IntriCon Corporation
Q3 2019 Earnings Call Transcript

Published: 5 Nov 2019

[Operator:]

Good day, ladies and gentleman, and welcome to the IntriCon Corp. Third Quarter 2019 Earnings Conference Call. [Operator Instructions]I would like to turn the conference over to your host Ms. Leigh Salvo, Investor Relations. Please go ahead.

[Leigh Salvo:]

Thank you. 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 assumption 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 31st, 2018.With that, I would now like to introduce IntriCon's CEO, Mark Gorder for a review of the company's third quarter performance. Scott Longval, the company's COO and CFO will 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 our call today. As we enter the final quarter of 2019, our teams remains vigilant and executing against the priorities we established at the beginning of this year.In short, these priorities include 1) to meet the volume demands of Medtronic. 2) To pursue business development opportunities in our medical biotelemetry business and leverage our core competencies and diversify our revenue maze.3) To seek partnership with best-in-class entrance in the emerging OTC Hearing Aid market and 4) to prudently expand our direct sales initiatives with hearing health express well temporary our marketing and advertising programs.Importantly, I am confident that we are on the right path to expanding our existing market opportunity in our two core businesses; Medical Biotelemetry and Hearing Health.As we have mentioned in the past, expanding in the new markets where strength is a micro military device producer allows us to enhance the mobility and effectiveness of body borne devices is key to our continued progress.I'd like to take the next few minutes to provide recent highlights in both of our core businesses in our outlook for the remainder of 2019. Scott will then provide a detailed review of our financial performance in thoughts and guidance for the year. We'll then open the call for your questions.Starting with our Medical Biotelemetry business, our results in the third quarter continue to reflect the impact of the timing of Medtronic's ongoing global commercial product launch of its 670G.Encouragingly, we anticipate seeing momentum of continuous glucose monitoring adoption and increased penetration in international markets commencing in the next few months following clearance in Germany in other targeted EU countries.We expect the initial ramp-up to be gradual with further acceleration in 2020 as customer support including patient education roles out. Looking further out, our recent interactions with the leadership team at Medtronic diabetes group provide us with even more confidence and enthusiasm for our relationship and the exciting developments in the pipeline.In addition to our commitment through Medtronic, we also made it the priority this year to seek market expansion opportunities that can best leverage our medical biotelemetry design, development, and expanded manufacturing capabilities.As we have commented on previously, our other medical business has been expanding primarily due to our medical coil expertise. Our new business development efforts have identified surgical navigation as a potential growth market which can capitalize on our core technologies including medical coils.We intend to leverage our micro coil and value-added micro coil assembling capabilities by investing in strategic platforms addressing surgical navigation specifically in the areas of interventional pulmonology and electrophysiology.Leveraging and coordination of our micro-miniature electronics, precision molding and medical coil technologies in the markets that have high growth rates in speed technology curves harbored significant potential for IntriCon.We look forward to sharing more details as these opportunities unfold in the coming quarters. On the manufacturing front, we have completed the required validations in qualifications in our facilities and equipped and are now waiting for specific customers to complete their internal validation and qualification.Upon completion of this, we will be operated at approximately 60% capacity. The excess capacity positions us well to be anticipated demand over the next several years.Turning to our second core business segment, Hearing Health. We have made many strategic physicians in material adjustments throughout the year to ensure we are best positioned with the right resources and infrastructure to be a significant player in new market opportunities that will result from components changes in legislation and open the hearing aid market to over-the-counter sales.The pending guidance from the FDA related to the OTC hearing aid app is expected this month and we believe we'll confirm the start of meaningful change in hearing health in 2020. Given the high cost of hearing aids today, we are excited to find the tremendous potential this change could have for hearing impaired consumers.As well as opened the market up to knowing good file to monitoring loss that can't justify the current high cost and hearing aids. We estimate the change in hearing health regulation, we'll create a $3 billion addressable hearing health market in the U.S.By enabling greater penetration of the 30 million plus hearing impaired individuals that remain unserved today. Additionally, we are beginning to see international opportunities with both that are seeking alternative sourcing models and non-traditional delivery options.While we continue to monitor legislative progress, we are making exciting progress with potential partners as well as selectively targeting direct sales opportunities. As we've highlighted in the past, our go-to market strategy and hearing health includes three channels.Indirect end-consumer, direct to end-consumer, and legacy OEM. I'd like to take a few minutes to cover some recent updates in each of these channels. Starting with indirect end-consumer. In the third quarter, we once again experienced a meaningful decline in revenue associated with the restructuring activity within a large insurance customers hearing health business.We now believe that this provide us model that's pivotal towards a more traditional brick and mortar approach triggering health that no longer alliance with our partnership strategy and approach to reaching the end customer.As a result, we expect revenues related to this agreement will continue to diminish throughout the remainder of 2019. Despite the short-term revenue decline, this will allow us to reallocate our resources efforts to enhance our ecosystem while consumer centric ecosystem of care and target other opportunities with the potential with better long-term results.Partnerships remain a key component of our gross strategy in the segment. We are especially excited about a number of recent developments potential business market leaders in the consumer electronic space who have we are aware of our pursuing healthcare initiatives.Establishing these partnerships would enable us to be a dominant early participant in this emerging value-based hearing health market. We are confident that we are taking the right steps to best align IntriCon with high profile parkers that value our ability to deliver superior hearing aids self-fitting software and customer care to the U.S. market.Turning to our direct to end-consumer business, we continue to see hearing health expresses a long-term opportunity in our closely monitoring expenses as we optimize our model for entry meant to the over-the-counter market to directly reach hearing aid customers.Importantly, once the final OTC hearing aid after regulation has been issued, we will be able to deploy technology in customer support to enhance channel efficiency and customer satisfaction. And finally legacy only and revenue which represents product sold into the traditional hearing health market continued to decline as anticipated.I am confident that our long history in unique ability to deliver state-of-the-art technologies including wireless, digital hearing aids and sophisticated self-fitting software solutions coupled with our customer care competency, positions us to be a significant partner and participate and participant in this exciting and expanding market.In summary, we have an exciting range of growth opportunities ahead of us. We have taken many of the necessary steps to best position IntriCon for success in those markets. In addition to our long-term partnership with Medtronic diabetes group, we are making significant progress identifying partners that can benefit from our medical biotelemetry expertise and will enable us to expand in to new growth markets.And with the upcoming legislative changes that promise to open the door to affordable over-the-counter hearing aids in the U.S. our hearing health business segment has the opportunity to see meaningful growth. Both interacting two partners and directly to the end-consumer. Supporting this opportunity is a tremendous leadership team and a strong balancesheet.Now I'd like to turn the call over to Scott to discuss our financials and guidance in more detail.

