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Obagi Medical Products, Inc. (NASDAQ:OMPI)

Q4 2012 Earnings Call

March 14, 2013 4:30 pm ET

Executives

Mark Taylor – Senior Vice President - Corporate Development and Investor Relations

Albert F. Hummel – President and Chief Executive Officer

Preston S. Romm – Chief Financial Officer, Vice President of Finance, Operations and Administration

Laura B. Hunter – Vice President, General Counsel and Secretary

Analysts

Annabel Samimy – Stifel Nicolaus

Elliot Wilbur – Needham & Co.

Irina Rivkind – Cantor Fitzgerald & Co

Rebecca Forest – Piper Jaffray

Scott R. Henry – Roth Capital

Operator

Greetings and welcome to the Obagi Medical Products Fourth Quarter 2012 Earnings Conference Call. At this time all participants are in a listen-only mode. Question-and-answer session will follow the formal presentation. (Operator Instructions) As a reminder, this conference is being recorded. It is now my pleasure to introduce your host, Mark Taylor. Thank you Mr. Taylor, you may begin.

Mark Taylor

Thank you, operator. Welcome everyone to the Obagi Medical Products Fourth Quarter and Full Year 2012 Earnings Conference Call. Earlier this afternoon, we released our financial results. The press release announcement is located on the IR section of our website if you haven’t already received a copy of it. This call is being webcast and a replay will be available on the website for 30 days.

Before we begin, let me remind you that today’s remarks will contain forward-looking statements within the meaning of federal securities laws. 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 the company’s SEC filings for more details and discussions of the factors that could cause actual results to differ materially from those projected in any forward-looking statements.

All information provided on today's call is as of the date of the live broadcast, Thursday, March 14 and Obagi Medical Products undertakes no obligation to update any such information. Discussing our financial and operating performance on today’s call are our President and Chief Executive Officer, Mr. Al Hummel; and Mr. Preston Romm, Executive Vice President and Chief Financial Officer.

With that, I'd like to turn the call over to Al.

Albert F. Hummel

Thank you, Mark, and good afternoon everyone. I am pleased to be here today to discuss our results for the fourth quarter and full year of 2012. I will cover our top line performance for the quarter and year and report on important growth initiatives underway including our new product pipeline and our e-Commerce initiative. I will then turn the call to questions for a more detailed operating and financial results and guidance. Then we will open it up for your questions.

Now turning to the fourth quarter. Net sales were $30.3 million versus quarter four 2011 sales of $30.6 million, this was driven by a 5.3% increase in international distributor revenues offset by a decline in licensing fees from our Japanese partner and a planned reduction in sales to certain U.S. accounts that we have identified to be re-selling our products to unauthorized internet retailers and often at deep discount to the in-office prices offered by our physician partners. While this planned reduction did impact sales by approximately $1.5 million for the quarter and $2.25 million for the total year.

We believe this is the right thing to do to protect the brand and the long term benefits realized in improving pricing and margins outlays the short term impact. We also believe that the majority of our current end user demand that is satisfied on the internet by this diverted product can be rechanneled back to the originating physicians with any residual volume serviced by a few authorized internet resellers we intend to keep going forward.

Our domestic physician-dispensed business posted $24.9 million in the quarter, flat with last year after netting out the effects of certain account closures. We continue to realize improvement in this segment due to the reintroduction of hydroquinone products in Texas. For 2012, total net sales were $120.7 million, up 6% from $114.1 million in 2011. International sales were $21.7 million, up 13% while the U.S. business was $99 million, up 4.4%. In total, we reduced sales to unauthorized internet resellers by $2.25 million.

Now let me review sales by product line for the fourth quarter and the year. Sales of Nu-Derm were $16.7 million in quarter four, up 4.5% from the prior year primarily due to the successful launch of our novel moisturizer Obagi Hydrate in November 2012. Obagi Hydrate is offered as both a vital component in the Nu-Derm System and is a standalone product. We are very excited about this moisturizer and its reception momentum in the market thus far. This is also the type of product we believe should sell well online given the millions of women that use a moisturizer daily and based on feedback from our own users.

