DynaVox Management Discusses Q2 2013 Results - Earnings Call Transcript

Feb.11.13 | About: DynaVox Inc.A (DVOXQ)

DynaVox (DVOX) Q2 2013 Earnings Call February 11, 2013 4:30 PM ET

Executives

Ray Merk

Michelle Heying Wilver - Chief Executive Officer, President and Director

Kenneth D. Misch - Chief Financial & Information Officer and Principal Accounting Officer

Analysts

Thomas J. Gunderson - Piper Jaffray Companies, Research Division

Brooks G. O'Neil - Dougherty & Company LLC, Research Division

Anthony Petrone - Jefferies & Company, Inc., Research Division

Operator

Good day, ladies and gentlemen, and welcome to the DynaVox Incorporated Quarter 2 2013 Earnings Conference Call. [Operator Instructions] Today's conference is being recorded. I would now like to turn the call over to Ray Merk. Please go ahead, sir.

Ray Merk

Thank you, Jamie. Good afternoon, ladies and gentlemen, and welcome to the DynaVox second quarter of fiscal year 2013 earnings conference call. On the call today from the company are Michelle Wilver, Chief Executive Officer; and Ken Misch, Chief Financial Officer. By now, everyone should have had access to the earnings release, which went out after market closed today. If you have not received the release, it is available on the Investor Relations portion of our website at www.dynavoxtech.com. This call is being webcast and a replay will be available on DynaVox's website.

In today's remarks, we will refer to adjusted EBITDA, adjusted pro forma net income and adjusted pro forma net income per share, which are non-GAAP financial measures. These measures should not be considered in isolation from, or as a substitute for, measures prepared in accordance with Generally Accepted Accounting Principles. A reconciliation of these non-GAAP financial measures to the most comparable measures, calculated and presented in accordance with GAAP, are available in the earnings release on the Investor Relations portion of DynaVox's website.

Before we begin, we would like to remind everyone that the remarks and responses to your questions that we provide today may contain forward-looking statements. These statements do not guarantee future performance and undue reliance should not be placed on them. These statements are based on current expectations of management and involve inherent risks and uncertainties that could cause actual results to differ materially from those indicated in any forward-looking statements, including those identified in the Risk Factors section of our most recent annual report on Form 10-K, as such factors may be updated from time to time in our subsequent periodic reports, which are filed with the SEC and available on DynaVox's website. DynaVox assumes no obligation to update any forward-looking statements.

And with that, I would like to turn the call over to the company's CEO, Michelle Wilver.

Michelle Heying Wilver

Thank you, Ray. Good afternoon, everyone. On our last two calls, I have discussed the macroeconomic factors currently challenging our financial performance. In the second quarter of our business, we continue to feel the impact of the difficult economic environment due to the following issues: the continuation of schools tightening their budget and the reimbursement policy changes by a significant alternative payer. In addition, the adverse event -- effect of the technology advances such as tablet computers has accelerated its impact on our sales during the quarter. We are continuing to focus our research and development on product innovation, which will provide even greater value to our constituencies. We are not yet able to announce launch dates or functionality on any upcoming product innovations due to competitive reasons.

As mentioned previously, we have also focused our sales efforts in those areas of the market where reimbursement is more readily available to meet the needs of the DynaVox customers. Now let me briefly discuss our performance by devices and software.

For the second quarter, revenue from our speech generating devices declined 26% year-over-year to $14.9 million. For the first half, revenue from our speech generating devices declined 25% year-over-year to $30.2 million. The factors behind this performance in the U.S. center around the negative impact from the changes in the reimbursement policy of a significant alternative payer for our devices, competition using technologies, as well as continued fund spending cuts by school districts due to recent declines and the future uncertainty surrounding their funding level.

As I discussed on prior calls, many school districts have already begun and are continuing holding back on spending in anticipation of potential cuts to their funding as a result of the sequestering of federal funds by the U.S. government as driven by the Budget Control Act of 2011.

As you all know, sequestering was to begin on January 1 of this year and has now been delayed, leaving an environment of uncertainty in school districts throughout the country. Our international markets continue to be challenged by the macroeconomic conditions that we have discussed previously.

