IntriCon Corporation
Q1 2017 Earnings Call Transcript

Published: 26 Apr 2017

[Operator:]

Good day everyone and welcome to the IntriCon First Quarter 2017 Results Conference Call. At this time, all participants are in a listen only mode. Later, you will have the opportunity to ask questions during the question-and-answer session. [Operator Instructions] Please note that this call maybe recorded and I will be standing by should you need any assistance. It is now my pleasure to turn the conference over to your Chief Financial Officer, Scott Longval. 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. 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, 2016. With that, I now 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 had a chance to review our first quarter press release. For the quarter, the company reported record net sales of 20.1 million compared to 18.1 million in the prior-year period. The increase was primarily due to year-over-year revenue gains from IntriCon's largest medical customer and included a 1.4 million contribution from Hearing Help Express or HHE. Net sales rose 13% sequentially from the 2016 fourth quarter. Looking at our three businesses, our medical business sales increased 19% in the 2017 first quarter, chiefly driven by our largest customer Medtronic. The gain was due to the expected production ramp up of Medtronic MiniMed 630G wireless glucose monitoring system. Higher first quarter production also resulted in a 1.9 million sequential increase in Medtronic revenue for the 2016 fourth quarter. Short term, we remain well positioned with Medtronic, with 2017 second quarter sales also expected to be at record levels and growth anticipated to continue throughout the second half of the year. Longer term, the future also looks favorable with Medtronic, in addition to the MiniMed 630G system, IntriCon has 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, it is scheduled to be launched in the spring of 2017. Turning to hearing health, sales in hearing health grew 9% from the prior-year first quarter, primarily stemming from a 1.4 million contribution from HHE. As previously announced, we acquired a 20% stake in DeKalb, Illinois based HHE, a direct-to-consumer mail order hearing aid provider in the fourth quarter of 2016. In January 2017, we announced that we have exercised our option to acquire the remaining 80% stake in HHE. The deal is expected to close in the second half of the year. Since taking our initial stake in HHE, we've made substantial progress integrating and optimizing the organization. Year to date we have completed the relocation of the business, which is expected to drive operating efficiencies and better work management by merging two locations into one, enhanced HHE's sales and marketing capabilities, and increased advertising spend, and introduced our first advanced digital hearing device the EarMate 4220 into HHE's portfolio. While we are new to this business and still determining the most critical lead measures, we have identified too that we believe demonstrate progress is being made. HHE's order backlog increased 20% from Q4 2016 to Q1 2017 driven by targeted advertising and follow up care. And we identified three new 3000 new leads during Q1 through focused lead generation advertising initiatives. As we identify other applicable lead measures, we intend to refine the metrics we report on in the future to provide greater visibility on our progress. Along with the addition of HHE, I'm excited to announce that IntriCon has entered into an agreement to acquire a 49% stake in Soundperience. Soundperience has designed state-of-the-art self-fitting hearing aid technology. Soundperience software applications are the first psychoacoustic way of analyzing peripheral hearing and central hearing processing. The company's self-fitting hearing aid technology is being used in the German market today most notably through our previously disclosed Signison joint venture with Soundperience. Currently the technology is PC based and is wired to the hearing aid during programming. However the system will be integrated with IntriCon's wireless hearing aids over the next few months and initially rolled out in Germany through our Signison joint venture. We believe strongly that incorporating self-fitting technology is a critical step in creating our high-quality low cost hearing healthcare ecosystem. Soundperience's technology has the potential to drastically reduce the price of hearing aids, drive greater access and increase customer satisfaction. We anticipate piloting a version of the cloud-based system with our wireless hearing aids in the US market by hearing help expressed in the 2017 third quarter. At the conclusion of our annual shareholders meeting this Thursday, we will be giving a short demonstration of the self-fitting software. HHE and Soundperience given IntriCon direct access to consumers and the emerging value-based hearing health care market and the ability to self-fit hearing aids. We believe that the combination will drive a lower priced alternative for consumers to purchase devices directly and successfully manage their own care experience circumventing layers of costs associated with a conventional hearing aid channel. Looking at some of the other hearing help initiatives, we also saw contributions from PC Werth during the quarter. In January 2017 we took steps to reduce PC Werth's cost structure by 200,000 and refocus sales efforts into the National Health Service clinics. Just yesterday we received formal approval from the NHS for a third device the Kamplex 940D which will enhance IntriCon sales opportunities. The Kamplex 940D which is a traditional behind-the-ear device is very appealing to the NHS because of its broad fitting range and advanced features. During the next quarter, we will launch our sales efforts for the Kamplex 940D as well as the previously approved Kamplex KITE device. We have identified 12 initial NHS reference sites that are willing to distribute non-Big Six hearing products, they fit at least 300 hearing aids per month and they are ripe and ready to try something different. We tend to place a qualified IntriCon employee in those NHS clinics to support the clinic fittings to patients where we will gather initial feedback. Once the initial 12 clinics have been engaged, we will reach and attract and convert further NHS sites using the initial reference sites. Our goal is to be delivering a 1,000 hearing aids a month through NHS by the end of 2017. Shifting now to public policy. There have been significant developments during the first quarter. Legislation was introduced in the House and Senate to make hearing aids available over the counter for those with mild to moderate hearing loss. Should it pass, this legislation has substantial implications for IntriCon and the entire value hearing health industry. The proposed legislation would require the FDA to write regulations ensuring that this new category over the counter hearing aids meets the same high standards for safety, consumer labeling, and manufacturing protections as all medical devices providing consumers the option of an FDA regulated device at lower cost. The Over-the-Counter Hearing Aid Act of 2017 has the potential to remove the significant barriers existing today that prevent innovative hearing health solutions. We believe that this legislation would invigorate competition, spur innovation and facilitate the development of an ecosystem of hearing healthcare that provides affordable and accessible solutions to millions of unserved or under-served Americans. Additionally these public policy changes all further support our strategic focus to gain access to the consumers and the unserved market. Now I'd like to turn the call back over to Scott.