Nu-Derm also benefited in the quarter from a repackaging of the Nu-Derm kit, which included Hydrate and a new sunscreen which was also very well received by our accounts. For the year, Nu-Derm posted sales of $62.7 million, up 4% reflecting the positive impact of Texas sales returning and the introduction of Hydrate and offset by the planned account closure.

Sales of our Vitamin C line increased 2% from the prior year to $4.8 million. Annual sales in 2012 were $18.6 million, up 12%. The introduction of our new Normal to Oily C Rx Starter Set which offers the benefits of both prescription strength 4% hydroquinone and a powerful antioxidant Vitamin C contributed incrementally to results. Our elasticity line which comprises ELASTIderm Eye Cream, gels and the 2012 launch of the complete complex eye serum recorded fourth quarter sales of $2.5 million, slightly down from the fourth quarter of 2011. Sales for the full year were $13.2 million, up 16%. This brand continues to lead the physician-dispensed eye treatment category and we anticipate building on this franchise in the coming years.

Turning now to the therapeutic product line, sales were $1.8 million, down 17% compared to $2.1 million a year ago, again primarily due to a reduction in sales to certain accounts. For the year, this segment posted $7.1 million or an increase of 9%. Lastly, sales from products classified as other were $3.7 million, down 5% compared to the fourth quarter of 2011. For the year, this segment posted $14.7 million, down 3%. This line includes Tretinoin, which is used together with Nu-Derm. Sales in this category were also impacted by the closure of certain accounts. We are confident that this Nu-Derm growth with new products and the availability of online ordering serve our Tretinoin business in future years.

Turning now to our new product pipeline, Obagi has a strong track record of developing new products. We have introduced 12 new products in the last five years. Reinvigorating this effort, we introduced two new products since our third quarter call, the first being Hydrate and the second is ReGenica Facial Rejuvination Complex, which we co-distribute in a partnership with Suneva Medical that commenced in January. ReGinca offers our physicians the ability to provide their patients with the next generation in growth factor technology and contains a diverse mixture of actives including growth factors such as keratinocyte growth factor and proteins such as collagen that renew skin throughout life. This product is used to heal the skin post laser or other skin resurfacing procedures.

We also repackage the number of our current products into a larger size, a liter and half liter, and market them as Professional Back Bar line that aestheticians and other skincare professionals will apply when performing facials and other procedures. We expect this product line will further create Obagi brand awareness and conversion throughout the medical practice.

Our product pipeline continues to be strong and we are on track to launch two additional products in 2013. These products are expected to complement and enhance both our systems and targeted products platforms. We remain committed to introducing three to four new products a year through 2016.

In the fourth quarter 2012, new accounts increased by 216 which brings total active physician accounts to 6,608 as of year end. While this is up from 6,566 at year-end 2011, our new account growth has slowed. This is a reflection of our shift in priority to growing existing customer practices versus signing on new accounts. Our focus now is increasing store sales, which we will accomplish by introducing new products, in house enhancing sales force productivity, launching the e-Commerce platform and closing accounts that supply product to internet resellers at deep discounts.

We continue to advance the development of our e-Commerce platform to commercialization. As discussed with you, the cornerstone of this strategy is providing our physicians with a customized storefront that link to the website and/or our Obagi site enabling their current and future Obagi patients to enjoy the speed and convenience of online shopping and fulfillment.

We, our physician partners recognize the growing importance of online shopping. There’s a substantial volume online today for Obagi products, few in large part by these unauthorized resellers and there is also the five million or more annual web searches for the word Obagi, some of which navigates through our site looking to find physician dispensers in particular ZIP codes. By hosting an online store for each physician partner and by making it easily accessible to patients, we give them an added tool by which they can capture as much Obagi business as possible.

