IntriCon Corporation
Q1 2018 Earnings Call Transcript

Published: 8 May 2018

[Operator:]

Good day, everyone, and welcome to the IntriCon First Quarter 2018 Results Conference Call. Today's conference is being recorded. And at this time, I would like to turn the conference over to Scott Longval, Chief Financial Officer. Please go ahead, sir.

[Scott Longval:]

Thank you, Operator. Joining me on today's call is Mark Gorder, IntriCon's CEO. 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 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 Analysis of financial condition and results of operations and our 10-K filing for the year ended December 31, 2017. With that, I'd like to introduce Mark for a strategic look at IntriCon's first quarter.

[Mark Gorder:]

Thank you, Scott, and thank you, everyone, for joining us today. I would like to begin by reviewing key highlights and results for the first quarter. After that, Scott will cover the financials in more detail, and then we'll take your questions. By this time, most of you have had a chance to review our first quarter press release. The company reported record net sales of $25.4 million, up 19.6% from $21.2 million in the prior year period. Gains from IntriCon's largest medical customer and growth in the value-based hearing health direct-to-end-consumer and indirect-to-end-consumer businesses drove strong top and bottom line performance. In conjunction with the revenue growth, we expanded our manufacturing footprint and made progress on the value-based hearing health technology front. Looking at our three businesses, our medical business increased 30.8% in the 2018 first quarter from the prior year period. The gain was primarily driven by the ongoing production of Medtronic's MiniMed wireless continuous glucose monitoring systems and related accessories that rose 42.9% over the 2017 first quarter. We are well positioned with Medtronic for 2018, providing key system components, including the CGM systems, sensor assembly and related accessories. We anticipate system demand to further increase throughout 2018. Over the last few quarters, key medical customers have invested in or made commitments to invest in $4.5 million in capital equipment. In response to these commitments in our rapid medical growth, we are expanding our manufacturing footprint. We have leased an additional 37,000 square feet of manufacturing floor space near our existing locations in Minnesota to accommodate robotic assembly of medical components and systems. In conjunction with the added space, we are also increasing our molding capacity. During the last 2 quarters, the company added 6 presses and has another 12 presses on order for delivery throughout 2018. The expansion of our robotic and molding capacity not only positions us to meet current demand but enables us to pursue new medical opportunities that would benefit from our core competencies. We expect to be fully operational in the additional space by mid-2018. Turning to hearing health. To provide greater transparency within our hearing health businesses, we started providing more detail of the quarterly revenue than we have historically. Specifically, we have broken out our 3 distinct revenue streams

[Scott Longval:]

Thank you, Mark. I'll begin by reviewing our first quarter financial results in more detail. For the 2018 first quarter, we reported net sales of $25.4 million, up 19.6% from $21.2 million in the prior year period. The increase was primarily due to the year-over-year revenue gains from IntriCon's largest medical customer and growth in the value-based hearing health direct-to-end-consumer and indirect-to-end-consumer businesses. As Mark mentioned, we refined our strategy within the value-based hearing health market and experienced a lot of exciting growth. To better focus our resources on the value-based hearing health opportunities, we are working on a plan to narrow the focus of our U.K. sales and distribution teams on opportunities that support this strategic goal. You can expect updates on this plan in future communications. IntriCon posted net income attributable to shareholders of $769,000 or $0.10 per diluted share versus a net loss attributed to shareholders of $270,000 or $0.04 loss per diluted share for the 2017 first quarter. First quarter gross profit margins were 33.2%, up significantly from 27.5% in the first year first -- the prior year first quarter. The increase primarily stemmed from greater volume. We expect this trend to continue throughout 2018. Operating expenses for the first quarter were $7.1 million compared to $6 million in the prior year period. The increase was largely due to increased advertising investments at HHE and other support costs related to key initiatives to drive the business' growth. Turning to other highlights. This afternoon, we filed a shelf registration and once it is declared effective by the SEC, will give us the option to sell up to 30 million of our securities covered in the registration statement. The statement replaces our shelf registration statement that expired during the first quarter. We have no immediate plans to raise capital under the shelf registration statement, but as a matter of strong corporate governance and allows us to be more agile and support our rapidly growing business needs, we believe it's prudent to have the offering available to the company on an as-needed basis. Lastly, in terms of guidance. Based on the information currently available, we anticipate the 2018 second quarter net sales to range between $25.5 million and $26.5 million. For the year, we're increasing our sales estimates, and we now anticipate sales to range between $105 million to $108 million. Now I'd like to turn the call back over to the operator, so we can take your questions.

