Obagi Medical Products, Inc. Q3 2008 Earnings Call Transcript

Nov.20.08 | About: Obagi Medical (OMPI)

Obagi Medical Products, Inc. (NASDAQ:OMPI)

Q3 2008 Earnings Call Transcript

November 6, 2008, 4:30 pm ET

Executives

Ina McGuinness – IR, Integrated Corporate Relations

Steve Carlson – President and CEO

Preston Romm – CFO, EVP of Finance, Operations and Administration, and Treasurer

Analysts

Katherine Lu – Oppenheimer

Angela Larson – SIG

Adam Greene – Stanford Group

Larry Neibor – Robert W. Baird

Operator

Good afternoon, ladies and gentlemen. Thank you for standing by. Welcome to the Obagi Medical Products third quarter earnings conference call. During today’s presentation, all participants will be in a listen-only mode. Following the presentation, the conference will be open for questions. (Operator instructions)

As a reminder this conference is being recorded today, Thursday, November 6, 2008.

I would now like to turn the conference over to Ina McGuinness. Please go ahead ma’am.

Ina McGuinness

Thank you, operator. This is Ina McGuinness with ICR. Earlier this afternoon, Obagi Medical Products released financial results for the third quarter and nine months ended September 30, 2008. If you have not received the press release it is available on the Investor Relations section of the Obagi Medical Products website at www.obagi.com. This call is being web cast and a replay will be available on the Company’s website for 30 days.

Before we begin, we’d like to remind you that today’s remarks contain forward-looking statements within the meaning of Federal Securities Law. These statements do not guarantee future performance and therefore undue reliance should not be placed on them. We refer you to the risk factors contained in Obagi Medical Products’ SEC filings for more detailed discussions of the factors that could cause actual results to differ materially from those projected in any forward-looking statements. All information provided in today’s call is as of the date of the live broadcast, Thursday, November 6, 2008 and Obagi Medical Products assumes no obligation to update any such information.

Participating in today’s call from the company are President and Chief Executive Officer, Steve Carlson, and Chief Financial Officer and EVP of Finance, Operations and Administration, Preston Romm.

And with that, I’d like to turn the call over to Steve Carlson. Steve?

Steve Carlson

Thank you, Ina, and good afternoon everyone. Overall we’re pleased with our financial performance during the third quarter. Despite the extremely challenging macroeconomic conditions which were compounded by the seasonally weakest time in the year for our business our sales declined only slightly and we maintained our track record of profitability.

Total revenues for the quarter were $26 million down about $300,000 and for the nine months ended September 30, 2008, our sales are up 5% to $79.2 million year-over-year. Although our businesses is not recession proof we believe it is fairly resilient and the top line performance appears to be more stable than that of the recently reported aesthetic procedure providers.

We also made good progress on the international front in the third quarter albeit with a modest 3.5% increase in sales. More importantly the implementation and placement of sales managers permanently in each of the key regions has resulted in ELASTOderm and CLENZIderm now being registered for sale in almost all our distributor countries and recently we signed new distribution agreements in China and Australia.

We believe we will begin to see the benefit of these initiatives in China, Russia, Japan and other key countries within the next three to four months and beyond.

During the quarter, our net income totaled $2.9 million of $0.13 per share which was in line with our expectations. Importantly we continued to generate strong cash flow from operations and ended the quarter with a very healthy debt free balance sheet that underscores our strong financial position.

In terms of product lines and segment performance, ELASTOderm, which includes our Decolletage system and our eye cream and gel saw sales rise 46% to $2.4 million. Our account penetration data indicates that more than 4,067 accounts have now purchased ELASTIderm products with approximately 241 new accounts have been ordered in the past quarter. Reorder rates were an impressive 83% for the eye cream and a strong 50% for Decolletage.

Additionally, we have been conducting comprehensive clinical studies and have been presenting these findings in industry events to demonstrate the dramatic improvements our patients experience when using ELASTOderm on total damaged skin on the chest and neck areas as well as skin around the eye. Based on the strong reorder rates we saw during the third quarter we remain enthusiastic about the future upside potential for this technology and product lines.

