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Obagi Medical Products, Inc. (NASDAQ:OMPI)

Q4 2008 Earnings Call

March 5, 2009 8:30 am ET

Executives

Steven R. Carlson - Chief Executive Officer and President

Preston Romm - Chief Financial Officer and Executive Vice President of Finance, Operations, and Administration

Ina McGuinness - Investor Relations

Analysts

Katherine Lu - Oppenheimer & Co.

Scott Henry - Roth Capital Partners

Lawrence Neibor - Robert W. Baird & Co.

Unknown Analyst - Sidoti

Operator

Good morning ladies and gentlemen and welcome to the Obagi Medical Products fourth quarter 2008 earnings conference call on March 5, 2009. (Operator instructions). I will now hand the conference over to Ina McGuinness.

Ina McGuinness

This is Ina McGuinness with ICR. Earlier this morning, Obagi Medical Products released financial results for the fourth quarter year ended December 31, 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 webcast, 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, March 5, 2009, 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.

Steven R. Carlson

Early good morning to everyone. When all businesses are certainly impacted by the US and world economy, we believe our overall performance in 2008 with revenues of $104.6 million, up 2% and especially our performance over the last two quarters with Q3 revenues at $26 million and Q4 revenues with a slight decline of $25.4 million shows that Obagi customers think about products and their efficacy as more a lifestyle decision than a discretionary cosmetic spend.

Supporting our resilience and overall stability, we continue to see strong new account growth with over 1300 new accounts for the year and a strong 343 new accounts in the fourth quarter. For 2008, our total number of active accounts increased 10% to more than 5700 accounts. Further, our physician-dispensed dermatology accounts group is 16% year-over-year. This continues to demonstrate that physicians are still pursuing ways to add additional revenues by incorporating the topical physician-dispensed business within their existing clinical practice.

We believe Obagi Medical Products consistence represents one of the easiest user-friendly yet still effective skin care therapies at a lower consumer spend versus alternative laser therapies, Botox, or Dermafiller injections.

Additionally, given the economy, we are exceptionally pleased with the recent launch of Rosaclear, the first cost effective prescription based physician-dispensed system for the treatment of the signs and symptoms of rosacea. Rosaclear has been widely and enthusiastically received in our first month of launch as it represents the fist highly effective treatment system for our dispensing physicians to successfully treat their patients who suffer from this socially disabling disease. In a recent clinical study, 90% of subjects shows at least one grade or 25% reduction in the severity of the signs and symptoms of rosacea after just two weeks of using the Rosaclear System. Investigators also reported an overall reduction in redness and continued improvement over the completed 4 weeks study period.

With an estimated 14 million people who suffer from the associated facial flushing and redness of rosacea, we believe this is unique opportunity for our company to treat a new patient population with a new non-cannibalizing Obagi system while leveraging our existing sales force and current account base.

Further, we continue to see progress from our investments to grow our international business. For the year and fourth quarter, revenues were nearly 12% and 17% up respectively. As we previously reported, we’re very pleased with the new and expanded relationship with Rohto Pharmaceuticals, our consumer distribution partner in Japan. We look forward to the near-term launch of our ELASTIderm product line in Rohto’s drug store distribution channel and the anticipated future launch of the more science and clinically based product line into the Prestige Department Store channel.

With the hiring of our three dedicated regional sales managers in Europe, Asia, and Latin America, we’re beginning to see some of the early benefits as we have now signed distribution agreements, received registration approvals, shipped initial orders, and have begun training physicians in China, Australia, and Russia. We’re now seeing the initial benefits of these initiatives to grow the international business and look forward to continued progress throughout 2009.

In terms of product line and segment performance, given the change in the economy and consumer spending trends in 2008 versus 2007, we are seeing corresponding shifts in our sales. In 2007, our new products of Condition and Enhance and ELASTIderm Décolletage were successfully positioned as synergistic and beneficial to improving overall patient outcomes and routinely use with an addition an existing Obagi product or system without an incremental cost to the patient and subsequent profit to the physician.

During 2008 as concerns over the economy continued, we believe patients began to shift their spending to more specific value or lifestyle cost-based decisions relating to a specific desired effect or outcome, for example, just treating their face or just treating their neck and chest with the Décolletage System.

