Capstone Holding Corp (CAPS) 2003 Q3 法說會逐字稿

Good morning and welcome to the OrthoLogic Corporation third-quarter 2003 earnings conference call. (OPERATOR INSTRUCTIONS). At this time, it is my pleasure to introduce Larry Delaney of The Berlin Group.

Good morning and thank you for joining us to discuss third-quarter and nine-months 2003 financial and operational results with management of OrthoLogic Corporation. OrthoLogic management will provide an overview of the results, and then we will 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 Reform Act of 1995. These forward-looking statements involved 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 10-K for the fiscal year ended December 31st, 2002 and other documents filed by the Company with the SEC.

OrthoLogic has filed a definitive proxy statement and other documents with the SEC regarding the proposed sale of substantially all the assets of its bone-growth stimulation device business discussed in this conference call. OrthoLogic stockholders are encouraged to read the proxy statement because it contains important information. The definitive proxy statement consensus stockholders of OrthoLogic seeking their approval of the transaction. Investors and security holders may obtain a copy of the proxy statement and any other relevant documents filed by OrthoLogic with the SEC for free at the SEC's Website at www.SEC.gov and at the Investor page of OrthoLogic Website, www.orthologic.com. Copies of the proxy statement and other documents filed by OrthoLogic with the SEC may also be obtained for free upon request from Barbara Dunford at OrthoLogic Corporation, 1275 West Washington Street, Phoenix, Arizona, 85281. And the telephone number, 602-286-5520.

OrthoLogic and its directors, executive officers and certain of its employees may be deemed to be participants in the solicitation of proxies for OrthoLogic stockholders in connection with the proposed transaction. Such individuals may have an interest in the transaction, including as a result of holding options or shares of OrthoLogic common stock stock. A detailed list of the names, affiliations and interest of the participants in this solicitation is set forth in the definitive proxy statement that was filed with the SEC on October 27, 2003.

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

Thank you, Larry. Good morning. I appreciate you all joining us today for our third-quarter 2003 conference call. With me today are Sherry Sturman, Senior Vice President and Chief Financial Officer, and Dr. Jim Ryaby, Senior Vice President and Chief Technology Officer.

I will begin with a brief overview of the third quarter. Sherry will provide additional details regarding the financial results, and Jim will provide an overall update on the Chrysalin Product Platform. Finally, before moving on to your question-and-answer session, I will provide you with financial guidance for 2003 and 2004.

We are very pleased this morning to tell you about our third-quarter results. Third quarter was an outstanding quarter for our company both financially and operationally. To begin with, revenues for the bone-growth stimulation device business increased 22 percent over the same quarter prior year. Since this growth rate is ahead of the estimated market growth rate, we believe we continue to gain market share.

Gross margins increased in the third quarter compared to the same quarter prior year, and SG&A expenses as a percentage of sales improved as well. The combination of these favorable results led to another quarter of profitability, as well as positive cash flow from operations.

In addition to the excellent financial results for the third quarter, we continue to make significant progress as well with the Chrysalin Product Platform. A number of new clinical sites were initiated for both our Phase III trial for fracture repair and our combined Phase I/Phase II trial for spinal fusion. We also completed a second successful preclinical trial for our potential Chrysalin product for cartilage defect repair.

Finally, as announced on October 9th, we signed an agreement to sell our bone-growth stimulation business to dj Orthopedics. Since that time, we have completed several of the initial steps in the process and have scheduled a shareholder vote on the transaction for November 26, 2003. We expect to close this transaction before the end of this year. Assuming the successful completion of the sale of the bone-growth stimulation device business, OrthoLogic will emerge as one of the few pure-play public companies in the orthobiologics segment of the worldwide orthopedic business, and we are excited about the future potential of the Chrysalin Product Platform.

Shelly will now provide you with additional financial details regarding the third quarter and year-to-date 2003 performance.

