Palomar Medical Technologies, Inc., Q1 2009 Earnings Call Transcript

| About: Palomar Medical (PMTI)

Palomar Medical Technologies, Inc. (NASDAQ:PMTI)

Q1 2009 Earnings Call

April 30, 2009 11:30 am ET

Executives

Kayla Castle – Investor Relations Manager

Dan Valente – Chairman

Joseph P. Caruso – Chief Executive Officer

Paul Weiner – Chief Financial Officer

Analysts

Anthony Vendetti – Maxim Group

Andy Schopick – Nutmeg Securities

Dalton Chandler - Needham & Co.

David Ratliff - Doucet Asset Management

Operator

Welcome to the Palomar Medical Technologies first quarter 2009 financial results conference call. (Operator Instructions). I would now like to turn the conference all over to Kayla Castle, Investor Relations Manager of Palomar.

Kayla Castle

Good morning and welcome to the Palomar Medical Technologies’ first quarter 2009 conference call. Before we start this morning’s call, there are a couple of items we’d like to cover. This conference call is on a recorded line, and you access the telephone replay of the call at 888-286-8010, pass code 65357877 or a webcast replay at Palomar’s website, www.palomarmedical.com through Thursday, May 7th.

Various remarks that we may make about future expectations, plans, and prospects for the company constitute forward-looking statements for the purposes of the safe harbor provisions under the Private Securities Litigation Reform Act of 1995. Actual results may differ materially than those indicated by these forward-looking statements as a result of various important factors including those discussed in the Form 10-K for the year ended December 31, 2008, and company’s quarterly reports on Form 10-Q which are on file at the SEC and available through Palomar’s website.

To supplement Palomar’s consolidated financial statements presented in accordance with GAAP, management uses the following measures defined as non-GAAP financial measures by the SEC—non-GAAP income before taxes, non-GAAP provision for income taxes, non-GAAP net income, and non-GAAP diluted earnings per share. The presentation of this financial information is not intended to be considered in isolation or as a substitute for the financial information prepared and presented in accordance with GAAP. In addition, the non-GAAP financial measures included in this call may be different from and therefore not comparable to similar measures used by other companies. For more information on these non-GAAP measures, please see the non-GAAP data included in the press release. This data has more details of the GAAP financial measures that are most directly comparable to the non-GAAP financial measures and the related reconciliation between these financial measures. Palomar management believes that these non-GAAP financial measures provide meaningful supplemental information regarding our performance by excluding certain items that may not be indicative of our core business operating results.

Palomar believes that both management and investors benefit from referring to these non-GAAP financial measures in assessing Palomar’s performance and when planning forecasting and analyzing future periods. These non-GAAP financial measures also facilitate management’s internal comparisons to Palomar’s historical performance and our competitor’s operating results. Palomar believes that these non-GAAP measures are useful to investors in allowing for greater transparency with respect to supplemental information used by management in its financial and operational decision making.

The information in this conference call related to projections and other forward-looking statements may be relied upon subject to the previous safe harbor statement as of the date of this call. The information and this conference call is the property of Palomar and should not be reproduced, recorded, or otherwise published without the expressed prior written consent of the company.

Joining us this morning are Dan Valente, Chairman; Joseph Caruso, President and Chief Executive Officer; and Paul Weiner, Chief Financial Officer. I would now like to turn the call over to Dan.

Dan Valente

Thank you all again for tuning into the conference call. As you all know, the future of the economy remains uncertain, but Palomar’s business model has and should keep us positive during these uncertain times, so once again let me say that I believe we will emerge from these current conditions in a stronger position and continue as a leader in our industry.

Now, let’s hear from Joe Caruso, Palomar’s CEO.

Joseph P. Caruso

The economic downturn that began more than a year ago continues to affect our business and industry. Economic turmoil has made this last quarter another challenging one for many companies, and we are no exception. We are feeling the effects of an overall economic slowdown, a decrease in consumer confidence, and additional tightening of available credit for our customers and patients. We are fortunate to have developed a diversified business model that includes a significant portion of our revenues being generated from multiple sources.