[Operator:]

[Operator Instructions]. Our first question will come from Andrew D'Silva with B. Riley FBR.

[Andrew D'Silva:]

My first question is going to be related to diabetes revenue. As far as that goes, are most of the capacity issues that we previously discussed behind us at this time? And then is growth only being driven by MiniMed? Or is the new Guardian Connect offering starting to [indiscernible] at this point? And the only reason I asked that is because the expanded market opportunity with Guardian into type 2 diabetes, obviously, is a much larger market opportunity for you or your components, I would assume, than type 1.

[Scott Longval:]

Great. Thanks, Andrew, for the question -- this is Scott. Appreciate it. So we are [indiscernible] in earnest to get through and make sure we have the infrastructure to meet all of our customers' needs, specifically in the diabetes space. So we think as of the end of the first quarter, we are on pace now and have the capacity or the plans to have the capacity in place to meet all of their needs. Secondly, as it relates to the specific products, I can't get into great detail. You did noted that the Guardian Connect product was approved by the FDA in May -- or excuse me, in March. And I know Medtronic has high hopes for that product and envision that to be a significant driver as part of their overall diabetes offering. So I can't really get into the specifics on the makeup of that revenue. All I can tell you is I know they're excited about that product. I know that they think that's going to be a great growth driver for them and not only in 2018 but in the years to come.

[Andrew D'Silva:]

You've discussed, but at least it's fair to assume that once that starts rolling out, it should be, at worst, meaningfully beneficial to you; at best, substantially meaningfully beneficial to you.

[Scott Longval:]

Absolutely.

[Andrew D'Silva:]

Okay. And do you think these margins that you saw in the medical segment this quarter are sustainable as we go throughout the year? I mean, you came in away ahead of what we were thinking about for the quarter. Were there any onetime benefits that we should take into account here? Or was the 33% gross margin rating really something that we should expect as being achievable going forward?

[Scott Longval:]

Well, I think the increase in the gross margin is something we've been talking about for quite some time that we felt like we had the ability to really leverage our capacity. And I think you saw that in the significant jump. Clearly, we're adding some cost to support the future growth not only in '18 but to position ourselves for beyond. We brought on the new manufacturing facility. We're working very hard to get that up and running, so there will be some added cost as part of that process that we'll incur in the second quarter. But on balance, we look at our gross margin makeup in that kind of the low- to mid-30s for 2018 as very achievable.

[Andrew D'Silva:]

Okay. And last question as it relates to the new manufacturing facility. In your comments, you highlighted that you're expanding your sales initiatives for both the hearing health side of the business as well as the medical business. Is the expansion of the 37,000 square foot facility primarily just a situation where you need extra capacity to service existing customers? Or is this a situation where now you feel very comfortable with the larger customers that you have and you're able to start looking at new customers, and you now have the ability to actually service them with a new manufacturing facility?

[Mark Gorder:]

Andrew, this is Mark. And I think you hit the nail on the head. We feel very confident now that we have this rapid growth from our largest customer and others that it's time to start investing and developing new relationships. And we have not been in that position in the past few years. So we anticipate starting to add manpower to be able to get into the marketplace, develop new relationship while as some additional engineering capacity to start to do extra bidding and concepting. And we have not been in that position before, so this is a great opportunity now to get more aggressive in that sense. However, as you know, being in an FDA space, there is nothing that will happen quickly there. So even though we decide that we're going to start increasing the marketing and engineering effort, it's at least a two to three year cycle on most of these FDA programs [indiscernible] longer you hold off doing anything, the longer you wait to start driving revenue. The new facility is scaled to basically handle our existing needs as we see it forming over the next two to three years. And anything we brought in beyond that, we would have to probably add additional capacity. So that current facility is really sized for the opportunities we already have in place. I don't know. Does that answer your question?

[Andrew D'Silva:]

That does answer my question. That makes a lot of sense. So the opportunity is opening up for you from a comfort standpoint where you can feel comfortable actually targeting new customers. But as you -- or if you do get new customers, you might actually have to add some more equipment to existing facilities.

[Mark Gorder:]

Exactly.

[Operator:]

[Operator Instructions]. We'll hear next from Jon Block with Stifel.

