Sonos, Inc.
Q2 2008 Earnings Call Transcript

Published: 25 Jul 2008

[Operator:]

Good day, ladies and gentlemen, and welcome to the SonoSite second quarter 2008 conference call. My name is Marsh and I'll be your coordinator for today's call. (Operator Instructions) I would now like to turn the call over to Ms. Anne Bugge. You may proceed.

[Anne Bugge:]

Thank you, operator, and good afternoon. This is Anne Bugge, Vice President of Corporate Communications for SonoSite. Before we begin, SonoSite issued its news release after the market closed today, July 24, 2008, regarding financial results for the second quarter ended June 30, 2008. If you have not yet received a copy of the release, please contact SonoSite Investor Relations at 425-951-1333 and a copy will be sent to you immediately. You can also access the release on SonoSite's website at www.sonosite.com under the investor section. A replay of the call will be available beginning at 4

[Kevin Goodwin:]

Thank you, Anne, and good afternoon everyone. Thank you for joining us on the call today. Also with us today is our new CFO, Bernie Pitz, whom I'll introduce a little later in the call. Before making my comments on the quarter, I want to let you know that we just, a few hours ago, received some very good news out of Madison, Wisconsin. The judge in the GE patent litigation case, that was set to go to trial on August 11th, granted summary judgment motions in SonoSite's favor on five of the six patents that GE has asserted against us. She ruled that one of the GE patents is invalid, and that SonoSite products do not infringe on the other four GE patents. She also granted summary judgment in GE's favor on two of the patents that we had asserted against GE, and she has not ruled on two of our remaining patents and one remaining GE patent. So of the six patents that GE claimed against us, one is still remaining, and of the four patents we asserted against GE, two are still standing. This is great news and we look forward to the trial in August. Now, I want to move on to the second quarter. Our momentum continued to be strong in the quarter at 25% gross. Second quarter revenue reflected an acceleration of demand for our new products. Excluding the impact of foreign exchange rates, worldwide revenues grew to 21%. The U.S. grew its revenues by 19%, and our international grew by 31%, or 24% excluding the impact of foreign exchange rate changes. Not only were the bookings strong, but there was improved linearity in the quarter, the way in which the bookings came into the company. Profitability also showed a nice increase, despite an increase in outside legal costs and a negative impact from lower interest rates. Bernie will address further details of the financial results in his comments. Overall revenue trends are looking strong across our business, both in the U.S. and internationally, with each of our three international reporting segments up over 25% for the quarter, including some benefit from foreign exchange rates. In the U.S., growth was strong in the hospital sector, and the physician office continued to show good year-over-year improvement. In the U.S. enterprise growth rates continued to be affected in the second quarter by the transition of Boston Scientific's Vascular division to a private equity company status. As you might remember, Boston Scientific has been selling our iLook product into the vascular access market in U.S. hospitals. On the new product front, both the M-Turbo and the S Series were the engine of growth in the second quarter. Together, they accounted for over half of our revenues in Q2, and grew sequentially over Q1 by more than 50%. Regarding these new products and awards, new production introductions and upgrades continued in the second quarter. During the quarter, we began shipping a major performance upgrade for the M-Turbo, which added four new transducers to address the abdominal, cardiac and nerve applications for adult and pediatric scanning. We also introduced a version of the S Series product line customized for pick nursing teams in the ICU and the cath lab. The S Series products are clearly gaining momentum with their highly simplified user interface and zero footprints. We were notified recently that the S Series product line received a second design award in the International Design Excellence competition sponsored by the prestigious International Designer Society of America and Business Week. We received the first design award for the S Series line from the European International Forum in March. Our product pipeline continues to be robust, and we have more exciting innovations coming from R&D later this year, so stay tuned. Now, we'll move over to litigation. As you probably saw earlier this week, we settled this Zonare patent case, and as a part of the settlement, we provided a very narrow license for 412 patent to Zonare towards existing Z.ONE products. In turn, Zonare licensed the patent for its cart design to us, also limited to a certain number of our existing products. There are also restrictions on transferabilities. The licensees cannot be applied to other products. Additionally, we provided mutual agreements not to sue each other for a certain period of time. On the M&A front, we continue to actively evaluate opportunities with complimentary resources that will contribute to create value for our shareholders. However, we have nothing specific to report at this time. So, with all that in mind, I'd like to introduce Bernie Pitz, our new CFO, and turn the call over to him for more detail on the financial performance in the quarter. Bernie joined us about 10 weeks ago. He is off to a great start. He is establishing a new mindset and management process for SonoSite as we head into the future. His career spans 26 years in global finance positions in telecommunications, software, wireless technology and medical technology industries, most recently as a CFO of Sybron Dental Specialties, an NYSE company that was acquired by Danaher Corporation. Earlier in his career, he served 15 years with Motorola, including an [anticipatory] assignment Beijing. Welcome abroad, Bernie, and I will turn the call over to you.