During the first quarter, 45% of our revenues were generated from sources other than capital equipment sales. We’re also benefiting from our efforts in developing distribution outside the US. Approximately 55% of our products and service revenue during the first quarter was from outside the US. We continue to focus on executing our diversified strategy by addressing the professional light-based aesthetic market today, working toward driving our technology to the mass consumer market, and capitalizing on the value of our extensive patent portfolio. This business model has enabled us to invest more in R&D than our competitors, and we will continue to do so.

Our goal is to remain cash flow neutral during this economic slowdown. This will not be easy as it is difficult to predict how long and deep this recession will be. However, I am pleased to report that we met this goal during the first quarter. We’ve taken steps to decrease our operating expenses in all areas of the company including reductions in head count and salary freezes. We’ll continue to monitor and adjust as we move forward. Our intent is to balance our short-term operating goal of cash preservation with our long-term opportunities as we invest in research.

We have built the core competency in light-based cosmetic devices, and we intent to maintaining it as we navigate through this tough economic period. These challenging times could be with us for a while. We do believe, however, that the long term outlook for light-based cosmetic devices remains a great opportunity and one that we are prepared to capitalize on. The strong companies will survive, and we plan to be even stronger when the recession ends. We will continue to build assets based on the strong foundation put in place over the past few years, so that when the recession ends and the economy begins to strengthen we will be ready.

Although today we are discouraged with the overall economy, this is also an exciting time for us. We have aggressively increased our product offerings, and will focus our sales efforts on those physicians that are willing and able to invest in their practice. We recently introduced a more powerful version of the Aspire platform. This new system is a 40 Watt diode laser platform that is focused on body sculpting. The first application we are addressing is liposuction, specifically minimally invasive laser assisted lipolysis. The Aspire has unique selectivity which uses a particular wavelength that is highly absorbed in the lipids present in fat cells. This selectivity allows the Aspire to treat the targeted fat cells more effectively and much faster than devices offered by competitors and is the focus of our product positioning.

We are marketing the procedure as Slim Lipo. The Aspire system uses a proprietary one time use delivery system. This per-treatment disposable revenue stream will build over time and could be an important contributor to profits with a large installed base. The ramp up in revenue is slower than we had anticipated due to the economy, but we are gaining momentum, and the feedback from those using the system is even better than expected.

Along with body sculpting, we are also well positioned with fractional technology. We have a full suite of ablative and non-ablative product offerings and complement our other light-based hand pieces. We recently introduced two important additions to the fractional family of products, XD and Groove Technology. Both of these technologies work to enhance our current offerings and provide for better and faster treatment outcomes for our customers and patients. Fractional technology provides a higher level of safety and efficacy for certain applications than non-fractional treatments and we are a leader in this technology.

We are focused on expanding market opportunity for our products outside North America. During the quarter, we shifted some of our marketing and sales efforts to areas outside the US that are not being hit as hard from this downturn in the economy. There is a great deal of opportunity for us outside North America. We have made a great deal of progress over the past few years with our plans to take our technology to the mass market. The Johnson & Johnson program is moving along well. We are pleased with the collaboration and believe that the products we’re working on today will provide us with opportunities to address very large markets.

Over the past few years, we’ve worked with Gillette and P&G and made substantial progress in moving light-based hair removal to the mass market including receiving FDA OTC clearance for our device. P&G continues to pay us $1.25 million per quarter prior to commercial launch of our product. We also continue to work independently on consumer hair removal devices. We also continue to execute our intellectual property enforcement strategy. We have a portfolio of very broad patents in a number of areas. We have nine executed licenses to our hair removal patents and are in negotiations with other companies as well. To date, we have received approximately $80 million in royalty payments from this valuable asset.