We believe we have also continued to gain significant market share displacing competitive products through continued investment and partnering efforts with our customer. As a result, we saw ELASTIderm and vitamin C based product and systems with strong 2008 growth combined over $4 million, up 21% and essentially flat in Q4 2008 versus Q4 ’07. Specially and specifically our ELASTIderm eye cream gel and our Décolletage system was up 39% or $3.3 million for the year, but down $137,000 or 6% in the fourth quarter, yet re-order rates continued at a strong 80% plus for the quarter. With our vitamin C products which include Obagi-C Rx and Professional-C, we saw sales increase $900,000 or up 8% for the year and slightly up for the fourth quarter.

Turning to sales of Nu-Derm, fourth quarter sales were down from third quarter sales by approximately $300,000 or 2% on a sequential basis. As Nu-Derm and Condition and Enhance began to compete for Botox and Dermafiller patient dollars in 2008 versus being added to those procedures in 2007, fourth quarter sales were $14.4 million, down 12% from a year ago. However, we are pleased to see re-order rates for Condition and Enhance systems continue at nearly 80%.

Last, regarding our soluble BPO technology which is in the CLENZIderm and SoluCLENZ product lines, we’ve continued to conduct comprehensive clinical studies to add further evidence and validity to the superior clinical efficacy compared to BPO antibiotic combination such as benziclen. We continue to release these study results via posters, presentations, and peer-review journals. In fact, as of today, we now have 15 studies that include 800 plus patients which consistently demonstrate the superior efficacy of the soluble BPO technology.

Specifically for CLENZIderm, fourth quarter sales were relatively flat of $100,000 versus Q3. However, re-orders rates for the sets continued at greater than 80%. Regarding our results for SoluCLENZ Rx Gel which we launched in pharmacy dispensed channel in August of last year, with sales of less than quarter million dollars, we are well off our targeted uptake volumes.

Near the end of 2008 and early 2009, we made several adjustments to leverage our clinical study success into future scripts. We shipped 100,000 plus samples for the field to have physicians conduct their own in-practice evaluation in SoluCLENZ efficacy. We shipped 75,000 reimbursement cards which copay patients’ out-of-pocket cost for up to three refills at $25 per script. We’ve also initiated and are conducting numerous key opinion meetings, supported physician education meetings, and dinner seminars to help drive more validity in dermatologists prescribing SoluCLENZ.

As you know, dermatologists routinely wait 10 to 12 weeks to assess patient results. So, we should begin to see the outcome to these combined efforts in Q2. Ongoing, we’ll continue to evaluate and adjust our actions accordingly to optimize the value of this unique product and technology.

Looking at our sales force, today we have 117 sales reps of which 44 are dedicated to the sale of therapeutic products. In comparison to our last call, this means we now have 134 domestic sales people versus 133 in mid of November.

In this economy, we’ll proceed carefully and we’ll continue to look at the proper allocation of sales people against existing accounts and do account demand going forward.

With that, let me turn the call over to Preston.

Preston Romm

Welcome everybody to the call. Our fourth quarter sales declined 6.7% to $25.5 million as compared to $27.3 million for the fourth quarter 2007. While we don’t like to see a decline in sales, we consider this top line performances are positive when faced with the worst global economic downtown in decades when compared to other aesthetic companies. Additionally, sales decreased from the third quarter by less than $600,000 or 2%, which we feel is a better indicator than year over year.

On an annual basis, our sales grew 2% to $104.6 million from $102.6 million in 2007 validating that our products are resilient to this economy and leans towards a lifestyle spend as opposed to discretionary. Net income for the fourth quarter 2008 was $2.2 million or $0.10 per fully diluted share or a weighted average 22.4 million shares outstanding. This compares to $ 4.5 million or $0.20 per diluted share or a weighted average 22.8 million shares outstanding a year ago. For the full year, we reported net income of $12.6 million or $0.56 per fully diluted share versus $15.2 million or $0.69 per diluted share in 2007.

Net income on a non-GAAP basis for the fourth quarter and total year 2008 includes $0.7 million and $1.3 million respectively for special items which I will itemize in a minute. Excluding these non-GAAP item, net income would have been $2.8 million for the fourth quarter and $13.9 million for the total year and earnings per share would have been $0.13 for the fourth quarter and $0.62 for the year.

There are 5 items which we highlighted towards our determination of non-GAAP net income since we believe they are not indicative of ongoing spending plans. Please refer to the GAAP versus non-GAAP reconciliation in our press release from this morning:

As previously disclosed and on a pre-tax basis, we won 12 of the direct-to-consumer awareness campaigns to determine and terminated this effort during the fourth quarter. We spent $322,000 during the fourth quarter and a total of $1.38 million for the year.