[Bernie Pitz:]

Thank you, Kevin. I am pleased to be here and excited about working with the team to identify ways in creating value and to execute on the major opportunities before us. As Kevin mentioned, second quarter revenue was up 25%, or 21%, excluding foreign exchange rate changes. The impact of foreign exchange rate changes on international revenue in Q2 was approximately 7%. So, the growth on a constant currency basis would have been 24%. Looking at the quarter by geographic segments, and comparing results to Q2 of 2007, U.S. revenues were $27.8 million, up 19%. Europe, Africa and Middle-East revenues were $16.7 million, up 34%, or 27% on the constant currency basis. Latin America and Canada revenues were $5.7 million, up 29%, or 26% on a constant currency basis. In Asia Pacific, revenues were $8.9 million, up 27%, or 17% on a constant currency basis. So, a very broad based performance overall. Total non- U.S. revenue represented 53% of total revenues, compared to 50% in Q2 of 2007. Gross margin in the second quarter was 70%, compared to 69% in Q2 of 2007. Changes in foreign currency exchange rates had a favorable impact of almost one percentage point. There were some other items that largely offset one another, including positive impact of a decrease in royalties of about $500,000, the negative impacts for write-off of about $600,000 of obsolete inventory, as well as an increased rate of trade-ins as customers wanted to upgrade to the new products. At $36.1 million, total operating expenses for the quarter grew by 16%, or 13% when excluding the foreign exchange impact. The rate adjusted increase of 13 points was primarily due to two things

[Kevin Goodwin:]

Thank you, Bernie, and as many of you know, once Labor Day is over we enter our busiest season of the year, with the most important trade shows starting in October, ending in December. We are seeing an excellent reception and a robust market for our products, and see positive signs of building momentum. During July, we had a major milestone, over $1 billion in cumulative revenues since we began shipping in September '99. We are closing in on an global install base of 45,000 systems, on this, our 41st conference call. We are looking forward to building on our progress in the quarter and continue to drive strong performance in this year and next, and with that in mind, I'd like to open the call for your questions, thank you.

[Anne Bugge:]

Operator.

[Operator:]

(Operator Instructions). Your first question comes from the line of Tycho Peterson for JP Morgan, you may proceed.

[Unidentified Analyst:]

Hi, it's (inaudible) sitting here for Tycho.

[Kevin Goodwin:]

Yes.

[Unidentified Analyst:]

Just a quick question for you about the quarter in terms of -- if you talk about the clinical applications, which ones do you see are growing fastest. Then I have a follow-up in terms of pricing and competition, if you can talk about competitive activity?