Our hair removal case against Candela is stayed for the time being as the patent office reexamines the Anderson hair removal patents. Re-examinations are common, and this was not unexpected. While we’re not happy with the delay, the re-examination process gives us the opportunity to add new claims in patent and show that existing claims are valid over all prior claims Candela and others have raised. Consequently when we go to trial, the strength of the claims should be further fortified.

In the short-term, our business like many others is being affected by a downturn in the overall economy. Over the past five years, we have successfully built our business and accumulated the assets needed for continued growth over the long term including a cash and marketable securities balance in excess of $120 million. We’re expanding our product portfolio with the Aspire body sculpting platform to address an ever-changing market. We remain focused on investing in the long term through R&D, and we’ll continue to strengthen our valuable intellectual property position. The recession will one day be behind us, and when that day comes, we will be ready to capitalize on the tremendous opportunity we have for light-based aesthetic devices that enhance the everyday lives of millions around the globe.

Now Paul will brief us on the financial performance for us.

Paul Weiner

Revenues for the quarter were $14.6 million as compared to $23 million for the same quarter last year. Product revenues for the quarter were $11.5 million as compared to $17.7 million for the same quarter last year. 58% of product revenues were in North America, and 42% were outside North America. At Joe had previously commented, product revenues are being affected by the weakened economy.

Ongoing royalty revenues decreased to $1.5 million from $3.2 million including last year’s $682,000 related to the recognition of the remaining portion of back-owed royalties from Alma. Licensees have reporting lower revenues due to the weakened economy, and we expect this lower royalty revenue to continue in the upcoming quarters.

Funded product development revenues consist of funding from Johnson and Johnson of $431,000 this quarter, as compared to $597,000 for the same quarter last year. Other revenues include the $1.2 quarterly payment from P&G related to the non-exclusive license granted to P&G for home use light-based hair removal for women. Product gross margin was 55% this quarter, as compared to 63% for the same quarter last year.

During the quarter, we were able to balance sales price, volume, and operating expenses which resulted in positive cash flows from operations. Product gross margin was negatively affected by lower product revenues which resulted in lower overhead absorption. As a percentage of worldwide product revenues, product revenues increased to 42% outside North America this quarter versus 37% for the same quarter last year.

Product international sales are at lower distributor transfer prices as compared to end-customer prices in North America. Research and Development expense for the quarter was $3.7 million as compared to $5.4 million for the same quarter last year. R&D as a percentage of total revenue was 26% this quarter as compared to 23% for the same quarter last year.

Selling and marketing expense for the quarter was $4.7 million as compared to $6.8 million for the same quarter last year. Selling and marketing as a percentage of total revenue was 32% this quarter as compared to 29% for the same quarter last year. General and administrative expenses for the quarter were $2.9 million, as compared to $6.2 million for the same quarter last year. G&A expense as a percentage of total revenue was 20% this quarter as compared to 27% last year.

Last year, we incurred an expense for investment banking fees related to the completion of international distribution agreement with QMed of $1 million. G&A expense this quarter also decreased from last year due to only $300,000 in litigation costs as compared to $2.4 million for the same quarter last year. We estimate that quarterly litigation costs of less than $500,000 throughout 2009. We’ve also reduced our operating costs to be more in line with the lower revenues.

Loss before taxes this quarter was $2.3 million, as compared to loss before taxes of $1.8 million for the same quarter last year. Net loss this quarter was $1.4 million, or $0.08 per share, as compared to a net loss of $1 million or $0.05 per share for the same quarter last year. We are pleased that we had $700,000 of positive cash flows from operations in this weakened economy.

The balance sheet is solid, with ample cash and cash equivalents of $122 million. We have been successful in maintaining extremely low accounts receivable days sales outstanding of 45, with very limited write-offs even as many of our customers and potential customers have limited access to financing. This again is an area that we have been able to keep in check by balancing sales volumes and positive cash flows from operations.

We are now ready to take your questions.

