IntriCon Corporation (IIN) 2019 Q2 法說會逐字稿

Good day, ladies and gentlemen, and welcome to the IntriCon Corp. Second Quarter 2019 Earnings Conference Call. (Operator Instructions) I would now like to introduce your host for today's conference, Leigh Salvo. Ma'am, you may begin.

Thank you. 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 the 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 materially differ -- 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 in our 10-K filing for the year ended December 31, 2018.

With that, I would now like to introduce IntriCon's CEO, Mark Gorder, for a review of the company's second quarter performance. Scott Longval, the company's COO and CFO will then cover the financial results in more detail, and we'll open the call for questions. Mark?

Thank you, Leigh, and thank you, everyone, for joining our call today. As we enter the second half of 2019, our team continues to execute against the priorities we established at the outset of the year, while carefully planning for several exciting growth opportunities on the horizon. To quickly recap our priorities for 2019 include: one, meet the demands of Medtronic; two, pursue development opportunities in our medical biotelemetry business that leverage our core competencies and diversify our revenue base; three, seek partnerships with best-in-class entrants in the emerging OTC hearing aid market; and four, prudently expand our direct sales initiatives with Hearing Help Express, tempering our marketing and advertising programs.

Our second quarter performance highlighted our commitment to executing on each of these priorities as we continue to focus on our 2 core businesses, medical biotelemetry and hearing health. In both of these segments, our strength as a micro-miniature device producer allows us to enhance the mobility and effectiveness of body-worn devices. Today, we are accomplishing this through partnerships with highly respected, marketing-leading companies throughout the world to provide high-quality medical devices, while selectively pursuing opportunities to reach end consumers directly.

During the first half of this year, we took a number of significant steps to better position the company for long-term growth and to best focus our priorities on our near-term core competencies. As most of you know, several weeks ago, we preannounced revenue of $29.3 million, which excluded contributions from our discontinued operations in the U.K.

I'd like to take the next few minutes to highlight some recent updates, our priorities for the remainder of this year and how we are positioning the company for long-term growth. Following my remarks, Scott will offer a more detailed review of our financial performance and updated guidance for 2019. We'll then open the call for your questions.

Starting with our medical biotelemetry business. Revenues for the quarter increased approximately 3.4% year-over-year and represented 71% of total revenue. Revenue growth in this segment of our business continues to be constrained by order volume related to Medtronic's ongoing global commercial product launch.

During the annual meeting of the American Diabetes Association in June, Medtronic's presentation highlighted their continued confidence in the near-term momentum and sustainable growth potential for its 670G well into 2020, specifically in international markets, where they are only just beginning to ramp up in selected parts of Europe, Australia and other markets around the world.

Encouragingly, Medtronic highlighted growing continuous glucose monitoring adoption and increased penetration in the international markets is a catalyst for their growth. And more recently, they announced their premarket approval submission to FDA, requesting approval for non-adjunctive labeling of their Guardian Sensor 3, which if granted, could broaden patient access. As an important long-term partner to IntriCon, we view this commentary as a further validation of our long-term growth opportunity in this segment of our business.

As we announced a few weeks ago, we secured a 4-year contract that further validates the strength of our relationship and commitment we share in delivering superior products in diabetes management. We are excited to be partnered with the market leader in this rapidly growing space and look forward to continuing to support them in the future. Importantly, we remain committed to diversifying our medical business. We continue to pursue opportunities in other market segments that can benefit from our design, development and manufacturing capabilities.

In addition to the important inroads we are making with potential customers for various medical coil uses, we are also pursuing other biotelemetry monitoring applications that hold significant longer-term potential. On the manufacturing front, we are progressing with the required validations and qualifications of our new facilities and equipment. As a Class III manufacturer of medical devices and components, the process is filled with rigorous requirements, and I'm pleased with the ongoing progress.

While the final validation and qualification require customer action, upon completion, we will be operating at approximately 60% capacity, positioning us to meet anticipated demand growth for the next several years.

Turning to our second core business segment, hearing health. We delivered valued solutions to customers, directly or with partners, through a compressive ecosystem of outcome-based hearing health care tools, including high-quality, low-cost products, technology, service and support. In this segment total revenue in the second quarter was down 13.6% over the prior year's second quarter. Our go-to-market strategy in hearing health includes 3 channels, indirect to consumer, direct to end consumer and legacy OEM. I'd like to take a few minutes to cover some recent updates in each of these channels.