[Kevin Goodwin:]

Okay, we don't breakout our clinical segment revenues; however we historically have commented on our focus and our focal points in medicine which are in emergency care, anesthesiology and critical care. All three of those segments are doing very well in growth; they are adopting and we are leading the charge and we believe increasing market share. Products are uniquely designed for that. We are seeing growth in other sectors as well as new market opportunities and other specialties. So, the basic formula or hypothesis of growth here at SonoSite is absolutely happening. Regarding pricing and competition, we feel pricing is holding up in an environment where there is more competition. That competition, however, is from the same players, primarily General Electric and few of the other major imaging companies. We do have in our view a significant market share lead in the segments that we focus on which are the point of care segments in the hospital and outside. So that's about what I can only say at this stage.

[Unidentified Analyst:]

So, are you seeing anything from (inaudible) at all?

[Kevin Goodwin:]

No, not at all.

[Unidentified Analyst:]

Okay, thank you.

[Operator:]

Your next question comes from the line of Alan Robinson from RBC. Please proceed.

[Alan Robinson:]

Hi, good afternoon.

[Kevin Goodwin:]

Hi, Alan.

[Alan Robinson:]

Nice quarter, well done there. Just a point of clarification, I presume the revised guidance does not include the news that we just heard from the GE decision, nor does it include the Zonare settlement. Is that correct?

[Kevin Goodwin:]

Let me have Bernie answer that. Yes?

[Bernie Pitz:]

Sure it does - the 9% to 11% operating margin does include the news and the ranges. Why? Because we don't have an internal estimate yet of exactly how much that will impact us, the debt balance --

[Alan Robinson:]

Okay, so it does include both news items, okay.

[Bernie Pitz:]

No only the GE item, it does not include the Zonare.

[Alan Robinson:]

I see, thank you. And in terms of the remaining GE patents that remains to be decided, which one is that. Could you give us an idea of broadly what it covers?

[Kevin Goodwin:]

Yes hold on a second. It is patent number 621327 and it pertains to DICOM; sorry, we are dropping patent documents.

[Anne Bugge:]

Really.

[Kevin Goodwin:]

So in an event it's a DICOM related patent.

[Alan Robinson:]

Okay, got you. Recalling the first quarter, you mentioned that US sales would have been higher -- had it not been for a push. Could you quantify the extent of that push in the second quarter, the extent to which it helped your US sales in the quarter that we've just had.

[Kevin Goodwin:]

Can't quantify it Allen, but I'll say that the business that rolled over from Q1 to Q2, I believe virtually all of it came in so it certainly contributed to the growth. However, I would not do too much of that information, because the US finished very strong. We had an excellent quarter on both of the US and international side and therefore carried a strong quarter, if you roll revenue momentum into the second half.

[Alan Robinson:]

Okay. And could you give us an idea what your, what the share of revenues brought buy the legacy MicroMaxx product was?

[Kevin Goodwin:]

You know we don't have that Bernie --

[Bernie Pitz:]

We don't break sales up by products, so we don't want to get that granular on it.

[Alan Robinson:]

All right, and just lastly; what kind of trends are you seeing in US hospital spending plans? Are you starting to see a slowdown in budgets, or no slowdown or perhaps just selective spending declines in areas where you are less exposed?

[Kevin Goodwin:]

We have not seen a slowdown in spending for what we sell and to whom we sell it. Remember, our technology is used to improve patient care efficiency, safety and overall quality. It absolutely improves physician performance through visualization. Frankly, I like our position. I think Toyota has positioned itself in the auto market with this new hybrid technology which solves a lot of problems given these shifting environment. We don't seem to be caught up in the capital spending problems of the larger more expensive hardware.

[Alan Robinson:]

All right, good news. Then actually just one last one, I am sorry - the settlement with Zonare. Does this imply or perhaps open the door to any collaboration going forward, perhaps the start of a new relationship either in terms of R&D collaboration or sales collaboration? It seems to me there is not too much overlap in your respective end markets.

[Kevin Goodwin:]

No, they are absolutely a competitor and so as a result I don't see much more collaboration than what we have just done.

[Alan Robinson:]

All right, that's all, thank you.

