IntriCon Corporation
Q1 2019 Earnings Call Transcript

Published: 30 Apr 2019

[Operator:]

Good day, ladies and gentleman, and welcome to the IntriCon Corp. First Quarter 2019 Earnings Conference Call. At this time, all participants are in a listen-only mode. Later, we will conduct a question-and-answer session and instructions to how to participate will follow at that time. [Operator instructions]. As a reminder, this conference call is being recorded. I would now like to introduce your host for today's conference, Ms. Leigh Salvo of Investor Relations. Ma’am, you may begin.

[Leigh Salvo:]

Thank you, Jimmy. Before we begin, I'd 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. Important factors that could cause such differences include, among others, those set forth under the headings Risk Factors and Management's Discussion and Analysis of Financial Condition and Results of Operation in our 10-K filing for the year ended December 31, 2018. With that, I'd now like to introduce IntriCon's CEO Mark Gorder for a review of the company's first quarter performance. Scott Longval, the company's CFO when then cover the financial results in more detail, and we will open the call for your questions.

[Mark Gorder:]

Thank you, Leigh. And thank you everyone for joining us today. We're off to a solid start in 2019, with progress made on each of the priorities we laid out at the start of the year. These included

[Scott Longval:]

Thank you, Mark. First, I’m excited to assume the additional role of Chief Operating Officer. I look forward to working with our talented teams across many disciplines that are critical to our continued delivery of the highest quality and innovative products that meets our customers' needs. Turning to the financial results. For the 2019 first quarter we reported net revenue of $30.1 million, up 18.7% from $25.4 million in the prior year period. The increase was primarily due to year-over-year revenue gains from our diabetes and medical coil markets. First quarter gross margins were 29.1%, down from 33.2% in the prior year first quarter. Gross margins were constrained by ongoing validation and qualification expense and excess capacity related to the recent manufacturing expansion. Operating expenses for the quarter were $7.9 million, compared to $7.1 million in the prior year period. The increase stemmed from increased advertising investments in our direct to end consumer and support costs related to key new business development initiatives. IntriCon posted net income attributable to shareholders of $775,000 or $0.08 per diluted share, versus $769,000 or $0.10 per diluted share for the 2018 first quarter. In terms of guidance, we are reiterating our previously stated guidance for the full year 2019, which included revenue of $128 million to $133 million and gross margins of 30% to 31.5%. We continue to anticipate year-over-year revenue growth and margin improvement for the full year 2019 and now anticipate the timing of certain orders related to our largest customers’ ongoing global commercial product launch will be more weighted towards the second half of the year. In 2019 we anticipate gross margins to be relatively consistent with 2018, despite the headwinds noted related to our manufacturing expansion and impact of pending long-term customer contract and a significant increase in depreciation. Long-term I believe we are well positioned for continuous growth from our core businesses. In addition to our revenue growth opportunities we anticipate that over time we will be able to leverage our current manufacturing infrastructure to expand gross margins for the high 30% range. Now I would like to turn the call back over to the operator so we can take your calls.

[Operator:]

[Operator instructions]. Our first question comes from Jon Block with Stifel. Your line is now open.

[Jon Block:]

I might ask maybe one or two more than I usually do. But maybe just a start off, the new medical customer, congrats on that. Is that sort of the new run rate in medical around that 3.5 million, 3.6 million per quarter for this year and then as you mentioned going higher next year. Was there anything that was sort of one-off specific to 1Q ‘19 in that other medical line?

[Mark Gorder:]

Scott?

[Scott Longval:]

Thanks Jon for the question, what we saw in the first quarter was some of the original benefit of some medical coil business from that new customer. We expect that to maybe temper a little bit in the second quarter and then begin to gain traction in second half of 2019. And then clearly as we look into 2020, anticipate that growing at a much cliff.

[Jon Block:]

And then with gross margins of 29.1%, I mean are you guys sort at the main blemish for the quarter about 100 bps below where we were -- I think you mentioned finalizing validation this year at which time it would be around 60% capacity if I got that all right. I guess Scott the question here is your confidence in averaging what we believe is close to 31.5% for the remaining nine months of the year versus the 29.1% to get you to the midpoint of that 30% to 31.5%, can you get there in light of not finalizing validation until the end of ‘19 maybe some thoughts and color around GMs would be very helpful?

[Scott Longval:]

Yes. I think the expansion itself, this is a monumental task, we're talking about bringing 17 presses online, various automation systems, numerous molds. So it's quite a bit of effort both internally and on our customers and then ultimately through the FDA. That said, we are confident with we're at in that process that we can get the final -- some of those presses through validation and run to the point where we can start to leverage that in the second half of the year. So we anticipate as we’ve laid out in the comments that we see the second half with year’s gross margins starting to benefit from those efforts. And additionally as we look into second half of the year we're confident that the overall revenue mix will be more favorable. So we think that will also play a part in helping us achieve the gross margins that we’ve laid out in terms of guidance for 2019. Q - Jon Block Then maybe one or two more from me. In that indirect to end consumer business, I think in the press release and on the call you mentioned something with one of your partners, is there a way go and try to quantify that specific to 1Q, I mean obviously that indirect business grew at a very healthy rate in 2018 year-over-year, flat to slightly down in 1Q ‘19, is there a way to go ahead and sort of quantify the effect that you saw on the March quarter?