For CLENZIderm, third quarter sales totaled $1.8 million, which is down about 2% year-over-year. However, account re-order rates remained strong at 83%. Our ongoing clinical studies continue to confirm high efficacy of CLENZIderm in treatment of acne due to our solubilized BPO antibiotic free formulations.

Turning to our core products, sales in Nu-Derm were $14.8 million down 9% from the year ago. Reorder rates for Condition and Enhance was 73% for the core systems. Sales of Obagi C Rx, Professional-C, Tretinoin and others equaled $5.8 million up 13% versus a year ago.

Further we completed our direct to consumer awareness campaign for our Condition and Enhance systems. While feedback from our physicians accounts was positive and we achieve a 200% increase in website hits since the program commenced, and we saw a significant increase in physician locator hits, we have determined that the market conditions does not warrant our further continuing to invest in this program.

Now let me update you on our SoluCLENZ Rx Gel, the first product we have launched in the pharmacy dispense channel at the beginning of August. For the first six weeks in the market SoluCLENZ generated minimal sales due to slower than expected up-tick from physicians. While this is disappointing, we still believe there is significant opportunity in the therapeutic market for SoluCLENZ especially for patients who do not view the treatment of acne as discretionary spending.

Our clinical data versus BPO clindamycin combinations continues to be superior. We believe this slower than anticipated up-tick was primarily due to the lack of trial samples and physicians concerned that SoluCLENZ will be pharmacy substituted by generic products. We’re pleased to report that we are rapidly moving forward to resolve both these issues. We shipped trial samples to the field this week and we are implementing a patient loyalty card, which will mitigate physicians’ concerns of pharmacy substitution. And of course our sales force will continue their efforts to drive product acceptance.

With only modest product penetration estimates for Q4 as we implement the above programs we look forward to report on our progress on our next earnings call.

Looking at our sales force, today we have 133 sales reps of which 44 are dedicated to sale of therapeutic products. In comparison to our last call this means we now have 133 domestic sales people versus 130 in mid-August. During the third quarter we also continued to have very strong new account demand and established nearly 300 new physician accounts. The total number of active accounts increased 12% year-over-year to more than 5600. Further our base dermatology accounts grew 20% from a year ago.

With that let me turn the call over to Preston.

Preston Romm

Thanks, Steve, and welcome everybody. Steve already touched on our net sales for the third quarter of $26 million compared to $26.3 million last year.

Year-to-date net sales were $79.2 million up 5% from $75.4 million last year with US revenues representing an increase of 4.4% and international revenues grew up 8%.

For the third quarter U.S. revenues were down by 1.9% year-over-year as a result of the economic downturn while the international revenues still grew at 3.5%.

Third quarter net income was $2.9 million or $0.13 per fully diluted share versus $3.9 million or $0.18 per fully diluted share for the third quarter of 2007.

Year-to-date net income totaled $10.4 million or $0.46 per diluted share, compared with net income of $10.7 million or $0.49 per diluted share for the same period last year.

Turning to our third quarter operating metrics. Gross margin decreased to 80.3% from 82.5% for the third quarter of 2007 primary due to a decline in the higher margin license fee and CLENZIderm Rx gel promotion programs.

Selling, General and Administrative expenses, which include depreciation, amortization and non-cash compensation expenses, rose 10% to $15 million compared with $13.6 million a year ago. Our ongoing cost cutting programs were more than offset by expenses associated with the SoluCLENZ Rx gel launch and support, the direct to customer awareness campaign and double rent paid during the quarter in conjunction with our move to the new headquarters. As anticipated, these expenses amounted to $1.6 million on a pretax basis of $0.04 per diluted share. On a year-to-date basis these expenses amounted to $1.9 million on a pretax basis or $0.05 per fully diluted share.

Net interest income for the third quarter amounted to $63,000 compared to a net interest expense of $355,000 during the same period last year. This improvement of $418,000 is due to positive cash flows and paying off our outstanding debt.

