IntriCon Corporation
Q4 2016 Earnings Call Transcript

Published: 17 Feb 2017

[Operator:]

Good day and welcome to the IntriCon Fourth Quarter 2016 Results Conference Call. Today’s conference is being recorded. At this time, I would like to turn the conference over to Mr. 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 call contains 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 as actual results may vary materially from the expectations contained in today’s call. Important factors that could cause such differences include, among others, those are set forth in 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 like to turn it over to Mark for a strategic look at IntriCon’s fourth quarter.

[Mark Gorder:]

Thank you, Scott and thank you everyone for joining us today. I would like to begin by reviewing key highlights and the results for the fourth quarter. After that Scott will I 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 fourth quarter press release. For the quarter, net sales of $17.7 million reflected the continued timing shift in orders from our largest medical customer. That said, sales rose 14% sequentially from the 2016 third quarter, and included $1 million contribution from Hearing Help Express. Fourth quarter results reflect our efforts to right-size and focus our business to take advantage of the emerging value hearing health opportunity, while maximizing our core medical business. To that end, we made meaningful progress establishing a new direct-to-consumer distribution channel during the quarter, and look forward to a strong first quarter and 2017 in both hearing health and medical. Looking at our three businesses, sales in our medical business decreased 8% in the 2016 fourth quarter, as I indicated. This was primarily driven by timing shifts with our largest customer, Medtronic. The lower sales to Medtronic were expected as they managed the transition of their recently FDA approved MiniMed 630G system. That transition is now over, and we began ramping up MiniMed 630G production in the in the fourth quarter which resulted in a $1 million sequential increase in Medtronic revenue from the 2016 third quarter. Looking ahead, we believe that we are well positioned with Medtronic with 2017 first quarter sales expected to be at record levels and growth to continue throughout the year. In addition to the MiniMed 630G system, we are also designed into the MiniMed 670G system, which was also recently approved by the FDA, and is scheduled to be launched in the spring of 2017. Additionally, we are working on other revenue opportunities with Medtronic that could result in notable gains in the second half of 2017. Turning to Hearing Help, sales increased 4% from the prior year fourth quarter, primarily stemming from the $1 million contribution from Hearing Help Express, which I highlighted earlier. As announced in November, we acquired 20% stake in HHE, a direct-to-consumer mail order hearing aid provider. Last month, we exercised our option to acquire the remaining 80% stake in HHE. The deal was expected to close in mid 2017. What's attractive about HHE is that it gives IntriCon direct access to consumers in the emerging value based hearing health care market. As we all know, untreated hearing loss in the United States is a substantial problem, and high device costs have created significant barriers to access for most Americans. HHE offers a lower priced alternative for consumers to purchase devices directly, circumventing layers of costs associated with the conventional hearing aid channel. We look forward to building on the HHE platform by leveraging our own technically advanced devices, and making targeted investments in management, marketing and advertising, and ultimately incorporating an online component. Since taking our initial stake, we've made meaningful progress integrating and optimizing HHE. We detailed some of those efforts in today press release. By the end of the first quarter, we intend to hire a DTC executive to manage HHE. We've already identified several key candidates. We’ll enhance HHE’s sales and marketing capabilities and increase advertising, a tactic historically proven to drive sales. And lastly, introduce IntriCon’s digital hearing aids and other technical advancements to HHE's customer base. Over the next few quarter, we intend to establish and report on key DTC metrics to highlight this business and allow you to better track our progress. Looking at some of the other hearing health initiatives, we also saw contributions from PC Werth during the quarter. That said, we took steps in January to reduce PC Werth's cost structure by $200,000, and refocused sales efforts into the National Health Service or NHS clinics. We are currently working with the NHS for approval of a third device the K940D, which will enhance our sales capabilities. The K940D, which is a traditional behind the ear device, is very appalling to the NHS, because of its broad fitting range and advance features. We anticipate approval of the K940D in the second quarter. In addition to HHE and PC Werth, we are focused on driving growth and creating efficiencies in our other value based hearing health care initiatives. Domestically, we continue to work with earVenture, a joint venture with the Academy of Doctors of Audiology, or the ADA. Over 650 ADA members have registered to join the earVenture program. And while audiologists have shown great interest in earVenture, they have been slow to participate due to targeted big-six pricing and audiologist struggles, and our unwillingness to embrace a new business model. Given that fact, we have taken steps to right-size earVenture without compromising the ability to promote the business model. While we do not view earVenture near-term as a meaningful contributor to sales, it continues to provide valuable industry insights and has the potential for future value by connecting it to our emerging DTC channels. Acknowledging the significant opportunity we have with HHE has prompted us to focus our efforts with the ADA and NHS and take these actions. Over the last decade, we've invested in technology and low cost manufacturing to design and build superior devices and fitting solutions to address the estimated 1 billion annual value hearing health market. And that’s what we're doing by going direct to the consumers. On the technology front, we continue to make great strides. In the first half of 2017, we anticipate a targeted release of our first wireless hearing aid, the Lumen 200B in the U.S. and German markets. This device will allow for command and control from a smartphone or related accessory. In addition, we have enhanced our self-fitting software technology through our Signison joint venture in Germany. By the end of the third quarter, we intend to have our Wireless Lumen 200B hearing aid integrated into the self-fitting software and beginning targeted pilots in Germany. By the end of the year, we anticipate a similar offering in the U.S. market. This system will provide for efficient fitting and greater access, and move us further along the path to establishing a holistic ecosystem of care in hearing health. With significant opportunities ahead of us, we felt it was critical to focus our financial and operational resources. As such, we have made the strategic decisions to divest our non-core cardiac diagnostic business, or CDM business. We have found a buyer for the business, and the sale is expected to close in the first quarter of 2017. Given all that we accomplished in 2016, we are excited about IntriCon's bright future, and what we can accomplish with HHE. And we look forward to sharing our progress with you. Now, I'd like to turn the call over to Scott.