Starting with indirect to end consumer, which comes from customers who sell to the end user through nontraditional models. We posted revenue of $2.4 million in the second quarter of 2019, down over the prior year period. Order delays associated with restructuring activity within a large insurance company's hearing health business impacted our sales in the quarter and are expected to continue through the remainder of 2019. One of our strategic priorities is to pursue partnerships that will enable us to be a dominant early participate in this emerging value-based hearing health market.

Looking ahead, we are continuing to seek opportunities with other independent hearing health participants and market entrants that can combine our hearing aids, self-fitting software and customer care with the highly effective consumer marketing and brand recognition. We are excited to have identified a meaningful number of potential candidates and our commencing discussions with several of them.

Turning to our direct-to-consumer business. Hearing Help Express revenue in the second quarter of 2019 was $1.7 million. As we have highlighted in the past, we are very excited about the emerging opportunity to directly reach hearing aid consumers. While we monitor legislative progress, we plan to continue to selectively pursue direct sales initiatives in a measured approach, while incorporating the insights we have gained in building an ecosystem of care to address this emerging channel. As a result, we intend to reduce cost to a prudent and sustainable level based on data-driven analysis, while we optimize our model.

And finally, legacy OEM revenue, which represents products sold into the traditional hearing health market, continued to decline as anticipated. For the second quarter of 2019, legacy OEM revenue was $2.5 million, a decrease of 16.6% over the prior year period.

Earlier this month, we completed the sale of our U.K. limited subsidiary accessory business assets and entered into a new U.K. distribution agreement with Puretone Ltd. And in connection with this repositioning, we closed our U.K. facility, resulting in an annual cost reduction of approximately $1 million.

On the regulatory front, we were really pleased to see an update from the FDA in June that highlighted action on the anticipated OTC regulation. We believe this update signals the regulation that's moving ahead as expected, and we look forward to potentially seeing draft guidance as early as this November. This legislation is designed to drastically reduce the cost and increase the access to high-quality hearing health care in the U.S. market. We are taking steps to ensure that IntriCon's core competencies are best leveraged to provide innovative hearing health solutions, such as self-fitting software and remote care, to most efficiently meet the needs of the vastly underserved U.S. hearing impaired population and help remove the significant barriers that exist today.

In summary, looking at our hearing health business holistically, I am confident that changes we have made not only reduce cost but will better enable us to focus resources on the emerging opportunity we have to disrupt the estimated $3 billion addressable hearing health market in the U.S., particularly in light of the pending legislation I just highlighted. I'm confident that our track record for excellence, combined with our unique ability to deliver state-of-the-art technologies, including wireless, digital hearing aids and sophisticated self-fitting software solutions coupled with our customer care competency resident in our DTC operations, best positions us to be a significant participant in this exciting and expanding market.

Now I would like to turn the call over to Scott to discuss our financials and guidance in more detail.

Thank you, Mark. Turning to our financial results. For the 2019 second quarter, we reported net revenue of $29.3 million relatively flat from the prior year. Growth continues to be fueled by our medical biotelemetry business, offset by what we believe are temporary declines in our hearing health business. Second quarter gross margins were 28%, down from 33% in the second year -- in the prior year's second quarter. Gross margins were constrained by ongoing validation and qualification expense and excess capacity related to the recent manufacturing expansion to meet the anticipated higher volume requirements of existing and future customers.

Operating expenses for the second quarter were $11.6 million compared to $6.7 million in the prior year period. The increase was driven by a $3.8 million noncash writeoff of Hearing Help Express goodwill and intangible assets, higher noncash stock composition expense, increased advertising investments in our direct-to-end consumer business and support costs related to key new business development initiatives. As Mark noted above, we are committed to lowering costs and gaining efficiencies in our value-based direct-to-consumer hearing health business, as we refine our sales model to better align with the emerging market opportunities. We posted a loss attributable to shareholders of $5 million or $0.57 per diluted share versus net income attributable to shareholders of $2 million or $0.25 per diluted share for the 2018 second quarter. Excluding the onetime noncash writeoff, we posted adjusted net income from continuing operations of $256,000 or $0.04 per diluted share in the second quarter of 2019.

Turning to guidance. As previously announced, full year 2019 revenue is expected to range from $115 million to $117.5 million. Full year 2019 gross margin is expected to range between 27% and 28.5%.. The reduced guidance primarily reflects the following anticipated factors: the impact of the discontinued operation of the company's U.K. facility, lower-than-anticipated order volume related to Medtronic's ongoing global commercial launch and order delays associated with restructuring activities within a large insurance customer's hearing health business.

