Anika Therapeutics, Inc. (ANIK) Earnings Call Transcript & Summary

Good morning, ladies and gentlemen, and welcome to Anika Therapeutics conference call announcing the acquisition of Parcus Medical and Arthrosurface. [Operator Instructions] Please be advised that today's conference is being recorded. [Operator Instructions] I would now turn the call over to Sylvia Cheung, Chief Financial Officer. Please go ahead.

Thank you, Catherine. Good morning, everyone, and thank you for joining us. I wanted to start by thanking everyone for your patience in waiting between Monday's announcement and today's call. We needed to announce the acquisitions on Monday from a compliance standpoint, and Joe was recovering from a case of laryngitis. And unfortunately, his voice is not 100% back, so joining me on the call today is Anika's Executive Vice President of Business Development and Strategic Planning, Jim Loerop. On Monday, we announced 2 important acquisitions that will help position Anika to deliver on our 5-year strategic plan. We are excited to be here to discuss the compelling benefits of these transactions as well as our vision for leveraging our assets and capabilities with the proven technologies at Parcus Medical and Arthrosurface. A copy of the press release announcing the transactions is available on our Investor Relations section of our website at anikatherapeutics.com. In addition, a slide presentation is posted on our website in the Investors Relations section under the Events & Presentations tab. We invite you to take a moment now to open the file, if you haven't already done so, and follow the presentation along with us. Please turn to Slide 2. Before we begin, please remember that certain statements made during this conference call constitute forward-looking statements within the meanings of Securities and Exchange Act of 1934. These statements are based on our current beliefs and expectations and are subject to certain risks and uncertainties. You should not rely on these statements, and the company's actual results could differ materially from any anticipated future results, performance or achievements referenced in them. Please also see our SEC filings for more information about factors that could affect our results. Please now turn to Slide 3. We are very pleased to discuss the acquisitions of Parcus Medical, a leading sports medicine company; and Arthrosurface, a leading provider of joint surface and preservation solutions for active patients. Each company brings unique and compelling benefits to Anika. They enhance our commercial capabilities and infrastructure, diversify our revenue mix and expand our product portfolio and pipeline. Please turn to Slide 4. At our Investor Day in September, we announced our 5-year strategic plan to expand our focus beyond osteoarthritis pain management into regenerative and replacement therapies for joint preservation and restoration. We detailed 4 key strategic pillars that would enable Anika to become a fully integrated customer-centric company, deliver sustained double-digit revenue growth and accelerate profitability. The first pillar of our plan is further developing Anika's talent and culture by fostering an innovative environment across our organization. Second is commercial acceleration through our U.S. hybrid commercial model and international expansion. Third is innovation through investments in R&D to expand and enhance our organic pipeline across the joint preservation and restoration continuum of care. Fourth is inorganic growth through tuck-in acquisitions that will complement our existing and future product portfolio. Over the last several quarters, we have detailed -- or continued our efforts to explore potential acquisition opportunities that would augment our technology, complement our existing product portfolio and enhance our commercial capabilities. We took a very disciplined approach, looking for companies that have a strong existing product portfolio, an established distribution channel, double-digit revenue growth potential and that would be accretive within 12 to 18 months. These 2 transactions are a culmination of those efforts, and we are excited for Anika's future with Parcus Medical and Arthrosurface as part of our organization. Please turn to Slide 5. Before these transactions, Anika principally provided first-line treatment for osteoarthritis pain management. These deals extended our product offering down the continuum of care into joint preservation and restoration and do so through an enhanced commercial infrastructure. Parcus Medical brings a broad offering of sports medicine solutions. Arthrosurface offers a wide array of joint surface and preservation solutions and has a strong position in the sports medicine market. This expanded therapeutic continuum across multiple fields increases Anika's total global market opportunity by approximately $7 billion, and importantly, joint preservation and restoration are both markets with significant unmet needs and where population demographics are creating tailwinds. In short, these acquisitions will significantly augment our current technology portfolio and help transform Anika into a unique and powerful global sports and regenerative medicine company positioned to deliver a more diverse array of products to patients and physicians. Importantly, these acquisitions will accelerate Anika's direct sales force build as well as expand our innovative product pipeline. These transactions will also further enhance our deep bench of talent with additional industry expertise. We're pleased to welcome a number of executives Joe had known and respected for many years, including during a period in which Joe served as the chief -- as the Executive Chairman at Arthrosurface before joining Anika. I would like now to turn the call to Jim as he starts Slide #7.