Income from operations was $4.8 million or 18% of revenue compared with $6.7 million or 26% of revenue a year ago as a result of higher operating expenses I just discussed. Income tax expense was reduced to $1.9 million from $2.5 million a year ago and our effective tax rate was at 39.7% [ph] for the third quarter 2008 as compared to 39.2% last year. As you know in October, Congress passed a bail out bill which approved the R&D tax credits for 2008 and 2009. As such the fourth quarter will include approximately $300,000 of year-to-date tax benefits, which will lower our effective annual tax rate to 38.8%.

Our balance sheet continues to be very strong. As of September 30, 2008 we had cash and cash equivalents totaling $24.4 million up $14.1 million from December 31, 2007. Working capital totaled $46.4 million and stockholders equity totaled $62.0 million.

In addition, we generated $13 million of positive cash flow from operating activities for the first nine months of 2008.

Finally moving to our guidance. We are revising guidance for the fourth quarter taking into consideration the continuing deterioration of the economy and its effect on strategic investments we previously thought would generate growth opportunities as early as the fourth quarter. As a result of these factors and our desire to remain conservative we now expect the fourth quarter revenue to be in the range of a $26 million to $27 million, an EPS in the range of $0.12 to $0.14 a share down from the previously guided $31 million and $33 million of revenue and EPS of $0.26 to $0.29 a share. This represents a flat to 4% decline in quarterly revenue from last year while total year revenues would be up from 2007 around 3%.

Given the current unstable worldwide economic conditions we think we will have better visibility of what to expect for 2009 after seeing the fourth quarter results and we will report these to you along with your year-end numbers. So keep in mind the following items with regard to 2009. Q3 and Q4 of 2008 are showing us that although we’re being impacted by the economy the core domestic dispense business is more resilient than the higher priced aesthetic procedures. In fact, we’re hearing that physicians are moving patients down the food chain towards our lower priced and effective topicals. We’re cautiously optimistic that this trend will continue.

We continue to add new accounts at a healthy rate and we’re gaining market share. Continuing to add new products to our offerings should add incremental revenues next year. We’re beginning to see some traction on the international front and finally we have over $24 million in the bank, positive operating cash flows and have a solid profitable business model. We don’t need to raise money either to run the business or survive this downturn.

With that operator let’s turn over to questions.

Question-and-Answer Session

Operator

(Operator instructions) Our first question comes from the line of Katherine Lu with Oppenheimer. Please go ahead.

Katherine Lu – Oppenheimer

Thank you for taking my question. First of all I would like to ask Steve – Preston about this question, where does your share repurchase program stand right now?

Preston Romm

Thanks Katherine, welcome to the call. As you know, last quarter the board authorized for management to spend up to $10 million for stock buyback. We had that approved but we had not implemented any money towards buying back stock at this point in time. I think particularly in this economy more than macro issues out there driving everybody’s stock price including ours and I’m not sure investing $10 million will alter that. And also particularly in this economy I think cash is king. On the other hand, we do have money that we don’t have the need for. So we will keep taking a look at stock buyback and report to you next quarter.

Katherine Lu – Oppenheimer

Okay, sure. I noticed you added another three salespeople to your sales team. So I’m just wondering some time down the road is there a point that you feel you will have enough salespeople and you don’t need to add additional and maybe do allocating between the existing accounts and new accounts. I’m just wondering if we will see this point sometime in 2009.

Steve Carlson

Katherine this is Steve and thank you for joining the call. Yes we did add three salespeople and as we have indicated in the past, we add salespeople as new account demand continues to drive that curve. We certainly in this economy are going to be very careful about new ads and will continue to look at what is the proper allocation of salespeople against existing accounts and new account demand flow as it goes forward.

Katherine Lu – Oppenheimer

Okay. Finally I just want to ask a question about your new product launches in 2009. How should we be thinking about the timing for those two new product launches and if I may, if it is possible, if I can ask although it a bit maybe further how should we be thinking about new product launches in 2010 and beyond?

Preston Romm

Yes as it relates to product launches and you know from history Katherine, we don’t provide specific details of the launch and the specific timing for competitive reasons but we remain confident and comfortable that we will have in 2009 and in 2010 at least two new product launches and importantly as we look at new products going forward, these are new products that we’re looking at expanding our opportunity to treat every patient that walks into a plastic surgeon or a dermatologist’s office. So, these are really new product launches for new applications, not new products that we’re looking at as step ups that have cannibalization impacts on our existing lines.