[Jonathan Block:]

Maybe two or three for me. Mark, certainly helpful breakout on the hearing revenue. Maybe if you could talk about where you see the legacy hearing revenues bottom. And then the second part to that same question would just be, Scott, at a high level, could you ascribe, maybe just rough gross margins, to the three different hearing businesses? I believe clearly, the direct would be the highest but wonder if you could give us sort of the magnitude of the delta between the three.

[Mark Gorder:]

Jon, I'll take the first one, then let Scott step in on those margins. As you mentioned, we've broken it into three categories, which we think are meaningful. We talked about this in the past because we've been investing and putting the footprint and to be able to grow this new value-based hearing health business. At the same time, we knew that the legacy business selling components and systems to the OEM manufacturers may be mainly the oligopoly was going to be in decline. And so I always liken this to changing -- around the freeway as a public company going about 60, 70 miles an hour, and we've got to change the tire on the car while we're in motion. So it's kind of what we were doing to transition from the OEM business to the direct-to-consumer business. And in that direct-to-consumer business, we have both our HHE channel, and then we sell technology and systems to all the other direct-to-consumer players like MDHearing, Eargo, to name a couple, firstSTREET. And we think that's in our best interest because we can grow the pie faster by not only supplying ourselves but supplying them in a way that doesn't hurt our efforts in the direct-to-consumer channel. Relative to the size of the legacy business, we see that continuing to decline. I think at some point, it kind of hits a plateau, and maybe I'll leave it to Scott to maybe give an indication of what we think that plateau is. And -- but we definitely think it's going to hit a plateau probably this year and probably won't decline much farther than what it is over the next few years. Scott, if you want to...

[Scott Longval:]

Thanks, Mark. In regards to the gross margin makeup between those 3 different businesses, as you noted, the direct-to-end-consumer business generates the highest gross margins, roughly between 72% and 75%. In that indirect-end-to-consumer, roughly 45% to 50%, and then on that legacy OEM business, significantly less and kind of that 35% range. So as the strategy moving forward, moving away from the legacy OEM into kind of the higher-value indirect-to-end-consumer and direct-to-end-consumer will warrant higher gross margins as well. And to Mark's last comments, in terms of that overall legacy revenue where we see that plateauing, you'll see that in the first quarter, we did roughly about $3.8 million. I'm thinking by 2019, we're looking at that number could be closer to maybe $2.5 million to $2 million a quarter, but that would obviously be more than offset by the gains that we're anticipating from those other two revenue segments.

[Jonathan Block:]

Got it, got it, very helpful. And then to your point also, more than offset your [indiscernible] margin profile of those other two businesses as well. Okay. Very helpful, I appreciate that. And then just staying on the HHE side of the business, it seems like you started to get maybe a little bit more aggressive. You mentioned the addition of six sales reps. You also talked about consummating for strategic relationships. Any more color you can give there? And then are there sort of numbers that you can put around in terms of what that right rep count might be longer term?

[Mark Gorder:]

Well, we're still probably hard to give you that number for the right rep count yet because we're still trying to sort through exactly what our mix ought to be for advertising and which target customers are we targeting. We do this very -- we're very data-oriented, so we are doing a lot of design of experiments to determine how to optimize our ad spend. And that will largely dictate how many call center people we need is the more we spend on advertising, the more call center people we're going to need. And we have not gotten overly aggressive yet on the ad spend as we're trying to work through a few issues to optimize the approach. But I think you'll see us get more aggressive in the fourth quarter of this year relative to the advertising spend. And at that point, we would probably look to hire more sales rep people in the call center exactly what that number is, I hate to give it yet, but we definitely -- you will see us get more aggressive in the fourth quarter.

[Jonathan Block:]

Okay. And the very last one for me, I promise, is just as far as -- you sort of mentioned a lot of good things going on in medical and many presses being put in. And when you sit behind a computer screen for most of the day, it seems like a very easy thing, but clearly, it's not. So Mark, maybe you can talk about you've been adding a lot of capacity, I believe, over the past 6 to 12 months. Just from an operational standpoint, how do you feel like the company has been handling that? And do you feel good about getting fully operational? I believe you stopped to mid-2018.