Now moving to education software, which all of you may recall is mainly comprised of our Boardmaker family of products. Our second quarter revenue from education software declined 16% to $2.7 million. For the first half, revenue from education software declined 35% year-over-year to $6.0 million. These declines were mainly attributable to state and local budget constraints, and to a lesser extent, the end of federal stimulus funds to the school.

Looking toward the remainder of the fiscal year, we still do not anticipate any significant improvement in our operating environment, and as we discussed on our previous call, we continue to expect these factors to challenge our financial performance throughout the year.

However, as we continue to operate in this challenging environment, we remain focused on: maximizing our opportunity in this underpenetrated market; developing important new products and solutions, which will enable us to maintain our leadership while adapting to a changing landscape in the health care, education and consumer markets; and controlling our costs, managing cash flow and reducing debt.

As I stated earlier, for competitive reasons, we can't share with you further information at this time about our upcoming new products, but we are excited about the progress we've made so far, and we believe with these products, we will be well accepted by our customers. We look forward to updating you on these initiatives and their market releases in the near future. And now, I would like to turn the call over to Ken.

Kenneth D. Misch

Thanks, Michelle. As a reminder, to help you better understand our operating results, in addition to providing GAAP information, we are providing adjusted EBITDA, adjusted pro forma net income or loss and adjusted pro forma net income or loss per share, which are non-GAAP financial measures. Please refer to the explanatory note under the caption Explanatory Note and Non-GAAP Financial Measures in our press release for more information.

Now for our financial results. Second quarter 2013 net sales decreased 24% to $17.6 million compared to net sales of $23.2 million than the same period last year. The net sales decline was attributable to a 26% decrease in sales of speech generating devices to $14.9 million and a 16% decrease in sales of our Special Education Software to $2.7 million. For the first 26 weeks of fiscal year 2013, net sales decreased 27% to $36.2 million from $49.4 million in the same period last year.

Gross profit for the second quarter also decreased 23% to $12.8 million, compared to gross profit of $16.6 million in the second quarter of the prior year. Our gross margin increased 100 basis points to 72.7% in the second quarter compared to a gross margin of 71.7% in the second quarter of the prior year. The increase in margin is mainly the result of decreased costs driven by a favorable outcome of a product liability matter, changes in certain employee benefits and lower royalty costs offset to some degree by lower sales volume.

For the first 26 weeks of fiscal year 2013, gross profit decreased 27% to $26.2 million from $35.6 million and gross margin increased 30 basis points from 72.1% to 72.4% compared to the same period of the prior year.

Operating expenses in the second quarter of fiscal year 2013 decreased 20% to $11.4 million compared to $14.1 million in the prior year. The decrease was primarily a result of lower margin expense, a favorable adjustment related to changes in our employee benefit programs and lower compensation expense. Our operating income was $1.4 million in the second quarter of 2013 compared to $2.5 million in the same period 1 year ago.

For the first 26 weeks of fiscal year 2013, operating expenses decreased 19% and operating income declined 69% compared to the same period of the prior year.

Second quarter GAAP net income was $0.1 million or $0.01 per share compared to $0.3 million or $0.03 per share for the same quarter 1 year ago. GAAP net loss for the first 26 weeks of fiscal year 2013 was $0.1 million or a loss of $0.01 per share compared to GAAP net income of $0.8 million or $0.08 per share in the same period of the prior year. Adjusted pro forma net income, as defined by the company, was $0.4 million or $0.01 per share for the second quarter of fiscal year 2013 compared to adjusted pro forma net income of $1.2 million or $0.04 per share for the second quarter of 2012.

Adjusted pro forma net income for the first 26 weeks of fiscal year 2013 was $0.8 million or $0.02 per share compared to $2.5 million or $0.09 per share in the prior year.