Our goal is to double the number of venues benefiting from our unique brands on an annual basis. And we believe this e-Commerce platform can facilitate that objective. We are currently working with our physicians and third-party software vendor on the final development phase of the site, and remain committed to launch trial sites with selected physicians in the second quarter of 2013 and to have this rollout nationally in the first half of 2014.

Of the 50 top accounts we introduced the concept in platform prototype II in September we since conducted in-practice meetings with many of them that have expressed interest in testing the site. Our physicians see the opportunity in this. Many have considered e-Commerce before, even tried it. But those models only gave the physician a nominal commission from third-party fulfillment house and they rarely see or interact with any of the customers who buy of their site.

In our case, physicians are excited because not only did they retain the full order, they control the patient relationship, which is the primary goal of our model. We want a system that brings our physicians new Obagi accounts, create better compliance and outcomes for current users and which result in significantly more sales and business for the practice. The key to this lies in the system design and integration where our platform will fit their practice workflow and be very patient physician and office staff user friendly. Once this is accomplished, all we are really doing is augmenting their current dispensing model. We like to think of this as technology that better links the point of care between the office and the Obagi user at home.

Now let me review with you the major e-Commerce milestones we have accomplished to date. We have completed construction of our 32,000 square foot facility in Utah which includes offices in a large modern warehouse facility and will serve as the hub for our online fulfillment business and eventually as the warehouse for all our product distribution. We have secured our wholesale distribution license in Utah and are on track to obtain all required state warehouse distribution licenses by the end of the second quarter. The frontend storefront, the physician portals as well as certain backend functions including the merchant function, customer service, administration and fulfillment functions are nearing completion.

We have engaged collaborative discussions with our top accounts to obtain their perspectives and feedback on the e-Commerce platform. We have identified initial trial users for the site. Our distribution partner with an online closed-door pharmacy is operational and geared to serve patients of nonaffiliated Obagi physicians. This site was developed by the same group that is developing our physician platform which will provide us valuable information as we advance our program to launch.

We are now positioned to begin trial testing the site with selected physicians in the second quarter. These accounts represent a cross-section of our customers based on size, geography and physician specialty. They are large Obagi accounts with one to three on premise practitioners, three to five in-house aestheticians managing skin care patient flow and sales, and we see as many as 100 patients a day and have electronic records or chart databases covering an average of more than 15,000 patients.

In the initial trial phase, each physician will have the online store front available by clicking an icon on their website. We will drive traffic and volume to these sites by providing the necessary marketing tools through our physicians and by developing a regionally targeted digital media strategy. We will evaluate these trial sites based on performance metrics and systems functionality including the degree to which per patient revenues increase, the cost of fulfillment, the level of patient compliance, increases in the number of new patients, increases in foot traffic to the physicians office and marketing efficiencies generated.

In closing, we have significant near term growth opportunities including our product pipeline, the new business driven by e-Commerce, and continued expansion of overseas. We have made enormous progress over the last 18 months on a variety of fronts that have enhanced value to our stockholders including improvement in the company’s regulatory and quality assurance function to better support our customers and to ensure that our third party manufacturers adhere to the highest quality standards.

Enhancing our product pipeline which we expect to result in the introduction of three to four products per year over the next four years, undertaking a number of marketing initiatives to increase brand awareness, taking substantial steps to reduce sales to certain U.S. accounts where we have identified to be reselling to unauthorized internet retailers. Commenced elimination of all single point of manufacturing failure by dual sourcing all of the company owned formula products and engaged in significant outreaching efforts to educate physician, organizations and legislators about our products and the importance of the active ingredients such as hydroquinone. We are well positioned for growth and look forward to another strong year ahead.

Now I would like to turn the call over to Preston.

