IntriCon Corporation
Q2 2020 Earnings Call Transcript

Published: 10 Aug 2020

[Operator:]

Ladies and gentlemen, thank you for standing by and welcome to the IntriCon Corp's Second Quarter 2020 Earnings Conference Call. At this time, all participants are in a listen-only mode. After the speakers' presentation there will be a question-and-answer session. [Operator Instructions] Please be advised that today's conference is being recorded. [Operator Instructions] I would now like to hand the conference over to your host today Investor Relations Ms. Leigh Salvo. Thank you. Please go ahead, madam.

[Leigh Salvo:]

Thank you, Megan. Before we begin, I would like to preface our remarks with the customary Safe Harbor statement. Today's conference call contains certain forward-looking statements. These statements are based on the current estimates and assumptions of IntriCon's management and are subject to uncertainty and changes in circumstances. Given these uncertainties, you should not place undue reliance on these forward-looking statements. Actual results may vary materially from the expectations contained in today's call. For a list and description of the risks and uncertainties associated with our business, please refer to the Risk Factors section of our most recent annual and quarterly reports on Form 10-K and Form 10-Q, respectively, with the SEC. With that, I would now like to introduce IntriCon's CEO, Mark Gorder, for a review of the company's second quarter performance. Scott Longval, the company's COO and CFO, will then cover the financial results in more detail, and at that point we'll open the call for your questions. Mark?

[Mark Gorder:]