[Scott Longval:]

Thank you, Mark. I'll begin by reviewing our first quarter financial results in more detail. For the 2017 first quarter, we reported record net sales of 20.1 million compared to18.1 million for the prior year period. The increase was primarily due to year-over-year revenue gains from IntriCon's largest medical customer and included $1.4 million contribution from Hearing Health Express. Net sales rose 13% sequentially from 2016 fourth quarter. IntriCon posted a net loss attributable to shareholders of 428,000 or $0.06 per diluted share versus net income attributable to shareholders of 15,000 or $0.00 per diluted share for the 2016 first quarter. The 2017 first quarter loss included a loss from discontinued operations of 277,000 or $0.04 per diluted share related to the divestiture of CDM business but also included non-reoccurring acquisition and redundancy expenses of approximately 211,000 or $0.03 per diluted share. As we've talked about previously, we've made the strategic decision to divest our non-core CDM business in order to focus financial and operation resources and value hearing health in growing the direct to consumer opportunity. We found a buyer for the business and sale closed in 2017 first quarter. On a pro forma basis, after adding back losses from discontinued operations, costs associated with HHE and Soundperience acquisitions and non-reoccurring redundancy costs in the UK, the company generated $60,000 in pro forma net income for the quarter. You can find a reconciliation of GAAP based net loss to adjusted net income in today's press release. Gross profit margins were 28.3% essentially flat with 28.2% in the prior-year first quarter. Operating expenses for the first quarter were 6 million compared to 4.6 million in the prior year first quarter. The increase was largely due to the inclusion of HHE in 2017. In terms of guidance, based on the information that's currently available, we anticipate the 2017 second quarter net sales to be in the range between 20 million and 20.4 million and positive EPS from continuing operations. For the year, we anticipate revenue to range between 79 million and 81 million. Turning to the Soundperience transaction, let me reiterate the terms outlined in that press release. Terms of the transaction include IntriCon immediately acquiring 17% stake followed by an additional 32% stake in the 2017 fourth quarter. This part of the initial investment we will receivable revocable worldwide license which is exclusive in the United States. Now, I'd like to turn the call back over to the operator so we can take your questions.

[Operator:]

[Operator Instructions] And we'll take our first question from Dick Ryan with Dougherty. Please go ahead your line is open.

[Dick Ryan:]

So Markey, I'm not sure I caught your full comments on Medtronic, obviously a strong quarter with their new products, but did you say you expect year-over-year growth across each of the remaining quarters for this year?

[Mark Gorder:]

Yes, we did.

[Dick Ryan:]

And when does the 670 get introduced?

