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Executives

Steven R. Carlson - Chief Executive Officer and President

Preston Romm - Chief Financial Officer

Ina McGuinness - Investor Relations

Analysts

Scott Henry - Roth Capital Partners

Brian Jeep - Sidoti

Anup Mehta – Canaccord Adams

Larry Neibor – Robert W. Baird

Obagi Medical Products, Inc. (OMPI) Q1 2009 Earnings Call May 7, 2009 4:15 PM ET

Operator

Welcome to the Obagi Medical Products first quarter 2009 earnings conference call. (Operator instructions). I would now like to turn the conference over to our host, Ms. Ina McGuinness of ICR.

Ina McGuinness

Earlier, Obagi Medical Products released financial results for the first quarter ended March 31, 2009. 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.

We’d like to remind you that today’s remarks 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 Obagi Medical Products’ 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 of the information provided in today’s call is as of the date of the live broadcast, Thursday, May 7, 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.

With that, I’d like to turn the call over to Steve Carlson.

Steven R. Carlson

Good afternoon to everyone. Looking at the aesthetic landscape, while we’re still being impacted by depressed economy, the aesthetic skin care market now and in the future remains a dynamic environment. Our first quarter net sales of $22.6 million were on the lower end of our guidance, we were pleased overall with the performance when taking into consideration the economy couples with historical normal softness in Q1 following a seasonally strong fourth quarter.

Regarding our views of the current and future industry, there are simple fundamentals one should not lose sight of. We have a growing aging population. Billions of dollars continues to be spent by consumers and patients seeking ever better skincare solutions. New neurotoxins and dermal fillers have recently and will continue to be approved and enter this market place. We believe these will provide a stimulus for future growth by driving increased consumer awareness and bringing more patients into the physician’s office in search of better and alternative ways of improved aesthetic outcomes.

In such an environment, we remain confident that our clinically proven efficacy, industry leadership in physician dispense, and value price point position us well for the remainder of 2009 and beyond. Supporting our current resiliency and greater stability versus more expensive cosmetic procedures, we continue to see strong new account growth with more than 329 accounts added during the quarter. Further, Nu-Derm sales were down only 6% versus recent market data indicating neurotoxins, derm fillers, and laser procedures were down 13% to 16% for the same period.

As of March 31, 2009, the number of active accounts totaled approximately 5800, up 8% from a year ago. This continues to demonstrate that physicians are actively seeking additional revenues by incorporating a topical physician dispensed business within their existing clinical practice. We believe our products and systems continue to be one of the easiest user friendly, yet still highly effective skin care therapies.

Further, we worked diligently to get Rosaclear launched earlier in the year because we believed we had a great system that fills an unmet need among men and women who are challenged by the facial redness associated with rosacea. Rosaclear was introduced late January and contributed $1.3 million in net sales during the first quarter. Rosaclear has been widely and enthusiastically received in its first 100 days since launch. 28% of our customers have already purchased Rosaclear which is a very good initial indication from our customers. With an estimated 14 million people who suffer from the associated facial flushing and redness of rosacea, we believe this is a unique opportunity for us to treat a new Asian population with a new Obagi system while leveraging our existing salesforce and current account base.

By geography, domestic sales represented 80% of revenues, yet declined 10% during the quarter. Our international business showed progress, but was not immune to the global economic downturn with sales down 14%. This was particularly prevalent in Japan, where we saw a decrease in licensing fees of roughly $400,000 due to economy and a delayed product launch. As we look forward to the launch of our Elastiderm product line into Rohto’s drug store distribution channel later this year and the anticipated future launch of the more science and clinically based product line into the Prestige Department Store channel.

Also internationally, we have added 8 new distributors for Elastiderm in the first quarter covering Russia, Ukraine, the Netherlands, China, Hong Kong, Australia, Vietnam, and Combodia. As a result, we are in a much better position in our international markets than we were a year ago to capture share and revenue growth as demand returns to normal levels. Of note, in Far East Asia which I visited last quarter, we recently launched in China, Hong Kong, Vietnam, and Cambodia and our Q1 business was up significantly with initial stocking sales of over $1 million.