[Mark Gorder:]

Jon this is Mark. I think from time to time, because we have these independent partners that we're working with, they have their own buying and launch cycles on some of these products and because they're all relatively large buyers as a percent of sales in that group, that has a big impact. We have a launch cycle with ebbs and flows. But overall we expect year-over-year that business to continue to grow as we’re bringing in more partners. So I would expect that in the second half of the year, we would expect to see that back on track to show continuous growth.

[Jon Block:]

And last question for me Mark, I might be sticking with you. You had some comments where the investment specific to the DTC or HHE business seemed to be under control, you acknowledged that you would be thoughtful on making the investments there. You obviously added some on the board with a ton of experience, with very impressive experience to these DTC types of businesses. So maybe can you take a step back and just share with us the company's latest thoughts around how aggressively you want to pursue the DTC hearing business and how you sort of feel the best approach to market there? Thanks guys.

[Mark Gorder:]

Good question Jon. I think the -- we look at the investment that we're putting into to HHE and into our manufacturing and technology infrastructure that supports all the legs of the stool here as being leverage-able across all these potential partners. So for example when we purchased HHE we bought a very good core capability for customer care, Hearing Health Telemedicine. That's going to be useful to all of our partners as we grow this business. So when we talk about -- we're going to invest prudently to continue to expand our core capability in Hearing Health Telemedicine. But at the same time, we're going to watch our spending very carefully on the marketing side. So as I mentioned in the press release we were increasing our expenditures going forward in outbound telesales while tempering the cost in ad spend. Where we see something is not producing the return that we expect, we will moderate that and try other things that we think have a better return on investment. So at the current state we think we will get a better return on investment on outbound telesales from a tactical standpoint. So we're going to prudently temper that advertising and marketing expense. Does that answer your question?

[Operator:]

Thank you. Our next question comes from Andrew D'Silva with B. Riley FBR. Your line is now open.

[Andrew D'Silva:]

I'll start with a couple of book keeping ones, Scott if you don’t mind. Could you just let me know what cash flow from operations, CapEx and stock-based comp were for the quarter? And then while you're pulling that Mark or Scott, can you discuss the new medical customer, is that an expansion with an existing customer or completely new customer, and just a color on that would be useful as well?

[Mark Gorder:]

Well we made a commitment to invest in trying to diversify our Medical business. Now fortunately we had some ongoing activity for the last several years trying to grow our medical coils space. And because that's in an FDA regulated environment, the lifecycle of getting a product from just patients through the FDA is very lengthy, so some of these -- this particular customer we’ve been working on for I would say three to four years, from starting the development of the product to where it’s now as FDA approval and they are starting to launch it. As Scott mentioned I think in the write up we expect modest sales in 2019 and more vigorous growth in 2020. We have other medical coil customers who are in a similar situation to the one that we just started to launch and we expect additional launches in the future in that product line. But in addition to that as we mentioned in our press release, we hired Doug Pletcher to head up VP of Business Development in the medical space and his role is more strategic and we expect that he will have a strategy of how to build the platform using our core technologies to take to a broader array of large medical device companies starting in the second half of this year. So there is a two-pronged approach there, there is a more tactical approach where we’re already gaining traction in medical coils and then a strategic approach where we're investing to take our core technologies, build the platform and reach a broader array of customers with body-worn medical device technology. Now I’ll turn it over to Scott.

[Scott Longval:]

Andy cash flow from operations, roughly $430,000; CapEx spend, $950,000; stock-based comp, $330,000; and depreciation and amortization was $810,000.

[Andrew D'Silva:]

And then Mark just following up on that comment so that was sort of completely new customer, it’s not like another subsidiary of a parent or anything like that, is that the correct assumption?

[Mark Gorder:]

Yes. Correct assumption.

[Andrew D'Silva:]

And then if you mentioned this, I’m sorry I was jumping between calls but last quarter call you noted establishing a new contract with a large exiting partner, any updates on that front?

[Scott Longval:]

Andy, this is Scott. We believe we are really close to securing a long-term contract while we're working to finalize that contract in the near-term. I think it's important to point out that relationship. It’s something that we've been working with this customer for well over a decade. We’re deeply integrated into their ecosystem. I think if you look at how both parties have worked over the last several years investing millions of dollars, there is a vested interest on both sides to get something finalized. So we’re working towards that, we’re excited to do that and when we do we will be able to share that with you.

