IntriCon Corporation
Q3 2016 Earnings Call Transcript

Published: 15 Nov 2016

[Operator:]

Good day everyone and welcome to the IntriCon Third Quarter 2016 Results Conference Call. Today’s call is being recorded. 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 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 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 among others, are those set forth under the headings Risk Factors and Management’s Discussion and Analysis of Financial Condition and Results of Operations in our 10-K filing for the year ended December 31, 2015. With that, I'd to introduce Mark for a strategic look at IntriCon’s third 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 third quarter. Then I will cover the Hearing Help acquisition we announced simultaneously and after that Scott will cover the financials in more detail and then we will take your questions. By this time most of you have had a chance to review our third quarter press release. For the quarter net sales of $16 million reflect the continued timing shift in orders from our largest medical customer. However despite this timing shift in orders we were able to deliver year-over-year revenue gains in hearing health and professional audio and we anticipate medical revenues will begin to rebound in our fourth quarter. Equally important we remain encouraged by our technology pipeline and the growing appetite for an alternative hearing health channel. Looking at our three businesses, sales in hearing health grew 7% over the prior year period, primarily due to contributions from PC Werth which we acquired in November of 2015. During the quarter we also experienced gains in value hearing aids, personal sound amplifier products and assisted listening devices. We are intently focused on opportunities in value hearing health versus the declining conventional channel. More on that strategy in just a moment. Our medical business sales decreased 17% in the 2016 third quarter, chiefly driven by IntriCon's largest customer, Medtronic. The lower sales to Medtronic were expected as they managed the transition of their recently FDA approved MiniMed 630G system. We anticipate Medtronic sales to begin ramping up in the fourth quarter as they launch the MiniMed 630G system. Long term, we believe we are well-positioned for growth with Medtronic. In addition to the MiniMed 630G system, IntriCon is also designed into the MiniMed 670G system, the world's first hybrid closed loop insulin delivery system, which was also recently approved by the FDA, and is scheduled to be launched in the spring of 2017. I will now give you some context for today's acquisition news. Within hearing health, there's a groundswell building for fundamental change among regulators and consumers. As a company, we are steadfast in our commitment to overcome barriers to device access and spur development and innovation. This is why, despite our lower revenue levels, we maintained our level of investment in mission critical ultralow-power wireless and DSP technologies during the quarter. These technologies are required to support our emerging alternative channels and our goal of delivering superior outcomes-based, affordable hearing healthcare directly to consumers. To that end we are very excited to announce that we are acquiring DeKalb, Illinois-based Hearing Help Express, a direct-to-consumer mail order hearing aid provider. Untreated hearing loss in the United States is a substantial problem, and high device price tags have created significant hurdles to purchase for most Americans. Hearing Help Express offers a lower-priced alternative for consumers to buy devices directly, circumventing layers of costs that have swelled within the conventional hearing aid channel. We disclosed terms of the deal in today's press release that went out at the same time as our earnings announcement. I'd like to share with you what, in our due diligence, we found appealing about Hearing Help Express. It has more than three decades of experience and a proven track record of excellent customer care for hearing aid patients. This acquisition gives us direct access to the emerging value based hearing healthcare market and a platform we can build. We will leverage our own technically advanced devices and make targeted investments in management, marketing and advertisement. Ultimately we will incorporate an online ordering and fitting component as well. I want to emphasize the point that purchasing Hearing Help Express is a key next step in our value based hearing heath care strategy. Why do I say that? Over the last decade IntriCon as a company has invested in the technology, in low cost manufacturing infrastructure, to design and build superior devices and fitting solutions. This is so we can successfully address what we estimate to be a $1 billion annual value hearing health market. With this acquisition we now have the channel infrastructure to directly reach consumers and importantly for millions, the ability to offer high quality hearing health care at a fraction of the cost. Through our other BBHH [ph] initiatives and tests we have formed alliances with other key partners, which have given us experience and vital learnings as we move aggressively into a more consumer facing role. Our Hearing Help Express purchase provides an efficient, traditional direct-to-consumer channel to reach consumers who likely don't have insurance to cover hearing devices. This is a channel that we can build on and expand by our technology and one that's complementary with many of our existing relationships. We anticipate Hearing Help Express will contribute $6 million to $7 million in revenue in 2017 and in the near term are intently focused on a three pronged approach to ramp up this business. First, identifying a Vice President candidate to lead Hearing Help Express. A search firm has been engaged and the process is currently underway. Second, once leadership is in place, enhancing Hearing Help Express sales and marketing capability and increasing advertising, a tactic historically proven to drive sales. And third, introducing IntriCon's digital hearing aids and another technical advancements to Hearing Help Express customer base. Currently Hearing Help Express offers primarily analog devices. We fully expect that capitalizing on this value based hearing healthcare opportunity will lead to both a very bright future for IntriCon and to long-term growth and shareholder value. And we're excited to share our future progress with you. Specifically we will schedule an additional investor call after the New Year to lay out more definitive plans and metrics for this business. Now I'd like to turn the call over to Scott.