We outgrew our headquarters and moved to a new more efficient facility in October. We spent $54,000 during the fourth quarter and a total of $215,000 for the year towards double rents during the construction and move.

We eliminated a number of people during the year to reduce costs; as such, we incurred $363,000 in the fourth quarter and $595,000 for the year towards severance costs.

We wrote off a product development prepaid expense relating back to a 2006 agreement. This non-cash charge amounted to $250,000.

Lastly, we executed new bank revolving line of credit in the fourth quarter eliminating an older, lower, and more expensive line. This resulted in non-cash write-off of $130,000 of debt issuance cost reflected in the interest expense line.

Let me review our key operating metrics for the fourth quarter and full year. Fourth quarter gross margins were 80% compared to 82% in the same quarter last year. Lower gross margins were primarily attributable to increased promotional costs designed to counter the effects of the economy. For the full year 2008, gross margin percentage was 81% compared to 82% for 2007. Selling, general, and administrative expenses totaled $16.1 million compared to $13 million for the fourth quarter of 2007. On a non-GAAP basis, SG&A expenses were $15.3 million. The majority of the increase in our fourth quarter SG&A expenses related to the launch and early support for the SoluCLENZ Rx Gel product line which impacted expenses by $1.4 million or $0.04 per diluted share.

Now, moving to the balance sheet; as of December 31, 2008, we were debt-free with cash, cash equivalents, and short-term investments totaling $19.9 million compared with $14.1 at December 31, 2007. Working capital totaled $44.1 million and stockholders’ equity totaled $60.5 million as of December 31, 2008. We are pleased that these metrics have showed improvement over 2007. Although we do not have cash needs, we executed a new line of credit for $20 million replacing an older, more expensive $10 million line. During the fourth quarter of 2008, we purchased 627,367 shares of stock in the open market at an average price of $6.37 per share for a total cash outlay of $4 million. This was pursuant to the stock repurchase plan previously approved and reported.

We conclude our call by providing guidance. Based on current trends in our core business and normal seasonality for the first quarter, we expect first quarter of 2009 net sales to be in the range of $22 million to $24 million and fully diluted earnings per share to be in the range of $0.08 to $0.10. Commencing during the fourth quarter we began to take significant steps to reduce operating expenses by reducing headcount approximately 18% excluding the sales personnel and eliminated all 2008 bonuses, reduced payments to outside service presenters, implemented a companywide shutdown for a week, and eliminated or reduced other nonessential expenditures.

With that operator, we can open the call to questions.

Question-and-Answer Session

Operator

(Operator Instructions). The first question comes from Katherine Lu - Oppenheimer & Co.

Katherine Lu - Oppenheimer & Co.

First of all, I did not catch this part; could you repeat what’s your current number of sales people?

Preston Romm

We have 134 which includes 117 of direct sales people; 134 total which includes inside and sales management.

Katherine Lu - Oppenheimer & Co.

You also mentioned about some personnel cuts, about 18%, is that correct?

Preston Romm

Right.

Katherine Lu - Oppenheimer & Co.

So, that’s more on the administration part?

Preston Romm

Yes. It’s non-sales, it’s the corporate people.

Katherine Lu - Oppenheimer & Co.

It seems from your press release you have been disappointed with the SoluCLENZ launch. I’m just wondering because it is a very challenging marketing environment and a lot of companies are using cost-cutting as a tool to achieve bottom-line growth; at which time would you feel you would say that is the point that you can stop maybe promoting this product and if there is any area you can see this year that will save your operating cost besides the non-sales personnel cut?

Steven R. Carlson

I think broadly certainly given this economy, we would continually look at what is prudent for us to reduce in SG&A expenses on an ongoing basis. As it relates to SoluCLENZ, as I indicated on the call, we are extremely bullish on the clinical efficacy that the studies continue to demonstrate to us. As I indicated, we have just put all the appropriate tools into the field late in the past year and early in the first quarter. We recognize, and I think you do also, that the dermatology prescription marketplace requires more patience and diligence than the direct selling business model we are in, in physician dispense, and I think appreciably there is a very important meeting starting today and going through the weekend with the American Academy of Dermatology in which additional information and clinical data will be released, and last but not least, as we indicated, we will continue to evaluate our options on how to optimize the value of both this product and the technology.

Katherine Lu - Oppenheimer & Co.