[Scott Longval:]

Thank you, Mark. Turning to our financial results for the 2019 third quarter as Mark noted, we reported net revenue of $26.9 million a decrease of 9% over the prior year period.Like core business segment, we have been using our medical biotelemetry business for the quarter or $19.1 million or 1.3% decline year-over-year and represented a 71% of total revenue. This decline was largely due to the continued impact of the timing of Medtronics ongoing global commercial product launch of the 670G Insulin Pump System partially offset by increased sales to our medical coil customers.In our hearing health business segment, total revenue in the third quarter was $6.4 million down 22.5% over the prior year third quarter. This decrease was largely due with a continued declining sales to a large insurance customer as Mark referenced earlier in his comments.Within the hearing health segment, indirect and consumer revenue was $2.4 million direct to end-consumer revenue to our hearing health express business was $1.5 million and legacy OEM revenue was $2.4 million. Third quarter gross margins were 25.2% down from 31.6% in the prior year third quarter.Gross margins were constrained primarily due to lower volume as well as ongoing validation in qualification expense and excess capacity related to the recent manufacturing expansion and meet the anticipated higher volume requirements of our existing and future customers.Operating expenses for the third quarter were $7.2 million compared to $7 million in the prior year period. The increased stem from higher non-cash stock compensation expense was $648,000 and severance expense slightly offset by a decrease in advertising expense in our direct to end-consumer business.We are committed to closely monitoring cost and gaining efficiencies in this segment of our hearing health business as we refine our sales model to better align the emerging market opportunities. We posted losses attributed to shareholders of $290,000 or $0.02 per deluded share versus net income attributed to shareholders of $1.9 million or $0.22 per deluded share for the 2018 third quarter.Turning to our guidance. Due to lower than expected diabetes revenue, revenue loss from our largest insurance customer and the impact of our constant reduction in advertising spend of 83G, we now expect full-year revenue of 2019 to range between a $112 million and a $113 million.Full-year 2019 gross margin is expected to range between 26.5% and 27%. Now I'd like to turn the call back over to the operator so Mark and I can take questions.