Thank you, Tom. I am pleased to give a brief overview of the Company's financial performance for the third quarter of 2003, starting with this summary of the income statement. Total revenues for the third quarter of 2003 were 12.5 million compared to 10.8 million in the third quarter of 2002. The 2002 third-quarter total revenues include 501,000 of Hyalgan royalties with bone stimulation revenues of 10.3 million. The increase in bone stimulation revenues over the comparable quarter of the prior year were 2.2 million, or 22 percent.

Gross profit as a percent of sales for this quarter was 85 percent. SG&A expenses were 7.8 million for the third quarter of 2003 or 62 percent of sales. Normalizing the 2002 revenue to exclude the Hyalgan royalties, the SG&A expenses of 7.2 million was 70 percent of sales. The continued improvement in SG&A as a percent of sales can be attributed to the strong collection in billings, resulting in lower bad debt expense, lower legal costs and continued efficiency in the administrative expense business.

R&D expenses were 2.5 million during the third quarter of 2003 compared to 722,000 during the third quarter of 2002. The increase in R&D spending is directly related to the higher costs required to advance the Chrysalin development program. The positive adjustment to the CPM divestiture and related gains line of 134,000 reflects the payments of the legal settlement from the purchaser of the CPM assets. Continuing payments of 75,000 a quarter are due to the remainder of this year. In future periods, approximately 700,000 plus interest is due for the settlement. In the third quarter of 2002, the Company adjusted total operating expenses by a positive 221,000 to the additional question of CPM receivables.

The net profit for the third quarter of 2003 was 506,000 or 2 cents per share. The net profit for the third quarter of 2002 was 1.4 million or 4 cents per share. The primary difference between this quarter and the comparable quarter of the prior year is first, Hyalgan royalties received in 2002 of 501,000; secondly, an 87,000 decrease in the gain recognized during 2003 for the CPM related adjustment, and third, the R&D spending during 2003 was 1.8 million higher than in 2002. Total revenues for the nine-month period were 34.3 million in 2003 compared to 30.1 million in the comparable period in 2002. The 2002 nine-month revenues include 1.9 million in Hyalgan royalties with bone stimulation revenues of 28.2 million. The year-over-year increase in bone stimulation revenue during the nine-months comparable period was 6 million or 21 percent. Gross profit as a percent of sales for the nine-month period of 2003 was 85 percent. We expect the gross profit to be approximately 85 percent during the fourth quarter.

SG&A expenses were 22.5 million or 66 percent of sales during the first nine months of 2003. Normalizing the nine-month 2002 sales to exclude the Hyalgan royalties, SG&A expenses were 73 percent of sales. The lower SG&A cost this year are a result of the improved collection percentages, lower legal costs, and stable administrative costs during a period when sales are continuing to increase.

R&D expenses during the first nine months of 2003 were 6.3 million compared to 2.4 million of the comparable period in the prior year. The increase in R&D expenses are related to the Chrysalin development program. The year-to-date positive adjustment to the CPM divestiture and related gains line of 479,000 reflect additional payments for the legal settlement. The positive adjustment of 1 million during the first nine-month period of 2002 was related to the additional collections of the CPM receivables.

The year-to-date net profit for 2003 is 1.2 million or 4 cents per share. The year-to-date net profit for the comparable period in 2002 was 4.1 million or 13 cents per share. The year-over-year decrease in nine months net profit is primarily related to the 1.9 million recognized in 2002 for Hyalgan royalties, the increase in R&D spending of 3.9 million over the comparable period of 2002, and the decrease of 568,000 in the gain recognized on the CPM divestiture line during the 2003 period.

Moving to an overview of the balance sheet, the Company ended the third quarter of 2003 with cash and investments totaling 39.5 million compared to 35.6 million at the end of 2002, an increase of 3.9 million for the nine-month period. The Accounts Receivable balance decreased slightly to 9.5 million during the third quarter of 2003 from 9.6 million at December 2002. The DSO at September 30th, 2003 was 79 days, decreasing from a DSO of 90 days at the end of 2002. The inventory balance has decreased to 2.3 million at the end of the third quarter from 2.6 million at December 2002. The DFI at the end of the third quarter is 125 days compared to 127 days at the end of 2002.