Katherine Lu – Oppenheimer

Great. Thank you very much.

Preston Romm

Thank you very much.

Operator

Thank you ma’am. Our next question comes from the line of Angela Larson with SIG. Please go ahead.

Angela Larson – SIG

You have been having to call and I know this is a difficult economic environment still I apologize up front what I want to ask you some pushy questions. When you look at your year-over-year comparisons you have added 45 sales reps compared to third quarter last year, yet your sales rate is relatively flat still at $26 million odd. So again why are you adding the sales reps if we’re not seeing the impacts in the sales line?

Steve Carlson

I think it is a good question Angela. As we look back a year ago and you will recall that the real core addition of salespeople was focused on the therapeutic dermatology space. We initiated that with approximately 25 people to support the launch of CLENZIderm, the soluble BPO position against BPO clindamyacin antibiotic combinations. So the initial 25 was therapeutic dermatology CLENZIderm predominantly focused and only recently as we launched into the pharmacy channel did we add on that incremental 20 individuals to support that prescribing dermatology community. Going forward, we will continue to relook at the proper allocation of people and the return on those investments.

Preston Romm

The other thing Angela, this is Preston. I think we changed how we classify the salespeople from last year too. There are 12 people that were here last year that were in either international sales or sales managers in BP [ph]. So, it is really like a 30 people increase. But still a valid question.

Angela Larson – SIG

Yes, because even if we look at the CLENZIderm line, the therapeutic line, I mean we’re still not seeing growth year-over-year even with these new bodies. And it is hard to believe that you know, the therapeutic model is the same as the aesthetic model where then the aesthetic model as you say physicians are saying that they want to move people to these products because they can’t afford more expensive things. Within the therapeutic model you happen to be the most expensive thing.

Steve Carlson

That I think going forward as I indicated on the call, one of the significant focus is to get SoluCLENZ traction moving in the right direction. We’re addressing the two biggest areas that we ever heard since launch which was the lack of trial samples and concerns over pharmacy substitution. So, we launched last week trial samples. We have a loyalty card that will be going out that reduce out-of-pocket costs to a maximum of $25. We have additional clinical data being released and we’re looking every week and expect a significant trajectory growth in those weekly scripts by the end of the year. We will report on that at the next earnings call but your are absolutely correct we’re driving and looking and expecting to get that ROI out of that therapeutic side of our business.

Angela Larson – SIG

Okay, and very last question I promise. Is when you look at your guidance for the fourth quarter it is flat to slightly down with fourth quarter ‘07 on the revenue side but significantly lower on the bottom line EPS side? Should we really be looking at the majority of that difference coming in the SG&A as you move to promote some of these newer products?

Steve Carlson

Yes. The main difference in there is SG&A and you hit the nail in the head the main difference in the SG&A is the additional salespeople and they’re supporting the therapeutic line.

Angela Larson – SIG

Okay, thank you very much.

Steve Carlson

Thank you Angela.

Preston Romm

Thanks.

Operator

Thank you ma’am. Our next question comes from the line of Adam Greene with the Stanford Group. Please go ahead.

Adam Greene – Stanford Group

Thanks. Good afternoon. A couple of questions, first Preston I think you mentioned a tax rate of 38.8 was that for the fourth quarter or for the full year of 2008.

Preston Romm

That will be for the full year.

Adam Greene – Stanford Group

Full year, okay.

Preston Romm

I think if I remember the math it comes down to an effective rate just for the fourth quarter alone of something like 35%.

Adam Greene – Stanford Group

Okay, thanks. And sticking with that line of question, the gross margin was down to kind of levels that we haven’t seen recently. Any reason for that or what was the reason for that?

Preston Romm

Part of it is comparing to last year it is the license fees down from $1.4 million to $1.2 million and that is basically all profit and the other is particularly on the therapeutic side on the CLENZIderm side little more promotions this quarter in the beginning of this year than last year. Those are the two main drivers.