[Scott Longval:]

Thank you, Mark. I'll begin reviewing our fourth quarter financials in more detail. For the 2016 fourth quarter, we reported net sales of $17.7 million compared to $18.4 million in the prior year. The decline was primarily due to year-over-year revenue shifts from Medtronic as Mark noted. Net sales did rise, however, 14% sequentially from the 2016 third quarter, and included $1 million contribution from HHE, so progress has been made. IntriCon posted a net loss attributable to shareholders of $1.9 million or $0.27 per share versus net income attributed to shareholders of $810,000 or $0.13 per diluted share for the 2015 fourth quarter. It's important to note that the 2016 fourth quarter included losses from discontinued operations of $1 million versus $0.15 per diluted share. Of which 800,000 resulted from a non-cash write-down of assets relating to the pending sale of our CDM business. Gross profit margins were 25.9% compared to 29.3% in the prior year fourth quarter. The decrease was primarily again due to lower revenue. Fourth quarter operating expenses were $5 million compared to $4.2 million in the prior year fourth quarter. And this increase was largely due to the consolidation of Hearing Help Express during the fourth quarter. In terms of guidance, based on the information that’s currently available, we anticipate the 2017 first quarter net sales to range somewhere between $18.6 million to $18.8 million, and post a positive EPS from continuing operations. And for the year, we expect the revenue range to be between $78 million and $80 million. With that, I'd now like to turn the call back over to the operator, so we can take any questions.

[Operator:]

Thank you [Operator Instructions]. We’ll take our first question from Ross Trujillo [ph] with RBC.

[Unidentified Analyst:]

You mentioned that you’re working on other opportunities with Medtronic. Care to elaborate on what they are?

[Scott Longval:]

Currently, we’re working with the diabetes group on the sensor and monitor portion of their wireless glucose offering. And with that, there is a number of related accessories that we’re doing. We're also looking at other operations that we could perform and service in, and those are the things that we're targeting for potentially the second half of the year.

[Unidentified Analyst:]

That soon?

[Scott Longval:]

Can't go into to great detail about that, but we're excited about those opportunities, clearly.

[Unidentified Analyst:]

Can you put any type of a potential dollar range on what that could mean to your revenues say a couple of years down the road, or however you want to give a timeframe?

[Scott Longval:]

I’d say for the difference activities we've engaged within that we’re not working on now, would be meaningful revenue, probably somewhere in the range of $5 million to $10 million annually for the different things we're talking with them about.

[Unidentified Analyst:]

And then going to the hearing side, I am fairly new to the story. Do you guys break-out your revenues based upon the hearing and the Medtronic? Can you give us an idea of how much revenues you head in the whole hearing aid area?

[Scott Longval:]

Ross, we do break that out in totality. And one of the things to note, going forward, we’re going be breaking them about even further to highlight what we're doing in the direct-to-consumer channel. So Mark mentioned here today in the fourth quarter, we did $1 million with Hearing Help Express. We’ll continue to break that number out throughout 2017. In the fourth quarter, we do talk about Medtronic and what we do with Medtronic. That business, that was about $7.2 million in the quarter and then total hearing health revenue in the quarter was approximately $6 million.