[Mark Gorder:]

Thank you, Jon. Good question. We have a tremendously capable operations team. And if you were probably to list our most significant skill sets, it's our ability to perform from the operations standpoint and build capacity and produce high-quality products. And the team has done a phenomenal job. The pressure has been significant as Medtronic is, I think, they've announced that they're doubling their requirements for this year, and that I think they're doubling it again for next year. So the growth is very large there, but we're handling it well. We are on daily calls with Medtronic. We work very closely with them as a team. And I think we're very comfortable with how we're progressing. The new facility, we anticipate being in there in June to start actually putting in the equipment that we've ordered. Right now, the leasehold improvements are going in over there. But by June, we'll be able to move in and start putting all the equipment in place. And I think we expect to have some operational revenue coming out of that plant probably by the end of that quarter towards the early part of the fourth quarter. So all in all, I think we're doing pretty well.

[Operator:]

We'll go next to Scott Billeadeau with Walrus Partners.

[Scott Billeadeau:]

Most of my questions were answered. But I'm wondering if you could give a little detail certainly on the capacity that you're expanding. You've talked about some molding capacity, some assembly new -- the new space, and that you got $4.5 million. Is that from 1 customer or a couple of customers combined? Maybe give us a little sense on where that is. When do you expect to start producing out of that? And when do you -- do you have to start selling it before you can start manufacturing out of there? Maybe give us a little update there.

[Scott Longval:]

This is Scott. Thanks. Good question, Scott. So the $4.5 million is capital that's been coming in from several different customers, not any 1 customer because we're seeing a lot of activity in this medical space. And as we noted in the press release, it's not just molding capacity, but a lot of this is focused on robotic assembly and system assembly, very value-added types of processes. So we're going through the process, as Mark just outlined, of outfitting the new space. We're going to have a lot of these presses over the next couple of quarters come in and automation systems come in into the new facility. And we believe starting by somewhere in the -- by closer to the middle of the third quarter, we're actually going to be recognizing revenue coming out of that new facility. Does that answer your question?

[Scott Billeadeau:]

Yes. No, that...

[Mark Gorder:]

I'll add a little bit more color about that, Scott. We have -- in Minnesota, we've got basically three manufacturing plants. One has been focused mainly on medical molding and assembly. The -- and the other one here was focused on microelectronics. But with a huge demand from these -- all these customers, we've decided to break out all the robotic assembly and put it into one facility. So the facility that's being added is going to house all of our systems automation and robotic assembly for the medical business. And the molding -- that clears up room at the molding plant over at Vadnais Heights to put in all these presses. So it's kind of a major reallocation as we move the automation systems over to the new facility plus add more there. And then we're backfilling in there with a lot of molding presses into the existing facility. So all -- the demand on all three plants has increased significantly. So we're going to do more microelectronics here in Arden Hills, more molding in Vadnais Heights and more robotic assembly in the new Arden Hills facility.

[Scott Billeadeau:]

Great. And with that, is there anything related to regulatory approvals or updates that you need? I mean, if you're doing something that's FDA-approved, do you have to then get another blessing if you move some part of it to a different plan? Any issues there at all or?

[Mark Gorder:]

You're absolutely right. That all has to be done. We don't anticipate any issues. We are working diligently with our key customers to make sure that all those FDA approvals are completed in a timely manner. And we don't think that, that will have any impact on our ability to execute for the rest of the year. So we're very comfortable with where we're at there.

[Operator:]

[Operator Instructions]. We'll go next to Josh Goldberg with G2.

[Josh Goldberg:]

Just following up on some of the questions so far, if it's okay. You broke out the diabetes and other medical this time. I think it was the first time I saw that. For just historical measures, I assume that the nondiabetes has been roughly flat to down the last couple of quarters?

[Mark Gorder:]

That's correct.

[Josh Goldberg:]

Okay. And regarding the hearing health business, the direct-to-consumer and indirect-to-consumer showing better trends, last quarter, you guys had a 6% sequential increase in hearing aid orders. This quarter, it went up to 13%. I realize that some of them are new orders. But I would assume that based on what we're seeing regulatory-wise and market-wise that the hearing health segment should have pretty strong growth this year on the direct-to-consumer and indirect-to-consumer side. I know in the first quarter, it was modest growth on a year-over-year basis. Do we expect that to kind of ramp here as the back half of the year for that segment?

[Mark Gorder:]

One of the prior callers had asked me about that. We intend to get more aggressive on advertising spend but probably not until about the fourth quarter because we don't want to get -- it's very important that you have a good balance between customer care and lead generation. And if you get too far ahead of yourself, you could create a lot of problems and create a bad consumer experience. So we're very carefully trying to go forward and optimize our process. And as we get more comfortable with that, we're going to get more aggressive on advertising. And our anticipated plan now is that in the fourth quarter, we're going to take another step function in advertising. And then you'll see probably the commensurate increase in lead generation of new hearing aid orders by the end of the year going into 2019. So that's how we envision it at this time.