Thank you, Leigh. Good afternoon and thank you for joining us. We hope you are all remaining safe and healthy. I would like to start our call by recognizing the IntriCon team. Over the past few months, I have observed our organization coming together to meet challenges, demonstrate incredible resilience and operate at the highest level, all while adapting to a new working environment. I would also like to congratulate Scott Longval on his appointment as IntriCon's next CEO. More than a year ago as I began to contemplate my transition, it was apparent that Scott's deep knowledge of our operations and financial structure, as well as true leadership qualities made him the obvious choice to fill the CEO role. With the full support of the Board, we made the decision to move forward, confident in his sheer vision and commitment to driving our next phase of growth into enhancing shareholder value. We began taking the steps necessary to ensure a smooth transition last year. As a result, throughout the past year, Scott has played an instrumental role in delivering the successful outcome of numerous critical milestones that I am confident will enable us to strategically evolve our business and best address key medical growth markets. After October 1, I look forward to working with Scott in an advisory capacity throughout the remainder of the year. In the meantime, we have actively commenced our CFO search. While we hope to have someone in place by the end of the quarter, the priority is identifying the right candidate to lead our finance team and grow with the company. In the meantime, we have a very strong financial organization currently under Scott, and the mechanisms in place to assure we have ample support through the transition. Now I'd like to cover some of the highlights of our second quarter performance. I'll then turn the call over to Scott for some additional thoughts on our business in the current quarter and going forward, as well as more in depth review of our financial results. We'll then open up the call for your questions. The IntriCon continued to deliver against the priorities we established at the outset of this year, and I'm proud of our accomplishments in the second quarter. Total revenues were $23.6 million representing a 20% decline over the prior year, exceeded our initial expectations at the time of our Q1's earnings call in early May. Due to the visibility afforded to us by ordering patterns earlier in the year from our largest medical customers, we were able to enter the second quarter with some degree of strength that carried through April and May despite the shutdowns impacting the macro environment. As we highlighted last quarter, we quickly implemented several measures to best ensure the health of our employees and their families, while maintaining operation critical processes to support our customers and our patients in our ongoing business. This enabled us to effectively plan for the remainder of the quarter and continue to operate at their capacity without interruption to our customers and our partners. In addition, our Hearing Health segment performed better than expected due impart to renewed access to audiologists, and solid orders from our indirect to end consumer customers. As a result, we exited the quarter with cautious optimism as we enter the second half of the year. Importantly the significant restructuring actions taken over the first half of the year coupled with adjustments made during the pandemic contributed to meaningful bottom line improvement and provided overall stability to our core business. I'd like to take the next few minutes to comment on progress in each of our core high growth medical markets, including diabetes, surgical navigation, hearing health and drug delivery. Starting with our diabetes market, sales to our largest customer represented 57% of total revenue in the second quarter. While we did experience the anticipated year-over-year decline in Medtronic business, actual results in the quarter were better than originally anticipated, driven largely by two factors. First, we saw continued strength from disposable sensors due to greater compliance from those diabetics using insulin pump systems. Second, CGM transmitter orders were stronger than anticipated due to growing interest in standalone CGMs than enable hospitals to provide remote monitoring and keep diabetes patients safely at home. Our relationship with Medtronic Diabetes Group remains as strong as ever. And as we look towards the second half of the year are confident that we are well prepared to continue to meet value bands and support their anticipated global product launches and upgrades. Next, turning to the surgical navigation market, this is a segment we are especially excited about as we see tremendous growth opportunity. From both opportunities to leverage our existing capabilities and micro miniature electronics, precision molding and medical coil technologies, as well as the new market opportunity opening up following our recent acquisition of Emerald Medical Services or EMS. Our medical coil business continued to deliver strong results during the second quarter, up over 35% over the prior year driven from customer demand, serving the interventional pulmonology and electrophysiology markets. As we noted on our last call, EMS has a successful history of delivering complex interventional catheters addressing a range of applications in the cardiology, peripheral vascular, neurology, radiology and pulmonology markets. In addition to driving growth in their existing catheter business, we believe EMS can enhance the content we provide an interventional pulmonology for lung biopsy and an electrophysiology for heart mapping and precise ablation. The integration of EMS is going well, if not exceeding our original expectations and contributed $1.1 billion to our revenues in the quarter. We continue to anticipate this business will grow in the low-double-digits throughout the remainder of 2020 and to be accretive to that income for the year. Over the next few months, we will be focused on accelerating business development activities, while completing the initial phase of integration, including renovation of space, consolidation of administrative functions and streamlining of critical processes. Next, I'd like to discuss our Hearing Health business. During the quarter, we continue to make good progress in further focusing our resources, including our remaining Hearing Help Express operations towards opportunities within an indirect to end consumer channel, targeting high profile partners that value our ability to deliver an ecosystem of care platform, which includes superior hearing aids, self-fitting software, that customer care to the U.S. market. As anticipated these actions in addition to providing a greater focus on more synergistic high growth opportunities, also substantially reduce associated losses. Despite the widespread disruption resulting from the COVID-19 pandemic we continue to engage in discussions with several commercial entities that are actively pursuing end customer healthcare initiatives and specifically solutions for the Hearing Health market including retailers, branding partners and pharmacies. However, shifts and legislative attention and FDA priorities resulting from the virus make the timing of an update on draft guidance of the OTC hearing aid regulation uncertain. We remain confident, however, that given the high cost of hearing aids today, and consumer enthusiasm for change, there remains tremendous potential ahead in the market. Earlier this year, we elected to postpone our self-fitting software clinical trial until such time as we can ensure the health and safety of trial participants. We have been working on safety measures and anticipate initially - initiating the clinical trial by the end of this year, with a goal of completing the trial by mid-2021. Lastly, our needle assembly business which today serves the drug delivery market remained relatively flat with prior quarters. We remain steadfast in our commitment to be a leading joint development manufacturing partner for miniature medical devices, including micro miniature products, microelectronics, micro mechanical assemblies, and complete assemblies that enable affordable and accessible healthcare and improve the quality of life for those we serve. I'm encouraged by the progress we've already made on the priorities we established for the year despite unprecedented changes to the global healthcare landscape in the wake of COVID-19. And those four priorities remain unchanged. One, meeting the volume demands of electronics, diabetes, business. Two, accelerating the diversification of our non-diabetes revenue by leveraging our core technology platforms. Three, continuing to pursue and secure partnerships that can utilize our hearing aid technology, self-fitting software, and customer care expertise. And lastly, implementing an organizational structure that best aligns with our focus on driving a sustainable pipeline of growth opportunities. At this point, I'd like to turn the call over to Scott to cover some of the trends we see emerging in the second half of the year. And importantly, his longer term views on the evolution of the business. Scott?