Preston S. Romm

Thanks, Al, and thank you everybody for joining us today. Starting with our sales performance, fourth quarter 2012 net sales totaled $30.3 million, which was up sequentially but down year-over-year by approximately $3,000. The difference was partially due to tougher comps in the fourth quarter of 2011 when our licensing partner Rohto launched several new products.

Additionally, we held back approximately $1.5 million of potential shipments that would have been diverted to deep discounters. For the year, net sales were $120.7 million, up 5.8% from $114.1 million in 2011. In the fourth quarter 2012, our international product sales were up 5.3%. At the same time, Texas sales continue to rise and we now have two full quarters of sales into Texas both showing sequential growth and I would say we are at approximately 80% of the sales volume we are at prior exiting the hydroquinone market.

GAAP net income for the fourth quarter 2012 was $7.3 million or $0.41 per diluted share and included approximately $1.7 million or an impact of $0.06 per diluted share, pretax charges for the development of the company’s e-Commerce and other gross initiatives. This compared to net income of $5.1 million or $0.27 per diluted share a year ago. We received $8.4 million from our insurance underwriter in connection with expenses incurred towards the 2010 and 2011 Zein Obagi lawsuit and settlement. This is reflected in our SG&A line. Additionally, we spent $759,000 in the fourth quarter towards retaining advisers.

On the non-GAAP basis, excluding these two items, net income would have been $2.6 million or $0.15 per diluted share. Please refer to our GAAP to non-GAAP reconciliation table on the back of our earnings release. Expenses related to the company’s internet and other growth initiatives totaled $1.7 million for the fourth quarter and were lower than previously expected due to timing. For the year, internet related growth initiatives expenditures totaled $8.6 million, with $5.8 million going to operating expenses and $2.8 million capitalized.

Gross margin for the fourth quarter 2012 was 77.7% compared to 79.2% a year ago due to component inventory write-offs and lower royalties from our Japanese partner. For the total year, gross margin was 79.2% versus 78.9% a year ago. Lastly, we generated positive cash flow from operations of $13.6 million bringing cash and cash equivalents at December 31, 2012 to $34.6 million.

Turning to guidance for the first quarter 2013 and full year, we are expecting sales for the first quarter of 2013 to be between $30 million and $30.5 million and diluted earnings per share between $0.09 and $0.10. The full-year 2013 net sales are expected to be between $126 million and $130 million and diluted earning per share between $0.80 and $0.84.

These estimates take into consideration the following expectations. One, continuation of the current economic environment and continued elimination of our accounts that our divert products to internet discounters particularly in the first quarter. Two, the total 2013 expenses associated with establishing the company's e-Commerce initiative of approximately $3.5 million. Three, 2013 investments associated with the physician outreach and competitive positioning predominantly as a result of a new competitor in our EMEA space of approximately $1.5 million. Four, annualized tax rate of 36%, which assumes to continue benefit of the R&D tax credit for both the years 2012 and 2013. The 2012 benefit would be recorded in the first quarter of 2013 and it assumes tax rate of 26%.

And lastly, diluted number of shares at $17.7 million. During 2013, we’ll report on a GAAP basis only since these costs are considered noble from an accounting operational point of view.

So with that, I’d like to open the line for questions operator.

Question-and-Answer Session

Operator

Thank you. We will now be conducting a question-and-answer session. (Operator Instructions) Thank you. Our first question comes from the line of Annabel Samimy with Stifel Nicolaus. Please proceed with your questions.

Annabel Samimy – Stifel Nicolaus

Hi, thanks for taking my questions. I have a few actually, first I want to start with the e-Commerce, we noticed that you have a line that you setup for e-Commerce revenues in the back end. That means that you’re going to be especially highlighting this sells directly to me out of e-Commerce and are there any other metrics that we should be thinking about or you're going to be talking about to be able to trust, to be able to measure the success of that program?