Adam Greene – Stanford Group

Okay. And then following up on Angela’s question, with the sampling of SoluCLENZ, how – what is the size of the sample, the full course of treatment or what –

Steve Carlson

The sample is a 2.7 mL little tube of SoluCLENZ and also in follow up with Angela’s comment about SG&A being up higher this year to last year, as part of the sales force, some samples are in there, some things driving the therapeutic side, you know, Steve talked about earlier.

Adam Greene – Stanford Group

Okay, thank you.

Steve Carlson

Thanks, Adam.

Preston Romm

Thanks, Adam.

Operator

And thank you sir. Our next question comes from the line of Larry Neibor with Robert W. Baird. Please go ahead.

Larry Neibor – Robert W. Baird

Thank you. Good afternoon gentlemen.

Steve Carlson

Good afternoon, Larry. How are you?

Larry Neibor – Robert W. Baird

I am fine. Thank you. How does reimbursement for SoluCLENZ stand at this point in time?

Steve Carlson

As we understand it Larry we have the majority of the coding agencies are waiting us with the unique code which doesn’t allow for generic multisource substitution. We have identified some coding that does allow for the substitution generically, which is why we have implemented the loyalty card to reduce that out-of-pocket cost even in those cases where there is a national allowable in order of generic substitution. For the majority of them, we have been able to get unique designation coding for but that is not obviated the physicians’ concerns as to will the patients actually get SoluCLENZ. So, we are providing formulary information and a loyalty card which is going out next week.

Larry Neibor – Robert W. Baird

Okay, why would the physicians be concerned about generic substitution?

Steve Carlson

In those cases where we don’t have unique coding the physician will be concerned because the patient going to the pharmacist will be offered a generic option as opposed to SoluCLENZ and if it is not designated as unique coding they can deface with a maximum allowable cost as opposed to a generic. The loyalty card will provide them with an offset to that. Their out-of-pocket cost will be max $25.

Larry Neibor – Robert W. Baird

Okay, next what has been the monthly trend in sales say July through October?

Steve Carlson

We don’t give out monthly data. You can see particularly on the core business that obviously the third quarter is down from the second quarter or flat. Each quarter seasonalization is skewed towards the end of the quarter. So it is hard to tell you month by month.

Larry Neibor – Robert W. Baird

If the economy continues to soften when do you reach the point where you decide to begin reducing operating expenses in order to maintain operating profitability?

Steve Carlson

(inaudible) it is not as it continues to decrease; the economy is having an effect on us. We are not growing as much as we are. It is prudent to take those actions continuously. As such, we have identified a number of expenses not just in SG&A but across the company that we have been taking actions – some of that benefit in Q3, we have more (inaudible) in Q4. You want see a lot of the benefit in Q4 but you’ll see the benefit in 2009. To give you an idea, we’re probably talking something in the – at this point in time high single digit cost reductions on our operating expenses in 2009 versus our current run rate.

Preston Romm

I think further to that Larry, one of the things that we are carefully monitoring and looking at is that right now with the negative impact on the number of procedures, we’re seeing a couple of trends and we have implemented a couple of programs recently. One, doctors are beginning to proactively shift from higher priced procedures to less sensitive priced OMP products. They’re looking to maintain patient traffic in the office at obviously at a lower revenue base to them. We’re partnering with physicians more than ever through our Obagi patient event [ph] program. Right now we’re targeting around 400 to 500 of those events in the fourth quarter. We have also initiated a new office staff training program and we will train approximately 3000 people in Q4 specifically on how to maintain and grow patient office visits and influence the buying decisions to lower priced yet still effective products such as OMP. And with that our expectation is we’re going to see continue to see robust new account growth in Q4 and beyond. So, we’re implementing some programs to really help physicians and partner with them to mitigate what obviously is out there in the industry of higher priced cosmetic procedures that have fallen off fairly substantially in Q3 versus Q2.

Larry Neibor – Robert W. Baird

Okay, Thank you.

Preston Romm

Thank you, Larry.

Operator

Thank you. Ladies and gentlemen, this concludes the question and answer session. This concludes the Obagi Medical Products third quarter 2008 earnings conference call. Thank you for your participation. You may now disconnect.

Steven Carlson

Thank you.

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