[Scott Longval:]

Thank you, Mark. I'm honored by the Board's confidence in appointing me as Mark's successor, and excited about the opportunity to lead our company forward. It's been a pleasure to work alongside this dedicated team. They've been part of the strategy and implementation of the recent transitions in our business. I'm confident these measures will not only enable us to continue to achieve success in the priorities we've established for the rest of the year, but will enable us to drive operational changes that will best enable IntriCon to focus on our core competencies in more synergistic, high growth medical markets, where we can have a meaningful impact, and as a result, the greatest growth. As we enter into Q3, we're seeing strengthening trends broadly across our medical business. While the macro healthcare environment remains fluid, I believe IntriCon has weathered the worst of the storm with several encouraging milestones on the horizon, including strengthening order patterns across our medical business, particularly with our largest customer in the diabetes segment, and our medical coil business. Furthermore, as Mark previously noted, we've adjusted our cost structure to provide greater business stability in today's uncertain business environment. Importantly, as part of this restructuring, we have begun to establish a structure that will enable us to better focus our resources on strategic market opportunities that are key to long-term growth. Turning to our financials. For the 2020 second quarter, we reported net revenue of $23.6 million versus $29.3 million in the comparable prior year period. The decrease was primarily due to the COVID-19 impact on our diabetes business in the legacy hearing health channels in the absence of revenue from high health innovations. By core business segment revenues in our medical business for the quarter were $18.1 million, a 13% decrease year-over-year and represented 77% of total revenue, which was relatively consistent with the prior year quarter. Again, this decline was largely due to the COVID-19 impact on diabetes offset by 21% increase in other medical and $1 million revenue contribution from Emerald Medical Services, which the company acquired in May 2020. In our Hearing Health business segment, total revenue in the second quarter was $4.5 million down 33% over the prior year, second quarter. Once again, this decrease was largely due to no revenue from health innovations in the COVID-19 impact on the legacy hearing health channel. However, as Mark noted earlier, we did see some upside in the segment due to impart a renewed access to audiologists and solid orders from our indirect to end consumer customers. More specifically, within the Hearing Health segment indirect to end consumer revenue was $1.4 million. Direct to end consumer revenue through our Hearing Help Express business was also $1.4 million, and legacy OEM revenue was $1.7 million. As previously announced in April, we took several steps to strengthen our balance sheet to reduce our cost structure, including reduction in headcount and a temporary salary reductions for Directors and management. The salary reductions, lowered expenses for the second quarter by more than $750,000 and were fully restored at the beginning of the third quarter. The company also incurred several one-time charges, totaling $2.5 million that impacted operating expenses. This included restructuring charges of $1.2 million, EMS acquisition expenses of $493,000 and CEO retirement costs of $823,000 partially offset by COVID-19 relief payments from the Singapore Government of $349,000. In the press release we have included a reconciliation of non-GAAP measures table in footnotes, summarizing those items. Second quarter gross margins were 28%, relatively flat year-over-year, primarily due to the cost reduction initiatives and favorable mix, offset by lower volumes. Operating expenses for the second quarter were $9.2 million compared to $11.6 million in the prior year period. As previously mentioned, we incurred several one-time charges during that quarter, totaling $2.5 million. During the prior year comparable period, we incurred a $3.8 million impairment charge. We posted net loss attributable to stakeholders of $2.5 million or $0.26 per diluted share versus a net loss attributed to shareholders of $5 million or $0.50 per diluted share for the 2019 second quarter. As presented in the reconciliation of non-GAAP measures table in the press release, the company posted an adjusted net loss of $143,000 or $0.02 per diluted share in the second quarter of 2020 versus a net loss of $1.3 million or $0.14 per diluted share for the 2019 second quarter. Lastly, our cash balance at the end of the quarter was approximately $28 million, which brings us to guidance. We continue to find that the COVID-19 outbreak and related uncertainties, create a broadly variable business environment for us and as a result, we remain unable to provide a meaningful guidance range for 2020. That said, as we enter into the second half of the year it appears our business trends are stabilizing. Furthermore, we believe our accelerated restructuring efforts have not only drastically reduced our costs structure without impeding our ability to meet customer demands, but also better positions IntriCon to pursue market opportunities that will enable us to best leverage our core competencies as we pursue targeted high growth medical markets. Now, I'd like to turn the call back over to the operator, so Mark and I can take your questions.