Preston S. Romm

Thanks, Annabell, this is Preston. I'll take the first part of that. The line we have in the back of the package is to be note that there is a different segment. So we will have three segment reportings going forward that we’ll measure down the gross margin line. Our normal physicians dispense business, our license business which at this point is really Rohto and that's our plan to continue with Rohto, and the third will be e-Commerce module. Since there was any revenue, we didn't – we try it, but that's what the orders want us to do for last year to show a line.

Annabell Samimy – Stifel Nicolaus

Okay. We will be able to see the break down of the product still and are there any other metrics that we should be going by in terms of maybe state-by-state licensing things like that.

Albert F. Hummel

I think that Annabel that...

Annabel Samimy – Stifel Nicolaus

Traffic on the sites whatnot.

Albert F. Hummel

We’ll be working on as I said metrics in the systems functionality. In the sense of perpetual revenue increases, cost of fulfillment, level of patient components, increasing number of new patients. So we will be working on a number of those company statistics in terms of how it’s reported in the financials. I think it will reported as President indicated in terms of the amount of the business we’re getting from e-Commerce. But the company will be, has a number of statistical ways to look at the success of the site.

Annabel Samimy – Stifel Nicolaus

Okay. If I can move over to I guess how you characterize the current economic environment, can you talk about that? And also talk about how you see the dynamics of the space playing out given acquisitions of SkinMedica and also [cycle phase] launch in non-hydroquinone product in the market and how you might be able to deal with the competitive pressures?

Albert F. Hummel

I think that obviously that's the great thing about America, there is lots of competition, and we are not afraid of competition, I think they are affordable opponent, but I think and we feel very strongly that product that they have introduced will not replace Nu-Derm in the physician's office. I think the quality of the system, the Nu-Derm system is physician in the physician's office is number one. We will maintain it is number one, we will spend to maintain it is number one.

I think that the new products that we're developing, the online commerce, and the focus on our employee and our sales productivity are ways that we will point towards additional growth. They are affordable competitor but in that physicians office we have gone in there and talked to the physician that really is a cornerstone of their practice and they believe and have seen the effects of 4% hydroquinone. And I think as I said, we’ve had many times other competitors say that they have a non-HQ lightener and each and every time those products have had some initial traction and then they fade away.

Annabel Samimy – Stifel Nicolaus

Okay. In the current economic environment, can you just characterize how you view that?

Albert F. Hummel

The current economic environment I think what we’ve seen in the past number of months and see selection I think that will continue. I mean there is still fights in Congress, but we are not projecting the economy to be robust growth nor we projecting it to drop of the base of the earth. I think what we see in the last number of months will continue to see.

Annabel Samimy – Stifel Nicolaus

Okay. And if I can just ask one more question on SG&A, you had mentioned you're making some additional investment in physician outreach, and I also noticed that your – I just want to understand your SG&A line for this quarter, it was $11 million. Do that include the e-Commerce investment or did not include the e-Commerce investment. So can you help us understand what the SG&A should be shaping out for this year?

Preston S. Romm

Well, if you look at Q4 it includes the $1.7 million for the e-Commerce and other initiatives, it also includes the $759,000 as I mentioned for advisors. It also includes the benefits of $8.4 million that we received back from the insurance company. So I think going forward you'd normalize for the advisors and the insurance settlements and that probably make sense.

Now the other hand, as I said in the guidance area, we have added some money $1.5 million for some of the competitive pressures that we are seeing from more customer outreach, more patient outreach, because your first question a competitor in the space.

Annabell Samimy – Stifel Nicolaus

Okay, thank you.

Preston S. Romm

Thanks, Annabell.

Operator

Thank you. Our next question comes from the line of Elliot Wilbur with Needham & Co. Please proceed with your question.

Elliot Wilbur – Needham & Co.

Thanks, good afternoon. Just a couple of quick ones here. Specifically with respect to 2013 guidance and the expected investment of $1.5 million associated with physician outreach, I'm assuming that's basically just trying to get more face time with physician community in light of elegant moment in the space and this is something unique and different from the e-Commerce initiative. I just want to confirm that.