In terms of product line and segment performance, regarding Elastiderm, you’ll recall we launched the Décolletage product system in the first quarter of last year. Therefore, the sales decline to $2.1 million is a bit distorted in the first quarter. We did continue to have a very strong reorder rate for the eye cream and eye gel of 84% and 76% respectively.

Décolletage also showed good reorder rate at 57%, despite our belief in this economy many patients are not expanding their spending from the face to include their neck and chest. Regarding vitamin C based products which include Obagi-C Rx and Professional-C, sales were $2.6 million, down 7% from a year ago.

Turning to the sales of Nu-Derm, first quarter sales were down from a year ago by approximately $800,000 or 6%. However, we’re pleased to see reorder rates for the Condition and Enhance systems continue at 77% and 59% respectively.

At the recent AAD meeting in San Francisco, we were pleased to present our very positive study data showing the best patient benefit of combination therapy where our Condition and Enhance system used with an IPL laser procedure was significantly better than IPL alone. We believe this is further compelling data supporting the use of Condition and Enhance to be combined with existing cosmetic procedures.

Last, as you know we recently terminated sales of SoluCLENZ in the pharmacy channel. Preston will go into the P&L implications of this decision, but we’ve taken particular care to ensure that our physicians understand that we will continue to support and publish compelling clinical data demonstrating the superior efficacy and safety of soluble BPO as found in our physician dispensed CLENZIderm MD system compared to BPO antibiotic combination products. We are pleased with the recent 10-week study results that were presented at the recent AAD which again showed CLENZIderm MD system resulted in a significantly greater reduction in non-inflammatory acne lesions than the leading BPO antibiotic combination product, BenzaClin.

So overall, we believe we’re well positioned as a leader in the physician dispensed channel with a strong salesforce, a growing account base, a solid future pipeline of products, and the continued ability to invest and growing market share as we partner with our customers to meet the needs of their patients.

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

Preston Romm

Before I get into the numbers, I want to discuss the financial impact of our decision to exit the SoluCLENZ product line in the pharmacy channel. We believe comparison of the year over year numbers and projections of future operations make more sense excluding this impact. Please refer to our GAAP versus non-GAAP table in our press release and is filed today on form 8-K.

One, we booked a reserve of $440,000 for all related inventory which is a prudent action to take. This reserve was booked to cost of goods sold and impacted gross margin percentage by 200 basis points. Two, we wrote off $416,000 of nonrefundable contractual deposits which is reflected in SG&A expenses. Third, SoluCLENZ operational impact for the first quarter excluding the two above-mentioned actions were revenue of $238,000, gross margin of $207,000, and operating expenses of $1,159,000 resulting in an operating loss of $952,000. Four, this has also impacted our salesforce. As you recall, we hired a 20-person contract salesforce to support the pharmacy channel. So as of today, 114 sales people in management, up 4, in the first quarter of 2008. Five, as a reminder, we will record an additional charge in the second quarter of between $500,000 and $900,000 for terminating certain contractual agreements, and finally number six, separately from SoluCLENZ, we recorded a severance charge of $120,000 during the quarter.

During the first quarter, net sales were $22.6 million, down approximately 11% from $25.4 million in the first quarter of 2008, primarily as a result of a weak economy. The numbers I’ll talk about in the remainder of this section will be non-GAAP excluding the items I mentioned earlier. Non-GAAP gross margins were 79.5%, essentially flat compared to 80.2% in the fourth quarter of 2008. We saw a negative impact to gross margin as we increased investments in promotional activities to drive new account growth and lower licensing revenue that Steve described earlier.

On the expense front, we successfully reduce operating expenses in a number of areas. Non-GAAP operating expenses for the first quarter totaled $14.8 million, compared to $15.7 million for the first quarter of 2008, representing a $900,000 or 6% reduction. We made excellent progress in cutting our costs, so we’ll continue to pursue expense reduction on an ongoing basis.

Non-GAAP net income for the first quarter of 2009 was $1.8 million, or $0.08 per fully diluted share, on a weighted average 22 million shares outstanding. This compares to $3 million or $0.13 per diluted share on a weighted average 22.8 million shares outstanding a year ago.