[Mark Gorder:]

They have said in their press release spring of 2017, which I think could be as early as May, but it could be late May or first part of June.

[Dick Ryan:]

Turning to HHE, 1.4 million, is that a level we should look out for Q2 as well.

[Scott Longval:]

No I think if you, Dick, if you heard the numbers of Mark highlighted on the backlog perspective, we think and we envision that revenue number for the second quarter will be a little bit higher than the first quarter.

[Dick Ryan:]

Has the digital hearing aids been introduced in that channel yet?

[Mark Gorder:]

Yes, there was one digital hearing aid has just been introduced to HHE.

[Dick Ryan:]

And what's been the delay to wrap up the remaining 80%?

[Mark Gorder:]

We are working right now with our bank to understand the best way to finance that transaction that gives us enough flexibility to provide the level of advertising that we want to provide. So just looking for the most flexible option.

[Dick Ryan:]

Listening to the FTC workshop last week, I mean obviously when you combine now with the FDA and the legislation everything does seem to be moving your way, other than the blocking and tackling you talked about, higher level, is very any other things that you're need to be doing or need to be working with to maybe help kick that door open a little further or faster.

[Mark Gorder:]

Well I think the - there's definitely a very strong consumer and political outcry for reform in the channel and we participated in the - during the week of March 13, Delain Wright, our VP of Business Development and myself were actually out in DC working. We actually visited Senator Warren's office and participated in the discussion of the language that was going in there, which we strongly support. And we get the opinion there that the political process is very much in favor of this and it's getting broad support. Now, with legislation you never know, but they're anticipating that something may happen as early as the fall. There's not much more we can do other than continue, we continue to reach out to the various members of the Senate and the House that are supporting this and let them know that there are manufacturers like IntriCon that as opposed to the Big Six are clearly supporting this legislation. So I don't think there's too much more we can do other than, Dick, but we are actively engaged in doing what we can.

[Dick Ryan:]

Okay. [indiscernible] you just get a few more agencies or whatever to pile on and then it just becomes this bureaucratic mass where maybe nothing moves that quickly, independently is there anything you can do outside the policies or regulations.

[Mark Gorder:]

Nothing that comes to mind other than continuing to communicate our support and by creating some of the technology infrastructure that we are building within IntriCon's HHE and building out our ecosystem of care, we took the position with Senator Warren's office that a lot of these things are already being done and they can clearly be done better and faster if they can get this regulatory obstacle out of our way. And so we continue to, I think we can continue to develop the technology and push our message out, but I don't think there's much more we can do beyond that.

[Operator:]

We'll take our next question from Scott Billeadeau with Walrus Partners. Please go ahead. Your line is open.

[Scott Billeadeau:]

Hey, guys. Just a couple of questions here. With HHE, you mentioned 1.4 million, is that 100% of their sales, given you only own 20%? Are you just reporting all of their sales and then also are you taking all of their expenses or will - maybe just walk through that for me if you could.

[Scott Longval:]

So, right now, the 1.4 million represents 100% of their sales. While we only own 20%, we're really the managing company of that business and because of that gap forces us to consolidate that business into our numbers. So the 1.4 again represents all their sales and if you look down to the bottom of the P&L, you'll see an allocation out for the percentage of gain or loss that gets allocated back to the 80% share for them. So we're only recognizing 20% of the bottom line impact.

[Scott Billeadeau:]

Right, which is a loss, so you'll be bringing those losses in, is that right? I mean, is that - so that business because I think you back out what something like 400, great that I forget the number off the top of my hand.

[Scott Longval:]

Yeah. So it will still be determined on how that's going to be handled, but one of the likely outcomes could be us having to bring that back in at some point.

[Scott Billeadeau:]

Yeah. Okay. And then with some experience, is there - what kind of and is that - is there a significant loss there, what's that business look at as, I'm just kind of trying to figure out as we say, two quarters down or three quarters down, when all of this - when you actually own 49% of that and you've got HEE all in, how much do you expect that to add to the expenses at that point?

[Mark Gorder:]

Scott, I think the short answer to that is Soundperience is a relatively small service business in the German market and their revenue is very, very low. I'm not sure the exact number off the top of my head, but this is primarily a technology play for us. I have met this gentleman back in 2011 and we had a couple of initiatives going to try to acquire a position at self-fitting technology. And one of those options got bought by Bose Corporation. And so the remaining - the next remaining viable candidate was Soundperience. And so we were very interested in getting a position in self-fitting technology. So we've been working on this for some time and we see it mainly as an opportunity to develop this technology, bring it in to the US market and support building out the infrastructure for our envisioned ecosystem of care in the value based hearing health space. And Scott may have some additional insight into what the financial impact is.