For clarification, let me explain how we define adjusted pro forma net income and adjusted pro forma net income per share. Adjusted pro forma net income represents net income before adjusting for the noncontrolling interest and after pro forma corporate income tax expense applied and assumed 38% rate, which includes a provision for U.S. federal income taxes; assumes the highest statutory rates apportioned to each state, local and/or foreign jurisdiction; and assumes the full exchange of holdings units of DynaVox Systems Holdings LLC for shares of Class A Common Stock DynaVox Inc.

Adjusted pro forma net income per share consists of adjusted pro forma net income divided by the weighted average number of the company's Class A Common Stock outstanding, assuming full exchange of holdings units of DynaVox Systems Holdings LLC for shares of Class A Common Stock DynaVox Inc. and giving effect to the dilutive impact, if any, of stock options and restricted stock awards.

Second quarter adjusted EBITDA, defined as income before income taxes, interest income, interest expense, impairment loss, depreciation, amortization and other adjustments, decreased 34% to $2.8 million compared to $4.2 million in the previous year. Second quarter EBITDA in fiscal year 2013 includes approximately $1.1 million of favorable nonrecurring items related to a product liability matter and changes in certain employee benefit programs.

For the first 26 weeks of fiscal year 2013, adjusted EBITDA was $4.4 million compared to $8.7 million during the same period of the prior year. During the second quarter of fiscal year 2013, we generated $1.5 million of cash from operations compared to $6 million for the second quarter of 2012. As of the end of the quarter, we had cash and cash equivalents of $14.1 million.

I would now like to turn the call back to Michelle.

Michelle Heying Wilver

Thank you, Ken. This concludes our prepared remarks. We would now like to open the lines for the question-and-answer portion of the call.

Question-and-Answer Session

Operator

[Operator Instructions] The first question comes from Tom Gunderson from Piper Jaffray.

Thomas J. Gunderson - Piper Jaffray Companies, Research Division

I just have 2 quick questions. One, Michelle, on the increased competition, accelerated impact from tablets, iPad has been out there a while, what in the quarter made you use the word accelerated impact, is it new software, is it new companies using an iPad, is it Apple making an effort in these areas? What particularly is showing the increased competition?

Michelle Heying Wilver

Thanks, Tom. A couple of things that we're seeing in the market, there's a couple of competitors that have made their software offering more robust for schools in particular. And the school districts are, right now because of budget pressures, electing to hold off and choosing free apps to solve some of their problems rather than paying for solutions.

Thomas J. Gunderson - Piper Jaffray Companies, Research Division

And are these educational software competitors or are these electronic consumer good competitors?

Michelle Heying Wilver

The apps that they're downloading could be -- they could be just small apps of ABC's education software apps, or they could be very small speech apps that are very small and they can download a few of them and talk specifically with the child with them.

Thomas J. Gunderson - Piper Jaffray Companies, Research Division

Got it. And then Ken, on the financial side, on the debt side, is there -- are there any covenants that we should be paying -- that are at risk that we should be paying attention to?

Kenneth D. Misch

Tom, thanks. We have the leverage covenant, which is certainly one we pay close attention to, which is really related to our trailing 12 EBITDA. We disclosed that in the 10-Q, we're at 1.62 versus a covenant of 2 right now. And in the past, as we've been getting close to that, we have the ability to pay down debt in order to manage that and we would continue to do that moving forward if that becomes an issue for us.

Thomas J. Gunderson - Piper Jaffray Companies, Research Division

But as we look -- I know you're on a different fiscal year, but as we look to calendar '13, you don't see any of the other covenants coming into play that we should be aware of?

Kenneth D. Misch

None of the covenants. Again, I think as we -- none other than the one I just discussed, I should say, as we look to continue to manage that, we may be required to make some additional prepayments of the debt that aren't scheduled.

Operator

The next question comes from Brooks O'Neil from Dougherty & Company.

Brooks G. O'Neil - Dougherty & Company LLC, Research Division

So when you mentioned the continuing burden of the decision by the alternative payer, I'm assuming there hasn't been any change in that situation, it's just sort of the ongoing drag of not having the benefit of having them in the marketplace. Is that true?

Michelle Heying Wilver

That's true. And just when we look at year-over-year comparables, that's part of the reason why you're seeing the differentiation.

