit as a percent of sales for the quarter was 85%. SG&A expenses were 7.3 million for the second quarter of 2003 or 64% of sales.

Normalizing the 2002 revenues to exclude the high Hyalgan royalties the SG&A expense of 6.7 million was 73 percent of sales. The comparative improvement of SG&A as a percent of sales can be attributed to the strong collection on billing resulting in a one percent lower bad debt expense, lower legal costs and the overall economies of scale as fixed administrative expenses have been kept relatively flat while the sales base continues to increase.

R&D expenses were 2.3 million during the second quarter of 2003 compared to $749,000 during the second quarter of 2002. The increase in R&D spending is directly related to the progress we've made on the Chrysalin development program. The positive adjustment to the CPM divestiture and related gains on it reflects the initial 345,000 received from the purchaser of the CPM assets for the legal settlement. Continuing payments of 75,000 a quarter are due in connection with the legal settlement through the remainder of this year. In future periods and additional $855,000 plus interest is due for the settlement. In the second quarter of 2002 the company adjusted total operating expenses by a positive $226,000 for the additional collection of CPM receivables.

Net income for the second quarter of 2003 was $558,000 or 2 cents per share. For the same period in the prior year net income was $1.3 million for 4 cents per share. The primary difference in net income is due to the Hyalgan royalties reflected in the second quarter of 2002 coupled with the increased spending on the Chrysalin program during 2003 of 1.6 million above the prior year spending.

Total revenues for the six month period were $21.7 million in 2003 compared to $19.3 million in the comparable period in 2002. The 2002 six month revenues included 1.4 million in Hyalgan royalties with bone stimulation revenues of 17.9 million. The year over year increase in bone stimulation revenues during the six month period is 21%.

Gross profit as a percent of sales for the six month period of 2003 was 85.5%. We expect our gross margins to be approximately 85% for the remainder of the year.

SG&A expenses were 14.7 million or 68 percent of sales during the first six months of 2003. Normalizing the six month 2002 sales to exclude the Hyalganhigh al gen royalties SG&A expenses were 75% of sales. The lower SG&A costs this year sales to exclude the Hyalgan royalties SG&A expenses were 75% of sales. The lower SG&A costs this year are the result of the improved collection percentages lower legal cost and our stable administrative costs during the time when sales are continuing to increase. SG&A expenses for the reminder of the year are expected to be approximately 70 percent pes of sales.

R&D expenses during the first six months of 2003 were 3.8 million compared to 1.7 million in the comparable period of the prior year. The increase in R&D expenses was again related to the Chrysalin development program. The positive adjustment of 826,000 during the first six month period of 2002 was related to the additional collections of the CPM receivables.

Net income for the six month period ending June of 2003 was 700,000 or 2 cents per share. For the same period in the prior year net income was 2.7 million or 8 cents per share. The primary difference in net income year over year is due to the Hyalgan royalties of 1.4 million during the 2002 period, increased expenses for the Chrysalin development program of 2.1 million during the 2003 period, and the 481,000 decrease in the gain recognized on the CPM divestiture line during the 2003 period.

Move to the balance sheet. The company ended the second quarter of 2003 with cash and investments totaling 37.5 million compared to 35.6 million as the end of 2002. An increase of 1.9 million. For the remainder of 2003 we expect the cash balances to increase moderately due to the increase spending for our Chrysalin development program.

The accounts receivable balance decreased from 9.6 million at December of 2002 to 9 million at the end of the second quarter 2003. The 600,000 decrease in AR during the six month period is a combination of no longer carrying a royalties receivable and the excellent collection experience. The DSO at June 30, 2003 was less than 84 days decreasing from a DSO of 90 days at the end of 2002. The inventory balance is decreased from 2.6 million at the end of fiscal year 2002 to 2.5 million at the end of the second quarter. The DSI for the end of second quarter 2003 was 137 days.

In March of this fiscal year the company announced the board had authorized the repurchase of up to one million shares of the company's common stock. We have not repurchased any shares during the fiscal year-to-date. In July of 1998 the company completed a private equity placement resulting in 600,000 outstanding warrants with an exercise price of 5.50. The initial value of the warrants was recognized over the ten month conversion period of a preferred stock. None of the 600,000 warrants were ever exercised. All of the warrants recently expired on July 9 of this fiscal year.

That concludes my review of the financial statements. Tom?

Thank you, Sherry. Dr. Ryaby will now provide with you an update the Chrysalin orthobiologic program. Jim?

Thank you, Tom. During the second quarter of 2003 the company made significant progress regarding the Chrysalin product platform. We continue to make progress on our two current human clinical trials. A phase III trial for factor repair and a phase I-II trial for spine fusion. As we have stated before we are encouraged that a number of prominent physicians are very interested in the Chrysalin development program and are participating in these clinical trials.