Assuming a successful completion of the pending sale for the bone-growth stimulation device business, the balance sheet of OrthoLogic Corporation will change significantly after the sale. The assets carried by the Company after the sale will consist of a cash balance of approximately 120 million, an Accounts Receivable balance of approximately $1 million for the Medicare receivables that is excluded from the sale, the 750,000 equity investment in Chrysalis Biotechnology and approximately 500,000 in property and equipment.

That concludes my review of the financial statement. Tom?

Thank you, Sherry. Dr. Ryaby will now provide you with an update on the various ongoing activities related to the Chrysalin Product Platform.

Thank you. During the third quarter of 2003, the Company made significant progress regarding the Chrysalin Product Platform. We continue to make progress on both preclinical studies and on our two clinical trials, a Phase III trial for fracture repair and a Phase I/II trial for spinal fusion. We are encouraged that a number of prominent physicians and institutions are very interested in the Chrysalin development program, and are participating in the clinical trials.

As an overview of the Chrysalin program, there are five orthopedic indications currently in addition to the product pipeline for Chrysalin. Three of these indications are being actively pursued. These are fracture repair, spinal fusion, and cartilage defect repair. The fourth and the fifth indications, ligament and tendon repair respectively, are in the preclinical planning stage with studies planned to initiate early in 2004.

Our most advanced clinical program is for the fracture repair indications. On previous conference calls, we had summarized the results of the Phase I/II distal radius fracture study, and these results have been presented at major national and international hand surgery meetings. We believe this has aided us in recruitment of high-quality centers for participation in the current Phase III distal radius fracture trial.

A Phase III fracture clinical trial is currently underway with expected enrollment of approximately 500 patients in 25 to 30 centers. As in our Phase I/II clinical trial, patients with unstable distal radius factors are being enrolled in this study. Patients are randomized to receive either Chrysalin or placebo by a single injection into the fracture site. These patients are followed radiographically and clinically for six months with an additional follow-up interview at twelve months. We are currently enrolling patients at 20 of our sites with the remaining sites identified and engaged in the approval process for participation in this study. We expect to have all sites enrolling by the end of this year, and enrollment is projected to complete during the summer of 2004.

Plans are being developed for an additional pivotal trial in fracture repair, which we would initiate mid-2004. The results of this trial will be included in the potential NDA filing in 2006.

Regarding the use of Chrysalin in spinal fusion, we are currently conducting a combined Phase I/II unit clinical trial. In this study, patients are randomized to a combination of Chrysalin with allograft at two doses of Chrysalin compared to patients randomized to autograft and spine fusion surgery. We currently have approximately one-third of the sites enrolling patients in this study, and we plan on completing enrollment by the end of 2004 for this protocol.

In addition, we are now developing an alternative strategy for the potential Chrysalin product for spinal fusion, which may enable us to accelerate the development program. We will provide an update on these plans on the January conference call.

The third indication in the Chrysalin Product Platform is the use of Chrysalin for cartilage defect repair. As we have reported previously, preclinical studies of Chrysalin for repair of cartilage defects showed encouraging results. We have recently completed a second preclinical study with the intended formulation for the initial human clinical trial, and the results of this study are very encouraging. We plan to hold a meeting for the FDA early in 2004 and remain hopeful regarding initiation of the human clinical trial in 2004. The fourth and fifth indications for ligament and tendon repair present major opportunities for OrthoLogic in the orthopedic soft tissue repair arena. We have developed plans to initiate preclinical studies for these applications early in 2004.