We remain very confident in our long-term goal. Our restructuring efforts will have a substantial effect on our bottom line, while at the same time allowing us to focus resources on new growth opportunities. In addition to our revenue growth opportunities, we anticipate that over time, we'll be able to leverage our current manufacturing infrastructure to expand gross margins to the high 30% range.

Now I'd like to turn the call back over to the operator so Mark and I can take questions.

(Operator Instructions) Our first question comes from Andrew D'Silva from B. Riley FBR.

Our next question is going to come from Jon Block from Stifel.

This is Tom on for John. Scott, maybe I'll start with you. On the medical side, our partners had some recalls. Can you maybe explain or frame what that means for IntriCon?

Yes. No. Obviously, I can't get into specifics in terms of our customers in recalls, but what I can say is the businesses that we're in and the relationships that we have and the products that we do with our customers aren't associated to any recall. And so going forward, we don't see any sort of meaningful impact to us related to some of the -- the point you referenced.

Okay. That's fair. And I guess, sticking with medical, Doug's now been with the -- Doug Pletcher's now been with the company for I think around 6 months. You already have had some small wins with medical. But can you talk to your conviction on more material medical wins over the next 12 to 18 months relative to where it stood 6 months ago?

Certainly. I'll take that. Doug is -- we've given him the task to go out and define the strategy for getting into our new medical business. And so he is well on the path of doing that and identifying several very interesting market opportunities. And over the coming quarters, we will try delineate those opportunities more clearly to our shareholders. They are a little bit more vague at this time. But we are definitely generating some very good opportunities in areas like brain monitoring, in epilepsy, sleep disorders. And then as you mentioned, in the medical coils area, there are a number of new applications growing in that area for using interventional catheters. The existing business that we have in coils is in 2 areas: one is programming of pacemakers and the other is interventional catheters. And some of the interesting areas they are doing cardiac ablation treatments and measuring positioning of those probes and taking biopsies in the lungs and trying to more accurately position taking those biopsies. And Doug is making significant inroads in defining market opportunities in all those areas. So we would anticipate that over the coming quarters we'll be much more definitive on where we're going there. But in the short term, you should continue to see a good progress in our medical coil area. Just -- a number of opportunities we've been working on for some time that are starting to bear fruit. And I think the numbers are kind of starting to show them.

And maybe -- this is Scott. Maybe I'll just follow on to Marks comments. And one of the things that we're very excited about has been the response to our already built core technologies and core competencies and how they fit into some of the opportunities that Mark laid out. As we've talked about when we first brought Doug on, we're very internally focused working with our existing OEM customers, Doug has been much more externally focused. And through that, we obviously believe that our technology and our competencies would be well received in the medical community. And that's what we're finding out. So now it is (inaudible) some of the shorter-term opportunities with the longer-term, larger opportunities and how we pursue those. And to Mark's point, we'll look to update the group as we proceed over the next 6 months and on into 2020.

And I guess, I would close with just one additional comment is that it's -- we went into this feeling that our core technologies would be very well received by many other medical device customers if we made the investment to get out there and identify those areas, and we're not disappointed in what we're finding.

Awesome. That's really helpful color. And then one quick one on hearing, if I may. Can you just remind us where you are with the self-fitting hearing initiatives?

Yes. Definitely. The -- as we announced in prior press releases, we have been working with a company in Germany, Soundperience, on developing a self-fitting technology we call Sentibo. That's been in progress in Germany for some time. We're intending to bring that over to the U.S. market and adapt it to use in direct-to-consumer channel, both with ourselves and with partners. And we're currently in the process of working with the FDA on submitting a 510(k) for clinical trials to prove out the technology in the U.S. market that's required before it can be used. And we're well along the path of having discussions with the FDA and defining exactly how that clinical should go forward. And we think we are on track with having that technology available in a timely manner when the OTC regulations are actually put forth and enacted, which we expect will be sometime in around mid-2020.

And our next question comes from Andrew D'Silva from B. Riley FBR.

And sorry if you highlighted any of this. I was moving between calls. So just let me know if you did, and I'll check out the transcript tonight. But could you just quickly just touch on what stock-based comp, depreciation, amortization cash flow from operations and CapEx was, Scott? And then Mark, as far as the 670G goes, I know you referenced the international launch and that being some of the reason for the revised guidance. But Medtronic provided a fairly consistent update as far as their annual outlook goes. Could you maybe clarify the difference between the 2 outlooks, as far as your revised guidance and then maintaining theirs?