Brooks G. O'Neil - Dougherty & Company LLC, Research Division

And when do we anniversary that decision change by them?

Michelle Heying Wilver

This quarter should be the last real significant quarter of that year-over-year comparison. There's a little bit of dribble into third quarter and fourth quarter, but it's not significant.

Brooks G. O'Neil - Dougherty & Company LLC, Research Division

Okay, that's good. And I mean, just broadly, I have to say, you're probably conservatively realistic about the outlook, but is there anything you would point to at this juncture that you might call even a little twinkle at the end of the tunnel?

Michelle Heying Wilver

Well, what we feel good about, Brooks, and we can't share with you right now is just what we have in our product development roadmap. Now our macro environment remains challenging and the fact that we have not launched the products, we just have to navigate to the time that we do launch the products. But what I feel really good at is we continue to talk with customers on a daily and weekly basis. We are not only talking with them about the idea and where we're going, we're starting to show them actual demonstrations of them, and we're getting some very good feedback and excitement from them.

Brooks G. O'Neil - Dougherty & Company LLC, Research Division

So you would say -- and again, I understand you don't want to talk about a lot, but you'd say these are much more cost competitive, but hopefully still quite robust products that you think could find a real niche in the marketplace that's out there today?

Michelle Heying Wilver

Yes. I think what these products do is take the new technology in the new world. And what we didn't do is just go out and react to those technologies and throw something out there, but we looked at how we could thoughtfully reengineer, re-innovate the space. And we're getting some real positive feedback from customers as they start seeing the demonstrations.

Brooks G. O'Neil - Dougherty & Company LLC, Research Division

And without being too specific, do you think that might have an impact in this fiscal year? Do you think it's more likely to be next fiscal year?

Michelle Heying Wilver

Yes. Unfortunately, I can't give you any timing. But right now, just because we haven't launched it, typically, when you launch, you still have a few months delay, so I wouldn't expect a whole lot.

Brooks G. O'Neil - Dougherty & Company LLC, Research Division

Okay, that's fair. And then, obviously in the past, there were some conversation about attempting to shift focus towards the adult market. Could you just give us any update there? What's you're thinking as now -- whether you -- whether that's still a viable strategy, whether you're having any positive impact there?

Michelle Heying Wilver

Yes. The adult market is 3 or 4x bigger than the child market. But with the child market and the new technologies and some of the things we're bringing into the space -- while we are still focused in the adult market as a really big opportunity, I also think the child market is going to be a real interesting opportunity for us to re-penetrate and take a leadership position.

Brooks G. O'Neil - Dougherty & Company LLC, Research Division

Okay, good. And then just one last one. If I was listening correctly, it sounds like at least in terms of the magnitude of decline, there were some improvement in the software business this quarter. Is that something you think -- is that because we're anniversary-ing or easier comparisons or is there in fact maybe a little bit of improvement in that business?

Michelle Heying Wilver

Yes. I think it's easier comparison, Brooks. We still see the school tightening the budgets and with the uncertainty, the education software comes in, in bumps right now. So I think as first quarter, you had a real -- you had a lot tougher comparisons since you did in second quarter, so you saw that, so called -- looked like -- it felt like an improvement, but we're still going to have a challenging year.

Operator

The next question comes from Anthony Petrone from Jefferies.

Anthony Petrone - Jefferies & Company, Inc., Research Division

I just want to begin with sort of looking at sequestering and as it relates to some of your larger state customers, is there any way to sort of quantify how many of your state customers down to the school level, which are tethered to state budgets? How many of those customers have not significantly contracted through the downturn? And if we do face a full sequestration at a later date, how many of those customers would be at risk of sort of pulling in demand?