[Operator:]

[Operator Instructions] Our first question it's from Jon Block from Stifel. Your line is open.

[Jon Block:]

Great. Thanks guys, good afternoon, thanks for taking the questions. Scott, in the first one or maybe two is for you, just to start with the gross margins. I think I'm just surprised at the magnitude of the detrimental, I'm just sort of running somewhat math.The revenues were down about $2.7 million year-over-year, the gross profit was down almost in equal amount and arguably that's where with your highest gross margin business and DTC hearing in a greater percent of sales in 3Q'19 versus 3Q'18. So, can you just talk about the 3Q'19 gross margins in light of the additional capacity and maybe most importantly how we think about it going forward?

[Scott Longval:]

Yes Jon, I think the challenge was working 2019 or 2018 was the expansion of our manufacturing capacity in 2018. That began kind of mid-year and by the time that we had that fully up in step was towards the end of the first part of 2019.So, a large part of the deterioration in margin was from the additional overhead cost we had as part of our new expansion and manufacturing footprints. If you also look at a little bit of the make-up of the margin, year-over-year slightly lower on the direct end-consumer business, which had some minor impact.

[Jon Block:]

Okay, got it. I guess, I can follow-up a little bit more offline.

[Scott Longval:]

And maybe I'll just expand on that, Jon. I think importantly, and Mark said on this is once we have we will final validations and qualifications at the new facility and the equipment from our customers will be at roughly 60% capacity.And so, we have the ability to leverage our infrastructure at which point we'll see a lot of the additional revenue in volume that we're anticipating in 2020 to be in this side of the margin line.

[Jon Block:]

Okay. And I guess, as a quick follow-up to that, the validation and qualification from your customers. Does that anticipate it Scott by the end of this year 2019 or 1Q'20 or what you expect that to occur?

[Scott Longval:]

I would say over the next two quarters, Jon.

[Jon Block:]

Okay. And then, maybe just a couple of follow-ups. The lower guidance looks like roughly $3 million to $4 million at the topline, is there a way to just even approximately parse that out of what is attributable to the medical business versus what you and Mark for hearing.And I guess within hearing it's mostly likely in that IDTEC business.

[Scott Longval:]

Correct. That's about 2/3rds of its coming from the medical side, third of its coming from the hearing health side.

[Jon Block:]

Okay, alright. And then Mark, for you. You alluded to some other medical opportunities, pulmonology electrophysiology. The timeline's for those to occur I mean you seemed a little bit more detailed this quarter relative to past quarters.I know however that you have to be designed into some of these platforms and as a result it does in a curve over now, but just do you sort of calling out specific opportunities if you can talk to when you think these might take hold.

[Mark Gorder:]

Good question, Jon. I think if I look historically a little bit of what we've been doing in the other medical side, we have spoken briefly about our expertise and medical coils which are used as sensors in interventional catheters.And we have made good strides over the last three years, developing good customer relationships with several players who are in that market. And because we've and you recall also that we brought that picture and I think roughly at the end of 2018, with the focus on new business development in the medical area based on our core technologies.And since we had made significant progress in medical coils, one of the first areas that Doug evaluated was the opportunities in the interventional catheter market has specifically we found that we have done very well in interventional pulmonology and to some degree in electrophysiology where we have already developed business relationships with customers and more various.And since we were or just along there, it seemed very appropriate that that would be a great area to look at how do we create a platform that we can build to serve customers in that market where we can add not only our medical coils but value added assemblies for that generate additional upstream revenue in that market.So, the reason we've given that more detail now is that we see that as a emerging opportunity, it seems to have a very good growth rate at a very steep technology curve that offer significant potential for us.So, I think we will begin a more and more detail out to this tree over the next few quarters as we become clear as to how our strategy will be to enter that market more forcefully and to make continued investments.

[Jon Block:]

Okay, great, helpful. One last word from me guys and then I promise I'll hop back in the queue. And you also talked a little bit more a bit more details around some partners for indirect and consumer hearing, calling our consumer electronics.Mark, at a high level, how would a partnership with one of those players look. How would it be structured and what I mean by that is would it be exclusive where you're sort of tied to one company.Would you expect multiple agreements that someone wants and exclusive because they want to keep out other potential competitors and consumer electronic companies, are you guys far enough along in your discussions where you can convey to us how that structure would look. Thanks for your time.