[Operator:]

[Operator Instructions] Your first question comes from the line of Jon Block, from Stifel. Your line is now open.

[Jon Block:]

Hey, Scott, hey, Mark. How are you?

[Mark Gorder:]

Hi, Jon.

[Scott Longval:]

How are you, Jon?

[Jon Block:]

Good, thanks. Maybe Scott, you should have closed making some comments here. So I'll pick up that. I just wanted you to discuss IntriCon's ability to do additional deals. And you mention EMS seems to be going well, integration a little bit ahead of plan, but I would think the environment can lend itself to additional opportunities. The environment is obviously highly fragmented and you guys have the balance sheet. So can you just talk about how we should think about some of those moving parts? You have your hands full with EMS that you think from an organizational standpoint, you can still pursue other deals over the next 6 to 12 months.

[Scott Longval:]

Yes, great question. Thanks, Jon. And that's a very important part of our growth strategy. Obviously, we've laid out what we think is a highly achievable organic growth strategy, but that needs to be augmented with M&A activity. EMS is a great example of one that we could do and do so with little disruption. As we mentioned on the call in the past, we believe that our Singapore management team can easily integrate that business with no disruption at the corporate level. So with that, we have begun to enhance and accelerate our corporate development efforts to begin to look at potential other acquisitions and build a pipeline. And our goal would be to look to be in a position to do something sometime during 2021. So we feel based on where we're sitting with Emerald based on our balance sheet, and in greater knowledge into the markets that we want to pursue that will be an ability to get something accomplished in 2021.

[Jon Block:]

Got it. Very helpful. And Mark, I'm going to shift over to the hearing side. You mentioned the trial, likely approved in mid-'21. And maybe that's in line with when the regs are put out there. Who knows? But the government certainly has their hands full with a lot going on to be fair. But I'm just curious if you're hearing anything more normal - on the timing of the regs per se, but just on the structure of it? In terms of how they may define mild or mild to moderate. Is there any more color that you're hearing coming out of Washington and when the regs are eventually put out there? How they might be constructed in that regard? And then I just got one more quick question.

[Mark Gorder:]

Well, I participated in a Hearing Industries Association meeting recently in the middle of July. And there was really nothing new forthcoming relative to the FDA other than they were totally awash with COVID-19 activities. And that it was most likely that hearing health was considered a low priority. Having said that, the industry was curious, they're assuming that the best case the regulations would come out would be mid-next year. And that's - that would be the normal statutory requirements. But it's most likely going to be delayed from that. And all we know, and we followed up with all our sources continually we haven't heard anything new on the regulation itself other than when the FDA approved the Bose submission for the de novo application for their self-fitting technology that in that de novo response by the FDA, it was clear they had made a lot of decisions relative to the specifications. And I would highly doubt that they will shift significantly away from what was authorized there. So the idea that mild to moderate, I think, if one skill to the looked at the specifications for the Bose device, they could figure out what kind of power levels and so forth would be most likely forthcoming when guidance is issued.

[Jon Block:]

Got it. And that would play to your advantage in terms of its still opening up the mild to moderate and having the moderate tag to it which would still open up a large chunk of the market to you and others, correct?

[Mark Gorder:]

Correct. And it's clear the industry will try to narrow the definition of moderate and those for greater consumer access will fight for a more liberal definition of moderate.

[Jon Block:]

Understood. Very helpful. And last one for me, Scott. While you still have your CFO head on, I thought a lot of positive surprises, one being the gross margin, essentially in line with a year ago, yet the top line was still $5 million to $6 million below the levels we saw in 2Q '19 in the past. The gross margin was very tightly correlated to your top-line. Here, we're seeing it recapture despite the top line that's $5 million or $6 million below. I think you've alluded to mix, but maybe can you talk about some other things that stick out favorably for the gross margin line? And maybe more importantly, when we think about the model going forward, is this the new base, this decline, and whether the 20% ish GM? Thanks, guys.