And then, with respect to your total top line guidance at the high end of the range $130 million with the plan increase of about 8% year-over-year doesn’t sound like an extraordinary number for a company in your space. However, if you look back historically that would be equivalent to about the highest level growth the company is generated in the past seven years. So I’m sort of curious, what you think would enable you to achieve the high end of your current sales guidance for 2013?

Preston S. Romm

Yeah, this is Preston. Your first question, your assumption is correct this is not e-Commerce, this is something incremental. Your second question on achieving the high end of the range of 8%, that something close to that is where the market’s growing, we also feel pretty good about the product pipeline particularly as Al mentioned the hydrate product coming out and starting off very decently in the first quarter. Texas coming back getting closer to 100% and our international growth I think we’ll still continue and so we are feeling pretty good about those aspects offsetting that I think we are little cautious about as Al talked about a fairly large guy getting in our direct space.

Elliot Wilbur – Needham & Co.

Okay. Then I have just two quick ones for Al as well. Al, in thinking about the black and better crack down on the some of the deep discounters here. I mean that still seems like it's kind of work in process and I guess I would have assume that you would have taken a more rapid approach to that. But still sounds likes its ongoing and certainly do just a quick Google search and it seems like there is just a never ending number of sites are continue to advertise Obagi products. I’m just kind of wondering where you think you are in that process in terms of eliminating this avenue of distribution?

Albert F. Hummel

I think that in terms of, as we discover people we cut them off, but I think we’re probably another six months away may be from discovering all of the big guys that are in that category. Unfortunately we can’t take them their websites, so in many instances I think you may find that rather advertising Obagi products, they really don’t have it. So that will take a period of time until they get discoveries I guess and go away. But we can’t shutdown their full website or their skin that they are showing.

So I think that our job is to make certain that there isn’t product availability out there and I think that as time progresses there will be no big discounters, from time to time we see people pop up and Amazon or whatever and then we go to them and one guy selling a tube or something like that. The availability of putting up a website and saying that you have something as opposed to being a commercial distributor of the product or two different things.

Elliot Wilbur – Needham & Co.

All right. And then last question for you, Al. Given all the license – given the intensification of competitive pressures in the space being consolidation and obviously having a much bigger player now sort of having its sight set on you obviously there is going to be a lot of concern about whether or not this Internet strategy is actually going to pay off. I mean when do you think shareholders can reasonably expect this strategy to begin to yield the tangible results, I mean we're talking about mid-2014, late 2014, and in the interim how you are thinking about alternative growth strategy such as reinvigorated focus on BD efforts or looking at the potential acquisition landscape?

Albert F. Hummel

I think that in terms of our new product pipeline, I really I’m excited about that. I think that we have some unique opportunities and I think Hydrate was just the first of those to drill product opportunities and line expansion, so number one to build product opportunities and line extensions. I think number two internationally, we focused internationally, especially as we are moving into Asia with appropriate distributors who have better reach, also focusing internationally on the productivity of our international distributors.

So I think international is going to give as a big opportunity. And lastly in terms of the e-Commerce, I think we have seen, as you have seen the number of code internet sites, so the fact is that this is already proven to be successful. And the aspect of how successful we are is the opportunity to drive it back into the physician practice and for the physician to be sharing in the benefits of the internet. It actually puzzles me in terms of how people say this can be successful, because it's already proven to be successful on the internet. And that's what we are fighting right now. Is the channel that success into the – truly appropriate partners?

Laura B. Hunter

Operator, do we have other questions?

Operator

Thank you. Our next question comes from the line of Irina Rivkind with Cantor Fitzgerald. Please proceed with your question.

Irina Rivkind – Cantor Fitzgerald & Co

Thanks for taking my questions. I just wanted to dive quickly into the advisory fee that you paid in the fourth quarter, was that for advisors to help you with your competitive response or the proxy contacts, can you just help us understand what thus for?