Question-and-Answer Session

Operator

(Operator Instructions) Your first question comes from the line of Anthony Vendetti with Maxim Group.

Anthony Vendetti – Maxim Group

I just have a couple of quick questions on the J&J agreement. Any more color, Joe, that you can provide on that? I know that’s been going well, as you said, and just give us a little bit more color on the different applications that you’re working on with them, and if you can give us a broad range of maybe when we could expect something submitted to the FDA.

Joseph P. Caruso

All of those specifics are actually in confidence and pretty close to the vest between us and J&J. We have moved the program along nicely. It’s been a great collaboration with the J&J folks. We’re happy with the progress, but we’re not really allowed to talk about a lot of the specifics around the program. We do think that the things that we are working on with J&J are very big opportunities for us in markets that are the right markets for this type of technology, and we’re hopeful that we’ll be successful in that program and that’ll also give us quite a nice incremental business that we don’t enjoy today.

Anthony Vendetti – Maxim Group

On the gross margin side, it came down a little bit obviously. You’re working in a difficult environment right now. Do you expect the product gross margin to stabilize around the 54-55% range, or if necessary, you won’t take down prices just a little bit more to be competitive if you’re seeing some discounting going on from your competitors?

Joseph P. Caruso

We haven’t really seen big discounting in these products. They’ve stayed within a range that is acceptable. What does affect the margin especially for is the volume—the overall total volume of revenue that goes through the plant because there is quite a big percentage of cost that is fixed cost as well as the geographic split. We’ve been increasing the amount of overall revenue that is from outside the US or outside North America, and that comes in at a lower gross margin, but we also don’t have the marketing and commission costs associated because we go through full service distributors for those types of sales, so what we do is look at really managing the business, managing pricing, managing margin, managing our costs to be in line with our goal through this economic slowdown, which is a neutral cash position and we were successful in doing that. Actually we had $700,000 of positive cash flow during the quarter. If things change and if some of our competitors do things that are different or do things that are different on pricing, we might take another look at it, but so far we haven’t had to really slash prices to maintain the positive cash flow that we see.

Anthony Vendetti – Maxim Group

So mostly it wasn’t due to pricing. It was mostly due to lower volume and of course there’s some fixed overhead there, and also due to greater percentage of international sales. Did you give the breakout of North America versus international for the quarter?

Paul Weiner

Yes, we had North America at 55%, and outside North America at 42%.

Joseph P. Caruso

That in the past has been as high as 70-75% in North America, so that’s why that shift makes a different in gross margin.

Anthony Vendetti – Maxim Group

Have you seen as some other companies have in the industry a shift more towards your core base? Do you have that breakout of core versus non-core for the quarter?

Paul Weiner

Yes, the core or plastics and derms is at 45%, and outside of that is obviously then 55%, so it’s a bit higher than it’s been in the past. Typically in the past, it’s been about 40% of derms and plastics and 60% other. So it is swinging a little bit more towards derms and plastics for probably a couple of reasons—one is we are certainly moving towards the laser lipolysis market which is more towards the derms and plastic side, but also on the financing side, which plays into this where they have easier access to capital than the other markets as well.

Anthony Vendetti – Maxim Group

I was wondering if you could just, Joe, maybe characterize the quarter. I know January and February were very difficult months. I’ve heard March is a little bit better. Have you seen some follow through in April in terms the market stabilizing here or is it too early to tell?

Joseph P. Caruso

It’s too early to tell. This business is the same for a lot of capital equipment manufacturers. The first two months of any quarter are normally slower than the last month in any quarter, so it was not unusual for us to see more activity in March than in January or February. We saw that last year, and we saw that this year, and we would expect that in the second quarter that we’ll see more activity in June than we see in April and May. It’s just the nature of the beast. There is a process that goes along in closing these sales. It seems like the people that are in the field in sales positions have a tendency to really work at the close of sales in the last month of any quarter, so it wasn’t anything unusual in the first quarter that we noticed.