[Unidentified Analyst:]

Of that $6 million, does that include the $1 million from the HHE?

[Scott Longval:]

No it does not. So it's an additional million on top of that.

[Unidentified Analyst:]

And then was HHE profitable?

[Scott Longval:]

Broke even in the first, in the fourth quarter, and as we look to accelerate that business, we think it's going to be slightly profitable into at least the first half of 2017. And then as aggressively as we can roll-out the sales and marketing program, we're anticipating to gain leverage on the bottom line in the second half of the year.

[Unidentified Analyst:]

And that’s what I was going to ask next, because based upon kind what you're talking about on, and it is exciting, what you're doing in that direct-to-consumer. But you've also got a fair amount of expense associated with developing the business. So, what type of --- are you expecting the profitability to continue to increase in spite of those expenses, or how should we think of that?

[Scott Longval:]

As Mark talked earlier in his comments, we’ll be doing or laying out metrics going forward, but I think we’ll help you better understand. But at a high level, Ross, what we want to do is come in there and offer product at a lower cost based on the fact that we control the manufacturing, which puts us in a unique position with anybody in that market. Further, it is just driving efficiencies in some of the processes they have today, and driving efficiencies in the marketing and advertising spend. And over the first four months, we've already identified areas where we can drive those types of efficiencies and gain leverage. So, I think it’s a little premature for us to layout what exactly that means to the bottom line in the first half of the year. What we wanted to is be in a position to have key metrics to really highlight the progress that we are making and set-up those metrics for the second half of 2017.

[Unidentified Analyst:]

And we can talk about this at a later day too as time progresses. But okay, that’s all for me. Thanks guys.

[Operator:]

Thank you. We’ll now take our next question from Dick Ryan with Dougherty. Please go ahead.

[Dick Ryan:]

Mark, when will you be introducing the digital hearing aids through the DTC channel? I'm not sure if I caught that. And then that maybe ties this German effort that you're going to introduce with your self-fitting hearing aid. Can you give us a little more clarity on that as well?

[Mark Gorder:]

Those two efforts are actually not connected. But rolling the digital hearing aids into HHE will start probably in March, and will be completed by the end of the second quarter. We’re going to roll several product lines in there. But that will be complete by the end of the second quarter. And the effort in Germany is more to develop and pilot self-fitting technology. So there are number of steps we're going to take there. The first step was to develop this partnership with the individual that invented this technology. And then we're doing that now, and what we intend to do in the second quarter is to integrate. We mentioned we were going to launch our Lumen 200B wireless hearing aid by the end of the second quarter. So, in the third quarter, we anticipate integrating that wireless hearing aid into the self-fitting technology, so that an individual can sit down at a smart device, like an iPad, and manipulate the iPad and self-fit their hearing aid wirelessly while they are doing it. And then in the fourth quarter, we would then take that technology and do a pilot in the U.S. market at HHE. So, those are probably the steps by quarter that we anticipate before 2017. Does that help with that question?

[Dick Ryan:]

Sure. And rolling up the remaining 80%, I think that's been now pushed to mid-year. What's delaying that, I mean you're already deep in the integration of it. So what's the timeline there?

[Mark Gorder:]

Right now, we are working with the bank to get out with the best cost structures to complete the acquisition. And again, we think that’s something mid-year as we look at it, just from a practical standpoint right now, we’re in a 100% control of the operations of the business and everything that we're doing it sounds and acts like we own 100%. So, that's not really slowing us down from a operational or strategic standpoint.

[Dick Ryan:]

And it looks like earVenture stalled out, and you’re making some changes with PC where it's over with the NHS. You've got here and looking for your third approval, but what revenues that we've seen beyond their core product line that they've always had, and what success have you been getting in front of the clinicians?