As an overview of the Chrysalin program there are three other orthopedic indications in active development. These are fracture repair, spine fusion, and cartilage defect repair. Our most advanced clinical program is for the fracture repair indication. A phase III fracture clinical trial is currently underway with expected enrollment of approximately 500 patients in 25 to 30 centers. This trial is focused on patients with unstable distal radius fractures. Patients are being randomized to receive either Chrysalin or placebo by a single injection into the fracture site. We have initiated approximately one half of the clinical sites for this trial and are on track with patient enrollment to date. It is expected that patient enrollment will be completed in the summer of 2004.

Regarding the use of Chrysalin in spine fusion, we are currently conducting a combined phase I phase II human clinical trial. This study will enroll approximately 330 patients at 15-20 centers. Patients are being randomized to a combination of Chrysalin with alagraph [ph] at two doses of Chrysalin and compared to patients randomized to autograph [ph] in spine fusion surgery. We have identified most of the sites that will participate in the study and plan to have all sites initiated by the end of this year.

The third indication in the Chrysalin product platform is the use of Chrysalin for cartilage defect repair. As we've reported previously, initial clinical studies of Chrysalin for repair of cartilage defect shows encouraging results. We plan to meet with the FDA later this year regarding initiation of a human clinical human trial for cartilage repair and data permitting will file an IMB subsequent to that meeting

In conclusion, we continue to make progress our in Chrysalin product development program. We believe that the Chrysalin peptide is one of the most promising orthobiologics in development for clinical applications. Tom, back to you.

Thank you, Jim. Before moving on to your questions I'll now provide you with guidance for the balance of 2003. We remain on track to achieve our goal of at least a 20% increase in sales of our bone growth stimulation products this year. We anticipate that the profits generated from our device business will be sufficient to cover the cost of the Chrysalin program this year and we now expect to finish 2003 at breakeven to slightly profitable on net income. We are continuing to evaluate all of our strategic options. We anticipate that the profits generated from our device business will be sufficient to cover the cost of the Chrysalin program this year and we now expect to finish 2003 at break even to slightly profitable on net income. We are continuing to evaluate all of our strategic options for the future and will provide you with updated guidance for 2004 on our next conference call after the close of the third quarter.

This concludes our formal remarks. At this time, we'll open the call up for your questions.

The floor is now open for questions. If you have a question or a comment, please press the number 1 followed by 4 on your touch-tone phone at this time. If at any point your question has been answered, you may remove yourself from the queue by pressing the pound key. We do ask while you pose your question you pick up your handset to refine optimum sound quality. Once again to ask a question please press the number one followed by four on your touch-tone four at this time. Please hold while we poll for questions. Thank you.

Our first question is coming from Chris Sheffutany [ph] from J. P. Morgan. Please go ahead with your question.

Thanks for taking my question. Hi Tom. Nice job with the quarter.

Good morning. Thanks, Chris.

Two questions if I may. On the filling effort for the OL1000 can you remind me of where you are in terms of number of reps. I know that had increased from the end of the year last year to first part of the first quarter. And what your thoughts are. What this are the number there.

Sure. Last year we completed the year with around 36 direct sales reps. We increased that number up to 42 which is the current number we're at now. That of course is supplemented by 15-20 distributors out there who have approximately 70-80 reps in their organization. So total feet on the street is in the neighborhood of 120. I hope that answers your question.

What would you say explains the reason for the continued really strong growth out of the OL1000. Is it competitive with the share gains because you seem to be growing ahead of the market but there are other factors.

Yes. Primarily it's focus effort on our part and our direct sales organization in particular which has led to significantly greater growth and market for the OL1000. In addition we believe the combined magnetic field technology which we believe is clearly superior to competitive products is gaining wider acceptance in the marketplace. And in addition I think that our growth compared to our competitors is significantly higher. We're gaining share and I think it's -- I believe it's combination of our focused effort and what we believe is superior technology. Also we're seeing I believe continued reasonably good growth in the market. Overall for long bone products.

If I could move to a question on R&D expense. This quarter was higher than I had projected. Clearly as you go through with the multiple trials you have a better gauge for what you think expense levels will be. Could you give a little guidance in terms of what think the second half of the year will look like in terms of R&D and maybe total spend for the year what's a reasonable range?

Sure we're figuring this year is going to be approximately 8 million dollars. In that range. We expect the third quarter and fourth quarter to be in the $2 million range. Maybe a little bit more. But in that range.

Great. Thanks very much.

Okay. Thank you.

Thank you. Our next question is coming from Eric Miller from Heartland Advisors. Please go ahead with your question.