Albert F. Hummel

I think the Board is committed to acting in the best interest of the company and its shareholders. And I think that the Board is always reviewing opportunities and that's why these advisors were retained.

Irina Rivkind – Cantor Fitzgerald & Co

Okay. And then moving into the ReGenica co-promote, can you talk about what you are seeing in the early trends in the quarter and also are you going to break out ReGenica in a separate line or is that going to be blended in with one of your other categories?

Albert F. Hummel

I'm going to blended it with another category. I haven't quite decided which category blends into and going forward we might be moving some of the products around a bit to really emphasize our pustules system versus specific product, individual products going after, kind of once you’re going after one element. So I’m not quite sure about that Irina, but we won’t be a standalone category.

Irina Rivkind – Cantor Fitzgerald & Co

Where you want to break it out and let us know how it’s going in terms of, how big do you think this thing is going to get?

Albert F. Hummel

It’s a very nice product and Suneva is the good partner and they have a pipeline of products that uses some more technology. We’ll tell you similar to what we are telling you about Hydrate how well it’s being adopted and what the reorder rate could be with that going forward.

Irina Rivkind – Cantor Fitzgerald & Co

Okay. And then I guess the last question I have is, do you have an update on what’s going on in the State of California and the investigation?

Albert F. Hummel

Yes, in March of 2012 they asked for information, a consumable amount of information which we provided to them. They have not asked for any additional information, and in addition to that, as you know the products are still available for sale in California. So I think that in that particular point right now, will they have all the information, they haven’t asked for more information, and they’re allowing the sale of the product in California.

Irina Rivkind – Cantor Fitzgerald & Co

All right thank you.

Albert F. Hummel

Thanks Irina.

Operator

Thank you. Our next question comes from line of David Amsellem from Piper Jaffray. Please proceed with your question.

Rebecca Forest – Piper Jaffray

Hi it’s Rebecca Forest for David. I just have one question around the international plans, do you intend to use e-Commerce there, or you know you are launching things similar for the international? And that’s my only question thanks.

Albert F. Hummel

I think Rebecca right now, we are going to be using our distributors for that top line growth for the moment. Eventually we’ll look at other opportunities in the Asian market. Clearly the Asian market has substantial opportunities for us.

Rebecca Forest – Piper Jaffray

Okay, but that doesn’t have an online component?

Albert F. Hummel

No.

Rebecca Forest – Piper Jaffray

Okay.

Albert F. Hummel

Currently not.

Rebecca Forest – Piper Jaffray

Okay, thanks.

Operator

Thank you. Our next question comes from the line of Scott Henry with Roth Capital. Please proceed with your question.

Scott R. Henry – Roth Capital

Thank you, guys. A follow-up quickly. First, I know you haven’t heard back from California and I guess a year now. I guess, I’m not sure what to do with that information. Do you expect that they will contact you to close out this investigation, or at some point is it not that to refer to as an investigation, but or is it that they are done. How should one translate that information?

Albert F. Hummel

Well, Scott I think in terms of translation as we are translating it, this information has been available to them for a year, and they have allowed the products to continue to be sold, so one would think that is a positive statement by the State of California. Now dealing with government agencies in terms of precisely how they resolve this – is dealing with a government agency. I think that, from their standpoint as I told you before, or you may not have remember before, they didn’t view this as traumatic in event as we had to portray it, because they said, they do this with companies all the time, they have this special legislative outreach in terms of what they can investigate, and they do this all the time with companies.

So their perspective as to the importance of than our perspective given a public company and they are investigating our products are potentially two different things.

Scott R. Henry – Roth Capital

Okay. Fair enough. That's good color. I appreciate that. Shifting gears gross margins dipped in the fourth quarter and I think there were some commentary in the release about it. Could you give a little color on gross margin, and I guess when we think about 2013 should gross margins look a lot more like the first three quarters in 2012 in the fourth quarter?