Anthony Vendetti – Maxim Group

Would you say April was better than January, or is that typically the case because January is usually one of the slowest months?

Joseph P. Caruso

I don’t think it’s really any different.

Anthony Vendetti – Maxim Group

Paul, the stock-based compensation this quarter was $800,000. Is that a good runrate to use for the remainder three quarters of ’09?

Paul Weiner

It is for now certainly. On a quarterly basis, that shouldn’t change unless there’s any change as far as issuances of options or anything else to employees throughout the year, but as of now, that’s an okay number to use.

Operator

Your next question comes from the line of Andy Schopick with Nutmeg Securities

Andy Schopick – Nutmeg Securities

Joe, I was wondering if you could give a little bit of an update on the sales force situation, put some color around what’s been happening, what still needs to be done if anything in terms of various regions.

Joseph P. Caruso

We made some adjustments in the beginning of the year. We adjusted our cost structure, we adjusted our headcount to what we thought would be a reasonable level, and we’re pretty satisfied with those adjustments. We now have about 30 territories in North America, and that seems to be the right number for us right now. There is enough activity, and there is enough lead activity and show and seminar activity that can be supported with that number. We may make some adjustments, one or two, but I don’t see any major adjustments as long as the revenue levels stay where we think they might be.

Andy Schopick – Nutmeg Securities

To what extent if any do you feel the current revenue performance is affected by any sales force issues or is it now pretty much market dynamics?

Joseph P. Caruso

I think it’s all market dynamics. You’re probably referring to a few years ago where we had some sales turnover because some people left to go to these start-ups that were looking to go public and things like that. That’s all behind us. We have a very stable group. We like the group that we have. It’s a well-trained group. We have excellent management in place over this group. We might make a change here or there, but I don’t see the type of turnover issues that we had about a couple of years.

Andy Schopick – Nutmeg Securities

A couple of other things if I may; do you see any opportunities beyond the traditional aesthetics market that you’ve addressed, and I am referring to some of the new medical applications; one that I have heard of very recently is using lasers to treat the toenail fungus. I am sure a variety of niche kinds of markets; is this something that makes sense for Palomar in terms of broadening and expanding its overall reach?

Joseph P. Caruso

We actually do devote some of our research efforts in the areas that are not classic applications or classically fit into some of our distribution models. There are some spin-off technologies that I think could work well with our current base and we do have some programs associated with that. The thing is that the economy is not a great economy to go out and test some of these things because even though they might work well, it may not be the right time to devote some of the applications that are outside really our core business because if you get into a non-core business as you know you do have to devote significant amount of time, effort, and resources before you actually get a good return on that. It may not be fair to test some of those things in this type of economy because you won’t really know whether that business model or that business aspect is truly a profitable one in this type of economy. So, we are still working on those things. We do have some potential in areas outside our core businesses, but it may not be the right time to really exploit those.

Andy Schopick – Nutmeg Securities

Finally, I wonder how you might characterize what your really assessing as indications of improvement in the market; how much of it is tied to consumer confidence, how much of it is tied to improving credit conditions, what are some of the things that you are really looking at to get a sense that this market is beginning to grow again?

Joseph P. Caruso

I think one of the leading indicators might be the credit situation. We see credit availability increase and we see FICO scores better acceptable to financing sources come down from where they are today. Then I think those things will be some leading indicators that we might look for growth. I think consumer confidence is also another one. Also, unemployment rates and the amount of people that are out of work and those types of things are also indicators for us. I think that because we operate in an industry that is driven by discretionary spending, we might see a little bit of lag in recovering growth from some other industries that you might compare to, but once the recovery starts happening, I think there will be a lot of pent up demand, a lot of pent up demand from consumers because they have been putting off some procedures that they either had in the past or were looking at during this recessionary time period, and I think an awful lot of pent up demand by our customers, the physicians. We still see quite a nice flow of traffic at these major medical shows; American Academy of Dermatology, the ASLMS, and some of these regional shows, the plastic show is this weekend out in Vegas; physicians still attending these programs and these shows are still coming by the booth and looking at the technology. They just are not sure whether today is the right time to pull the trigger on a capital equipment purchase. He doesn’t want to purchase, it just means that they might be holding off until they see the signs of overall recovery. That’s a good thing for us and that’s why we still attend these shows and spend the dollars in marketing.