[Scott Longval:]

Yeah. Thanks, Jon, for the question. Our gross margin has had a couple of things that were impacted during the quarter but possibly; one, we mentioned the temporary salary reductions that we instituted for the second quarter that had about 175 basis points impact on the margin. As I mentioned, we added those back into play in the third quarter. So we won't get the benefit of that as we move into the back half of the year. And from a mixed perspective, roughly about 200 basis points of positive impact from a favorable mix. So we don't expect the mix to be that favorable again, as we move into the back half of the year. But we have done a lot in terms of reducing our cost structure. So that base that we entered into the year with in terms of our cost of sales is now lower.

[Jon Block:]

Got it perfect. Thanks, guys.

[Mark Gorder:]

Thank you, Jon.

[Operator:]

Your next question comes from the line of Kyle Bauser from Colliers Securities. Your line is now open.

[Kyle Bauser:]

Hi. Good evening. Thanks for all the updates here. Just a couple questions here. So we obviously saw a massive outside investment into Medtronic's diabetes business to drive its pipeline. Of course, several key management changes in that business as well. How has anything changed if at all from IntriCon's perspective? It seems like there should be a lot of upside to this partnership, given all the attention that diabetes is getting right now within Medtronic?

[Mark Gorder:]

Yeah, great question. Thanks. And that was the big announcement coming out of ADA was the $331 billion deal that Medtronic coupled with Blackstone to fund research and development initiatives for the future development of the diabetes group segments. But couple things for me; one, the commitment of Medtronic to that diabetes market, they obviously envision that market in that business to be a much bigger piece of the overall Medtronic pie. So that commitment there, I think speaks volumes with that agreement in place. And for us, it's very exciting. It gives us an opportunity to work with Medtronic, where they can be more forward thinking and spend more money in research and development. As an adjoint development manufacturer, somebody who is we've set our design engineers has set out there that our design engineers to provide them solutions for the diabetes market, it just provides more opportunity. So I think it's something that is obviously going to be great for Medtronic. And we believe that likewise, it can be a great agreement and affects us in a very positive way. Now, that being said, if you look at those investments, and what they're earmarked for their future platforms, and these are platforms that can be out three to five years. So we're not going to get immediate benefit out of it, but again, can put us in a position to sustain the long-term growth that we anticipate coming out of that diabetes market.

[Kyle Bauser:]

Got it. Agreed. I appreciate that. And sort of following up on a previous question. I mean, IntriCon from a valuation perspective right now is easily one of the most economical names out there. I mean, obviously, Medtronic's business is in a transition state and the hearing aid opportunity has been in a holding pattern here. Obviously, very nice acquisition EMS, which is a nice addition. But I'm just curious how you've been thinking about ramping shareholder value here. I mean, in the midst of COVID perhaps spending cash to buy back shares might not be an option despite the cheap price. But what other options are you considering to kind of get the stock moving in the right direction here?

[Mark Gorder:]

That's a great question. Clearly, it's been frustrating to see our stock being depressed as the way that it has been. When you look around the markets and you see other businesses out there getting significant valuations at a much higher clip than us. You see one, just over the last couple of weeks in the hearing health space, with year ago raising a significant amount of money. And then you look across some of the more medical pure plays and you'll see multiples that are significantly higher than us. Look, there's no silver bullet in it as much as I liked the idea of buying our stock back cheap. That's not going to solve our problem. We have to grow out of our problem. And we've laid out a strategic plan that we think will be additive both organically and inorganically. And our focus is to execute and if we do that over the coming quarters and be in a position where we can go out and tell the story and build back some credibility. I think the stock will definitely take care of itself. So I don't see us doing any short-term activities to prop up the stock other than better execution going forward.

[Kyle Bauser:]

Okay, got it. And then one more if I may. And on the self-fitting software trial set to potentially enroll later this year, approval mid next year. But can you remind me did that enroll at all at the beginning of the year? And when you begin to enroll again, where is that going to be taking place? How many sites is it?

[Mark Gorder:]

We're anticipating one site and we're currently exploring a partnership with a very experienced and proven University laboratory that would assist us in conducting the trial. And we did not enroll anyone. We have not gotten to the point where we're going to start enrollment. When COVID hit we just completely shut that down because we couldn't guarantee the safety of any elderly patients coming in. So we anticipate that in the - towards the end of the year, we would start the trial and we're hoping to complete it by mid next year.