[Scott Longval:]

Thank you Mark. I'll begin by reviewing our third quarter financial results in more detail. For the 2016 third quarter, the company reported net sales of $16 million compared to $17.3 million in the prior year period. We posted a net loss of $1,339,000 or $0.19 per share versus net income of $628,000 or $0.10 per diluted share in the 2015 third quarter. Gross profit margins were 22.8% compared to 26.7% in the prior year third quarter. The decrease was primarily due to lower revenue and slightly less favorable sales mix. Operating results for the third quarter were $4.7 million compared to $3.9 million in the prior year third quarter. The increase was largely due to the inclusion of PC Werth acquired by IntriCon UK in November 2015. Sequentially, IntriCon decreased operating expenses $343,000 in response to temporary lower revenue levels. Turning to other financial metrics, our net debt of $8.8 million decreased sequentially from $9.6 million primarily due to tight working capital management specifically greater inventory control. Our total cash cycle days at the end of the third quarter were 83. This is a decrease from 86 days from the end of the 2016 second quarter. In terms of guidance, based on information currently available, we anticipate fourth quarter net sales to increase by approximately $1 million from the 2016 third quarter excluding any potential contributions from Hearing Help Express and near breakeven from a profitability perspective with notably stronger results in the first quarter of 2017. Turning to Hearing Help Express transaction, let me reiterate the terms outlined in that press release. We have already acquired 20% stake in Hearing Help Express. We expect to exercise our option to acquire the remaining 80% of Hearing Help Express before the end of the year. Terms of the transaction, assuming exercise of the option include $1.3 million cash at closing guarantee of $2 million note and an earn-out. Now I'd like to turn the call back over to the operator, so we can take your questions.

[Operator:]

Thank you. [Operator Instructions] We'll go first to Scott Billeadeau with Walrus Partners.

[Scott Billeadeau:]

Well, hi guys. I got just a couple of questions here. One just related to Medtronic. As you mentioned the 630G will be shipping - they are launching in Q4. But also the 670G in the spring. I'm wondering do you have a sense, will there be a pause for people to wait for 670G or will Medtronic will take very minimal inventory of the 30G with the 670G coming. Do you have a sense for what that transition? Because historically transitions haven't been fun for you.

[Mark Gorder:]

That's a good question Scott. As you know the 630G was delayed significantly and the 670 actually came far in advance from when they were expecting it. But we understand and I don't know to what extend that Medtronic has made it public any of the information, so I have to careful about what I disclose. But I know that they planned on encouraging people to take up the 630G through various incentives. I don't know exactly what those incentives are, but they are anticipating a good rollout of the 630G and they want to be very careful on the launch of the 670G because it's the first product in the artificial pancreas category. And they want to make sure that all of the quality controls are in place as they launch that. So we don’t anticipate there is going to be a significant dip like there has been in the past because they can do a planned rollout here and they don't anticipate being reactive.

[Scott Billeadeau:]

And then is there any different content that you guys have between the two?

[Mark Gorder:]

No. The content is pretty much the same except that there are obviously slight modifications to the content for the 670 versus 630. But it's primarily the same platform.