Congratulations on another great quarter. Curious on the -- Tom, do you still see the bone stimulation market itself growing at around 12-15%?

I think that number might be a little high, Eric. I think -- we're believing the market's probably closer to growing 10. Something like that. 10-12. That's a blended rate. I believe it is still growing around 15 or so on the spine side. I think it's probably growing around 10 or so on the long bone side. Maybe high single digits on the long bone side. So the blended rate I think I'm more comfortable with something in the 10-12% range.

On the phase 3 for the fracture healing, how is this -- now is this all double blind studies? You won't know any results until you get to the end? Or will you be you know able to track as the study goes forward about how the results are coming versus the phase one and two?

Let me ask Dr. Ryaby to answer that question.

This is double blind placebo controlled trial. So that's correct. We will not know results necessarily until the -- until we've completed enrollment in the study.

Okay. And just last question. With the cash up now at 37 million, Tom, what's your sort of sense for timing of when you, you know, got to sit down and obviously with next year with probably you know 3 different clinical studies going on when you make that strategic decision on whether you partner or you do something different?

That's very important question, Eric. We are in a fortunate position that over the last several years we've managed to amass a fair amount of money on our balance sheet. But that question is going to be visited by our board and has been recently and we will conclude our thoughts on that as I indicated earlier before the end of the third quarter and expect to provide an answer to that on the after we release results for the third quarter.

We do have a number of options available to us. I think we've talked about these in the past. We do continue to get significant interest on the partnering side of Chrysalin both in the orthopedic community and in the pharmaceutical community. As I mentioned earlier we believe Chrysalin is significantly moving up on the radar screen simply because it is in human clinical trials and is a unique platform as a small peptide. We believe for its indications in the world.

So the options are all on the table. We will make some decisions here I believe clarifying that during the third quarter and I will be in a position at the end of the third quarter on our conference call likely in October early November to give guidance there.

Okay. How about one more question. On the competitive front for Chrysalin, what do you see out there right now?

On a fracture acceleration product or product to accelerate fracture repair I don't believe we've seen anything in human clinical trials that has that kind of capability. There are a lot of people who are working on different things and I'll ask Dr. Ryaby here in a minute if he wants to comment on that. But the Chrysalin product for acceleration of fracture repair we're not aware of any competitive product that has yet entered human clinical trials. We've seen instances where companies have been looking at small peptides and looking at alternatives because, of course, the excessive costs associated with large molecule therapy like bone morphogenic protein -- people are looking for more much cost effective potential therapies and certainly small peptides like Chrysalin present a very attractive alternative. But to my knowledge no one else has entered human clinical trials. Dr. Ryaby, do you have a perspective on that?

I think Tom is absolutely right. To our knowledge there are no other companies right now investigating a fresh fracture injectable therapy in the United States. I think you are aware that there -- as Tom as stated -- that there has been some interest and some reports on animal studies both from Japan and the U.S. about other molecules that might in fact influence fracture repair. But again to our knowledge none of these molecules are currently in human clinical trials.

Okay thanks a lot.

Once again if you do have a question or comment please press one followed by four on your touch-tone phone at this time. Our next question is coming from Bill Plavonic [ph] from First Albany. Please go ahead with your question.

Great. Thank you. Please go ahead with your question.

Hi, Bill. How are you?

Good. Just had a couple questions. First for Sherry Why is the SG&A -- going forward.

You faded out. Could you ask that again please.

Why is SG&A going up to 70% of sales in the back half of the year?

When you look at how we performed the first six months, Bill, we're right around I think 68%. The increase is because we did have some savings that we recognized the first six months that won't go forward through the rest of the year. But we still anticipate significantly lower cost than we did during 2002 during that time.

Okay. And then I always ask the question, Tom, can you give us a feel for what the split between the long bone and the spinal was in the quarter?

We can give you some idea. They were not exactly even. There's a little bit more in spinal was in the quarter. There's a little bit more in the OL1000 side than in the spine side. But both of them were sequential growth over prior quarter.

Okay. And then what's your feeling for what J. and J. is out doing out there? They were adding a bunch of direct reps. How are they with that program and are you pleased with what J. and J. has done year-to-date?

Let me go back and refresh for those who are not as familiar as you with the program. J. and J. and their division (inaudible) as our marketing partner on spinal logic. They made a commitment at the end of last year to more than double, in fact nearly triple, the number of orthobiologic specialists in their sales organization that would be focusing on SpinaLogic. They told us it would take approximately the first half of this year to get all of those people on board. To our knowledge they have hired all of those people and they are on board. And we are beginning to see a contribution.

So I believe they have followed through on what they said they were going to do. We do have targets established for them in our contract for this year in terms of SpinaLogic sales. And they have an opportunity I believe with a strong effort in the second half of the year to achieve their target. But that remains to be seen. We're just starting the third quarter.