Finally, our preclinical group here at OrthoLogic with our academic collaborators have recently presented positive results on Chrysalin effect in an additional bone repair model, distraction ostheogensis (ph). This data with presented at the American Society for Bone and Mineral research meeting in Minneapolis in September. This ongoing preclinical research continues to provide important scientific support for the Chrysalin development program.

In conclusion, we continue to make progress in our Chrysalin product development program and are excited about the potential of the Chrysalin product pipeline. Tom, back to you.

Thank you, Jim. Before moving on to your questions, I wanted to provide you with guidance regarding the outlook for the balance of 2003, as well as 2004.

We are maintaining our existing guidance for 2003 with revenues for the bone-growth stimulation device business expected to be in the $46 to $47 million range and full year net income of 4 to 5 cents per diluted share. If the sale of the bone-growth stimulation device business to dj Orthopedics concludes as expected before the end of this year, these numbers will change. However, until a final sale occurs, we are maintaining this guidance for 2003.

For 2004, assuming the sale of the bone-growth stimulation device business closes before the end of this year, OrthoLogic would begin the new year with approximately 120 million in cash and investments. Depending upon the rate of enrollment in the ongoing and anticipated human clinical trials, as well as the outcome of our discussions with the FDA, we currently expect to have net expenditures of 22 to 23 million in 2004. This would be made up of approximately 20 million in the costs associated with the development of Chrysalin Product Platform, as well as approximately 4 million in general and administrative expenses. These costs would be somewhat offset by approximately 1.5 million in interest income for the year.

Operator, that concludes our opening remarks. We will now open the call up for the questions.

(OPERATOR INSTRUCTIONS). William Plavonic, First Albany.

The first question is you keep talking about the 120 million in cash and investments at year-end. As it sits now, you have almost 40 million, your are selling the stem business for 93 -- that is over 130 million. Is my math wrong somewhere? Am I missing something?

Why don't I have Sherry address that issue. Obviously we have costs associated with the sale of the business, as well as severance costs and some things for the transitioning employees, but, Sherry, do you want to address that?

When you look at the math, we are excluding the 7.5 that will be held in the restricted accounts for the escrow, and then we have approximately 5 million that is going to be dedicated to the process of the sale.

Okay.

Bill, if I might comment on that. If you looked at the documents which were attached to the filing with the proxy, there is a $7.5 million escrow. It is a two-year escrow. That escrow we are entitled to the interest off of the 7.5 million for the two-year period of time, and that is obviously there to balance out any potential claims that an enquirer might have. So we anticipate hopefully we will get most of that certainly by the end of the two-year period, but that is why there is a differential between your number and ours.

Okay. Does the sale price -- are there any adjustments with fundamental performance of the business in the near-term before the close date?

Adjustments? I am not sure I understand your question.

If you continue to do exceedingly well, is there a possibility that that price they are going to pay will go up?

No. That is a fixed price, Bill.

As we look at growth in the stem business, I was wondering if you could give us an idea or some color on was there stronger growth in the spine; was it in the longbone? Maybe some types of growth rate or mix or something like that?

Yes, I can comment a bit on that. As you know, our competitors do not do that, but we have been a little more generous I think in that regard. I can tell you that of the overall growth rate, the growth rate in the longbone segment of business -- the OL 1000 business -- was ahead of 25 percent, and the growth in the spine business was somewhere in the 18 percent range, for a blended rate of somewhere around 22.

Okay. Would you say that the change in (inaudible) are starting to come unstrung?

Well, I would say that the Pew (ph) marketing agreements that we have is certainly working well, and they had a very good third quarter. This was the best quarter we have had yet in the spinal stimulation business, and we are certainly hopeful that that will continue.

What do you attribute the above market growth rate for the longbone business? What do you attribute that to? You're growing almost three times. If you above 25 percent, you are almost at three times the market rate.

Well, I think there are a couple of answers to the. The first one is I think the fruition of a two-year focused strategy by our direct sales organization on selling bone-growth stimulators. We have expanded our direct salesforce, and a number of those reps are performing certainly at or better than expectations. Again, with the focused strategy, we have been able to go into certain markets and have a significant amount of success. So I would say first is the focused strategy.