[Mark Gorder:]

That's a great question, Jon. I don’t I want to give a little nuance to that. I don’t think we're far enough along to give a detailed description of how such a partnership might work. But I can tell you that we are talking to partners in that are complementary to us that are in the market now, people like Year Go that we've talked about in past calls.We are looking at partners that provide benefits through various plans that could potentially partner with our direct consumer business, insurance companies and the like we're also looking at branding partners which include major retailers, drug stores, people like Walgreens, CVS, Specsavers in the U.K.The interesting thing is that all of these potential partners can be served by the core technologies that we're developing both on the product side, on our self-fitting software remote care as well as the things we're doing in the director consumer business like pick pack & ship customer service and teleradiology.It's clear that different partners will value different components in that array of core technologies. So, it's not clear to what's yes exactly how that will emerge but we do feel that the investments we've made are putting us in a position to talk to multiple partners and position ourselves in different ways.And I think we have to be prepared to pivot depending on which opportunities appear to be the most advantageous. And I say it's pretty much here at this point but I think some clarity over the next 12 to 18 months will be possible.Does that answer the question, Jon?

[Jon Block:]

It does, Mark. Great, guys, thanks for your time.

[Operator:]

Our next question it's from Andrew D'Silva from B. Riley FBR. Your line is open.

[Andrew D'Silva:]

Hey good afternoon, thanks for taking my questions. Just to start off, can you let me know what depreciation amortization, cash flow from operations and CapEx was for the quarter. And then, why you're pulling that, I was just looking at the guidance, does it take into account anything beneficial happening with Medtronic at the EU at all.It seems like they announced some progress with the reimbursement being established in Germany. But like should we just mute things as really in a holding pattern right now until the 780G is out or is there some upside that we should be thinking about internationally with the 670 in the interim.

[Scott Longval:]

So Andrew, this is Scott, I'll pick the first part of your question. The amortization and depreciation was $820,000 to the quarter. Cash flow from operations was negative $323,000 and CapEx for the quarter was $1,428,000.If that relates to the guidance for the full-year, what typically we have seen after Medtronic gets approvals in certain geographic areas, there is a period of educating the medical community educating their install base and typically that takes several months. So, as we started thinking about how are we going to view the rest of the year.We basically discounted anything from the international market as it related to Medtronic. Now, with all that being said, Mark and I and our executive team had the chance to interface with the leadership team with the diabetes group last two weeks ago. And I can tell you they are very bullish on their business both domestically and internationally.So, we are excited about where we're heading, we're excited about how they are executing the product pipeline overview that they provided at 88 and we think this was going to be a great catalyst as we start thinking 2020.

[Andrew D'Silva:]

Okay, great. And then, as it relates to United, when they brought their announced related to the epic integration in acquisition, they noted that including access to hearing aids at up to like an 80% discount to traditional devices, was what they were targeting.Can you just reconcile how they're able to maintain that kind of a discount relative to traditional brick and mortar while going into brick and mortar and that leveraging a either in online or direct to consumer platforms somewhere there where you have?

[Mark Gorder:]

Andy, this is Mark. I think they're going to be operating a whole range of services and I doubt that all of them will be 80% discount. There'd probably be some 80% discount and some not. Because they the epic model works through the traditional channel.And they provide subsidies for the consumer but in many cases they're buying more expensive devices. Scott, do you have anything to add to that?

[Scott Longval:]

No, I think that's -- what we'll see and I think most likely would to get to that model is can be as typically what is what turns dividers will do which will get access to the networks and then be again to squeeze cost out of that very rapidly. So, ultimately we'll probably be somewhere between the 80% in something a little bit higher.

[Andrew D'Silva:]

Okay, that makes sense. And then, as it relates to self-fitting, there is a couple or actually just one item posted on the federal register. I know we're still waiting for draft guidance to come out but does that self-fitting documentation in the code of federal regulations provide you with enough confidence or enough inability to follow your 510-K for the self-fitting aspect and kind of move forward knowing that that's likely part of the guidance?

[Scott Longval:]

Yes, it does Andy, that's a very good comment because the initially the both receive and a de novo approval from the FDA for their self-fitting technology. But if there was not a lot of documentation for coming is exactly is what was approved.And that reference you just made, clarified a lot of things that we're involved in the de novo approval for both. And it clearly gives us confidence that what we're doing with our clinical trial for the self-fitting technology that we have will be very well-received by the FDA.I think that will also --.