[Josh Goldberg:]

Okay. And Mark, since you have a background on that space, I mean, some of the valuations are getting in just that segment alone. I know some private companies are getting valuations in hundreds of millions of dollars. Maybe talk a little bit about that for some new investors here.

[Mark Gorder:]

Well, you raised an interesting point. When you think about -- our model is direct from the manufacturer to the consumer. And in the indirect -- in the other -- a lot of the other players that are raising capital don't have the infrastructure in place that we have in terms of manufacturing capacity and footprint from Minnesota all the way to Asia. In addition, the technology portfolio we've developed is critical in building an ecosystem of care that as we anticipate the OTC legislation being effected -- implemented later this year or early next year, any -- these players that are raising all this money still don't have some of those capabilities that we've already put in place. So we -- our belief is that we're a leader in positioning ourselves for this emerging space in OTC because we've got the technology portfolio and the manufacturing footprint already in place plus a lot of work we're doing on optimizing our channel strategy. So I think that gives us a pretty good foothold to compete with anybody. And we should get recognition for the value that we've created there as we go forward because we're in a good position to drive revenue growth in that space, to your point.

[Josh Goldberg:]

Okay, great. Just two more for me. I guess, first, I think going into the year, I think you talked about how you expected that every quarter, sequentially, you should expect to grow, and obviously, you got off to a great start in March. Is there any reason to believe that, that has changed based on your forecast? It seemed like you should grow every quarter this year with probably some additional profit every quarter as well.

[Mark Gorder:]

Yes. We agree that, that should be the case. And a good steady trend until the fourth quarter, and then we anticipate that we're going to step on the gas a little bit.

[Josh Goldberg:]

Ratchet it up. Okay. And just regarding the relationship with your biggest customer. I mean, I know for a while they have been supply-constrained. And do you have any sense of where you are relative to sort of where they want to be in terms of supply? Have you sort of hit the comfort zone where they -- they're matching demand with supply right now? Or are they still supply constrained going forward?

[Scott Longval:]

Yes. Thanks, Josh, for the call. We really can't comment specifically on their capacity. All I can tell you is I know that we're doing everything to be prepared to meet their expectations for growth.

[Josh Goldberg:]

Just said differently, so you can just hear me. Would it be fair to say that you exited on a weekly run rate with them faster than what you entered the quarter with?

[Scott Longval:]

Yes, I would say, broadly, that our revenue, as we've kind of laid out in our general forecast for 2018 of sequential growth quarter-over-quarter, that we're trending in that direction.

[Operator:]

Our next question will come from Dick Ryan with Dougherty.

[Richard Ryan:]

I got on the call late. Sorry if this is a repeat. But does United and NHS fit into the new -- is that the legacy bucket in the hearing health breakout now?

[Scott Longval:]

So our direct-to-insurance business falls into the value-based indirect-to-end-consumer. And the NHS business over in the U.K. falls into the legacy OEM business.

[Richard Ryan:]

Okay, okay. And can you just give an update on the U.K.? What you're seeing over there with kind of new product introductions? What sort of traction you're seeing?

[Mark Gorder:]

Well, we anticipate putting our new wireless technology over there. The NHS is very interested in that. We're trying to restructure that business down to where it's only selling hearing aids to the NHS. And we're on track to do that during the next quarter or so.

[Scott Longval:]

And Dick, we'll continue to update the group as we move through the quarter on some of the plans going forward there.

[Operator:]

That will conclude our question-and-answer session for today. I'd like to turn the conference back to Mr. Mark Gorder, CEO, for any additional or closing remarks.

[Mark Gorder:]

Thank you, Operator. Once again, we appreciate you taking time out of your day to join the call. In closing, I'd like to reiterate that we are excited with the direction we're headed. The first quarter was an exceptional start to the year with record revenue, driven by our key medical and value-based hearing health businesses. The expansion of our robotic and molding capacity positions us to continue to drive growth in our medical businesses and build the assets to pursue new medical opportunities. Furthermore, continue to make meaningful progress developing and advancing our direct-to-consumer hearing health channel, providing affordable and accessible solutions to millions of unserved or underserved Americans. Thank you again for joining our call. Look forward to speaking with you next quarter.

[Operator:]

Again, that will conclude today's conference. Thank you all for your participation. You may now disconnect.