But I would say at least at this point we believe that they're tracking on the number of people they said they were going to put in and if they get a good strong second half effort they have an opportunity here to achieve their goal.

And how many reps was that? Are you able to say.

About 80. Up from about 30.

And then I was wondering if you -- the orthoframe product. Any success with that?

We've had some success but when we started the year we anticipated we might do half a million dollars so on orthoframe this year. We think the number now is closer to 150 to 200,000. The reason is we've just had extraordinary success with the OL1,000. And it's very difficult to ask the reps to defocus off of the OL1000 which is the main driver in order to sell orthoframe so we have several reps who have had success selling orthoframe and continue to do so. But again the significant over achievement in the OL1000 is commanding most of the rep's attention. It's just been a terrific year for that product.

Okay. Then lastly, on the spinal fusion study for Chrysalin, considering the existing product out there in the marketplace, do you feel you are going to have difficult on enrolling sites for this?

I don't believe we're going have difficulty enrolling sites for this. We only needed 15-20 sites. I believe most of them have been identified. As Jim indicated we expect to have all of them initiated by year end. Jim, do you have -- want to offer a perspective on that?

I think you know there are several other products that are currently being evaluated such as OP1 from Striker and Spine fusion. But we've not seen at all any reluctance on the part of the investigators that we have contacted and now -- and agreed now to participate in our clinical trials. So I believe that there are probably still many qualified sites out in the United States that would still be available for doing investigational drug studies. And again I think we're on track with progress in that spine fusion trial.

Okay. Then, Tom, can you remind us when exactly you started the program of adding those direct reps into the OL1000?

Actually it's been a couple-a-year effort. Prior -- previously in 2002 we had added half a dozen reps then this year we've also added a half a dozen. We actually made that decision late in the the fall and our sales management team did a great job of getting those people on board and they actually hit the ground running early January. So most of them are approaching 6 months on the job.

Great. Thank you so much.

Okay. Thank you, Bill.

As a reminder if you do have a question or comment, please press the number 1 followed by 4 on your touch-tone phone at this time. Our next question is coming from Brian Metsler of Kendallwood Capital. Please go ahead with your question.

Thank you. Actually most of my questions were answered but I did have one more. If you could tell me about the anticipated design of the trial for cartilage defect repair. How do you intend on looking at that?.

Sure. Dr. Ryaby, would you like to address that?

Well, Brian, this will certainly be a phase I potentially and combine the phase II study. And all likelihood this will be a dose escalation study and a relatively small trial probably on the order of anywhere from 50-80 patients. So this will be in patients with acute traumatic defects of the articular surface and it will be looking at Chrysalin which is actually formulated in a sustained release delivery vehicle which will in fact be surgically implanted into the defect site. So that's a quick overview of what the general ideas are.

Are there any plans for going forward with degenerative joint disease and cartilage repair in that population?

I think the initial focus will clearly be in these acute traumatic defects and really that's the staging ground ground for that. Spreading the potential applications to, say, early stage OAO defects caused by early stage OA. But certainly for this initial clinical evaluation we're trying to have a much more clearly defined population.

Right. Okay. Thank you.

Our next question is coming from Lyman Herd. Please go ahead with your question.

Hi, Dr. Ryaby. I would like a little background if I could on the enthusiasm for the Chrysalin? I assume it's based on the mice study of mice is that true?

Well in fact there have been a lot of clinical preclinical studies performed both by our group here as well as collaborators at academic institutions around the country and really its that cumulative evidence of the effect of the peptide on fracture repair, spine fusion cartilage repair and the cellular effects that we've seen that really provide that foundation for the enthusiasm we have here at OrthoLogic on the potential applications of the peptide.

Thank you.

Our next question is from a follow-up question coming from Bill Plavonic from First Albany. Please go ahead with your question.

Great thanks. Tom, as I look at the numbers here and you know I am always trying to pin these down a little better. But by my calculation -- actually first question is was spinal stem growth in line with the market growth roughly year over year?

I believe it was higher.

Okay. And then that means that you saw something like a ten percent sequential increase in the OL1000 then?

Let's see I think -- let me see. No you are talking about quarter to quarter. I don't have that number in front of me, Bill. But it was significant. Probably in that range.

Impressive. Thank you.

Ladies and gentlemen, there appear to be no further questions in the queue at this time. I'd like to turn the floor back over to presenter for any closing remarks.

Thank you, operator. Let me conclude this call by again thanking you for taking the time to join us today. We're very pleased with the performance of OrthoLogic in the first half of 2003. And we are very optimistic about the future of the company. Have a good day.

Thank you. This does conclude today's teleconference. You may disconnect your lines at this time and have a