[Scott Billeadeau:]

Great, thanks. And then a question on the Hearing Help Express acquisition. One thing is what channel conflict can this will this provide in terms to kind of got some relationship with the academy and the partnership with the audiologist, does this not kind of cut them out. I'm just trying to get me comfortable with how this is in the channel conflict with that channel.

[Mark Gorder:]

There is some very good data out there, there were some studies done on direct-to-consumer channel, that 80% of the people that go into the direct-to-consumer channel would not likely go to the conventional channel. So we see that there is significant segmentation between the two markets. In the one case, you've got people who can afford hearing aids that have been going to this market for decades. And the market we're addressing is primarily people, who - where cost is a significant barrier. So what we're finding is that there is significant market segmentation between the two channels and we anticipate that there is some that we can provide a link up to the academy by referring people who cannot be helped by the more direct to consumer method. If they're hearing loss is more complex. In many cases they will need to be referred. And so we see that the two could be very complementary at the long run.

[Scott Billeadeau:]

And then last question related to that, you mentioned you're looking for leadership for that entity. Did the leadership not come with, what was there someone leading that firm that is kind of exiting completely, maybe give us a little info on that.

[Mark Gorder:]

Well, there is talent to come there. But there isn't a lot of - where we see this market going, is it starting out as mail order business. And the gentlemen that was running it is retiring. And we're going to replace the leadership with an individual that far more knowledgeable about how to market over the Internet. We see that the emerging market will consists more of baby boomers who are more tech savvy. They're going to do more of their shopping over the internet. Our existing business is primarily directed at mail order to 70 to 80 years olds who still use mail order predominantly in many cases to receive information. So we are going to transition this business overtime to a segment of younger users and we are going to need that kind of talent. So we anticipate building that structure from the ground up.

[Scott Billeadeau:]

Okay. Great, thanks. I'll hop back in the queue.

[Operator:]

[Operator Instructions] We’ll go next to Dick Ryan with Dougherty.

[Dick Ryan:]

Great, thank you. Say Mark, can you give us a little more context on Hearing Help, you put a marker out there of $6 million to $7 million for next year. Just wondering what would - how do you break that down from their existing level versus what you would hope to add on with your digital products. And also can you talk a little bit about margin expectations?

[Mark Gorder:]

That’s a good question Dick. I think we are very conservative in the press release. Historically the business has at least done this or better, going back years, they had significantly cut back in their advertising for financial reasons in the last few years but they had previous to that run at much higher revenue levels. And we’re anticipating just I think in the press release we had the revenue level that they have done last year just projecting that forward. So we would anticipate that, with number one, with higher advertising revenue and number two, with putting digital products into the realm where they previously had analog products, should provide a much better consumer experience. And relative to the margins for us the margins are significantly higher because rather than if you look at the OEM business we sell devices in the OEM market for anywhere from $60 to $120, $130 per unit. In the OEM market even the analog devices selling today are in the $300 to $400 range. So obviously the cost doesn't change at all but the selling price goes up considerably where your expenses are higher in the direct to consumer obviously is a lead generation. And that will be new for us, but from the margin standpoint, the margins will be significantly higher in the DTC business and they are in the OEM business.

[Dick Ryan:]

What investments are needed to I think you mentioned having the standup some online ordering and feeding capabilities, what sort of investment and how quickly can you ramp that effort?

[Mark Gorder:]

Well, short-term we would simply add digital product in the existing advertising methodology to what's already been done and just scale that. So there is a significant scale up that can be done just with those two things, the introduction of improved fitting technology we see as more of the longer term investment and should not impede us from getting good solid revenue growth out of this business as it is with more advertising and better products like some of our digital platforms.

[Dick Ryan:]

Okay. Hey, one more on this front. Has this business grown over the last say two, three, four years or so?

[Mark Gorder:]

This particular business as I mentioned they had cut back on their advertising in recent years. So it was actually lower in the last couple of years that has been prior but this market is growing tremendously. We see the direct to consumer market as being and diverge of a significant growth period. And I - there were some interesting, I think we’ve mentioned in the past that some of reports that had come out relative to the President’s Council on the Advancement of Science and Technology, the PCAST report and the Institute of Medicine and both recommended changes in how hearing aids are distributed and regulated. And the FDA had taken up a symposium to gather information back in April, but there is considerable consumer pressure mounting. In fact just last week, a bill was introduced by Senator Warren and Senator Grassley to among other things mandate that the FDA create an over-the-counter hearing aid category. And we think that this represents the continued up swell and consumer pressure, the understanding that hearing aids are very, very expensive. In fact they sell for about 20 to 30 times the manufacturing cost. And we think that the direct-to-consumer market is very large and we can with proper execution grow quite rapidly into this market.