I was impressed by Nu-Derm Condition and Enhance related performance in 4Q, but what I noticed is some smaller product lines like ELASTIderm or CLENZIderm actually had more dramatic sequential decline. So, I am just wondering if you can elaborate the market dynamics for those two lines. Have you seen any material change in competitive landscape that’s impacted and will impact your sales this year?

Steven R. Carlson

I think that’s a question, Katherine. I think one of the important things to look at, as you’ve indicated in this marketplace is to look at what’s happening quarter over quarter on a sequential basis because certainly 2008 moving into 2009 is a different environment and economy than we were operating in 2007. So, overall, broadly as we look at the product lines, the sequential business is holding up quite stable and more resilient and certainly as reported with aesthetic cosmetic procedures, which have certainly seen or experienced and reported substantially greater quarter-over-quarter declines. As we look at ELASTIderm and Vitamin C, we see those actually being quite strong and we think that is the result of the market share gains that we’ve had in this environment as we continue to invest with our customers; we find ourselves displacing a number of competitive products that are being replaced now by ELASTIderm and our Vitamin C product lines.

Operator

The next question comes from Scott Henry - Roth Capital Partners.

Scott Henry - Roth Capital Partners

First, I would just like to say I think you guys are doing a commendable job given the economic backdrop you have. There is not much you can do about that, but looking out to 2009, I know you are only giving guidance on a quarterly basis, but if we assume that we stay where we are today, what kind of trend would you expect to see in ’09 earnings? It seems like you probably have a little more launch costs from SoluCLENZ and the RosaClear product, but I just want to get your thoughts on the trend, again assuming we stay where we are today.

Preston Romm

I think on the EPS line, we will start to see some of the bulk of the benefit of these cost reductions in Q2 and Q3; so we’ve seen improved EPS over what we’re giving guidance for Q1 and then Q4 is normally our seasonally high quarter, so I’ve trend that line for both top line and bottom line.

Scott Henry - Roth Capital Partners

And then, you are in the middle of new product launches. With regard to SoluCLENZ, would you say your goal is to make that a cash breakeven product in 2009, whatever means that may be?

Preston Romm

Yes, certainly that is our goal, and we are making some adjustments into the product line and making it easier for our doctors to prescribe scripts and we will assess it as we go. Our goal is to be profitable with that product line.

Scott Henry - Roth Capital Partners

Shifting over to RosaClear, I definitely heard a few positive comments about the launch; could you give us a little color on how we should think about that product? At what point do you think it will be a breakeven product, and how do you think of it in terms of magnitude as far as size?

Steven R. Carlson

As you know, rosacea is a underserved disease state right now. A very large patient population that exists that has signs and symptoms, the redness and facial flushing, that is currently treated. We also anecdotally have gotten very enthusiastic response in our physician dispense channel as this is a disease state that previously there have not been opportunities for dispensing physicians to provide opportunities to treat those signs and symptoms. So, we believe there is a very opportunistic marketplace in front of us, as we look at orders of magnitude, this feels like ELASTIderm launch, very successful with continued growth and momentum going forward. We are seeing very positive account penetration and already seeing early reorder rates. So, we do view this as a very profitable line and a growth opportunity for us. Importantly, it is the same call, same sales force, but expands our opportunities to treating new patient population than we previously treated with our existing Obagi line.

Scott Henry - Roth Capital Partners

And then I guess just going through a few of the line items when we look out to next year; I thought licensing and royalties at $1.4 million was a little higher than we expected, is that just seasonal trends or is that a good go-forward number?

Preston Romm

It’s tough to tell; it’s a bit seasonal and a bit go forward, it should be in that range, and as you know we’ve expanded our relationship with Rohto to include all ELASTIderm lines and working together on other products, so we expect good improvements on that license line and with Rohto during 2009.

Scott Henry - Roth Capital Partners

And then the gross margin line, again it was higher this quarter, higher last quarter; going forward should we be thinking more about 20% or more about 19% in that line?

Preston Romm

On the gross margin line?

Scott Henry - Roth Capital Partners

Yes, in terms of the COGS percentage.

Preston Romm

I think Q4 and Q3 were both around just under 20% COGS, just a little bit over 80% point something on gross margin line. I think that probably smells right. We’re doing more promotional activity to offset the economic downturn to help our doctors out as we did in 2007 and in the first quarter of 2008. I think that is probably a gross margin percentage to go forward with. We forego a price increase at the beginning of 2009, which we normally do in this economy, I think it helps out our doctors. I think this is probably a good number to use to go forward.

