IntriCon Corporation
Q3 2015 Earnings Call Transcript

Published: 10 Nov 2015

[Operator:]

Good day and welcome to the IntriCon Third Quarter 2015 Results Conference Call. Today’s conference is being recorded. At this time, I'd like to turn the conference over to Scott Longval, Chief Financial Officer. Please go ahead.

[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 assumption of IntriCon’s management and are subject to uncertainty and changes in circumstances. Given these uncertainties, you should not place undue reliance on the forward-looking statements. Actual results may vary materially from the expectations contained in today’s call. Important factors that could cause such differences include among others those set forth under the headings risk factors and management’s discussion and analysis of financial condition and results of operations and our 10-K filing for the year-ended December 31, 2014. With that, I'd like to introduce Mark with the strategic look in 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. After that, Scott will cover the financials in more detail and then we will take your questions. By this time, most of you had a chance to review our third quarter press release. For the quarter, we reported revenues of $17.3 million and earnings of $0.10 per share, it increased both sequentially and over the prior year. In addition to the solid financial results, we made further strides during the quarter advancing our initiatives in Value Hearing Health by announcing a supplier agreement with AudioNova, launching a joint venture with The Academy of Doctors of Audiology, ADA called earVenture LLC and acquiring the assets of PC Werth Ltd, a leading supplier of hearing healthcare products and equipment to the United Kingdom's National Health Service or NHS. Looking at our three businesses, sales in hearing health decreased 17% from the prior year quarter primarily due to decreases in the conventional channel. It is previously noted the conventional channels experienced a trend of continuing market consolidation. As a result, the large six manufacturers now control approximately 98% of the global market. However, during this time, market penetration has stagnated as end-consumer prices have drastically increased. While conventional hearing health sales are down from the prior year, IntriCon remains focused on building the infrastructure required to secure other notable partners who can benefit from the company's value outcome-based hearing health model. We anticipate these initiatives will drive robust hearing health growth in future quarters. Shortly, I will comment further on these efforts. Our medical business sales increased 28% in the 2015 third quarter primarily driven by sales to our largest customer Medtronic. For the second consecutive quarter, our Medtronic business posted record quarterly revenue led by the MiniLink REAL-Time Transmitter and related accessories sales which are incorporated in Medtronic’s MiniMed 530G insulin pump and continuous glucose monitoring, or CGM system. We also manufactured various accessories associated with Medtronic CGM System, including the recently announced MiniMed Connect, which links the MiniMed pump and CGM to certain smart devices providing users with a discreet and real-time view of their blood sugar information. We anticipate continued Medtronic revenue strength going forward. Looking at our professional audio communications business, sales declined 42% from the prior year period. The decrease was anticipated and related to the conclusion of our Singapore government contract in 2014. We will continue to leverage core technologies in professional audio communications to support existing customers as well as seek related hearing health in medical product opportunities. I'll now briefly touch on other key initiatives, most notably in Value Hearing Health. In a recent letter to President Obama, the President’s Council of Advisors on Science & Technology or PCAST, the group who advise the President and make policy recommendations to strengthen our economy in foreign policy that works for the American people addressed the low hearing health market penetration levels we had long discussed. They indicated that untreated hearing loss in the United States is a substantial national problem. PCAST supported this assessment with references to the high device cost and low levels of innovation in the distribution channels creating further barriers to access. They also highlighted the steering [ph] percentage of the U.S. population that is untreated, a group that is statistically associated with higher risks and social isolation, depression, dementia, false [ph] and inability to work travel or be physically active. Recommendations from PCAST including revised FDA regulations and changing the current distribution channel as well as creating new channels to increase the opportunities for consumer choice. This letter also received strong support from influential customer groups such as the Hearing Loss Association of America. A link to the PCAST letter can be found on our website. This assessment is in line with our communications over the last several years and highlights the need for outcomes-based hearing healthcare model in which the best value added devices and software technology are coupled with varying levels of practitioner intervention to provide the most efficient lowest cost solution to the individual consumer. We believe this will significantly improve market penetration bringing hearing healthcare to millions of people who today cannot afford care through the conventional channel. In fact, earVenture is a testament to the emerging value channels. It capitalizes on IntriCon's established reputation as a leading provider of high quality low-cost hearing aids and the ADA’s respective position as the only national membership association focused on ownership of the audiology profession through autonomous practice and clinical excellence. Initial earVenture product offerings will help audiologist compete in any market and help underserved or never-served populations. Furthermore, we are very excited with our recently announced acquisition of PC Werth Ltd, IntriCon was able to gain direct access to the NHS in greater control over efforts to accelerate new market penetration and serves the United Kingdom's sizeable hearing health needs. The transaction will require various NHS contracts to be novated, which we anticipate completing in 2015. The NHS is widely seen as the most efficient hearing aid delivery system in the world, supplying an estimated 1.4 million hearing aids annually. Through the first half of 2016, IntriCon will be executing on its integration plan which will include relocating, reallocating resources and investments, and leveraging corporate infrastructure. Once integrated, we expect the acquisition will generate over $4.5 million in revenue on an annualized basis and the accretive to earnings per share. Putting all of these recent developments and initiatives into context, we have positioned IntriCon as a leader in the emerging hearing healthcare model through ongoing investments in sales, marketing and research and development. In addition to our current partnerships and customers, we are aggressively pursuing prospective partners and customers to expand our outcomes-based hearing healthcare model. Now, I’d like to turn the call back over to Scott.