Michelle Heying Wilver

Yes. It's tough to bring that out. Let me tell you a couple of reasons why: Not only do you have the variable of the sequestration and the uncertainty of future school budgets, but in our business specifically, when stimulus funds were -- or had back in 2010, 2011, and a little bit into 2012, our fiscal years, what we found through studies is that some of those school districts bought in advance. And so, it's hard for us to distinguish some of the real variables of what's going on within their budgets. The second reason is, as schools start taking advantage of the new technologies, some of their budgets that they're looking at, they're spending and really focusing on investments. They're not really the software companies or things like that, but they're investing on our infrastructure for their networks. They're investing on their cloud-based computing support and all their IT infrastructure. And so for the monies that they do have to spend, the district administrators that I'm talking with tell me that they're looking at the infrastructure support and investing in that today because with all the new technologies, they're expecting companies to come out with newer solutions on those technologies.

Anthony Petrone - Jefferies & Company, Inc., Research Division

So then if we extrapolate down the road, if there is no sequestration and they are preparing the IT infrastructures, potentially, if further cuts are not put in place, we could see a pickup in demand at some point, if there is somewhat of a lead time, really, relative to when budget decisions are actually made and purchase decisions?

Michelle Heying Wilver

Sure. If the uncertainty goes away, I think the challenge that we all have is that it's really hard to predict, and you've got not just the sequestration, but state-by-state, you got the challenges within the state. What we see on the back of the envelope is states with natural resources really have a better -- schools have a better position in their education funds. But that's not an overall perfect rule.

Anthony Petrone - Jefferies & Company, Inc., Research Division

So they're switching gears, to move on to another topic. A few quarters ago, there was an issue of private pay, a contract that switched over. So I'm wondering if there's any update on the private pay side, and specifically as it relates to that contract, in particular, but any others where there may or may not be any changes?

Kenneth D. Misch

Anthony, it's Ken. I think what you're referring to is the alternative payer. That was a specific geographic region of the country that had an alternative payer that was a simple reimbursement process. They had made their change about a year ago. Well, actually, it was in the second quarter of last year, really. So this is kind of the anniversary of that now. And we have not received any other type of notification from any other payor like that, nor do we have any significance inside of the company -- the rest of our payers are your traditional Medicare, state Medicaid and the commercial insurers.

Anthony Petrone - Jefferies & Company, Inc., Research Division

Okay. So with that alternative payer there, there's -- is it a 1-year contract they signed or do you expect any change to what they agreed to last year?

Kenneth D. Misch

It's more of a reimbursement rate and our reimbursement philosophy with respect to their charter. So with an organization that had a charter in terms of what they provide to certain types of people and then what they decided they were going to reimburse or not reimburse for those types of people, and basically what they decided to do was they wanted to become a secondary payer basically on a device from DynaVox as opposed to a primary payer.

Anthony Petrone - Jefferies & Company, Inc., Research Division

Got it. And then last 1 for me is just as we look in R&D and, Michelle, fully aware that we're not going to going into product specifics, but as you weigh just where you are in the development of some of these new products, I'm wondering by what extent you may or may not need to increase the R&D investments. Fully aware that you did degenerate operating cash flow this quarter, but if we look at the absolute cash balance, it did come down some $4 million. So I'm just wondering the need to increase on the short-term with sort of balancing the balance sheet constraints?

Michelle Heying Wilver

Sure. It's a really good question. The R&D expense and our run rate -- while the dollars may have changed slightly, we found some better efficient way of bringing some of the new solutions to market with, again, the changing technologies out there. As things become more mature in the marketplace, you can become more efficient as, say, equipment manufacturer, and so that's what you're seeing in the financials.

Kenneth D. Misch

And Anthony, really quick, just the cash balance, too is represented as a comparison from year-end to the second quarter end, and there was a $6 million debt prepayment that was made in the first quarter.

Anthony Petrone - Jefferies & Company, Inc., Research Division

Right, right, right. Well, I just see -- which there could be a second one, taking that in consideration as well? So...

Kenneth D. Misch

Just wanted to make sure that that was included in your analysis there.

Operator

At this time, I am showing no further questions. I would now like to turn the call back over to Michelle Wilver.

Michelle Heying Wilver

I'd like to conclude our call by thanking our employees, our Board of Directors and our valued customers for their continued support, and I want to thank all of you for your participation on the call today.

Operator

Ladies and gentlemen, that does conclude the conference for today. Again, thank you for your participation, you may all disconnect. Have a good day.

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