[Kevin Goodwin:]

Thank you.

[Operator:]

Your next question comes from the line of [Jerrin Holds] from Thomas Weisel Partners. You may proceed.

[Jerrin Holds:]

Thank you, good afternoon. Have a question on the Zonare patent. Can you just explain why that the case was settled? It just seems like the 412 patent for SonoSite could be interpreted is more important than the Zonare patent. Can you just help us understand why that was settled?

[Kevin Goodwin:]

Well, that will require going through the settlement itself. And I would say that we made a sensible move in our view not one that really would imply anything about the value of the two patents in our opinion. And at this stage, I'd say, it will be seen I think in the long-term as a good move.

[Jerrin Holds:]

So they can still sell their Z.ONE with the scanner, but they are prohibited from coming out in the market with another handheld device under 10 pounds, is that correct?

[Kathy Surace-Smith:]

Yes this is Kathy Surace-Smith, SonoSite's General Counsel. As the license on the 412 only extends to the Z.ONE product line, it does not extend to any other products under 10 pounds.

[Jerrin Holds:]

Okay, so could Zonare come out with another 10 pound machine as an adjunct to either the Ultra or one of their other systems?

[Kathy Surace-Smith:]

Not without infringing the patent or violating the license terms.

[Jerrin Holds:]

Okay and in regards to the GE case, Is the 412 in your case still outstanding?

[Kathy Surace-Smith:]

The 412 was not involved in this particular case we are discussing today. There is a separate law suite by GE in the same court room filed in May of this year, seeking to invalidate the 412. And that is in process that litigation separately from this initial one which was filed by them last May.

[Jerrin Holds:]

I see, okay and just lastly on products. It seems that the S Series is doing very well, given the design and the features of the zero foot print idea. Are there any companies out there that appear to be entering this space and if so are there, how do you feel about the patent surrounding that type of technology? Thanks a lot.

[Kevin Goodwin:]

Well there are other companies growing look-alike products in this space, look-alike in the sense to say our Turbo products, clam shell design. No one so far is coming at the marketplace with this highly innovative S strategy that we have employed and that the IP applications are implications of the same for both product lines. So, that's really the way to think about that.

[Jerrin Holds:]

Thank you.

[Operator:]

Your next question comes from the line of Charley Jones from Barrington Research. You may proceed.

[Charley Jones:]

Good afternoon, nice quarter.

[Kevin Goodwin:]

Thank you.

[Charley Jones:]

I think so. I have questions here and Bernie, welcome and…I'm missing Mike, but welcome.

[Bernie Pitz:]

Thank you

[Charley Jones:]

I'm missing Mike, but welcome. Could you give us the percentage of revenue that M-Turbo made up? The reason why I asked is, we used to really talk about just MicroMaxx and I'd like to have it for comparison purposes?

[Bernie Pitz:]

Yeah, we don't break them out individually - just indicated that the two were over 50% M-Turbo and S Series.

[Charley Jones:]

Okay. Is that it? Kevin you are not going to break out M-Turbo?

[Kevin Goodwin:]

Well, no. We'll do only [visually] which is to give you commentary on the sector, which is the sum of the two, M-Turbo and S, but Bernie got it right.

[Charley Jones:]

Okay. And then what are the two patents that are still outstanding on your end for GE discussed in the…?

[Kevin Goodwin:]

Hold on a second, we have our general counsel who will help with you that.

[Kathy Surace-Smith:]

The two patents of ours that are still outstanding are the 6569101 and the 6962566, and we are hoping for rulings on those and the one outstanding GE patent in the next few days.

[Charley Jones:]

Okay, great. And then what's your time line for the 412 patent?

[Kathy Surace-Smith:]

Well, that's up to the court. At this point the trial is set for next year, beginning of next summer.

[Charley Jones:]

Okay, and did you receive, did the patent that you cross licensed within Zanore? Did that help with the ruling today or does that have any implications in any of the future cases? You probably can't talk about the last part of that, but?