Preston S. Romm

Yeah Scott, this is Preston. The fourth quarter was a bit of anomaly compared to the fourth quarter of 2011. Part of it was the license fee, which as you know is the 100% gross margin that had an impact of about 70 basis points or 80 basis points. The exchange rates not really in our favor at these days there, but the main impact in the fourth quarter was riding of some component inventory. And as you know, periodically not very often that happens to us with an 80% gross margin business we rather in the side of having inventory shipped out to our customers then running that fairly tight.

So I think going forward, I think the model of 79% plus maybe might has a little bit is the right answer, but we also think that the efforts we are doing on cutting out these heavy discounters is going to paid us back in the longer term, and get us back over 80% gross margins. But I wouldn't model that just yet until we see that.

Scott R. Henry – Roth Capital

Okay, thank you. That's helpful. And these advisor fees that came up in the fourth quarter, I'm guessing that they will come up again given that you’re ongoing a Proxy Fight in 2013. One, is that a fair assumption, and I guess two within your guidance of $0.80 to $0.84 how much do we think we could have in one-time advisor fees or whatever you want to call associated with the proxy challenge?

Preston S. Romm

I think Scott, they’re not included in the $0.80 to $0.84, but we didn't ask for the contest, but we're committed to creating shareholder value and focused on growing the company. And so beyond the fees we incurred and announced today we’re not disclosing guidance for proxy related cost. So in effect some ways we don't know the absolute outcome of all the alternatives.

Scott R. Henry – Roth Capital

Okay. So I mean I just want to flush that out a little bit. I mean obviously you've already expensed, you've already incurred some expenses in the Q1 for an upcoming Proxy Fight, and you know you have expenses in Q2 heading into the shareholder meeting. Have those expenses or those calculated when you come up to your $0.80 to $0.84 guidance or will those expenses which we can anticipate make it lower than that?

Preston S. Romm

They are not included in the $0.80 to $0.84 or the first quarter guidance, Scott that would be the only thing I will call out at this material as the non-GAAP item otherwise I’ll be reporting GAAP, so again they are not in the number, and I’ll report those separately. So you can track to the $0.80 to $0.84.

Scott R. Henry – Roth Capital

Okay, great. That's helpful. I think that's it from me. Thanks guys.

Preston S. Romm

Thanks Scott.

Operator

Thank you. (Operator Instructions) Thank you, we do have a follow-up from Irina Rivkind with Cantor Fitzgerald. Please proceed with your question.

Irina Rivkind – Cantor Fitzgerald & Co

Thanks. I just wanted to see if – with regard to the e-Commerce spending that you guided to in 2013. Are you thinking this is the end of the spending or you anticipate more investment in the e-Commerce platform in 2014 and beyond?

Albert F. Hummel

Well, I think Irina the aspects of e-Commerce as we said kind of continual operations $2 million to $2.5 million, the aspects of how we gauge, how successful what's happening – what spend we want to do it will be relative to the sales that we’re generating. So it's just like a marketing budget here. We have a marketing budget, we spent on marketing, but that is due to increase sales. So I think that there will be some rationale between what we're spending, what type of sale, sales volume that we're getting.

Irina Rivkind – Cantor Fitzgerald & Co

Okay. And then just the last one, I believe you guys have already set up your independent for e-Commerce distributor that's not tight to a physician side, is there any kind of color you can give descriptively is to how that one is doing and if there is a lot of orders coming through that? Thanks.

Albert F. Hummel

Couple of things, is only been up for a little while and in addition to that not in all states. So in terms of tractions for website it will take good six months in order to get [absolute tractions]. We'll be tracking as we move along, but as I said is not even in all states yet.

Irina Rivkind – Cantor Fitzgerald & Co

All right. Thank you.

Albert F. Hummel

Okay Irina.

Operator

Thank you. There are no further questions at this time. This concludes today's teleconference. You may disconnect your lines at this time. And thank you for your participation.

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