Operator

Our next question comes from the line of Dalton Chandler - Needham & Co.

Dalton Chandler - Needham & Co.

Just wanted to followup on the question on your comments about the international mix and gross margins; even though the gross margin is lower on international sales, would the operating margin be similar?

Joseph P. Caruso

Yes, the operating margin should be about the same.

Dalton Chandler - Needham & Co.

With regard to the cost cutting you’ve done, did we see the full effects of that in the first quarter or will we see some more of it in the second quarter?

Paul S. Weiner

Most of it you would have seen in the first quarter. In the second quarter there is still some room potentially for a decrease, but a lot of it was in the first quarter.

Dalton Chandler - Needham & Co.

With regard to the Aspire platform, can you give us any indication when we might see the next procedure launch on that platform?

Joseph P. Caruso

We haven’t publicly indicated that yet. We have some ideas about things that are very complementary to that platform, but we have not indicated when those things will be launched. The SlimLipo procedure is giving us results that we are very impressed with now, I can tell you that. All of the doctors that have the SlimLipo really like it. For the most part, it’s changed their practice. It’s really increased their procedures, increased their revenue. We have some physicians who now have a system that are doing almost all of the procedures as SlimLipo procedures and most of their practice is around body sculpting. So, it is an important application, we’re very pleased with the results, we’re very pleased with the outcomes, and it will be good driver especially when the economy turns around.

Dalton Chandler - Needham & Co.

I know you’ve always avoided commenting on specific products, but you’ve launched a number of new products in the last 12 months including the Aspire and others; could you comment on the contribution of new products to revenue?

Paul S. Weiner

Certainly we have different hand pieces and other things related to the StarLux; that’s all part of the StarLux in assisting our sales there. With the Aspire and SlimLipo launch, that certainly has increased over what we did a year ago because we just launched it within the last 12 months and we see continued more sales in that area. We would expect that between StarLux and the SlimLipo, we would like to see it somewhere around half and half of each over the coming quarters.

Dalton Chandler - Needham & Co.

When you say half and half, you’re talking product revenue?

Paul S. Weiner

That’s correct.

Operator

Our next question comes from the line of David Ratliff - Doucet Asset Management.

David Ratliff - Doucet Asset Management

I only have one question that I don’t think has been asked. You had a nice drop in your accounts receivable, about roughly 9.5%. I don’t have any recall of you guys having any kind of problems with collections, but that wasn’t a bad debt write-down or anything; and have you been seeing any problems with your customers paying their bills?

Paul S. Weiner

No, not at all. We’ve been watching that very closely. Our DSOs are what we calculate to be at around 45 days, that’s been pretty consistent although it was 43 the quarter before and then in the 50s and 60s prior to that. So, we’re at the lowest level we’ve really ever been in DSOs, and we noticed that about a year and a half ago; we really tightened our credit seeing what was coming up ahead of us as far as where the economy was and the financing was going. So, we’ve been able to actually drive our DSOs down to lower levels and we haven’t had any write-offs to talk about. So the decrease in the receivables balance is not due to write-offs; just really monitoring and continues to stay on top of customers to get the invoices paid that much quicker.

Operator

There are no more questions at this time. I would now like to turn the call over to Dan for closing remarks.

Louis P. Valente

I hope we answered your questions as directly and clearly as possible. Thanks for tuning in. We look forward to hearing from you on our next call which is scheduled for Thursday, July 30th. Have a good day.

Operator

This concludes Palomar’s first quarter 2009 financial results conference call. Thank you for attending. You may disconnect at this time.

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