Andy, this is Scott. I think I'll take both of those questions. For the stock-based comp for the quarter, $537,000. Depreciation and amortization was $818,000. Cash flow from operations was $1.7 million. And CapEx for the quarter was $1.4 million.

And then in terms of your question on Medtronic and the outlook that they've provided at the ADA in early June. I think they gave a presentation where they talked about organic growth of 6% to 8% for their fiscal year 2020. Now keep in mind their fiscal year runs essentially May 1 through April 30. And so they talked about their 2020 fiscal year that actually leaps into our fiscal 2020. And then further, if you look at the guidance they gave, they talked about most of that was going to be on stronger second half launches, particularly in the international market. So if you think the stronger second half for them really is our November through April.

So that gives us, again, a lot of confidence as to where that business is moving. We wanted to take a more cautious approach as we thought about guidance for the second half of the year because this has been a little bit elusive in terms of the timing. And so that was the test that we took when we thought about guidance, but also the confidence that we have as we move into 2020.

Okay. So it would be a fair assessment to say that there is a chance that some of that could fall into the fourth quarter. Or that 2020 for your calendar year would be very potentially strong in the beginning of the year relative to this year.

Yes. That's definitely true consistent with the remarks.

Okay. Perfect. Their -- Medtronic, again, is expecting to have a pretty big overhaul next couple years, when it launches its PCL platform. Could you maybe let us know how you are integrated today and how you'll be integrated in that platform? It's just a very different-looking CGM system. And I'm just curious how the disposables would work?

Yes. That's another great question. As part of that ADA presentation, they outlined their product pipeline for the next several years. The 670, obviously, which they are still battling to get the international approval; the next-generation pump, the 780, which again they're targeting to get approval here in the U.S. in the next 12 months, and then eventually it will find its way into the international market. Both of those platforms are built off of the CGM that we provide for Medtronic today. And so as you think about the next several years coming off of those lines, we feel that we're very positioned -- very well in place for growth.

As you think about the personal closed-loop platform that you talked about, they highlighted that initially it looks like it is going to be based off of the current transmitter platform that they have, but eventually, that visions into a disposable CGM that would be ultimately something that could support the personal closed-loop system. We can't get too far ahead of ourselves in terms of what we talk about our customer's business due to confidentiality. So I can't go into great detail. What I can say is, obviously, we've worked with Medtronic for quite some time. We just signed a 4-year supply agreement that I think kind of signifies their confidence in what we do and what we can deliver. And so as they start to envision new platforms, we want to make sure that we're at the table talking to them and making sure they understand what we can provide. So all I can tell you is that we're aggressively doing that, and we feel confident with that relationship.

Okay, great. And the last question from me is just related to the OTC Hearing Aid Act and the guidance that's expected to come out from the FDA. Could you maybe elaborate on some of the pushes and pulls? And what could be viewed as like a very positive guidance? And what maybe would be, in your eyes, a not so great outcome?

Yes. I'd be glad to. They -- I was just out visiting the FDA a couple of weeks ago on July 23rd to discuss our 10(k) submission, and we had a pretty good discussion about that. And I think the legislation highlights a couple of things that are critical to us. One is that the regulation should allow for perceived mild-to-moderate hearing loss. And the word perceived is important because a lot of times people perceive their hearing loss to be better than it is. So for example, you might have severe hearing loss, and if somebody asked you the question, you might say, "Well, I've got moderate hearing loss." And that's kind of well-known. So what the legislation allows is for the consumer to decide what is mild to moderate. That's good for us because the -- that allows for a more -- higher power hearing aid to be sold into the OTC market, which increases the addressable market that we can obtain with the OTC category. And our feeling is that the FDA is going to be relatively liberal on that regard. There is already some published -- they already approved an FDA De Novo application composed for a self-fitting device that had a power level about 120 dB SPL, which is pretty good from our perspective. So the fact that, that's already been approved indicates to us that the legislation is going to be pretty favorable going forward relative to specifications that would allow a relatively large addressable market.