Great. Thank you, Sylvia. So as Sylvia said, please turn to Slide 7. So before I discuss the Parcus Medical business in greater detail, I'd like to briefly review why we believe this acquisition will create substantial value for Anika, our patients and our shareholders. First, Parcus Medical's hybrid commercial structure diversifies our revenue base away from Anika's legacy partnership model and accelerates the avenues for future growth. Second, the talented team at Parcus will serve to strengthen our product development, regulatory and manufacturing capabilities as the company comes with an existing pipeline of products expected to be introduced over the next several years. Third, Parcus Medical's position in the market immediately expands our direct access to the high-growth ambulatory surgery centers or ASC market. And fourth, Parcus brings seasoned leadership from high-performing sports medicine companies, including Arthrex, Conmed and Smith & Nephew. Its executive team, led by President Mark Brunsvold, will join Anika and continue to lead the Parcus Medical business. Please turn to Slide 8. As you know, Parcus Medical is a leading sports medicine company. It has a broad portfolio and a strong commercial distribution network providing natural cross-selling opportunities across the combined companies' orthopedic surgical product portfolio. Parcus Medical also has a track record of double-digit revenue growth and is expected to generate a modest adjusted EBITDA profit in 2019. Turning to Slide 9. Parcus Medical has a diverse product family that helps facilitate surgical procedures on the shoulder, knee, hip and distal extremities. It markets and distributes its products to surgeons in more than 60 countries through broad distribution networks in the U.S. and internationally. The business employs approximately 45 professionals and is headquartered in Sarasota, Florida, an important hub for orthopedic technologies. Slide 10 provides an overview of Parcus Medical's broad offering of orthopedic implants and instrumentation used by surgeons to repair and reconstruct damaged ligaments and tendons. Parcus Medical designs, manufactures and distributes implants and instrumentation used by orthopedic surgeons in sports medicine procedures to repair the shoulder, knee, hip and distal extremities. Turning to Slide 12. I'd like to now discuss the strategic rationale behind the Arthrosurface transaction. First, Arthrosurface significantly enhances our commercial capabilities with the addition of a hybrid sales organization of approximately 35 sales representatives and more than 100 distributors in the U.S. Second, it accelerates our product platform strategy by further expanding our portfolio and pipeline across the joint preservation and restoration continuum. We are particularly excited about its innovative R&D pipeline, which will provide multiple growth drivers for Anika in the coming years. Third, it further diversifies our revenue base away from Anika's legacy partnership model, and we anticipate it will accelerate Anika's future revenue growth. And fourth, Arthrosurface's solutions are highly complementary to our existing product portfolio as well as that of Parcus Medical's. Please turn to Slide 13. Arthrosurface is a leading provider of joint surface and preservation solutions for active patients with a broad range of surface implant solutions for the shoulder, wrist, knee, foot and ankle. The company also has an innovative product pipeline, a highly complementary commercial infrastructure and offers potential cross-selling opportunities with Anika's product portfolio. Turning to Slide 14. Arthrosurface has over 150 surface implant solutions which it markets and distributes to more than 5,000 surgeons in over 25 countries through its hybrid commercial model. More than 100,000 patients have been treated with its implants since the company was founded in 2002. Arthrosurface employs approximately 60 professionals and is headquartered just down the road from Anika in Franklin, Massachusetts. Its executive team, led by President and Chief Executive Officer Steven Ek, will join Anika and continue to lead Arthrosurface's business innovation. Slide 15 highlights Arthrosurface's broad offering of surface implant solutions used by surgeons in the sports medicine procedures. Arthrosurface is a global leader in joint preservation technology, manufacturing less invasive joint replacements that are clinically proven to help patients stay active by increasing range of motion and reducing pain. The company product portfolio features more than 150 different surface implant curvatures for the knee, shoulder, hip, ankle, wrist and toe. So please turn to Slide 16. As I noted earlier, combining the talented teams and innovative portfolios of these highly -- 3 highly synergistic companies solidifies and significantly expands our position in the sports and regenerative medicine market. It also strengthens our ability to launch multiple innovative products over the next several years as we drive sustained growth across our businesses and enhance value for patients and shareholders. Importantly, both companies bring a unique set of commercial elements to integrate with Anika's current sales and marketing organization, including approximately 40 direct U.S. sales representatives and more than 200 distributors. I now turn the call back over to Sylvia to review the key terms of the acquisition. Sylvia?