Moving to the balance sheet, we’re pleased at the end of the first quarter with such a healthy balance sheet. As of March 31, 2009, we had cash, cash equivalents, and short-term investments totaling $23.2 million. This is up from $19.9 million at December 31, 2008. Key balance sheet metrics also improved as of March 31, 2009, with working capital increasing to $45.4 million and stockholders’ equity rising to $61.6 million. We generated positive cash flow from operations of $4.2 million during the quarter.

To bring everyone up to date on our stock buyback program, we did not purchase any stock during the first quarter due to the timing of releasing our year end and first quarter results. As a reminder, we have an authorized stock buyback plan to spend up to $10 million and $4 million in the fourth quarter.

Before I conclude the call, let me provide our guidance for the second quarter. Based on current market condition and the impact of cost reduction efforts, the company expects sales for the second quarter 2009 to be in the range of $22 to $24 million and fully diluted earnings per share to be between $0.10 and $0.13 on 22 million shares outstanding. This guidance excludes the planned pretax charge of between $500,000 and $900,000 to be taken in the second quarter of 2009 associated with the terminating of certain contracts related to exiting the pharmacy channel. What this represents is a flat to slight increase in sequential revenue from the last quarter and a real improvement in earnings due to our cost reduction efforts.

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

Question-and-Answer Session

Operator

(Operator Instructions). Our first question comes from the line of Scott Henry - Roth Capital Partners.

Scott Henry - Roth Capital Partners

When I look at the GAAP versus non-GAAP, I just wanted to make sure where everything is coming out of. Obviously the 233 is coming out of the COGS line. Are the other adjustments wholly coming out of SG&A with the exception of tax?

Preston Romm

On the COGS line is the $400,000 of inventory reserves and the $207,000 of SoluCLENZ operating gross margin. Out of the SG&A line comes $1,159,000 of SG&A related to selling and marketing SoluCLENZ in the pharmacy channel along with $416,000 reserved for the non-contractual obligations.

Scott Henry – Roth Capital

How many reps do you currently have?

Preston Romm

We have 114 sales people inside sales and management, and that’s up four from a year ago, normalizing for the contract salesforce.

Scott Henry – Roth Capital

How many managers on top of that?

Preston Romm

That includes managers.

Scott Henry – Roth Capital

Shifting gears, is there any timeline for the SoluCLENZ out-licensing or how should we think about that?

Preston Romm

There is no timeline. Steve and I continue to talk to people. They’re in various stages of discussion with various people, and I think we just wait and see, so no comment at this time.

Scott Henry – Roth Capital

Shifting to Rosaclear, certainly a very strong launch. Could you talk about the run rate in March and how we should think about it going forward? I’m just trying to trying to think about the rest of year relative to the number you guys put up in Q1 of $1.3 million.

Preston Romm

The $1.3 million, we’re quite pleased with, and that’s really from launch in late January through the end of March, and a good reorder rate and a good pickup by our customers, and so the question we’re going to look at going through Q2 is that really the initial stocking which we generally see when launch a new product, or is that going to be a continuation, so what I like to do is report back to you in the second quarter and give you an indication of how well Rosaclear is doing post launch.

Scott Henry – Roth Capital

What are the expectations for new product launches now? I know you just launched one, but if we could just think, do you expect to launch another product within 2009? How should we think about that?

Steven Carlson

As we’ve indicated before, we target two product launches in a year, so yes, our plan at this point in time subject to obviously successful completion of development and clinical trials is to launch a second product in 2009.

Scott Henry – Roth Capital

How should we think of your business? If we think about everything in terms of seasonality in the EPS line, if we think of the environment staying at the status quo, would you look for sequential growth quarter over quarter or how should we think of it? Should Q4 be slower than the other quarters? Just any color you can give on that.

Steven Carlson

I think broadly and you’re right it’s a complex question because we don’t have a normalized economic environment, but we do see shifts in our business of 2 and 3 typically softer as people go on vacations with a stronger fourth quarter as everyone comes back and wants to look aesthetically better for the holidays, and I think that seasonality trends across the whole aesthetic industry. It’s not specifically subject to us, so as we look at going forward with the decisions that we made to exit the pharmacy channel, we certainly see going forward improvements in earnings as Preston indicated.

Operator

Your next question comes from the line of Larry Neibor with Robert W. Baird.

Larry Neibor – Robert W. Baird

On the Rosaclear launch, I think you booked $1.3 million in sales. Is that all stocking orders or are there refills in there also?