[Andrew D'Silva:]

Okay, last -- oh go ahead.

[Scott Longval:]

Sorry, it is when is -- that obviously what we're supposed to do to the federal registers important but I also think our one-on-one discussions with the FDA gives us a lot of confidence or more we're heading with our self-fitting technologies well.

[Mark Gorder:]

Good point, Scott.

[Andrew D'Silva:]

Okay, good to hear. And just last question from me, it's just really related to outside the self-fitting, now that we have some clarity on that like what other major points do you really need to get hammered out with the guidance.For 1) to understand the indirect partnerships that can be established and then 2) for your direct to consumer business, what would you need to see the FDA put out for you to move one direction or an another?

[Mark Gorder:]

Well I think, the way the regulation is written, if they implement it per the legislation that allows us to bypass the professional and make the channel more efficient. And when we talk to these potential partners whether the retail partners, ITEC partners etcetera. They're all looking for that clearance.Because none of them want to get into a regulatory bind with the FDA or they're trying to sell or service a device. It's clearly a medical device.And so, the OTC designation of mile-to-moderate and no interference from any state are critical. And I think they're going to go forward exactly per the legislation which will open the market, make it more efficient and drive a lot of innovation.

[Andrew D'Silva:]

Okay, perfect. Thank you very much and good luck closing out the year.

[Mark Gorder:]

Thanks, Andy.

[Scott Longval:]

Thanks, Andy.

[Operator:]

Our next one is from Kyle Bauser from Dougherty & Company. Your line is open.

[Kyle Bauser:]

Hi good evening, and thanks for taking the questions. Just following-up on the clinical activity to support the self-fitting 510-K application. Since the bow serenade will I'm assuming be the predicate, will you enroll as many subjects as they did, I think it was a 125.And then, what sort of follow-up time and endpoints are you considering for that trial to support the application?

[Mark Gorder:]

It's a great question. The Bostrom [ph] actually ran a couple of different trials, they -- we don’t have to report quite as many subjects as those, I think we're going to run about 85 subjects. But the FDA is looking for a trial similar in nature to what Bostrom did.So, that requires about 85 subjects. And we're in the process of organizing that and hope to be starting it shortly and I'm not sure exactly the timing yet because finding the 85 subjects will be the long pole of the TAT.

[Kyle Bauser:]

Alright.

[Mark Gorder:]

But it certainly shouldn’t take more than a few months, more than three to four months.

[Kyle Bauser:]

Sure. And so, still kind of on track for potential submission I'd say in Q1 for a mid-2020 approval?

[Mark Gorder:]

That's what we're trying to do, yes.

[Kyle Bauser:]

Okay. And then, following-up on Jon's prior question with regard to one of your priorities to seek partnerships in the OTC market. Can you speak a bit more about what you're hearing the appetite is for some of these partners tending the market in specifically if we assume they're in a holding pattern pending the release of this draft OTC regulation?What do you think gives a potential partner the most pause and I'm thinking about things such as how the FDA might define, mild-to-moderate hearing loss or potential clinical requirements for OTC approval. Any color here would be helpful, thanks.

[Mark Gorder:]

I think the biggest issue is that the regulation allows you to use to bypass the professional because a lot of these retailers they're not healthcare providers, they're not going to want to get into the healthcare business. They're looking for partners to provide that aspect of it.But they want to be able to position these devices in their marketing matrix and be able to sell them without any restriction from the FDA. So, that's I think that's the thing that's giving the pause, it's the any interference from any state regulation.This classification are going to be relatively straight-forward. What it takes the fed a mile to moderate losses, pretty well known the document that Andy referenced is pretty spot out and what that specification will probably look like in terms of output power and gain and all those kind of things.So, I think the critical point will be that they want to be assured there's no regulatory hassles to dispense systemize, no interference from any state agencies.

[Kyle Bauser:]

Sure, okay, that's helpful. That's it from me, thanks so much.

[Operator:]

And that brings us to the end of the Q&A session of today's call. I will now turn the call over to Mr. Mark Gorder for the closing remarks.

[Mark Gorder:]

Thank you, operator. Thank you again for joining our call today. The IntriCon team continues to locate and act upon new opportunities that grow and diversify our business and I would like to thank them as well as their shareholders for your continued support.We look forward to seeing many of you during upcoming conferences and are getting trips. Have a great evening and thank you for joining our call.

[Operator:]

This concludes today's conference call. Thank you, for participating. You may now disconnect.