[Scott Longval:]

Thank you, Mark. I’ll begin reviewing our third quarter financial results in more detail. For the 2015 third quarter, the company reported net sales of $17.3 million compared to $17 million in the prior year period. IntriCon posted net income of $628,000 or $0.10 per diluted share versus net income of $558,000 or $0.09 per diluted share for the 2014 third quarter. Gross profit margins were 26.7% compared to 26.3% in the prior year third quarter. The increase was primarily due to higher overall sales volume. For the 2015 nine month period, IntriCon reported net sales of $51.1 million and net income of $1.4 million or $0.23 per diluted share. This compares to the 2014 nine month net sales of $51.8 million and net income of $1.9 million or $0.31 per diluted share. Included in the 2014 nine month results was a loss from discontinued operations of $270,000 or $0.04 per diluted share. Gross profit margins decreased slightly to 26.5% from 27.1% in the prior year period nine month period; the slight decline was primarily due to product mix in lower overall sales volumes. Operating expenses for the third quarter in nine months were $3.9 million and $11.8 million respectively, increasing a 128,000 or 438,000 over the prior year comparable periods, primarily due to increased support cost for value hearing health initiatives. Turning to other financial metrics. Our debt was $7.1 million was consistent with the 2015 second quarter. A total cash cycle base at the end of the third quarter was 68, this was a slight increase from 65 days at the end of the comparable prior year period and sequentially. All now was the solid quarter for IntriCon as we continued to deliver profitability while building the infrastructure required to secure high potential growth opportunities. Now, I’d like to turn the call back over to the operator, so we can take any of your questions.

[Operator:]

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

[Scott Billeadeau:]

Hi, guys. Got just a question about the PC Werth acquisition. Can you maybe talk about what’s you have bought there in terms of equipment and revenue and then maybe give us a little characteristic of what you bought in this acquisition?

[Mark Gorder:]

Certainly, Scott. PC Werth had established the longstanding distribution business in the UK and they have a couple of key product areas. One is, selling test equipment, audiological test equipment and accessories for audiological use into the National Health System, and that’s a sizeable part of their business, I would say maybe 35%-40%. And then there is another probably equally large amount where they put in audiological communication systems for use in schools and other venues where hard to hearing people would congregate, and that’s probably about 80%-85% of their revenue and then there is a few smaller non-material aspects in their business, but we’re obviously mainly interested in the part of the business that’s directed at the NHS where we figure that with our initiatives we can drive a lot of growth into PC Werth with primarily hearing aid sales and also accessories and so forth that we would bring to bear. So, that’s roughly their revenue make up and they are in a lot of assets per se, it's more of the people and the relationships, the PC Werth sales and marketing team has over the past 15-20 years developed very strong relationships with the NHS which was our key purpose for engaging them initially with our partnership contract and probably even more so as we have the opportunity to purchase the company was maintaining and securing those key relationships. I hope that - does that answer your question?