[Scott Longval:]

Yeah. So we'll be acquiring that and they will be reported under the equity method of accounting. So there will be no revenue or loss or excuse me, no revenue or operating expenses flowing through our statements that would simply be a one line item on our P&L with a gain or loss from Soundperience and what I can tell you, it's essentially a breakeven business.

[Scott Billeadeau:]

And for you guys, the key was to get the US license to use that. That was the key. Yeah. Okay.

[Scott Longval:]

Correct. Along with some first right of refusals and protecting a very valuable asset that's going to be critical for building this ecosystem of care.

[Scott Billeadeau:]

Okay. Just another question on your revenue guidance. You've got 20 million and roughly - you put up 20, you're going to put 20 and next quarter, you kind of guided 79 to 81. So that suggests second half flat with first half? I think you mentioned you may see some with your large medical customer, was there a little bit of a fill upfront? So is that issue or I'm just trying to figure out how that mapped it, because it kind of suggests there's no sequential growth here for a little bit?

[Scott Longval:]

I think if we talk about the largest customer, I think Mark noted that we're envisioning seeing that continued growth and if you look at that range, we did up the range from where we previously announced it last quarter. We believe that we can be at the high end of the range of that number. But at this point, we want to take maybe a little bit more of a conservative approach and help things play out as we're not necessarily in control of Medtronic's launch cycles. But the guess, today as we sit here, we think based on the information, we can definitely hit the top end of that range.

[Scott Billeadeau:]

Great. Thanks. And then just one last quick question on, certainly sound is really interesting to have the self-fitting and particularly if someone doesn't have to be tethered to a PC, maybe just kind of in my head, I'm trying to understand the wireless self-fitting, would that be an instance where HHE can ship them out, that person can either log onto a computer and do a talk, Wi-Fi or Bluetooth to the headsets and go through a fitting process. Is that - am I kind of in the right range of what?

[Mark Gorder:]

You're in the right range, Scott. You're in the right range. I would characterize it as probably the initial embodiment body would be to send out a - in fact the way it's been piloted in Germany, they're actually doing a professionally managed self-fitting where they bring them into the shop, they set depiction down at an iPad, which Soundperience provides and then that patient walks through it on their own and then the professionals there kind of oversee it. But what we envision it transitioning is eventually that wired link gets removed and it would be a low energy Bluetooth connection between the hearing aids and the smart device and then we could send that - either the patient would have a smart device and download an app or we would send them a smart device and then they would use that VLE connection to walk through the process defined by the app and self-fit the device. So you were right on as to how you described it.

[Operator:]

[Operator Instructions] We'll take our next question from Larry Haimovitch with HMTC. Your line is open. Please go ahead.

[Larry Haimovitch:]

Good afternoon, gentlemen. Couple of questions on hearing a business. Number one, on an apples-to apples basis, so the same-store sales, what was the growth in that business in Q1, in other words, taking out the increments from HHE, did that business grow on a same store basis?

[Mark Gorder:]

When you look at Hearing Help, you've got to break it into our traditional business and our new emerging value based business. The traditional business is declining as we've said in the past because of the consolidation by the big guys. And so if you take that business aside, the value based business is growing because we've got in that category, United Healthcare. Some of the stuff we're doing in the UK, HHE will now fall into that category. So that part of the business is on the upturn. And I think we're nearing the end of the downturn from the traditional business. We have very little business left with the big guys, I think it's the big six manufacturers, there's only about 1.5 million of revenue left in that category and in 2017 and then we will have a lot of legacy business with some of our Chinese customers and small US customers and other global customers. Does that kind of answer that?

[Larry Haimovitch:]

Yeah. In case we were the UK business, it looked very promising and you're making real headway in terms of approvals with the National Health Service, how are revenues trending? I know it was a bit of a bump when you first acquired it kind of getting integrated, maybe some people issue whatever. Do you see that business, has it grown in the past couple of quarters and what do you foresee for that particular segment of the hearing aid business at this point, Mark?