[Mark Gorder:]

Let me take the earVenture question first, Dick. I think what we've seen there is a couple of things. We’ve made assumptions that they would be willing to change to a different business model, and we also assume they’d be looking for an alternative to debug six manufactures. And what we found was that they’re very reluctant to change their business model. Even though they recognize they to need to change and we've got a number of these people signed up. They are still not over that hump of actually making the change. And what's made that more difficult for them is the big guys have come in and targeted price reductions to directly offset what we're trying to do. And that slowed them down. Even though they should be changing, because they are buying from the people competing with them, because of the -- the big guys have consolidated retail and the six manufacturers that own all this retail shops that are directly competing with the independents. So, we find it frustrating that they aren’t changing, but we think they are going to change eventually. And we want to be in a position to link our DTC efforts into the professional, because we do think there is going to be a need to provide additional care to a certain percentage of the patients that we deal with at Hearing Help Express. On to the PCW, in 2016, as you recall we acquired that business at the end of 2015 due to some difficulties that the business ran into. We would have preferred initially that that’d be a distribution arrangement. But in order to secure our channel and the contract to the NHS, we actually took over the business and ran it. There were some difficulties stabilizing that business during the first half of 2016. There were some of the product lines in PCW were actually contracted from the big six. And when they found out that we have bought PCW, they pulled those product lines. That resulted in some loss revenue and losses in the second quarter. In addition we had to move the business, which resulted in some one-time cost that we had to deal with plus the inconveniences that you run into trying to move the business. So, we're hoping that during the second half of last year, we stabilized that. And our goal now is to try to drive hearing aid unit growth in there while getting that business to a profitable position. And we think we will, with the steps we've taken in cost reduction with the fact that we've got to move and the loss product lines from the big guys behind us, the fact that we get this new 940G in there, we think we will have this business in a good position by mid-year. And to-date the hearing aid sales have been very slow because we didn’t have a complete product line. The 940G is a more versatile behind the hearing aid with a wider fitting range, and it’s a more modern look to it than the initial ones we put in there. And we had our APT product in there, which is a small in-the-ear device, but that’s a very niche product. And what the clinics are waiting for was for us to fill all the product lines. So, we will have completed that in the second quarter, and we hope that all these efforts we put into it will allow us to drive the business forward. But those have been some other reasons why it's been slower than anticipated.

[Dick Ryan:]

One last one, I mean, you’ve had some inklings of legislative efforts. But certainly the FDA getting rid of those waivers, obviously, would help the DTC market. But what else are you seeing in may be the conventional channel that’s coming your way, or going the other way, if you will?

[Mark Gorder:]

Well, I think that all the direction is going in the direction of greater consumer choice and less regulation. And we probably mentioned this at the investor call on January 26th that the senators Warren and Grassley had introduced a bill calling for over-the-counter category of hearing aids, and had put that bill before Congress. And I think as a result of that, the FDA has speed-up their review of their regulations, and are now considering and taking input on what should OTC category look like and how should it be regulated. And I think movement in that direction will be very swift. I would guess that for talking a year from now, we will have some kind of a document from the FDA with some guidance recommendations for an OTC category. And that only is going to help us. The waiver already helps us. We can already do what we need to do. The OCT category might allow us to more rapidly move self-fitting technology into the direct-to-consumer market. So I would guess we're going to make good progress on the regulatory front during 2017.

[Operator:]

Thank you [Operator Instructions]. We’ll move on to our next question from Scott Billeadeau with Walrus Partners.

[Scott Billeadeau:]

I'm wondering if you give us a little feeling of what you’re selling. The cardiac monitoring business, give us a sense of what is the revenue? Is there any profitability there? As that goes away, what it do the Company?

[Mark Gorder:]

Sure. In the fourth quarter, we had about $200,000 worth of revenue from the cardiac business and for the year it was about $1.2 million. And that’s been relatively consistent, Scott, over the last couple of years. We have sustained some more significant losses from that business. If you look at the financial statements for the year, we recorded a loss of little over $1 million from that business, directly related to the operations and then we wrote-down some assets. So, for us, it was a business that has promise, but we have to focus. We have real significant opportunities in large markets with both Medtronic and everything we're doing on the value hearing health side. So, the thought process behind that was we need to focus our time, effort and resources. And so it was a decision that was made that we thought would best position us to realize the opportunity in front of us.

[Scott Billeadeau:]

And then I kind of tried go through and just the break out of the revenue, I thought, you said Medtronic was like $7.2 million, direct-to-consumer was $1 million, the rest of the hearing health was about $6 million. That leads to roughly $14.2 million, if there is a couple of hundred, of course I don’t know if that was in discontinued. But where is the other $3 million or $3.5 million, how would you bucket that?

[Mark Gorder:]

So we have medical business outside Medtronic. We do business for Smiths Medical, some other large medical OEMs that mix-up a little over $2.5 million. And we also have a professional and audio communications business over in Singapore, and that's selling high-end headsets into groups like Bose, Audio-Technica, and the Singapore government. So, that makes up the balance of the revenue.