[Scott Billeadeau:]

Okay. Yeah, I guess so was there any - in terms of couple of the key people there who’ve got the relationships up within NHS. Did you secure them with any longer-term or did they have some earn-outs or is there something that keep them in the company?

[Mark Gorder:]

They all have employment contracts in place so yes, we did secure all of the key individuals for at least one year.

[Scott Billeadeau:]

And then, maybe just discuss just a little bit, the conventional hearing business and what’s your mix now on the hearing side given that the conventional hearing, I mean how much of the revenue there do you consider value or outcomes-based as opposed to conventional at this point?

[Mark Gorder:]

At this point, Scott very little the revenue is in the value segment. As we mentioned that at the start, we've - during the course of 2015, we have established a number of these key relationships. On the positive side and the negative side, they took longer to develop than we thought, so we’ve generated very little revenue in 2015, we expect to see some revenue here in Q4 and then during the course of 2016, we expect to see a lot more revenue out of those initiatives as we pump-in marketing and sales efforts into those opportunities, but as we mentioned with the AudioNova, with the ADA, and earVentures and with acquiring PC Werth, we expect those two as well as other ones that are in progress to generate a lot of revenue in 2016, but to-date the hearing health mix is almost all traditional.

[Scott Billeadeau:]

Okay. And would you - is sales now with your, I guess your PC Werth distribution into NHS, is that all considered conventional in your mind?

[Mark Gorder:]

We would consider that in the value market because the NHS is probably the best example in the global market of an organization that has put in an outcome-based system throughout their organization and they’re one of the few that have done that. So that we would consider in the value space for us.

[Scott Billeadeau:]

Okay, great. But nothing, no real revenue there yet?

[Mark Gorder:]

Not yet.

[Scott Billeadeau:]

Okay. All right, that helps. I'll get back, let someone else ask.

[Mark Gorder:]

Thank you, Scott.

[Operator:]

[Operator Instructions] And we go now to Dick Ryan with Dougherty.

[Dick Ryan:]

Thank you. Hey Mark just following-up on the PC Werth, you talked about a 4.5 million or higher annualized run rate, just to clarify that’s on their existing business, are you or maybe you are, are you including any hearing aid sales on that number or that's just the core revenues that you acquired.

[Mark Gorder:]

That’s correct, Dick. That’s just a core revenue in any hearing aid sales we generate is over and above that, so we expect more than that when you add in the hearing aid sales for next year.

[Dick Ryan:]

Yeah, okay. And you have the joint venture announcement with the ADA or the partnership and there was a pre-order period for the members of the ADA I think they had a period before the end of September and then non-members could order, maybe you don't want to give specifics, but can you give us a sense of how that order period occurred, I know that’s probably outside your control, it’s maybe driven more by the ADA but what’s going been the experience there so far?

[Mark Gorder:]

Well, so far we've signed up about 350 to 400 of the 1200 ADA members as signed up to join the earVenture plan. And we’ve taken and delivered some initial revenue, nothing material, but we - to be honest, we haven’t really kicked off the heavy marketing and sales efforts that starts with the ADA show in Washington DC which takes place starting this coming Thursday which is I believe the 12th and so we’ve got our major effort going on there. We expect to launch a number of marketing efforts after that email blast that type of thing to start putting the pressure on to drive revenue. So we do expect some revenue in Q4. I wouldn’t say it’s going to be sizeable but we should start growing that business starting in Q4.

[Dick Ryan:]

Are there any financial requirements on the 350 or so that have signed up or isn’t there any real commitment there financially from them yet?

[Mark Gorder:]

No, there are other than the ones that have ordered. But there is no requirement to sign up other than you have to be an ADA member, and interesting - a few people have become ADA members that were not ADA members before in order to get into the program, so we’ve seen some movement in that direction.