[Scott Longval:]

Dick, this is Scott I just want to echo some of Mark's comments on the DTC industry. We see this industry growing, where we think we're unique and can outgrow the industry is we will be the first, at least to our knowledge, the first manufacturer developer of hearing aids that are taking devices directly from the manufacturer to the consumer. So from a price cost perspective we have a very distinct advantage over the competition in this industry.

[Mark Gorder:]

And maybe to add another point on to Scott, when you look into the marketplace and see some of the direct-to-consumer companies that are currently in the market, we sell product to a lot of those people. So they are middle man between the manufacturer and the consumer. So in this case we own our own manufacturing in Asia and we own our own technology. So we are in a position to take that directly to the consumer through this newly acquired channel.

[Dick Ryan:]

Is there a way to put market size out there in how many competitors you might be dealing with initially.

[Mark Gorder:]

The way we take the market Dick was we looked to some of the markets in Europe that had already eliminated cost as a barrier. So if you go to Scandinavia you go to the UK where they have national health plans. Their penetration rates are between 40% to 70%. The US market it's about 20%. So the way we calculate the market is you overtime it's possible with the right execution for a number of competitors to step in here and increase the penetration by an additional 20%. And if you figure the 20% of the hearing impaired population which is growing by the way with the aging baby boomers. And you calculate it by Binoro Fit [ph] for most of those roughly 70% of hearing impaired now have a Binoro Fit. So it's about 1.7 times the number of hearing impaired. And you multiply that by about $200 to $250 per device you come up with a $1 billion market. We think that's an achievable market overtime by eliminating cost as a barrier. There are so many Americans that can't afford hearing care and the current market is way out of their ability to participate.

[Dick Ryan:]

Okay. Maybe one last one, can you kind of give an update on what's happening over in the US with PC Werth?

[Mark Gorder:]

Yeah, as we mentioned we've purchased that business back in November. And originally - our original goal there was to set them up as a distributor. But events led to the fact that we have to acquire them. And we acquired them in November and we have to move the business so we moved it in Q1. And we've kind of stabilize it. There were originally some suppliers to the PC Werth market that were tied into the big six. And those suppliers moved away from us. We had to replace those suppliers which we done. We've also added to the sales force there and we're introducing a couple of new products. So it's been slower than we would have liked but we have stabilized the business. We've got a very strong relationship with the technical and management teams at the National Health Service to the point where they're going to participate with us on clinical trials in Q1 of next year on some of the new wireless fitting technology which could enhance the productivity of how aids are fitted in the UK. And we're also introducing a new product in Q1 which is widely anticipated to help us grow the revenue there. We have shipped initial devices in there. It's going much slower than we would have liked, partly due to the fact that some of these product lines had to be replaced and we have to get a new product line in there that was delayed so to speak. But we think by Q1 we will have put the business in a very stable condition and look forward to growing it next year.

[Dick Ryan:]

Okay, thank you.

[Operator:]

And we'll take a follow up question from Scott Billeadeau with Walrus Partners.

[Scott Billeadeau:]

On the direct-to-consumer, how much of that business do you have now with other core vendors? And do you expect that go away as you become direct competitors to them?

[Mark Gorder:]

Well, the interesting thing is that we have we are very high technology provider. And there aren't many suppliers providing the low power DSP and wireless technology into these middle man so to speak. So we provide these guys with high end amplifiers and to some cases complete devices and we're not easily replaced. And so we don't see that in the short term that this is going to have much of an impact there. And I think our business with the large manufacturers has pretty much gone away as we talked in the past. I think if you look back to the business we used to do with the big fixed manufacturers. If you go back 10-15 years we had over $25 million in business with those manufacturers. This year it will be $1 million to $2 million. So we pretty much taken that hit with that group. So we anticipate some erosion but not, I would say not significant erosion going into 2017.