The second has to do with the technology. We simply have the best technology, and over a period of time with a focused strategy, the more the reps have an opportunity to present the benefits of our technology versus our competitors, the more successful we are having in the marketplace. So I think it's really a combination of those two things. Again, we are ahead of the growth rates of our competitors, at least the ones who have reported, and it is a good bit faster than the overall market growth right now.

I think we need to balance that by recognizing our base of business in the longbone business is significantly less than our competitors. So while we are growing significantly faster, there is still plenty of room to develop.

I will jump back into queue.

(OPERATOR INSTRUCTIONS). John Toback, HealthPoint (ph).

Just a quick question. Dr. Ryaby, you mentioned an additional pivotal trial for depressed fracture beginning in mid-2004 I think. What exactly is that? I don't think I have heard that before.

Yes, John. Basically it is part of our overall NDA strategy for a fracture repair product. We're considering to conduct an additional human pivotal clinical trial. We do not believe that this will impact on our timeline for a successful NDA filing, or I should clarify -- a potential NDA filing data permitting in 2006.

When exactly may that be in 2006? Early 2006?

I don't think we are in a position today to really comment on when in 2006 we would see that NDA filing.

Would be the difference between the pivotal trial compared to what the current clinical trials you have been investigating?

This would certainly be what we would call a confirmatory clinical trial that would really augment and complement the current Phase III trial.

What would be the size I guess compared to the ongoing trial of the Phase III right now?

I think until we really meet with the Food and Drug Administration regarding the design of this clinical trial, we will not be able to comment on the size for the number of investigational centers.

And you had mentioned, I guess I will let that go. Sherry, I had a quick question on the SG&A. I think you were a little bit below where I certainly had you and I think what you were guiding to in the past. What do you expect to see in the fourth quarter? Would you expect it to remain around this level, or where do you think you may be at year end as a percentage of sales?

I think we will maintain the lower percentage of sales that we recognized during the third quarter during the fourth quarter up until the completion of the sale.

William Plavonic.

Just for Dr. Jim Ryaby again. On the confirmatory trial, is that going to be distal radius factor, same type of fracture, same everything?

Well again, Bill, I think that it is hard for us now to really provide a detailed description of what this trial will look like, as well as the fracture type that will be studied. Because again until we meet with the FDA about this, we are not going to speculate.

But I just want to say that certainly over the past six months we have been conducting a very detailed review of the overall NDA strategy. So our feeling is to make the filing as robust as possible, we have included additional elements in this process, and one thing is to consider the conduct of an additional pivotal clinical trial. So I think that is all we are prepared to say right now. I don't know if Tom has another comment to make on this.

The only thing I would add is in all of our development work on the NDA strategy and the potential filing in 2006, we certainly anticipate that whatever additional clinical trial work we may do for the fracture repair product would be concluded in that time frame so that we could then incorporate that data into the filing in 2006. So it is changing our target date here or our timeline; it just may in our view be worthwhile to do this to add confirming data to support the NDA filing and make it as robust as possible.

Okay. And then a couple of questions for Sherry if I may. On the CPM receivables, you reported 132,000. You also said there is 75,000 in both the third and fourth quarter. Is that buried as a reversal in the SG&A line, that 75,000?

Actually there is a separate line there. There is a little bit of a distinction. It it's hard to grasp. In 2002, it was a collection on the CPM receivable that was lingering after the sale. In 2003, it's purely related to the legal settlement. So when you look at that line item that is right below the R&D data that is separate, that is what that is identifying for you.

You made the comment of 75,000 credit for both quarters, so that 75 is in that 134?

It is. We received 75,000 a quarter, and then currently if there are additional payments that we received from some of their prior commitments, there is an agreement that that would be contributed to the principal balance that is owed to us. So that is why it went from 75,000 up to the 134.