[Dick Ryan:]

Okay, maybe shifting over to Medtronic. What can you give us for a sense of how the European sales are going whether it's 630, I don’t think they’ve filed or in the U.S. as yet, but how is that business looking for you?

[Scott Longval:]

Dick, this is Scott. Thanks for the question. We had the privilege of being out in California not too long meeting with their executive team, and the feedback we received on the European launch, the 640 has been all very positive, now the consumer responses has been great. There are some additional functionalities you know into that product line. I think they've stated publicly that they anticipate being here in the U.S. market sometime in 2016, so we’re excited to be part of that program and to continue to support their initiatives in the wireless glucose monitoring market.

[Dick Ryan:]

Okay. I’ve seen the inventory build in Q3 from Q2, is that for either side or both Medtronic or the hearing aid side?

[Scott Longval:]

It's really a split between the initiatives on the hearing aid side. Clearly, we had built up inventories to start preparing for things like the AudioNova contract, things with earVenture, the program, with the NHS and as we're taking on some additional product lines with Medtronic, we’re starting to see some inventory build on that side as well. So, if those are really being driven off of what we anticipate to be sales drivers here in the fourth quarter and into 2016.

[Dick Ryan:]

Okay. One last one from me. Mark, the Presidential Advisory Council and then the HLAA endorsement, I mean it looks like you guys kind of ghost [ph] brought those recommendations for them. But what can we expect as far as those agencies driving change through the channels and seeing more effort on the value hearing side?

[Mark Gorder:]

I think realistically all these recommendations are going to take time. I think the point we would make with this is, this is the first time that a national organization has started to get a message out about serving more people and the fact that there needs to be change. And the message prior to this has been dominated by the large manufacturers. And I think the point to take away from here is, this is the first time we’ve seen a major initiative supported by several agencies and speakers that are recommending change and they're not the only one, there is the Hearing Loss Association of America has stepped up and have been talking about this for some time and they clearly endorsed these recommendation, there is also the Institute of Medicine which is supposed to release their findings any day now and we know from inside our discussions that their recommendations are going to be almost the same as the PCAST. So, I think what it represents is that see change in the attitude among professionals towards getting a different message out to the public. We’re excited about that because, we think it’s a message that needs to come out there, hearing aids are overpriced, the delivery models need to be outcome-based and substantially lower price points need to be driven into the market through new channels in order to provide greater access and affordability to the consumer.

[Dick Ryan:]

Good. Okay. Thanks Mark. Good quarter.

[Mark Gorder:]

Thank you. Thank you very much, Dick.

[Operator:]

And we’ll go now to Larry Hemovich [ph], private investor.

[Unidentified Analyst:]

Good afternoon, gentlemen.

[Mark Gorder:]

Hey, Larry.

[Scott Longval:]

Hi, Larry.

[Unidentified Analyst:]

Couple of questions mainly around the NHS. I am assuming that you have not recorded any revenue to-date from the NHS whether it's just too where like...

[Mark Gorder:]

That’s correct.

[Unidentified Analyst:]

Okay. Go ahead, sorry.

[Mark Gorder:]

I would just say you are correct. It's in the early stages and there is a show at around Thanksgiving, it's called the British Audiological Association and our big launch there is going to start at that show and we got some major marketing efforts similar to what we’re doing with the ADA and PC this week, we’re going to be launching a major effort there to get feed on the street and the message out to all the various clinics in the UK. We’re targeting I think about 60 clinics initially and the kick-off will be at that show and it's roughly Thanksgiving week.

[Unidentified Analyst:]

Okay. So, we don’t expect guidance from you unless I'm sure it's very difficult to project their plan, but I just wonder how we should, what I mean - what do you think is a reasonable for this business as you look out. I mean certainly in several years it could be tremendously important to you. I mean if I follow a number that could be a million dollars of sales next year, is that a billable number, is that seem reasonable, is that seem fairly high, or fairly low or it's good numbers one would throw out.