Steven Carlson

Certainly as we launch new products, we want to make sure we have good depth and breadth of distribution, and the majority of the 1.3 certainly is representative of initial stocking. Having said that, we were very pleased to see nearly half of our accounts reorder Rosaclear product within the first quarter, so again really strong indication we’re into a new marketplace, existing patients within a clinical practice, and as you know, we’re the first to introduce the first system for that rosacea treatment which doesn’t cannibalize any existing products that we have, that we positioned for elasticity, acne and photo damage.

Larry Neibor – Robert W. Baird

I think you mentioned 28% of your account base so far has purchased inventory. I guess that leaves somewhere around 4000 accounts that have yet to purchase inventory. How will you complete penetration of those accounts and on what timetable?

Steven R. Carlson

I think historically and again this is a new indication in a new space for us, so we’re learning as we go, but generally speaking we looked at getting the majority of our accounts within a 6- to 9-month period. Make the introduction, have them participate in their own existing trials, which you know is normal in this industry, and really provide feedback from those patients as to the benefit and the efficacy of the system, so as we go through the remainder of 2009, we’d anticipate getting very good continued distribution with the Rosaclear system.

Larry Neibor – Robert W. Baird

Just on a macroeconomic level, are you seeing any change in the business from the beginning of quarter to end of quarter or is it consistent through each month of the quarter?

Steven R. Carlson

As we’ve indicated before, Q4 is always a strong quarter in this aesthetic marketplace. Q1 is historically slower than fourth quarter, so in normal sales trends, we see the first month of a quarter coming off a strong third month end of a quarter certainly being slower and having a sequential ramp month over month in each quarter, and I think that’s consistent. We are not any different than the neurotoxin business or the derm filler business in that regard.

Operator

Your next question comes from the line of Brian Jeep – Sidoti. Please go ahead at this time.

Brian Jeep - Sidoti

Can you tell me again what the gross margin is for Rosaclear roughly?

Preston Romm

We really don’t give out gross margin by product, but it really fits into our profile.

Brian Jeep - Sidoti

The roto products and the licensing revenue, what should we expect for next quarter? Is that going to pick back up or is this the run rate that we should expect?

Preston Romm

Again, that included in range that we have given of $22 to 24 million. I really don’t want to pick out one product line or one customer to tell you what it might be or might not be.

Operator

(Operator Instructions) The final question comes from the line of Anup Mehta – Canaccord Adams.

Anup Mehta – Canaccord Adams

For Rosaclear, was that being distributed by your entire sales force through the launch in the first quarter and was it being focused on certain accounts or was that released to the entire account base?

Steven Carlson

The whole aesthetic sales organization was certainly launching Rosaclear to its account base. Appreciate we still had the Inventive sales organization that was focused on SoluCLENZ so those 20 reps in the pharmacy channel were not exposed to and were not talking Rosaclear to their accounts.

Anup Mehta – Canaccord Adams

Given the current economic climate, are you expecting any changes to your sales force through 2009 that we can anticipate?

Preston Romm

I think given the economic climate we anticipate our sales force remaining stable. We’re seeing continued revenues out of those existing, so we don’t look to add. We also at this time don’t see a need to reduce that sales organization.

Anup Mehta – Canaccord Adams

Do you believe there’s an opportunity for any co-promotional activity with another company within the space that perhaps doesn’t carry a topical skin health Rx product and is that something that you guys are looking into?

Preston Romm

I think given the strength of our marketplace and the leadership position we have in topical aesthetics, we’re consistently exploring new and better ways to have strategic partnerships that allow for incremental leverage and the strength within our customer segment.

Operator

Next question is a followup question from the line of Larry Neibor with Robert W. Baird. Please go ahead at this time.

Larry Neibor – Robert W. Baird

Steve, you mentioned that your sales force has been stable. Do you mean in terms of overall numbers or in terms of having very low turnover?

Steven Carlson

We see the overall number remaining relatively stable, and we’re seeing very little turnover of people leaving the organization.

Operator

That was the final question today. Ladies and gentleman, we do thank you for your participation in today’s call. You may now disconnect your lines at this time.

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Source: Obagi Medical Products, Inc. Q1 2009 Earnings Call Transcript
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