[Scott Billeadeau:]

Okay thanks.

[Operator:]

And we'll go next to Larry Haimovitch with HMTC Investment Management.

[Larry Haimovitch:]

Good afternoon gentlemen.

[Mark Gorder:]

Hi Larry.

[Larry Haimovitch:]

So small questions on the deal, how long has it been since you've been working on this deal? When did you first get the [indiscernible] and then how long is it been for the process from kind of start to the conclusion?

[Scott Longval:]

We've long been moving down this process not only with Hearing Help Express but we've also been looking at other potential targets within the DTC industry. As we went through that evaluation it became clear to us that Hearing Help Express was the best fit for IntriCon at this point. I think Mark highlighted some of the things in today's call that drove us to Hearing Help Express most notably, the high level of customer service and the vast customer lift. So I would say we've started kind of more of the heated discussions with them over the course of the last nine months and trying to figure out a way to structure the deal that made sense for both parties and we were able to do that and happy to get it behind us and allow us now to focus on driving revenue in this channel.

[Larry Haimovitch:]

Do you know Scott if there were any other bidders or any other interested - that affected the price at all?

[Scott Longval:]

No, to our knowledge, as we kind of went through this process we were really the only bidder there to our knowledge. And that being said we did hear that there were other people in there expressing interesting and that was confirmed. But for us it was such a vital next move Larry that we need to move and move on it as quickly as we could. And frankly if we can come out and do the things that we’ve outlined on today's call and in terms of growing this business, this is going to be a tremendous deal for IntriCon and IntriCon shareholders.

[Larry Haimovitch:]

Scott, tell me a little bit more about the due diligence process. Did you hire some outside people to help you to evaluate the channel and the products and the service, or was all the due diligence done internally?

[Scott Longval:]

That's a good question, Larry. There has been some interesting data published on the DTC market. There was a study that was done in early 2014 from one of the leading researchers in the hearing health industry, it was published in the - I believe it was the Hearing Journal, Mark, by Dr. Sergei Kochkin and Dr. Kochkin actually led all of the studies of MarkeTrak for the Hearing Aid industry. And he did a study on the DTC market and specifically on Hearing Help Express. And through that study he basically compared that model and their customer satisfaction level to what the traditional channel was seeing. And his conclusion on that - for that study was Hearing Help Express had superior customer satisfaction and the only areas where customer satisfaction was higher were if the traditional channel would use best practices in fitting a device. Taking all those pieces of data and that's just one area that we looked that. Frankly Larry, to Mark’s point we work with the lot of these direct to consumer companies. So we know a little bit about their business and obviously as we got more interested we did even more diligence on those companies. So it was a pretty in-depth diligent process with not only internal resources but external resources as well.

[Larry Haimovitch:]

Great. Follow-up question on that, there is an only adage in probably investment banking and some other sales and finance that every deal has some hair on it, what hair did you see in this deal that gave you cause for pause or maybe some concerns or I'll let you answer the question this way, if this deal doesn’t work out to the hopes that you currently have where would you think it might reflect?

[Scott Longval:]

Well, I think I'd step back and I'd just look at market itself. And it appears to us with everything that has been published and this grounds swell of just interest coming from our politicians, our consumer groups, the advancement in technology that this market is coming. So if I look at the Hearing Help Express acquisition itself we are putting in a new management team there. We think there is highly capable people there today. But we felt like new leadership was important for us to take the step from traditional mail order company to maybe a more progressive online marketing company. But really Larry just by understanding what other people are doing in this market, there are growing without some of the tools that IntriCon has which is its own manufacturing, and its own set of technology, both in the hardware and the software side. SO we really are very bullish on this acquisition. We put a lot of time and effort in making sure that we’ve identified the right target and now turning into the last part of ‘16 and to ‘17, we are going to invest heavily to insure that we see the type of growth that we know this market can bear.

[Larry Haimovitch:]

I have a couple more - sorry, go ahead please.