Thank you, Jim. Please turn to Slide 17. Under the terms of the agreement with Parcus Medical, Anika will acquire all outstanding membership interests of the business in exchange for an upfront payment of $35 million in cash, subject to customary adjustments. In addition, the company's unitholders will be eligible to receive an additional $60 million contingent upon successful achievement of certain commercial milestones. Parcus Medical is expected to generate approximately $12 million to $13 million of revenue for the full year of 2019, representing growth of approximately 15% year-over-year, and is anticipated to deliver modest adjusted EBITDA profitability in 2019. Under the terms of the agreement with Arthrosurface, Anika will acquire all outstanding share of the company in exchange for an upfront payment of $60 million in cash, subject to customary adjustments. In addition, the company's shareholders will be eligible to receive an additional $40 million contingent upon successful achievement of certain regulatory and commercial milestones. Arthrosurface is expected to generate approximately $28 million to $30 million of revenue for the full year of 2019, representing annual growth of approximately 10%, and is anticipated to deliver a modest adjusted EBITDA loss in 2019. We plan to fund both acquisitions' upfront payments with existing cash on hand. Combined, the transactions are expected to be adjusted EBITDA and operating cash flow positive in 2021 and thereafter. In addition, we're very confident that these transactions meet the business and financial acquisition targets that we have previously laid out, and we look forward to sharing additional qualitative and financial metrics on our upcoming earnings call. While the primary rationale for these acquisitions is highly complementary strategic fit, commercial infrastructure and strong revenue growth potential, they also deliver an attractive financial profile, and we expect double-digit growth from both going forward. Combining both transactions, there are contingent payments of up to $100 million. These milestones are spread out and fairly back end weighted, mostly payable in 2021 and 2022. The transactions are subject to approval by the unitholders of Parcus Medical, the shareholders of Arthrosurface and other customary closing conditions. We expect both acquisitions to close in the first quarter of 2020. Turning to Slide 18. We expect these acquisitions to be significantly diversifying our product portfolio and revenue base. As you can see on the right chart, Anika's domestic Monovisc and Orthovisc franchises combined will represent approximately 50% of pro forma revenues, down from the approximately 70% that is represented before the transactions. Importantly, the addition of Parcus Medical and Arthrosurface is expected to increase the amount of revenue generated under a hybrid and direct commercial model. We expect that this combination can build upon what each business has achieved individually and creates a high-growth sports and regenerative medicine company. We believe that the acquired companies will be accretive next year and the consolidated business will deliver the growth laid out in our 5-year strategic plan. Anika has a strong track record of performance and a culture of financial discipline, and we're committed to continuing to prudently deploy our capital to the most value-creating opportunities. Now before we turn the call over for questions, I would like to tip my hat to Jim Loerop and his team. The entire Anika team is energized about the prospect of these combinations, and we're confident these transactions will create substantial value for our shareholders. I believe strongly that the execution of these transactions and the integrations would demonstrate the commitment that we have given to deliver our 5-year strategic plan for growth. Part of our calculus in pursuing these acquisitions was the consideration that building out a direct sales organization can be a time-consuming and earnings-dilutive endeavor. Expanding our commercial capabilities through these deals not only accelerates the time but do so in a more efficient way as the targets already have the broad product portfolio and they are marketing through their channels. In summary, these acquisitions are expected to: one, immediately add a base of high-growth revenue from expanded direct and commercial partnership platforms; two, enhance and accelerate our commercial capabilities with a proven sales team visiting common call points and equipped with a broader product portfolio; three, derisk future operations by diversifying our product and revenue mix while gaining far greater optics and control on new product categories; and four, significantly expand our product pipeline with exciting and innovative technologies in the coming years. We are committed to maintaining our focus on operational excellence and financial discipline as we execute on our growth strategy and transform Anika into a global sports and regenerative medicine company. One last housekeeping note as it relates to financial and guidance. We plan to keep with our promise of providing annual guidance along with our year-end results, which we expect to report in normal course in February. Our 2020 guidance will obviously reflect the impact of the acquisitions. And in the Q&A session today, we will not be providing an update on Anika 2019 results and are not yet ready to deliver on our full year guidance for 2020. Thank you. And I'd like now to turn the session over to the operator for the Q&A session. Thank you.

[Operator Instructions] And our first question comes from Mike Petusky with Barrington Research.

Exciting news. Congratulations. So I guess I wanted to ask around Arthrosurface particularly. It looks like you guys call out the innovative R&D pipeline they have. It looks like part of the contingent consideration is based on regulatory milestones. And I guess I just wanted to ask, do -- I mean Arthrosurface business, is there a number of products that are sort of under development that you expect to get regulatory approval for in 2020? Or can you just speak to the current pipeline they have? And then also, I suspect that they've never had the sort of balance sheet strength and cash flow strength you guys are going to bring to that. And could that possibly accelerate their R&D product development?

Thank you, Mike. We're very excited about the innovation and the robust pipeline under the consolidated, combined 3 companies. To answer your question, yes, there are multiple candidates in the pipeline. And you've noted correctly that certain earn-outs or milestones are based on regulatory, in addition to commercial milestones. Arthrosurface does have a track record of product innovation and product approvals, and we're excited about combining their pipeline with Anika's. We do expect that after we go through an internal assessment of all the candidates, we will be able to prioritize and accelerate our R&D efforts. And from a timing standpoint, as I mentioned before, the earn-outs both in terms of regulatory and commercial will be over the course of the next 3 years and heavier toward the 2021 time frame.