[Kathy Surace-Smith:]

Yes, you are right. I can't. But, it has no bearing on either of these, the first case or the second case.

[Charley Jones:]

Okay that's helpful.

[Charley Jones:]

Bernie or Kevin, could you talk a little bit about international revenue growth? Could you highlight some areas where you are particularly strong, whether its Japan or China or just Europe Western or Eastern or --?

[Kevin Goodwin:]

Yeah, China not beyond what we already did, we broke it out by the four regions that we normally report on, and beyond that not going into by countries specific information.

[Charley Jones:]

How did Japan do? Can you even go there? Is it starting to recover?

[Kevin Goodwin:]

No, we are not going to provide any sales numbers on a particular country.

[Charley Jones:]

Okay. At what point do we -- do you guys have a buyback in place and if not would you consider one Kevin?

[Kevin Goodwin:]

I'll let Bernie handle that.

[Bernie Pitz:]

No, not currently and at some point in time if we don't believe we have an opportunity to invest the cash and exceed our weighted average cost to capital then we would consider either that or a one time dividend.

[Charley Jones:]

Okay so you don't have any plans to buy back the bonds?

[Bernie Pitz:]

No, there are currently no plans over there.

[Charley Jones:]

Do you guys have things in your pipelines or I am having things falling out of the pipeline, because they didn't workout?

[Bernie Pitz:]

Sure as Kevin mentioned we're actively looking at a number of opportunities and at this point don't have anything specific to report, but we are active.

[Charley Jones:]

Okay, and then could you comment a little bit on how this shift from MarketBridge has helped you?

[Kevin Goodwin:]

Well, it has definitely helped us. It has been the rule since we started the company. We get better execution and performance when we manage it and do it ourselves. So MarketBridge gave us the starting point to work with; we have integrated that successfully and quickly and we've seen very nice improvement in the first half. We're very happy with our private office sales team and clearly it's a positive, the transition.

[Charley Jones:]

So how many sales reps you are up to now replacing that?

[Kevin Goodwin:]

We are at about 70 territories in the US.

[Charley Jones:]

So you are allotted about 45 before, 48…

[Kevin Goodwin:]

That was about the average in the year ago, yes.

[Charley Jones:]

Right, so you have gone a little bit just top end of that range that you talked about in the last quarter at least and not a couple more?

[Kevin Goodwin:]

That's correct.

[Charley Jones:]

On the G&A, you talked about removing some of the GE litigation expense from your SG&A to go to the higher operating profit guidance that you have. Can you give us any more granularity on that? It was $3.5 million for the quarter. You still have a couple things outstanding, any help would be helpful.

[Bernie Pitz:]

Right, now we have some late breaking news here just this morning. So we are currently evaluating where we are at with our difference cases and have nothing to report in terms of second half expenditures and outside legal costs.

[Charley Jones:]

So, it broke this morning but your guidance includes the information, right.

[Bernie Pitz:]

Yeah, we had to put a range on there, Charley because we don't have very specific information as you can imagine with the information just coming out today. So took a quick look at what it could do under a number of scenarios and included that in the operating range that we gave.

[Charley Jones:]

Were there any other positive contributors to that? You guys weren't expecting in the beginning of the year and now are you going to have a lot of spending?

[Bernie Pitz:]

Well, I think probably the biggest one is that we have taken our revenue up for the year, right, that has a positive impact, so that's the biggest item.

[Charley Jones:]

Okay, thanks a lot guys.

[Bernie Pitz:]

Thank you.

[Operator:]

Your next question comes from the line of Charles Chon from Goldman Sachs. You may proceed.

[Charles Chon:]

Hi everybody, thanks for taking the question.

[Kevin Goodwin:]

Okay Charlie.

[Charles Chon:]

I just want to confirm one response before. Did you say that for the remaining patent was not included as part of this summary judgment decision today. Are you expecting a decision on those three patents before the case goes to trial on August 11?