[Andrew D'Silva:]

And the guidance is kind of around where you would expect the renegotiated contract to shake out, is that a fair assumption or do you think that there could be some variance related to how the guidance to shake out based on how the partnership is established?

[Scott Longval:]

No. There is no relation.

[Andrew D'Silva:]

And then can you help cross-walk Q1 gross margins for me, I think about 90 bps -- basis points lower than Q4. On a segment-by-segment basis it seemed somewhat close sequentially from a top-line standpoint at least. I’m just trying to figure out where the majority of the margin compression happened during the quarter. I mean the manufacturing utilization issues I believe were still relevant last quarter as well. So just trying to figure out why there was a little bit more compression this quarter?

[Scott Longval:]

Yes, correct. There was in uptick what we noted in the call and in the press release on just the cost associated with going through the valuations and qualifications, so adding some additional expense in the first quarter that we didn’t recognize in the fourth quarter.

[Andrew D'Silva:]

And just one last one from me. If you could maybe discuss the value based contract that you highlighted with Medtronic that was established with Blue Cross and Blue Shield at Minnesota? How many of those do you think can be established or what's the landscape look like for [BBC] contracts right now? And then from your experience with previous product rollouts, how beneficial are they to actually ramping up sales?

[Mark Gorder:]

Very good question, I think if you step back and broadly look at what Medtronic is doing that’s a definitely an area of focus not only in the diabetes group but corporate wide, trying to enter into these value-based agreements. This isn’t the first one they have but obviously something that they are very excited about. And if you think about the products which they are offering in the diabetes group that’s form under this outcome-based value-added umbrella are really supported by the monitoring, the diabetes glucose monitoring, and the importance of ensuring the patient is keeping their A1c levels within that defined range provides the best outcome. So as they enter into these agreements and they continue to expand on that front, we believe we're going to be the beneficiary of that as the demand for CGM continues to increase.

[Operator:]

Thank you. And our next question comes from Dick Ryan with Dougherty. Your line is now open.

[Richard Ryan:]

When you look at the indirect market part of that’s United, part of that are the other vendors, collective of vendors that are going to consumer market in their own right. We’ve seen that go back from the levels of Q3 and Q4. Can you talk about where that weakness occurred, is it more on the United side or the other vendor side?

[Scott Longval:]

I can’t get into specific make up of that. But as Mark mentioned, we have a couple of large customers to drive that revenue base. And for the number to end up where it was in the first quarter, obviously it was impacted by a large customer.

[Richard Ryan:]

And then Mark what's your current thoughts on the FDA write up for the coming regulations?

[Mark Gorder:]

Good question. I was out in DC again at the end of March to assess where all this was at and I feel still that the FDA will issue some type of guidance document by the end of 2019 and then by statute they have a period of time where they have to allow for comments and that could take as long as six months. So I would say that our expectation is mid 2020 that the regulation will be in effect. Now statutorily they could take another year longer than that. But the feedback that I got when I was there was that there is a lot of pressure to get this done, that the politicians, such as center Senator Warren's office being part of pressure on to get this done and we think the FDA will move sooner rather than later. So that’s the current feedback that I have from my most recent discussions.

[Richard Ryan:]

What are you guys doing now on your self-fitting software, where do you stand in that process?

[Mark Gorder:]

Well, two folds, we had an initiative as we’ve mentioned in the past going in Europe. That's still going very well. We’re using that to test and debug the technology. So that's going well in Germany. They are doing expansions now into Australia and Switzerland over there. But the real benefit of that in the long-term is coupled with the OTC legislation. We can do self-fitting directly to the consumer without including a professional in the process. It allows us to create a much more efficient and more value-added process for the consumer. Now where we stand on that, we're in the process of submitting a 10-K with clinical trials in the US to get FDA approval to put that in the US market and our goal is to get that done prior to the release of the regulations. So we’re the process of defining what our 10-K submission will look like and then moving that forward. And we’re benefiting from the fact that those already got a de novo approval for a self-fitting science that was announced in October of last year. So that allows us to do a 10-K substantial equivalence to what they did and we have every confidence to believe that our technology is a substantial equivalent. So our goal is to get that done by mid-2020 so that we're ready for a OTC completion of the regulations.

[Operator:]

Thank you. And I’m showing no further question in the queue at this time. I would like to turn the call back to Mark Gorder, President and CEO for any closing remarks.

[Mark Gorder:]

Thank you again for joining our call today. I’m pleased with the solid performance the IntriCon team is making and would like to thank them as well as our shareholders for your continued support. We look forward to seeing many of you during upcoming conferences and marketing trips. Have a great evening.

[Operator:]

Ladies and gentlemen, thank you for your participation in today's conference. This does conclude your program and you may all disconnect. Everyone, have a great day.