Okay. Great. And could I just ask a follow-up? On the commercial milestones, is that around primarily revenue growth, EBITDA growth or like a combination of both?

On the commercial milestones, they are primarily related to revenue growth and in certain case, achieving certain targeted revenues.

And our next question comes from Joe Munda with First Analysis.

Can you hear me okay?

Yes, we can hear you well.

Yes.

Congratulations on the 2 deals. Just 2 quick questions here. One, you said that the -- both deals would be accretive. Is that accretive to earnings? Is that -- just want to be on the same page here.

Yes, we are looking at accretive to earnings. And in terms of the specifics, we will be addressing those on our upcoming earnings call.

Okay, okay. Perfect. And then I was wondering if, high level, you could give us some sense of what the gross margins for each business were or even what the expense structure looks like for both companies, but particularly gross margin, if you can.

Yes. So we will not be providing details on each individual company's financial profile. However, I can mention that from a gross margin standpoint, the company's historical performance is in the mid-70 -- sorry, mid-60 to low 70 range when you look at the 2 together.

So together, in the 60% to 70% range is what you're calling for?

Right.

Okay, okay. Clear. And then just real quick in regards to that. The milestones that are tied to the commercial, is there anything in there for gross margin levels in regards to the milestones?

No. The earn-out or milestone payments are commercial revenue targets-driven. And in the case of Arthrosurface, there are regulatory-related milestones, but not gross margin milestones.

And our next question comes from Jim Sidoti with Sidoti & Company.

Can you hear me?

We can, Jim.

Great, great. So you said you're going to add about 40 direct reps and 200-plus distributors. How do you see it playing out over the next couple of years? Do you keep all those distributors? Or is there some overlap there and maybe you don't keep them all?

Yes. I would turn over to Jim to answer this question from an integration and a strategy standpoint.

Sure. Thanks. So Jim, I think, over time, I think the commercial organizations will determine the distributor side. I don't think there's any immediate plans to make any real changes on that, but over time, we'll assess what we would do on the distributor side. But I think, as you heard, the highlight of the transaction was gaining both the sales infrastructure as well as the distribution network, and so we see those as being key components of that. But we'll continue to assess that going forward in terms of how we look at that scale and so forth.

Yes. If I may just add a couple of points here. This is very much a growth story. So we're adding to our existing capabilities by adding approximately 35-or-so domestic sales reps and adding a pretty complementary set of distributors to our hybrid model. So as Jim mentioned, we're looking to keep the existing structure and look to leverage this network to expand our revenue and presence.

And will those direct sales reps have access to the combined company's products? Or will they stay focused on the Parcus or the Arthrosurface or the Anika products?

Yes. In the immediate term, we will maximize the 3 sales teams and they will focus on their existing products currently being carried by those channels and share product interest and leads. The 4 Anika regional sales directors, which we've talked about in our previous earnings calls, are going to continue to focus on growing the TACTOSET market. And longer term, as Jim said, we'll be looking to leverage the infrastructure and cross-sell.

And how does -- these 2 deals, how does it affect the relationship with Mitek and DePuy? Is there any change there?

We do not expect any change from the -- when we look at the existing relationship with Mitek. If you think about Anika's business, we have currently about 70% of our business in the domestic Orthovisc and Monovisc franchise, which is more an office-based call point. The Anika surgical products, TACTOSET, rotator cuff and other regenerative therapies are in the operating room setting. So we call those orthopedic surgical solutions. And Parcus Medical product portfolio as well as Arthrosurface product portfolio really complement our surgical portfolio very well, and that is where we are building our hybrid as well as direct sales force. So our relationship with Mitek continues to be strong, and we are building out our operating room franchise with the acquisition of Parcus Medical and Arthrosurface.

Okay. And then the last one for me. Do you anticipate any material integration charges? Or are you going to keep these businesses relatively the same as they are right now without any major consolidations?

We expect that the 2 entities will be maintained independently. At the same time, there are certain activities that we will take on, for example, on the system side, and we'll look to manage certain efficiency-driven integration activities in year 1. In terms of the dollar amount, we'll provide that information on our upcoming earnings call because the timing of closing certainly would impact the timing and the expense as well.

Thank you. And that concludes our Q&A session. I'd like to turn the call back over to Sylvia Cheung for closing remarks.

Thank you, Catherine. Thank you, everyone, for your time this morning. We believe these acquisitions are strong strategic fits for Anika and will solidify our position in the sports and regenerative medicine market. We look forward to seeing many of you in San Francisco next week and updating you again in the future. Thank you, and have a great day.

Ladies and gentlemen, this concludes today's conference call. Thank you for participating. You may now disconnect. Everyone, have a great day.