[Mark Gorder:]

When we took on PCW initially, it was kind of a distressed business. We had hoped as we've said in the past that we could maintain it as a distributor, but when it ran into issues we figured, we wanted to defend our position with the NHS. So we took it on and initially they had I think a pretty good first quarter, but once the big six manufacturers who were providing some product lines into PCW for distribution, they pulled those away from us and we had to sort of stabilize the business, which we didn't in Q2 of last year of 2016. Scott, relative to growth quarter-over-quarter I'm not sure what the percentage was.

[Scott Longval:]

So we saw growth Larry from Q3 to Q4, we saw growth again here from Q4 into Q1. And I think if you look going forward, where we really need to drive growth is in the hearing aids. So we've laid out a strategy that we want to be a supplier to the largest consumer of hearing aids in the world, which is NHS. And we have the technology to do it. What we need to do is make more inroads on the hearing aids front. We think the approval yesterday is a significant step forward. The device, it has a wide fitting range. This is something that now we're going to take into the targeting clinics, as Mark laid out. We'll be reporting on our progress with this device in to those clinics at the end of the second quarter and continue to keep you guys informed and have the transparency and our progress because that is our number one goal with PC Werth. So I guess we'll continue to update shareholders as to our success in getting into those clinics.

[Larry Haimovitch:]

Approximately what's the annualized run rate for PCW right now?

[Scott Longval:]

Right now, the annual run rate is about $4.5 million.

[Larry Haimovitch:]

And that's above what it was when you acquired it, wasn't that right?

[Scott Longval:]

Correct. And we've kind of seen the revenue go down in the immediate, immediately when the Big Six pulled back and we've built some of that up, but again kind of the long-term approach and viability of that business, we have to be selling hearing aids and so we feel like we have put our best foot forward now. And it's now getting into those clinics and convincing them that our products can meet the needs of their consumers.

[Larry Haimovitch:]

Scott, who calls on those clinics, are they direct IntriCon PCW employees or are they distributors that carry other product line?

[Scott Longval:]

Direct IntriCon employees that have some audiological experience and good knowledge of the NHS and how it works.

[Mark Gorder:]

To that point, we talked a little bit how we restructured that business and put more focus on sales people within the NHS. We hired an individual that formerly worked at the NHS as an audiologist. So that gentleman has a very good understanding of the inner workings of the NHS. Gets to know how to navigate some of those land mines. So again, we feel like we've taken steps to put ourselves in position to be successful and now really the focus over the next couple of quarters is execution.

[Larry Haimovitch:]

Okay. And then one more question on the whole hearing aid business and I will jump back in the queue. And that is, I know you were looking for someone to really run that business, you made some progress, I think you may have brought somebody on as a consultant, bring us up to date on the leadership in that business that's focused specifically on that business aside from you guys who obviously have other responsibilities as well?

[Mark Gorder:]

So, as we said, Larry, IntriCon is an OEM manufacturer. We aren't a direct-to-consumer company. So we knew we had to bring talent on board to run and integrate with us and grow that business. So we hired - initially went on a search for a consultant to run it in the interim term. And it turns out that that gentleman was very qualified in direct-to-consumer, running direct-to-consumer businesses and digital marketing. And we're in the process of seeing if that position could be made, not a temporary position, but a permanent position. And the gentleman who runs it, his name is Jim [indiscernible]. He will be at our annual meeting on Thursday. And he has also brought on a very talented director of marketing who has put digital marketing systems into a couple of businesses prior to HHE and between the two of them, they are in the process of analyzing our strategy for marketing into that business and we're trying to figure out what the right mix is to optimize driving growth in that business. So that's where we're at with the management structure.

[Operator:]

[Operator Instructions] And there are no further questions at this time. So I'll return the call to your Chief Executive Officer, Mr. Mark Gorder.

[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 I'm very excited with the direction we're headed. We're encouraged by our start to 2017. Sales are ramping as expected and we have the infrastructure in place to deliver long-term growth. Moreover, we're excited about creating and cultivating a new channel to deliver superior outcomes based affordable hearing healthcare directly to consumers. We look forward to sharing our successes with you in the future and thank you again for joining the call. And as I mentioned earlier, if you're at the annual meeting, you'll be able to see a very nice presentation of our self-fitting technology. So thank you, everyone.

[Operator:]

This does conclude today's program. Thank you for your participation and you may disconnect at any time.