[Mark Gorder:]

Yeah, I think it's difficult for us to say. What I would say about the NHS is clearly the opportunity was something that we thought we can make a big push in and penetrate that market. And the NHS been their largest purchaser, a fewer needs in the world sourcing as the 1.4 million, we believe that we can get in there and with our value offering in our technology pipeline have begun to take market share. I think at this point it’s a little premature for us to start putting quantities around that we think it can do, clearly one of the directives that we had was to gain greater access and control over that so we could push our sales and marketing plan to maximize revenue share gains. So, I think we’ll be in a much better position there to answer that question next quarter after we’ve had a little bit more time to put our sales and marketing team in place and start getting direct feedback from the various clinics.

[Unidentified Analyst:]

Okay. Let me try and approach it a little bit differently without trying to push it too hard. What kind of ASPs per unit do you expect to get for the NHS?

[Mark Gorder:]

Typical ASPs into the NHS range from $75 to $125.

[Unidentified Analyst:]

Okay. So, if we say it's an average of 100 that would mean 10,000 units if my math is correct for next year, but you'd sell to them about 10,000 units. Roughly how many units go through the NHS every year, I am sure it's millions, I would think it'd be millions?

[Mark Gorder:]

1.2 million.

[Unidentified Analyst:]

1.2 million. So, we’re not talking about you gaining massive market share for it to be a contributor next year and committed contributor would be $1 million or more?

[Mark Gorder:]

Yeah. I'd say that’s reasonable. Yeah.

[Unidentified Analyst:]

Okay. Good. And is that carrying a reasonable gross margin to you?

[Mark Gorder:]

The margin make up on the NHS is slightly less than what we see in other markets but not too far off.

[Unidentified Analyst:]

Okay. So your gross margins are low relative to many companies because of the type of business model you have but now you are making this device and you’re selling it directly so I would think the gross margins would be above corporate average, wouldn't it?

[Mark Gorder:]

Yeah. Let me be clear. The reason our margins are in the upper 20s has little to do with the product and more has to do with our corporate infrastructure and we'd set-up manufacturing facilities in more cost areas of the world and we’re in a position today to triple our outflow of hearing aid devices with having very little in overhead lower infrastructure costs. So when I say that it is lower in margin make up, lower on a contribution margin make up, but clearly greater than the gross margins that we’re experiencing today.

[Unidentified Analyst:]

Yeah. Okay, good. And overtime presumably as you developed more manufacturing expertise, absorb more the fixed cost, the gross margin profitability I would assume would continue to be improving?

[Mark Gorder:]

Absolutely. One of our stated goals Larry to that point is based on some of the volumes that you’re going to see come through in 2016 as we anticipate been on a run rate 30% gross margins by the end of next year. And that’s largely due to just the additional revenues that we were anticipating for 2016.

[Unidentified Analyst:]

In that 30% number you just throw out, is that corporate average for next year, is that your guess for corporate average?

[Mark Gorder:]

Just on the run rate at where we would be by the end of the year.

[Unidentified Analyst:]

Right. So gross margins between now and the end of next year let's say Q4 of next year in your view at this point show a nice trend upward.

[Mark Gorder:]

Right.

[Unidentified Analyst:]

Correct. Okay, perfect. Okay, thanks very much.

[Mark Gorder:]

Very good. Thanks, Larry.

[Unidentified Analyst:]

You’re welcome.

[Operator:]

And now we will conclude our question-and-answer session. I’ll now turn the call back to Mark Gorder, Chief Executive Officer. Please go ahead.

[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 am encouraged with the progress we’ve made throughout 2015. Although, we still have progress to make. Financially, we expect our momentum to build through year-end and we are on track to achieve sequential revenue growth from the fourth quarter and higher sales year-over-year for 2015. Strategically, we have made significant progress in building our value hearing health infrastructure, securing new channel partners and advancing our technology portfolio. With clear evidence of an emerging value hearing health market opportunity and new partnerships coming on Board coupled with our strong Medtronic business, we are poised for future growth. We look forward to updating you on our progress next quarter and thank you again for joining the call.

[Operator:]

This concludes our conference. Thank you for your participation.