[Scott Billeadeau:]

And then going forward just wondering on the R&D line is there -- what’s the game plan there in terms of what you expect to be spending. Obviously, there’ll be some spending on the DTC that’s more SG&A, I guess or probably from S for the most part there. But any thoughts on what the R&D line will look like going forward?

[Mark Gorder:]

What we're doing as a result of this focusing, Scott, is it allows us to stabilize the R&D line. And R&D dollars that we're going into cardiac will be diverted into the emerging value based hearing health, and will be put towards accelerating development of our wireless hearing aids that we talked about here recently. I think it was Dick's question that I address there. We have a number of initiatives coming out quarter-by-quarter this year, and that diverted R&D will be targeted there. So, we would anticipate that the R&D line is probably stable, slightly down from 2016.

[Scott Billeadeau:]

And then follow-up just on the earVenture business, I think you talked about how. Is there a little -- these guys are getting some good dollar margins from the big guys, even though the prices are coming down, there is so much cushion there. Or is it more of a, like I don’t get in trouble for selling IBM, so to speak, if I sell one of the big guys. Do you have a sense for, is it that there is good margin there and that's the issue as opposed to anything with brand or perceived difference in quality that's keeping that group from selling your product?

[Mark Gorder:]

Well, I think it's more of the -- they are in a business where it’s a retail model of selling an average of $2,300 per year hearing aids, and that's their business. And IntriCon is not in that business. We’re in the business of providing outcome based medical devices that achieved the best consumer satisfaction in difficult listening environments. So we don’t put a lot of the bells and whistles on there that they are used to in the retail model. Their model is probably geared to complexity and ours is geared to simplicity. Because the consumer needs devices that are very easy to operate, and you take them out of the box and they work. So I think we're in a different business. And so when we go and offer them that business model, they look at it as one little product niche in their total offering, and they are having difficulty figuring how do I fit this value-based, outcome based, medical device into my general offering of retail hearing aids at $2,300 a piece. Whereas in direct-to-consumer, we don’t have that issue that we’re selling that to everybody. And I hope that makes sense, but there…

[Scott Billeadeau:]

Yes, like you say, there is -- the issues is that even with these independent guys, it's still -- they still -- most of their money is made on the margin for selling these things, not on a healthcare service. I mean that’s just the way the stuff is peddled at this point. Is that right?

[Mark Gorder:]

Exactly right, Scott.

[Scott Longval:]

And I think what we're finding is what's reinforcing our excitement about the direct-to-consumer market, where Mark talked about some of the big six coming in and offering target price reductions. And those price reductions did not get shared with the consumer. So, even by introducing lower prices into that market, it ultimately does not get pass to the consumer. And with the growing need and the heightened awareness, it's only demanding a new disruptive channel.

[Scott Billeadeau:]

Yes, and I guess that's the issue, is it does -- as you do the direct-to-consumer, does there have to be -- there has to be some test or some audiologists or someway and it’s a matter of to bypass that whole margin for these guys. What can be done, I'm not quite sure. What can be done directly now without that guy involved?

[Mark Gorder:]

The current DTC model, we have a very good -- we call it our customer care center at HHE. There is about nine to 10 licensed professionals who are actually taking those calls and assisting the patients in adapting to their hearings aids. So, a health care component of DTC offering is very critical. You can't take them out of the box and just put them on and adjust. You need some professional assistance, and we provide that at HHE. And I think when you start thinking about, if you combine this customer care model with self-fitting technology that can provide remote access. And ultimately you're going to a large number of these patients that don’t need this gold standard where you go into a bricks-and-mortar shop and have somebody hand hold you at a very high price. We can, by putting technology in the device and using that to our advantage, I like to call out the uberization of the hearing healthcare model is that the technology infrastructure allows you to replace some of what the professional does, and by putting it into the fitting technology. So we think that our model is a great compromise in taking people that don’t need the gold standard and given them a very high quality medical outcome based device.

[Operator:]

Thank you. And that concludes today's question-and-answer session. I would now like to turn the conference back over to Mr. Mark Gorder, Chief Executive Officer for 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 would like to reiterate that I’m excited with the direction we are headed. Our established medical business is rebounding nicely, and has a long runway for success. With record first quarter sales and the near-term horizon, in the emerging value-based hearing healthcare channel, we’re faced with tremendous opportunity. We’ve taken meaningful steps forward and look forward to additional progress in the coming quarter. With solid execution, the future looks bright for our organization. And we look forward to updating you next quarter. Thank you very much.

[Operator:]

Thank you. And that does conclude today’s conference. Thank you for your participation.