[Mark Gorder:]

I was going to add to that too, Larry I think specifically we have to execute on generating and converting leads, and in order to scale it. So our assumption is that we will increase advertising which all these businesses are doing and they seem to be effective doing it. So we want to - we have to prove that we’re also effective doing it. This business has done it in the past before they were forced for cash reasons to scale back on their advertising. And we think we can scale advertising back up again and by paying attention to not only the advertising but good sales technique to convert the leads into very need sales, we think that we can be effective. Others are doing it and we just have to make sure we stand fast and make sure we are also doing it properly.

[Larry Haimovitch:]

I’ve got a couple more questions, I don't want to hog the floor as it were. If you want me to step back and queue I can and then come back or continue, it's up to you guys. You can see the queue and the operator can see the queue.

[Mark Gorder:]

Go ahead.

[Scott Longval:]

Go ahead Larry.

[Larry Haimovitch:]

Okay. So thank you. So you mentioned looking for seasoned executives to run this business. I thought we talked about this in the past but it seems to me from meeting you and talking to you, from time to time that you had a search out for quite a while, am I correct that you’ve been looking for several months now?

[Mark Gorder:]

We actually, we started the process above two months ago, defining the job descriptions. So I think when you and I talked, we had just recruited a search firm, skilled in this area and so we've been at it for about two months.

[Larry Haimovitch:]

Okay, okay. I thought for some reason was longer than that. Okay. And then my second question is on the next two quarters, the quarter we are in, and the next, the first quarter. I couldn't understand from what you said that you are expecting Q4 to be up or down in revenue from last year?

[Scott Longval:]

We are coming at it from the sequential quarter. So it will be down from the prior year quarter, but up sequentially about a $1 million. And that will include any contributions from Hearing Help Express.

[Mark Gorder:]

And it's down because we are still in the Medtronic transition and that will kick in, sounds like Q1, you said it will be up, so Medtronic will now kick in very nicely in Q1, and hopefully for the rest of the year.

[Scott Longval:]

Yeah, we are starting, we anticipate to start to see some of that kick-up in the fourth quarter, which is part of the reason you are going to see some of the growth in the fourth quarter over the third quarter and then looking forward to the first quarter we anticipate, as they do, having been kind of firing on all cylinders. And we will start to see more of a historical revenue levels from Medtronic and anticipate that growing throughout the year.

[Mark Gorder:]

Okay, and then last question on the acquisition, most times when companies make deals they say it's accretive, it's dilutive. I realize you are losing money, making money in different quarters. But how do you view the acquisition as regards of accretion or dilution?

[Scott Longval:]

We envision this will be in a creative acquisition in 2017.

[Larry Haimovitch:]

Okay. Okay. And $6 million to $7 million is kind of your preliminary look at 2017?

[Scott Longval:]

Correct, and as noted in the script today, we are going to hold an additional investor call sometime in January and we will layout more definitive plans and metrics related to Hearing Help Express. As you can appreciate we’re in there right now, still learning some things and we want to be transparent about this business but we also think we are better off being cautious and doing so until we have all the facts and to lay that out early next year.

[Larry Haimovitch:]

Yeah, because you and I talked Scott and Mark about putting together some metrics for the whole hearing business and in particular PC Werth and you gave us a little bit a color on PC Werth as I recall and when you and I talk on the phone we get some color but we never really at least in my opinion, never really seem to understand how to view, how well its going and so the metrics that you can provide for acquisition and even for the whole hearing aid business would be very helpful to us.

[Scott Longval:]

Understood and agreed.

[Mark Gorder:]

Yes, 300% Larry.

[Larry Haimovitch:]

Okay. Great, thanks guys.

[Operator:]

And we’ve no further questions in the queue I’d like to turn the conference back over to Mr. Mark Gorder for any additional or closing remarks.

[Mark Gorder:]

Once again we appreciate you taking time out of your day to join call. In closing I would like to reiterate that I’m excited with the direction we are headed, our established medical business will rebound nicely and has a long runway for success and in the emerging value based hearing healthcare channel we’re faced with tremendous opportunity. And we’ve taken a giant step forward with the acquisition we announced today and with solid execution the future looks very bright for our organization. Thank you again for joining in the call.

[Operator:]

Again, that does conclude today’s presentation. We thank you for your participation.