Scott Henry - Roth Capital Partners

Just scrolling to the bottom of the income statement; the tax rate was a little lower in Q4, I think it was 22%; and going forward, should we still be thinking about 39%?

Preston Romm

Look at 38% and 39%, what happened in fourth quarter is probably the stimulus package that was signed in October included in extension of the R&D tax credit; so we had a year-to-date pickup in the fourth quarter. Normal tax rate going forward should be around 38%.

Scott Henry - Roth Capital Partners

And then the share buyback, you did do a little lit bit there; do you expect to keep doing that; you obviously do have cash and you’re cash flow positive?

Preston Romm

We’ll look at that Scott as we go through the year and see if it makes sense.

Scott Henry - Roth Capital Partners

The final question more for Steve on the competitive outlook; do you see anything different, do you see a few players leaving the market and specifically, people always wonder about Allergan; are you seeing any inroads from them into your customer base?

Steven R. Carlson

As we look at the competitive landscape, I think we are in a unique position as you already indicated. We’ve got a strong cash position, we’re positive operating cash flow, we continue to invest in our customer base, and we believe that is helping us gain market share and displacing competition that aren’t in the unique position that we are in, and overall we see 2009 in the aesthetic landscape a pretty exciting place as a number of additional toxins or fillers will enter this market place, and we think will provide a stimulus to help drive more consumer awareness and more consumers shifting into the physician office looking for better and alternative ways for aesthetic outcomes, and as a result, I think our price point and our efficacy will help us in 2009 as those companies launch their new products.

Operator

The next question comes from Lawrence Neibor - Robert W. Baird & Co.

Lawrence Neibor - Robert W. Baird & Co.

You mentioned that you hope SoluCLENZ will be breakeven on a cash basis in 2009; what sales level would be required to reach breakeven?

Preston Romm

Looking at the IMS status, probably something around 4500 to 4600 scripts a month. That would give us a breakeven point.

Lawrence Neibor - Robert W. Baird & Co.

And what type of increase would that be from your current level?

Preston Romm

Pretty high, probably about 4 or 4-1/2 times increase from where we are today.

Lawrence Neibor - Robert W. Baird & Co.

How many sales people do you have dedicated to that product line?

Steven R. Carlson

We have the entire therapeutic sales force which is 44 dedicated to it, and we also utilize some of the other sales force as we see the opportunity.

Lawrence Neibor - Robert W. Baird & Co.

Will there be an opportunity for these dedicated reps or a need for the dedicated reps in the physician dispense sales channel should you make that decision?

Steven R. Carlson

Yes, absolutely.

Operator

The next question comes from (Unknown Analyst) - Sidoti.

Unknown Analyst - Sidoti

I guess on the cost-cutting measures, you said that it should materialize more in quarter 2 and quarter 3; how big an impact do you think that will have?

Preston Romm

I am not committing to a number, we think it could approach high $3 million to $4 million for the year compared to the amount of money we were spending in SG&A in Q3 and Q4.

Unknown Analyst - Sidoti

On the SG&A line again; are there going to be significant costs carried over into March, around the launch of RosaClear and possibly SoluCLENZ?

Preston Romm

Yes, there could be a little with RosaClear just because it’s a new product and there was some promotional launch material. SoluCLENZ; yes, there will be some carryover too with sampling and some of the doctor events we are putting on. So, Q1 is being impacted a little bit by those two.

Unknown Analyst - Sidoti

On the RosaClear side; that will probably continue into quarter 2, but on the SoluCLENZ would you expect that also?

Preston Romm

Yes, we are going to invest in SoluCLENZ and drive this to a profitability cash positive. At the same time, we are looking at any alternatives with SoluCLENZ that would benefit the technology.

Unknown Analyst - Sidoti

Last question on the share buybacks; you’re still possibly shopping; at the current share price, possibly a better opportunity than fourth quarter?

Preston Romm

Yes, certainly the stock prices are down. We are going to evaluate all the variables that go into that. During 2008, we spent a little over $4 million in CapEx for both the building and the new ERP system. We certainly don’t see that need of CapEx in 2009. So, as we are generating cash, we will be taking a look at stock buyback at these prices.

Steven R. Carlson

Thank you operator. I think that will conclude the call for this morning and thank you everybody for joining us at this early hour especially on the West Coast. Have a great day.

Operator

Thank you. This concludes the conference call. Thank you for participating. You may now disconnect.

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