[Kathy Surace Smith:]

That would be the normal procedure, when summary judge motions are pending. So we still have those motions on those three patents pending and judges typically will decide them before trail starts.

[Charles Chon:]

Okay, so stay tuned for those three patents. All right, the other question I had was just trying to piece together a couple of [dart points] you threw out there. You indicated that the US finished strong in the quarter. I was just wondering are you talking about the typical inter core trends that we see or that our pre-customary for cap equipment purchases or did you see a different sort of kind of trajectory through out the quarter there?

[Kevin Goodwin:]

Well Charlie, what I saw as mentioned in the script was greater linearity, more consistent momentum week-by-week and a very strong finish. So we are about trying to go over board I'd say they had a really strong quarter and really almost ran the table for the quarter. We feel good about that it was a sort of a step forward for our sales force; it doesn't mean anything for the future they have still have to do it again but was an encouraging sign.

[Charles Chon:]

So when you are talking about linearity, I'd like to just focus on that for a quick second here. I am wondering what the read through is there. Are you trying to suggest that the sales funnel is much more stacked than, what you have seen in the past, is that the linearity that you are talking about. And also is linearity just only in the US or we are seeing that across broad including outside the US as well?

[Kevin Goodwin:]

Well the later part of your question is very reasonable and that we have seen increased what I'd call weekly consistency and performance. So investors see that as a positive, may be linearity is a little bit of a wrong word. Otherwise our sales pipelines both US and international are very strong and getting stronger that's something we measure daily, weekly and monthly and those of course are leading indicators for us and they are definitely strong. So we see a good front end which is the pipeline. We have seen a good weekly backend which is a conversion to revenue and in general, we see a broadening in performance improvement the numbers that Bernie broke out from a geographic sector standpoint. I think these are good examples internationally, even without the dollar gains. And then on the US side we saw wider breath of performance and better weekly consistency. So, overall a good start, a good quarter to manage.

[Charles Chon:]

Great. And regarding the last question, in the first half of the year, we see international as a big part of the revenue mix. I understand that FX has a big part to do with this, but from here on out can you just tell us how we should think about the US OUX mix for the remainder of the year?

[Kevin Goodwin:]

Sure, it's expected to be quite strong in the second half as well and approximately 50% of our business is expected to come internationally as it has over the first half.

[Charles Chon:]

Okay. So, then in terms of the US revenue growth opportunity, could we see a increase beyond what we've seen here in the first half and not to mention the second quarter growth trend?

[Kevin Goodwin:]

Well, Charley lets say it this way, the international group is doing very well and they are growing better then expected. Therefore they are gobbling up a bigger part of the mix, whereas the US group is on target. So, that's what's causing a shift. I expect the US to be on target in the second half. As you know the US has a seasonally big buying period coming up Labor Day to New Years Eve. So, that is where their dollar scale is likely to really move up, however can't say enough about the international group. They are really moving it and they are trying to catch up this year. So we will take a 50

[Charles Chon:]

Just to add one last question. In terms of US hospital growth, how strong was that growth during the quarter?

[Kevin Goodwin:]

We're not going to break that out but it was excellent Charley.

[Charles Chon:]

Okay, thank you very much.

[Kevin Goodwin:]

Thank you.

[Operator:]

And we have no further questions on the line and I would like to now turn the call back over to Mr. Kevin Goodwin. You may proceed.

[Kevin Goodwin:]

Thank you, well as I mentioned earlier today marks our 41st conference call as a public company. We've now shipped over $1 billion in cumulative revenue. We are on our way to 45,000 installed systems. We have established a vital new category in medicine and I could say for the entire management team that we quite seriously feel like we are still just getting started. So we look forward to working with everyone in future and we will continue to do our best, thank you.

[Operator:]

Thank you for your participation in today's conference and this concludes the presentation and you may now disconnect. Good day.