But we would expect another 75,000 in the fourth quarter is what you are telling us?

At a minimum, yes.

As well as going forward into 2004, Bill. In the numbers that we have given you, there is the anticipation of 75,000 received each quarter of the fourth quarters of next year.

How long will that continue?

The total outstanding balance is --

Right around 700,000, plus interest. They have the option at any point in time to pay it off or to follow their payment schedule for the settlement.

So that is certainly through 2004. If they stayed on the current schedule, it would take us through probably 2005.

I understand you actually just clarified that. Great. Then what about the wrist fixator? Is that product going to be let go?

No. In fact, that is part of the assets that are being sold to dj Orthopedics as part of the sale of the bone stimulation business. They will acquire the rights, the inventory and so forth for the OrthoFrame product as well.

(OPERATOR INSTRUCTIONS). William Plavonic.

It is Brian Wong. I have got a couple of questions. First for Tom, obviously you are taking market share from your competitors. What sort of a competitive response have you seen from them? Pricing pressures or anything?

No. Actually we have not seen really much in the way of pricing pressures. You're recognizing in this business that managed care and Medicare primarily set the pricing for the business. There is pricing from Medicare, and then the managed care companies take a percentage of Medicare list, and so they primarily set the prices. There has not been that kind of a response.

We have seen recently some additions being announced of salespeople for at least one of our competitors. But again, you would have to direct your questions to them as to what they are doing. I am really not sure. I am just very pleased that we are having the success we are.

Isn't that still under an APC code? Medicare pricing, does that come under an APC code?

No. We have an ICD9 code.

For Jim, is there any more progress from Chrysalis, what their research is doing, and any indications how they are doing? How is that progress going? Any non-orthopedic complications?

I think I am at liberty to tell you that research there is progressing both on the basic science, as well as on their preclinical studies at both dermal repair and cardiovascular. They have plans to initiate their Phase II study in diabetic ulcer wound healing I think early in the next year or by mid-2004. So that is the only current update I can really give you.

Certainly, as you know, you are welcome to call Darrell Carney, who is President and CEO of Chrysalis to get a further update.

I would just add to that you can also take a look at their TecVes (ph) presentation which occurred in Boston a couple of weeks ago. I am not sure whether that is on the Website, but you may be able to get information directly from Chrysalis where they outlined their various opportunities.

But I would say that there are some very interesting indications that they are working on and what they have publicly talked about. I was particular impressed with the potential revascularization data they have generated in preclinical studies for cardiovascular repair. It is quite compelling. But I would direct you to contact them directly, Dr. Darrell Carney at Chrysalis Biotechnology, and I think they can help you.

Actually one last question. Are there any options for you to acquire Chrysalis, the company, at any point in time or at any certain prices?

There is no predetermined formula for that. We are an investor in the company. As part of the initial work we did back in 1998, we made an equity invest money investment in Chrysalis Biotechnology of $750,000, and I believe they have had a financial round since then, but I think our current ownership has indicated to me as in the 5 to 6 percent range of their Company. However, they continue as an independent entity, and there is always opportunities for further collaboration down the line, but we don't have anything specifically at this time that we are prepared to talk about.

Thank you. There are no further questions at this time. I will turn the floor over to Tom Trotter.

Thank you all for joining us again today. We look forward to continuing our positive work here. We are targeting now for as we said the shareholder vote on November 26. We would like to encourage all the shareholders to respond because it is a very important vote. Assuming a successful vote there, we would move forward as quickly as possible with a conclusion to the transaction.

But we are really looking forward to moving into a future in orthobiologics. We think this is the place to be in orthopedics work, and since we are one of the few companies with products in human clinical trials for orthobiologics, we like our position and our opportunity going forward.

So thank you again, and we will be reporting to you in January after the conclusion of the fourth quarter. Have a good day.

This does conclude today's teleconference. Please disconnect your lines at this time and have a great day.