So what we know so far, we're pretty pleased with what we're hearing. And the commissioner at the FDA issued a document a few weeks ago. I don't -- I can probably have Scott dig up the reference. But they indicated that there was going to be a November issuance. I was not able to confirm that during my FDA discussions, but the commissioner did put that in a public document. If that's the case, then the FDA has 6 months after the issuance to actually put out the regulation and that includes a public comment period. So we're pretty optimistic that mid-2020 the regulations will be in place.

Sorry, I actually had one more question. The comment period can be included in the 6 months. So if it's 60 days, then it would be 4 months from there, not 60 days plus 6 months?

Correct. We -- as we understand it. This was a discussion we had that the FDA legal department has indicated that they believe that, that 60 days is included in the 6 months.

Our next question comes from Dick Ryan from Dougherty.

Mark, to tag along on that FDA. Can you file your submission, your 510(k), or when in the FDA process can you file your 10(k) submission?

Well, what happens is we put in a presub application, and we request the FDA give us guidance as to the outline for the clinical trial models that we are proposing. And we had this meeting on the 23rd, and they are relatively -- they were very -- with a good dialogue, a good, I would say, collaborative dialogue, and we got a good positive response out of them. So we can start our clinical trial within a few weeks. And -- but you still have to go through the clinical trials and you have to present the findings to the FDA. They review that and then will give you a go or a no-go. So we're anticipating that the clinical trial will take a few months. So we're probably looking at the end of the year before we would have something submitted back to the FDA.

Okay. So you wouldn't have to wait if it is mid-2020. You wouldn't have to wait until then to file.

No.

You can do it in -- while the process is underway. Okay. What are you guys doing on the -- in the direct-to-consumer side? You're rationalizing cost, but can you talk about kind of where you're taking people out of or adding as your internal sales group's still up and running? And what's the headcount with that?

Can't really speak to that, but I'd say let me speak more philosophically that what we realize is that we really got to take a pencils-up approach to make sure that the advertising expenditures that we're undertaking are producing the result we expect. So we're really trying to reduce our cost to a prudent and sustainable level, while we optimize the model. So I would say we're kind of in a product development mode there. We're trying to put in all of the measurement systems we need in order to assure that our KPI is measuring the outcomes that we expect are actually happening. And so we're going at this very prudently. So I think we talked about reducing advertising costs last quarter, and we started that. We're doing more of that as we speak. And we'll keep you appraised as to the effect of that, but you should see an improving bottom line quarter-by-quarter for the rest of the year in the direct-to-consumer business.

Okay. And on the indirect side, that had some pretty decent numbers, Q3, Q4 of last year. They've tailed off Q1, Q2. What are you seeing on the indirect side?

Well, the main reason there as we said in the announcement was a restructuring going on at one of our large insurance partners. And we anticipate that will carry on through the rest of the year. But offsetting that, we're continuing to look for partnerships outside of our existing ones and looking at potential partners, like Bose, Best Buy, and trying to make business development efforts there because we think some of those people could be very good indirect-to-end consumer partners. So even though that we're disappointed that the restructuring took place, and it's got a short-term impact. We expect that'll eventually recover. And then we're also driving -- growing these other relationships.

Maybe I'll just add one comment on top of that. One of the things we're seeing as the legislation's becoming nearer and nearer is more and more parties are interested in this space, and they're coming from numerous different channels and working for partners that have the type of technology in terms of hearing aids and fitting software and customer support fulfillment that IntriCon has. So as we get closer to legislation, we see more and more people that are interested, and it's going to be our job to make sure that we position ourselves as the best case supplier for these partners and choose the ones that have business models which we think can be successful longer term.

And I'll add to what Scott said there, too. We have some very valuable assets in our direct-to-consumer business. Not only do we have for IntriCon, we have the high-quality devices, we have state-of-the-art self-fitting technology and things that are needed to build an ecosystem of care, but down at HHE, we also have very good teleaudiology capability. And pick, pack and ship capability, which is critical to support some of these partners that are looking to get into the business that have marketing capabilities, but they don't have that back end. So we're looking at providing not only devices and software but also back-end teleaudiology and pick, pack and ship to some very exciting partners.

And I'm showing no further questions. And now I would like to turn the call back over to Mark Gorder for any further remarks.

Thank you, again, for joining our call today. I'm pleased with the progress the IntriCon team is making and would like to thank them as well as our shareholders for your continued support. We look forward to seeing many of you during upcoming conferences and marketing trips. Have a great evening, and thank you for participating in the call.

Ladies and gentlemen, thank you participating in today's conference. This concludes today's program. You may all disconnect. Everyone, have a great day.