[Kyle Bauser:]

Got it. Okay. That's helpful. Thanks for taking the questions.

[Operator:]

Your next question comes from the line of Andrew D'Silva from B. Riley FBR. Your line is now open.

[Andrew D'Silva:]

Hey, thank you very much for taking my questions. I hope everybody's doing well. My first question just relates to Medtronic's recent cross patent agreement with Tandem. I was just curious how you see that benefiting or impacting the business as it relates to the CGM space and your partnership with Medtronic?

[Mark Gorder:]

Yeah, Andy to the best of my knowledge in my understanding when that agreement was struck where I think there was some back and forth where both thought maybe they were infringing on each other's technologies related to the pump. So this was a clean settlement of that going forward. So longer term, I don't really see that having much impact in terms of our business with Medtronic.

[Andrew D'Silva:]

Okay, great. And just to stick with Medtronic really quickly, as far as EMS is - revenue that came out of Medtronic. Do you know what the total customer concentration was with Medtronic, including CGM and EMS?

[Mark Gorder:]

Yeah, so for Medtronic for the quarter, roughly diabetes was $13.5 million and about $750,000 out of EMS into the cardio group.

[Andrew D'Silva:]

Okay, perfect. And as it relates to Hearing Help Express and you changing initiatives as you move from that being a sales and marketing engine into development and testing engine for you, can you just describe that transition? Are you still using them as sales and marketing arm? And if not, what have you learned so far by utilizing them as a product development and testing engine for the company?

[Mark Gorder:]

Well, one thing, we learned over the past 12 to 18 months as we tried to - started to explore working with branding partners and retailers was the value they placed on teleaudiology customer care and service. And it was clear that if we were going to go in that direction that outbound telemarketing was not going to be a good path for us to pursue. So the restructuring predominantly focused on putting Hearing Help Express in a position, where the required assets were still in place, while significantly reducing the cost of operations. So we feel at this point, we're in very good shape with IntriCon being the developer of hardware, fitting software and HHE providing customer care and service and wrapping that into a complete offering for branding partners and retailers. We think that at this point, we've restructured the business into a very good position.

[Andrew D'Silva:]

Okay. And my last question just has to do with CGM sales. So it's been, we're a little bit more than two years since the 670 was rolled out in search of scale reasonably want to get rid of all the inventory issues. Have you started to see just second orders of transmitters from earlier adopters of the 670G? And what kind of a benefit has that had thus far as you think about 2020 or going forward?

[Scott Longval:]

Yes, Andy great question, this is Scott. And that's kind of the natural cycle that we've seen, right? So if you go back to the 530G into the 630 and the 670, the typical transmitter will last two years, and then you have that replacement. So as we started to see patients ramp up on the 670 in early 2018, we're now seeing those replacement units. And that's a big chunk frankly, of what we're seeing today, in terms of our top-line revenue coming from transmitters. As we look forward into the second half of the year and into 2021, we're excited about the 770G and the 780G platforms that we believe are of a great potential for Medtronic to begin to plough back some of the market shares that has lost over the last several quarters.

[Andrew D'Silva:]

Okay. And just last question for me. Maybe we talked about this a year ago or so, on one of the conference calls. You were moving from a manual to an automated semi process for further sensors and that would have some sort of change at least on revenue. I think that the net would be the same, but the gross revenue number would be a little bit different. Has that transition taken place? Have you moved over to the automated system for sensor assemblies?

[Mark Gorder:]

No. We anticipate that will begin in short order. And this will be widened over probably a couple of years Andy. So I think the initial impact was thought to be more significant than what we believe it will be now, so you will see farthered in at least over the next six, probably eight quarters.

[Andrew D'Silva:]

Okay, wonderful. Thank you very much and best of luck, going forward.

[Mark Gorder:]

Thank you, Andy.

[Scott Longval:]

Thank you, Andy.

[Operator:]

I don't see any question at this time, you may continue.

[Mark Gorder:]

Thank you again, for your time, and continued interest in IntriCon. Have a great evening and thank you for joining our call.